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(1) Summary of Business and Significant Accounting Policies
Summary of Business
CH2M HILL Companies, Ltd. and subsidiaries (“We”, “Our”, “CH2M” or the “Company”) is a large employee-controlled professional engineering services firm, founded in 1946, providing engineering, construction, consulting, design, design‑build, procurement, engineering‑procurement‑construction (“EPC”), operations and maintenance, program management and technical services to United States (“U.S.”) federal, state, municipal and local government agencies, national governments, as well as private industry and utilities, around the world. A substantial portion of our professional fees are derived 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 according to instructions to Form 10-Q and the provisions of Article 10 of Regulation S-X that are applicable to 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 annual audited 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.
In the opinion of 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 our Annual Report on Form 10-K for the year ended December 30, 2016.
Revenue Recognition
We earn revenue from different types of services performed under various types of contracts, including cost-plus, fixed-price and time-and-materials. We evaluate contractual arrangements to determine how to recognize revenue. We primarily perform engineering and construction related services and recognize 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 contract. In making such estimates, judgments are required to evaluate potential variances in schedule, the cost of materials and labor, productivity, subcontractor costs, liability claims, contract disputes, and achievement of contract performance standards. We record the cumulative effect of changes in contract revenue and cost at completion in the period in which the changed estimates are determined to be reliably estimable.
Below is a description of the four basic types of contracts from which we may earn revenue:
Cost-Plus Contracts. Cost-plus contracts can be cost plus a fixed fee or rate, or cost plus an award fee. Under these types of contracts, we charge our clients for our costs, including both direct and indirect costs, plus a fixed fee or an award fee. We generally recognize revenue based on the labor and non-labor costs we incur, plus the portion of the fixed fee or award fee we have earned to date.
Included in the total contract value for cost-plus fee arrangements is the portion of the fee for which receipt is determined to be probable. Award fees are influenced by the achievement of contract milestones, cost savings and other factors.
Fixed-Price Contracts. Under fixed-price contracts, our clients pay us an agreed amount negotiated in advance for a specified scope of work. For engineering and construction contracts, we recognize revenue on fixed-price contracts using the percentage-of-completion method where direct costs incurred to date are compared to total projected direct costs at contract completion. Prior to completion, our recognized profit margins on any fixed-price contract depend on the accuracy of our estimates and will increase to the extent that our actual costs are below the original estimated amounts. Conversely, if our costs exceed these estimates, our profit margins will decrease, and we may realize a loss on a project. The significance of these estimates varies with the complexity of the underlying project, with our large, fixed-price EPC projects being most significant.
Time-and-Materials Contracts. Under our time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we expend on a project. In addition, clients reimburse us for our actual out of pocket costs of materials and other direct expenditures that we incur in connection with our performance under the contract. Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared with the negotiated billing rate and markup on other direct costs. Some of our time-and-materials contracts are subject to maximum contract values, and accordingly, revenue under these contracts is recognized under the percentage-of-completion method where costs incurred to date are compared to total projected costs at contract completion. Revenue on contracts that is not subject to maximum contract values is recognized based on the actual number of hours we spend on the projects plus any actual out of pocket costs of materials and other direct expenditures that we incur on the projects.
Operations and Maintenance Contracts. A portion of our contracts are operations and maintenance type contracts. Revenue is recognized on operations and maintenance contracts on a straight-line basis over the life of the contract once we have an arrangement, service has begun, the price is fixed or determinable and collectability is reasonably assured.
For all contract types noted above, 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 when the change order can be estimated. Management evaluates when a change order is probable based upon its experience in negotiating change orders, the customer’s written approval of such changes or separate documentation of change order costs that are identifiable. Additional contract revenue related to claims is included in total estimated contract revenue when the amount can be reliably estimated, which is typically evidenced by a contract or other evidence providing a legal basis for the claim.
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.
Accounts Receivable
We reduce accounts receivable by estimating an allowance for amounts that may become uncollectible in the future. Management determines the estimated allowance for uncollectible amounts based on their judgments in evaluating the aging of the receivables and the financial condition of our clients, which may be dependent on the type of client and the client’s current financial condition.
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 work performed and revenue recognized on contracts in process using the percentage-of-completion method.
Fair Value Measurements
Fair value represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Assets and liabilities are valued based upon observable and non-observable inputs. Valuations using Level 1 inputs are based on unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date. Level 2 inputs utilize significant other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly; and valuations using Level 3 inputs are based on significant unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. There were no significant transfers between levels during any period presented.
Restructuring and Related Charges
An exit activity includes but is not limited to a restructuring, such as a sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations. The Company recognizes a current and long-term liability, within other accrued liabilities and other long term liabilities, respectively, and the related expense, within selling, general and administrative expense, for restructuring costs when the liability is incurred and can be measured. Restructuring accruals are based upon management estimates at the time they are recorded and can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded. Nonretirement postemployment benefits offered as special termination benefits to employees, such as a voluntary early retirement program, are recognized as a liability and a loss when the employee accepts the offer and the amount can be reasonably estimated.
Goodwill
Goodwill represents the excess of costs over fair value of the assets of businesses we have acquired. Goodwill acquired in a purchase business combination is not amortized, but instead, is tested for impairment at least annually. Our annual goodwill impairment test is conducted as of the first day of the fourth quarter of each year, however, upon the occurrence of certain triggering events, we are also required to test for impairment at dates other than the annual impairment testing date. In performing the impairment test, we evaluate our goodwill at the reporting unit level. We have the option to assess either quantitative or qualitative factors to determine whether it is more likely than not that the fair values of our reporting units are less than their carrying amounts. If after assessing the totality of events or circumstances, we determine that it is not more likely than not that the fair values of our reporting units are less than their carrying amounts, then the next step of the impairment test is unnecessary. If we conclude otherwise, then we are required to test goodwill for impairment by comparing the estimated fair value of each reporting unit to the unit’s carrying value, including goodwill. If the carrying value of a reporting unit does not exceed its fair value, the goodwill of the reporting unit is not considered impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
We determine the fair value of our reporting units using a combination of the income approach, the market approach, and the cost approach. The income approach calculates the present value of future cash flows based on assumptions and estimates derived from a review of our expected revenue growth rates, profit margins, business plans, cost of capital and tax rates for the reporting units. Our market based valuation method estimates the fair value of our reporting units by the application of a multiple to our estimate of a cash flow metric for each business unit. The cost approach estimates the fair value of a reporting unit as the net replacement cost using current market quotes.
Intangible Assets
We may acquire other intangible assets in business combinations. Intangible assets are stated at fair value as of the date they are acquired in a business combination. We amortize intangible assets with finite lives on a straight-line basis over their expected useful lives, currently up to ten years. We test our intangible assets for impairment in the period in which a triggering event or change in circumstance indicates that the carrying amount of the intangible asset may not be recoverable. If the carrying amount of the intangible asset exceeds the fair value, an impairment loss will be recognized in the amount of the excess. We determine the fair value of the intangible assets using a discounted cash flow approach.
Derivative Instruments
We primarily enter into derivative financial instruments to mitigate exposures to changing foreign currency exchange rates on our earnings and cash flows. We are primarily subject to this risk on long-term projects whereby the currency being paid by our client differs from the currency in which we incurred our costs, as well as intercompany trade balances among entities with differing currencies. We do not enter into derivative transactions for speculative or trading purposes. All derivatives are carried at fair value on the consolidated balance sheets in other receivables or other accrued liabilities as applicable. The periodic change in the fair value of the derivative instruments related to our business group operations is recognized in earnings within direct costs. The periodic change in the fair value of the derivative instruments related to our general corporate foreign currency exposure is recognized within selling, general and administrative expense
Retirement and Tax-Deferred Savings Plan
The Retirement and Tax Deferred Savings Plan is a retirement plan that includes a cash or deferred arrangement that is intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code and provides benefits to eligible employees upon retirement. The 401(k) Plan allows for matching contributions up to 58.33% of the first 6% of elective deferrals up to 3.5% of the employee’s quarterly base compensation, although specific subsidiaries may have different limits on employer matching. The matching contributions may be made in both cash and/or stock. Expenses related to matching contributions made in common stock for the 401(k) Plan for the three months ended March 31, 2017 were $2.6 million as compared to $5.5 million for the three months ended March 25, 2016.
Recently Adopted Accounting Standards
In March 2017, the FASB issued Accounting Standards Update ("ASU") 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The amendments in this ASU require that an employer disaggregate the service cost component from the other components of net benefit cost and report the service cost component in the same statement of income line item as other compensation costs for the relevant employees. Additionally, only the service cost component of net benefit cost would be eligible for capitalization. The ASU requires that the other components of net benefit cost be presented outside of income or loss from operations on the statement of income, separate from the service cost component. The amendments in this update should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic benefit cost and net periodic postretirement benefit in assets. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, and early adoption is permitted. Currently, the net periodic pension expense or income related to our defined pension benefit plans in the U.S. and internationally is presented within selling, general and administrative expense. Therefore, we anticipate the adoption of this ASU to impact the presentation of our statement of operations, including the subtotal of income or loss from operations. Refer to Note 13 – Defined Benefit Plans and Other Postretirement Benefits for detail of our net periodic pension expense or income by component.
In January 2017, the FASB issued Accounting Standard Update ("ASU") 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment. This ASU was issued with the objective of simplifying the subsequent measurement of goodwill for public business entities and not-for-profit entities by eliminating the second step of the goodwill impairment test. As a result, an entity would perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. During the three months ended March 31, 2017, we early adopted this standard which will be effective for our annual goodwill impairment test to be conducted as of the first day of the fourth quarter of 2017. We do not believe this ASU will have a material impact on our financial statements.
In January 2017, the FASB issued Accounting Standard Update ("ASU") 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business). This ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU will be effective for fiscal years beginning after December 15, 2017, and should be applied prospectively. Once effective, we will apply this guidance to determine if certain transactions are acquisitions (or disposals) of assets or businesses, but we do not believe this ASU will materially change how we currently evaluate similar transactions.
In October 2016, the FASB issued Accounting Standard Update ("ASU") 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. This standard amends the guidance issued with ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis in order to make it less likely that a single decision maker would individually meet the characteristics to be the primary beneficiary of a Variable Interest Entity ("VIE"). When a decision maker or service provider considers indirect interests held through related parties under common control, they perform two steps. The second step was amended with this ASU to say that the decision maker should consider interests held by these related parties on a proportionate basis when determining the primary beneficiary of the VIE rather than in their entirety as was called for in the previous guidance. The adoption of this standard in the current reporting period did not have a material impact on our consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU was issued with the objective to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The new standard will require companies to recognize the income tax consequences of an intra-entity transfer of non-inventory assets when the transfer occurs. This ASU will be effective for fiscal years beginning after December 15, 2017, and early adoption is permitted. We are currently evaluating the impact of the adoption of this ASU on our financial position and results of operations.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance for eight specific changes with respect to how certain cash receipts and cash payments are classified within the statement of cash flows in order to reduce existing diversity in practice. This ASU will be effective for fiscal years beginning after December 15, 2017, and early adoption is permitted, and it should be applied using a retroactive transition method to each period presented. We are currently evaluating the impacts the adoption of this standard will have on our consolidated statements of cash flows, focusing on the impact our cash flows related to distributions received from equity method investees and contingent consideration payments made subsequent to business combinations. We anticipate that approximately $15.9 million of the acquisition related payments within our investing cash flows for the year ended December 30, 2016, of which zero occurred in the three months ended March 25, 2016, will be reclassified to financing cash flows as a result of adopting this ASU.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payments Accounting. During the three months ended September 30, 2016, the Company elected to early adopt ASU 2016-09 with an effective date of December 26, 2015. As a result, the Company recognized the excess tax benefit of $1.3 million within income tax benefit on the consolidated statements of income for the three months ended March 31, 2017, and, upon adoption, previously unrecognized excess tax benefits of $11.1 million resulted in a cumulative-effect adjustment to retained earnings for the year ended December 30, 2016. The adoption did not impact the existing classification of awards. Excess tax benefits from stock-based compensation of $2.1 million for the three months ended March 25, 2016 were restated into cash flows from operating activities from cash flows from financing activity. Additionally, adopted retrospectively, the Company reclassified $1.9 million and $2.0 million of employee withholding taxes paid from operating activities into financing activities for the three months ended March 31, 2017 and March 25, 2016, respectively. Following the adoption of the standard, the Company elected to continue estimating the number of awards expected to be forfeited and adjust its estimate on an ongoing basis.
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU is a comprehensive new leases standard that was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We continue to assess the impact of adopting ASU 2016-02, but expect to record a significant amount of right-of-use assets and corresponding liabilities. Based upon our operating leases as of December 30, 2016, we expect to have in excess of $500.0 million of undiscounted future minimum lease payments upon adoption of this standard.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments issued with this ASU require equity securities (including other ownership interests, such as partnerships, unincorporated joint ventures, and limited liability companies) to be measured at fair value with changes in the fair value recognized through net income. An entity’s equity investments that are accounted for under the equity method of accounting or result in consolidation of an investee are not included within the scope of this update. This ASU will be effective for annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods, with early adoption permitted. We believe this standard’s impact on CH2M will be limited to equity securities currently accounted for under the cost method of accounting, which as of March 31, 2017 are valued at $3.4 million within investments in unconsolidated affiliates on the consolidated balance sheet. We do not expect the adoption of this standard to have a material impact on our consolidated statements of operations.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and subsequently modified with various amendments and clarifications. This ASU is a comprehensive new revenue recognition model that is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU also requires additional quantitative and qualitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU, as amended, is effective for annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods. Companies may use either a full retrospective or a modified retrospective approach to adopt this ASU. CH2M is currently evaluating the impact of this ASU, the subsequently issued amendments, and the transition alternatives on its financial position and results of operations. Currently, we have identified various revenue streams by contract billing type, client type, and type of contracted services. We are reviewing our contracts in the various revenue streams in order to isolate those that will be significantly impacted as well as to identify the relevant revenue streams for disaggregated disclosure. After our assessment is complete, we can begin estimating the potential financial impacts of the new standard as well as identify necessary controls, processes and information system changes.
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(2) Changes in Project-Related Estimates
We have a fixed-price Transportation contract to design and construct roadway improvements on an expressway in the southwestern United States. The project is approximately 75% complete as of March 31, 2017. In the year ended December 30, 2016, we experienced cost growth resulting in total changes in estimated costs of $121.3 million, none of which occurred during the three months ended March 25, 2016. The 2016 cost growth was primarily a result of survey engineering and design challenges, rework of previously installed work and client-caused delays, including limited daytime access to portions of the site, greater than expected subcontractor costs, subcontracting work previously planned to be self-performed, the sum of which resulted in increased material quantities and work and delivery schedule extensions. We also had severe weather including record rainfall, and production shortfalls resulting from differing site conditions and engineering rework.
In the quarter ended March 31, 2017, the project team increased the overall estimated costs for labor and materials by a total of $23.5 million. The cost growth was predominately related to unanticipated field conditions and labor resource restraints, some of which costs are being included in claims submitted to the client. While the project team believes that the increase in costs is sufficient to cover known issues, additional design, fabrication, construction or labor resource issues could be encountered resulting in further cost growth. Certain of these additional costs are believed to be the result of construction errors incurred by a subcontractor as well as specifications provided by the client that were determined to be incorrect.
We expect to seek resolution of these first quarter 2017 issues from the subcontractor in addition to seeking resolution of the outstanding change orders and claims through a combination of submissions to the Disputes Board under the terms of the contract and direct negotiations with the client. Change orders and claims totaling approximately $100.0 million have been submitted to the client. We have received favorable, non-binding recommendations from the Disputes Board on some of the claims. We have not been able to reach a mutual resolution with the client on these claims or the other change orders submitted. CH2M will continue to aggressively pursue its entitlements based on claims and change orders, including litigation if it cannot reach resolution with the client. Accordingly, we cannot currently estimate the timing or amounts of recoveries or costs that may be achieved or incurred through these resolution processes, and as such, we have not included any recoveries from these change orders and claims in our current estimated project loss.
While management believes that it has recorded an appropriate provision to complete the project, we may incur additional costs and losses if our cost estimation processes identify new costs not previously included in our total estimated loss. These possible cost increases include extensions of the schedule to complete the job, lower than expected productivity levels, and performance issues with our subcontractors. These potential changes in estimates could be materially adverse to the Company’s results of operations, cash flow or liquidity.
All reserves for project related losses for projects related to our continuing operations are included in other accrued liabilities and totaled $71.1 million and $71.2 million as of March 31, 2017 and December 30, 2016, respectively. Refer to Note 14 – Discontinued Operations for additional details regarding projects reported within discontinued operations.
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(3) Segment Information
In the first quarter of 2017, we implemented a new organizational structure to more fully align global operations with the Company’s client-centric strategy, resulting in three sectors: National Governments, Private, and State & Local Governments. Each of these sectors has been identified as a reportable operating segment.
Costs for corporate selling, general and administrative expenses, restructuring costs and amortization expense related to intangible assets have been allocated to each segment based on the estimated benefits provided by corporate functions. This allocation is primarily based upon metrics that reflect the proportionate volume of project-related activity and employee labor costs within each segment.
Certain financial information relating to the three months ended March 31, 2017 and March 30, 2016 for each segment is provided below. Prior year amounts have been revised to conform to the current year presentation. Costs for corporate selling, general and administrative expenses, restructuring costs and amortization expense related to intangible assets have been allocated to each segment based on the estimated benefits provided by corporate functions. This allocation is primarily based upon metrics that reflect the proportionate volume of project-related activity and employee labor costs within each segment.
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Three Months Ended March 31, 2017 |
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Three Months Ended March 25, 2016 |
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Gross |
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Equity in |
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Operating |
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Gross |
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Equity in |
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Operating |
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($ in thousands) |
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Revenue |
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Earnings |
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Income |
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Revenue |
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Earnings |
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Income |
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National Governments |
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$ |
475,679 |
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$ |
4,494 |
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$ |
10,666 |
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$ |
446,724 |
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$ |
6,308 |
|
$ |
763 |
Private |
|
|
289,280 |
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(131) |
|
|
9,271 |
|
|
348,097 |
|
|
287 |
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|
14,496 |
State & Local Governments |
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|
475,474 |
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|
2,998 |
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|
9,514 |
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|
492,189 |
|
|
2,458 |
|
|
25,763 |
Total |
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$ |
1,240,433 |
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$ |
7,361 |
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$ |
29,451 |
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$ |
1,287,010 |
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$ |
9,053 |
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$ |
41,022 |
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(4) Stockholders’ Equity
The changes in stockholders’ equity for the three months ended March 31, 2017 are as follows:
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Common |
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Preferred |
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(in thousands) |
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Shares |
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Shares |
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Amount |
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Stockholders’ equity, December 30, 2016 |
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25,148 |
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4,822 |
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$ |
445,538 |
Shares purchased and retired |
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(512) |
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— |
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(24,028) |
Shares issued in connection with stock-based compensation and employee benefit plans |
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133 |
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— |
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5,587 |
Net income attributable to CH2M |
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— |
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— |
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13,959 |
Other comprehensive income, net of tax |
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— |
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— |
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15,585 |
Other comprehensive income attributable to noncontrolling interest, net of tax |
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|
|
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(136) |
Deconsolidation of a subsidiary's noncontrolling interest |
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— |
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— |
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87,838 |
Income attributable to noncontrolling interests from continuing operations |
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— |
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— |
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4,257 |
Loss attributable to noncontrolling interests from discontinued operations |
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(60) |
Investment in affiliates, net |
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— |
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— |
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2,806 |
Stockholders’ equity, March 31, 2017 |
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24,769 |
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4,822 |
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$ |
551,346 |
Preferred Stock
As of March 31, 2017, the Company had 50,000,000 shares of preferred stock, $0.01 par value, authorized. On June 22, 2015, the Company designated 10,000,000 shares as Series A Preferred Stock with an original issue price of $62.22 under the Certificate of Designation. On June 24, 2015, the Company sold and issued an aggregate of 3,214,400 shares of Series A Preferred Stock for an aggregate purchase price of $200.0 million in a private placement to a subsidiary owned by investment funds affiliated with Apollo Global Management, LLC (together with its subsidiaries, “Apollo”). Total proceeds from the preferred stock offering were $191.7 million, net of issuance costs of $8.3 million. The sale occurred in connection with the initial closing pursuant to the Subscription Agreement entered into by the Company and Apollo on May 27, 2015 (“Subscription Agreement”). On April 11, 2016, Apollo purchased an additional 1,607,200 shares of Series A Preferred Stock for an aggregate purchase price of approximately $100.0 million in a second closing subject to the conditions within the Subscription Agreement. Total proceeds from the preferred stock offering were $99.8 million, net of issuance costs of $0.2 million.
Under our agreement with Apollo, the maximum consolidated leverage ratio is 3.00x for 2016 and beyond, consistent with our Third Amendment to our Amended and Restated Credit Agreement. As of March 31, 2017, we were in compliance with this covenant. Management continually assesses its potential future compliance with the consolidated leverage ratio covenant based on estimates of future earnings and cash flows. If there is an expected possibility of non-compliance, we will discuss possibilities with Apollo to modify the covenant consistent with discussions with the Company’s lenders or utilize other means of capitalizing the Company to anticipate or remedy any non-compliance. The expected cash outflows required to fund the project losses discussed in Note 2 – Changes in Project-Related Estimates and the related impact on earnings will put a financial strain on the Company that may require an amendment or other remedies to be pursued by management if certain earnings estimates or cash flow improvement initiatives are not achieved or if required to facilitate restructuring plans.
On April 28, 2017, we filed a Certificate of Amendment to the Certificate of Designation of Series A Preferred Stock which increased the annual rate at which dividends accrue on the Series A Preferred Stock from 5% to 7% beginning April 1, 2017. Refer to Note 16 – Subsequent Events for additional details regarding the amendment.
For a summary of the terms and conditions related to the Subscription Agreement, refer to our Annual Report on Form 10-K for the year ended December 30, 2016.
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(6) Variable Interest Entities and Equity Method Investments
We routinely enter into teaming arrangements, in the form of joint ventures, to perform projects for our clients. Such arrangements are customary in the engineering and construction industry and generally are project specific. The arrangements facilitate the completion of projects that are jointly contracted with our partners. These arrangements are formed to leverage the skills of the respective partners and include consulting, construction, design, design-build, program management and operations and maintenance contracts. The assets of a joint venture are restricted for use only for the particular joint venture and are not available for general operations of the Company. Our risk of loss on these arrangements is usually shared with our partners. The liability of each partner is usually joint and several, which means that each partner may become liable for the entire risk of loss on the project. Furthermore, on some of our projects, CH2M has granted guarantees which may encumber both our contracting subsidiary company and CH2M for the entire risk of loss on the project.
Our financial statements include the accounts of our joint ventures when the joint ventures are variable interest entities (“VIE”) and we are the primary beneficiary or those joint ventures that are not VIEs yet we have a controlling interest. We perform a qualitative assessment to determine whether our company is the primary beneficiary once an entity is identified as a VIE. A qualitative assessment begins with an understanding of the nature of the risks associated with the entity as well as the nature of the entity’s activities including terms of the contracts entered into by the entity, ownership interests issued by the entity and how they were marketed, and the parties involved in the design of the entity. All of the variable interests held by parties involved with the VIE are identified and a determination is made of which activities are most significant to the economic performance of the entity and which variable interest holder has the power to direct those activities. In determining whether we have a controlling interest in a joint venture that is not a VIE and the requirement to consolidate the accounts of the entity, we consider factors such as ownership interest, board representation, management representation, authority to make decisions, and contractual and substantive participating rights of the partnership/members. Most of the VIEs with which our Company is involved have relatively few variable interests and are primarily related to our equity investments, subordinated financial support, and subcontracting arrangements. We consolidate those VIEs in which we have both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive the benefits from the VIE that could potentially be significant to the VIE. As of March 31, 2017 and December 30, 2016, total assets of VIEs that were consolidated were $211.9 million and $220.3 million, respectively, and liabilities were $191.6 million and $385.9 million, respectively. As of December 30, 2016, $19.0 million of the consolidated assets and $203.9 million of consolidated liabilities were related to an Australian fixed-price Power EPC joint venture which was deconsolidated upon termination of the underlying contract on January 24, 2017. Refer to Note 14 - Discontinued Operations for additional details.
We held investments in unconsolidated VIEs and equity method investments related to continuing operations of $65.7 million and $66.3 million at March 31, 2017 and December 30, 2016, respectively. As of March 31, 2017, as a result of deconsolidating the Australian joint venture during the three months ended March 31, 2017 as discussed above, we held a negative investment in unconsolidated VIE related to discontinued operations of $83.4 million. Our proportionate share of net income or loss is included as equity in earnings of joint ventures and affiliated companies in the consolidated statements of operations. In general, the equity investment in our unconsolidated affiliates is equal to our current equity investment plus our portion of the entities’ undistributed earnings. We provide 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 agreements.
As of March 31, 2017 and December 30, 2016, the total assets of VIEs related to continuing operations that were not consolidated were $391.5 million and $479.2 million, respectively, and total liabilities were $302.2 million and $304.9 million, respectively. As of March 31, 2017, total assets and liabilities of the unconsolidated VIE related to the Australian fixed-price Power EPC joint venture included in discontinued operations were $6.1 million and $181.2 million, respectively. These assets and liabilities consist almost entirely of working capital accounts associated with the performance of single contracts. The maximum exposure to losses is limited to the funding of any future losses incurred by those entities under their respective contracts with the project company.
|
(7) Goodwill and Intangible Assets
The following table presents the changes in goodwill by segment during the three months ended March 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands) |
|
National Governments |
|
Private |
|
State & Local Governments |
|
Consolidated Total |
||||
Balance as of December 30, 2016 |
|
$ |
12,753 |
|
$ |
146,913 |
|
$ |
318,086 |
|
$ |
477,752 |
Foreign currency translation |
|
|
225 |
|
|
906 |
|
|
5,278 |
|
|
6,409 |
Balance as of March 31, 2017 |
|
$ |
12,978 |
|
$ |
147,819 |
|
$ |
323,364 |
|
$ |
484,161 |
The following table presents the changes in intangible assets by segment during the three months ended March 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands) |
|
National Governments |
|
Private |
|
State & Local Governments |
|
Consolidated Total |
||||
Balance as of December 30, 2016 |
|
$ |
433 |
|
$ |
23,988 |
|
$ |
13,603 |
|
$ |
38,024 |
Amortization |
|
|
(121) |
|
|
(621) |
|
|
(3,474) |
|
|
(4,216) |
Foreign currency translation |
|
|
7 |
|
|
17 |
|
|
537 |
|
|
561 |
Balance as of March 31, 2017 |
|
$ |
319 |
|
$ |
23,384 |
|
$ |
10,666 |
|
$ |
34,369 |
Intangible assets with finite lives consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
Net finite-lived |
||
($ in thousands) |
|
Cost |
|
Amortization |
|
intangible assets |
|||
March 31, 2017 |
|
|
|
|
|
|
|
|
|
Customer relationships |
|
$ |
174,641 |
|
$ |
(140,272) |
|
$ |
34,369 |
Total finite-lived intangible assets |
|
$ |
174,641 |
|
$ |
(140,272) |
|
$ |
34,369 |
December 30, 2016 |
|
|
|
|
|
|
|
|
|
Customer relationships |
|
$ |
172,880 |
|
$ |
(134,856) |
|
$ |
38,024 |
Total finite-lived intangible assets |
|
$ |
172,880 |
|
$ |
(134,856) |
|
$ |
38,024 |
All intangible assets are being amortized over their expected lives of between two years and ten years. The amortization expense reflected in the consolidated statements of operations for the three months ended March 31, 2017 and March 25, 2016 totaled $4.2 million and $4.7 million, respectively. All intangible assets are expected to be fully amortized in 2024.
At March 31, 2017, the future estimated amortization expense related to these intangible assets is:
|
|
|
|
|
|
Amortization |
|
($ in thousands) |
|
Expense |
|
2017 (nine months remaining) |
|
$ |
11,559 |
2018 |
|
|
4,251 |
2019 |
|
|
3,518 |
2020 |
|
|
3,518 |
2021 |
|
|
3,518 |
2022 |
|
|
3,518 |
Thereafter |
|
|
4,487 |
|
|
$ |
34,369 |
|
(8) Property, Plant and Equipment
Property, plant and equipment consists of the following:
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Land |
|
$ |
5,021 |
|
$ |
5,021 |
Building and land improvements |
|
|
106,354 |
|
|
107,140 |
Furniture and fixtures |
|
|
25,586 |
|
|
26,009 |
Computer and office equipment |
|
|
158,441 |
|
|
157,542 |
Field equipment |
|
|
130,616 |
|
|
130,681 |
Leasehold improvements |
|
|
76,803 |
|
|
75,492 |
|
|
|
502,821 |
|
|
501,885 |
Less: Accumulated depreciation |
|
|
(263,252) |
|
|
(255,289) |
Net property, plant and equipment |
|
$ |
239,569 |
|
$ |
246,596 |
Depreciation expense from continuing operations reflected in the consolidated statements of operations was $10.7 million and $10.8 million for the three months ended March 31, 2017 and March 25, 2016, respectively.
|
(9) Fair Value of Financial Instruments
Cash and cash equivalents, client accounts receivable, unbilled revenue, accounts payable and accrued subcontractor costs and billings in excess of revenue are carried at cost, which approximates fair value due to their short maturities. Fair value of long‑term debt, including the current portion, is estimated based on Level 2 inputs, except the amount outstanding on the revolving credit facility for which the carrying value approximates fair value. Fair value is determined by discounting future cash flows using interest rates available for issues with similar terms and average maturities. The estimated fair values of our financial instruments where carrying values do not approximate fair value are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2017 |
|
December 30, 2016 |
||||||||
|
|
Carrying |
|
Fair |
|
Carrying |
|
Fair |
||||
($ in thousands) |
|
Amount |
|
Value |
|
Amount |
|
Value |
||||
Equipment financing |
|
$ |
7,631 |
|
$ |
7,195 |
|
$ |
8,152 |
|
$ |
7,662 |
Note payable by consolidated joint venture |
|
$ |
2,485 |
|
$ |
2,295 |
|
$ |
2,483 |
|
$ |
2,284 |
We primarily enter into derivative financial instruments to mitigate exposures to changing foreign currency exchange rates. These currency derivative instruments are carried on the balance sheet at fair value and are typically based upon Level 2 inputs including third-party quotes. At March 31, 2017 and March 25, 2016, we had forward foreign exchange contracts on major world currencies with varying durations, none of which extend beyond one year. As of March 31, 2017 and December 30, 2016, we had $0.8 million and $1.2 million of derivative liabilities, respectively.
The unrealized and realized gains and losses due to changes in derivative fair values included in selling, general and administrative expense are as follows:
|
|
Three Months Ended |
||||
|
|
March 31, |
|
March 25, |
||
(in thousands) |
|
2017 |
|
2016 |
||
Unrealized gain (loss) from changes in derivative fair values |
|
$ |
394 |
|
$ |
(598) |
Realized loss from changes in derivative fair values |
|
$ |
(1,705) |
|
$ |
(774) |
|
(10) Line of Credit and Long-Term Debt
On September 30, 2016, we entered into a Third Amendment to our Second Amended and Restated Credit Agreement (“Credit Agreement”). The Credit Agreement provides for a revolving credit facility of $925.0 million (“Credit Facility”) which matures on March 28, 2019. Under the terms of the Credit Agreement, we may be able to invite existing and new lenders to increase the amount available to be borrowed by up to $200.0 million. Additionally, the Credit Agreement has a subfacility for the issuance of standby letters of credit up to $500.0 million, a subfacility of up to $300.0 million for multicurrency borrowings, and a subfacility of up to $50.0 million for swingline loans.
Certain terms and conditions of our Amended Credit Agreement as of March 31, 2017 are as follows:
· |
The maximum consolidated leverage ratio is 3.00x for 2017 and beyond; |
· |
For the three quarter period ending March 31, 2017, the amount the Company was able to spend to repurchase its common stock in connection with its employee stock ownership program was limited to $75.0 million, and, thereafter, up to $100.0 million during a rolling four quarter period less the amount of any legally required repurchases of common stock held in benefit plans; |
· |
CH2M’s ability to pay cash dividends on preferred stock is limited until no more than 10% of our consolidated adjusted EBITDA consists of the cash and non-cash charges related to restructuring charges and project costs and losses in any rolling four quarter period and subject to minimum pro forma leverage ratio; |
· |
No proceeds from asset sales can be used to repurchase common or preferred stock; and, |
· |
No large acquisition until no more than 10% of our consolidated adjusted EBITDA consists of the cash and non-cash charges related to restructuring charges and project costs and losses in any rolling four quarter period. |
All other terms of the Credit Agreement are consistent with those of the previous amended credit agreement entered into on March 30, 2015, and are disclosed in the Annual Report on Form 10-K for the year ended December 30, 2016. The Credit Agreement contains customary representations, warranties and conditions to borrowing including customary affirmative and negative covenants, which include covenants that limit or restrict our ability to incur indebtedness and other obligations, grant liens to secure their obligations, make investments, merge or consolidate, and dispose of assets outside the ordinary course of business, in each case subject to customary exceptions for credit facilities of this size and type.
As of March 31, 2017, we were in compliance with the covenants required by the Credit Agreement. Management continually assesses its potential future compliance with the Credit Agreement covenants based upon estimates of future earnings and cash flows. If there is an expected possibility of non-compliance, we will discuss possibilities with the Company’s lenders or utilize other means of capitalizing the Company to anticipate or remedy any non-compliance. The expected cash outflows required to fund the project losses discussed in Note 2 – Changes in Project-Related Estimates and the related impact on earnings will put a financial strain on the Company that may require an amendment or other remedies to be pursued by management if certain earnings estimates or cash flow improvement initiatives are not achieved or if required to facilitate restructuring plans.
On April 28, 2017, we entered into a Second Lien Indenture through which we issued Senior Second Lien Notes due 2020 with an aggregate principal amount of $200.0 million and an annual interest rate of 10%. Refer to Note 16 – Subsequent Events for additional details regarding the terms and conditions of these agreements.
Our nonrecourse and other long-term debt consist of the following:
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Revolving Credit Facility, average rate of interest of 3.7% |
|
$ |
507,822 |
|
$ |
487,009 |
Equipment financing, due in monthly installments to September 2021, secured by equipment. These notes bear interest ranging from 0.22% to 3.29% |
|
|
7,631 |
|
|
8,152 |
Note payable by consolidated joint venture, due July 2019. This note bears interest at 6-month LIBOR plus 2.5% |
|
|
2,485 |
|
|
2,483 |
Other notes payable |
|
|
194 |
|
|
230 |
Total debt |
|
|
518,132 |
|
|
497,874 |
Less: current portion of debt |
|
|
2,233 |
|
|
2,242 |
Total long-term portion of debt |
|
$ |
515,899 |
|
$ |
495,632 |
At March 31, 2017 and December 30, 2016, company-wide issued and outstanding letters of credit and bank guarantee facilities were $130.0 million and $134.2 million, respectively.
|
(11) Income Taxes
After adjusting for the impact of income attributable to noncontrolling interests, the effective tax rate related to continuing operations on the income attributable to CH2M for the three months ended March 31, 2017 was 27.8% compared to 36.1% on the income for the same period in the prior year. The effective tax rate attributable to CH2M for the three months ended March 31, 2017 was lower compared to the same period in the prior year primarily due to the favorable impacts associated with increased foreign earnings as a result of transfer pricing and favorable investment results related to key employee life assets. Recent discussions regarding tax reform may result in changes to long-standing tax principles which could adversely affect our effective tax rate or result in higher cash tax liabilities. These discussions include a reduced corporate tax rate, repatriation of foreign earnings, cash, and cash equivalents, and cross border adjustability. Additionally, our effective tax rate continues to be negatively impacted by the effect of disallowed portions of meals and entertainment expenses.
As of March 31, 2017 and December 30, 2016, we had $6.5 million and $8.0 million, respectively, recorded as a liability for uncertain tax positions, included in which was approximately $1.7 million and $2.6 million, respectively, of interest and penalties. We recognize interest and penalties related to unrecognized tax benefits in income tax expense or benefit.
We file 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, United Kingdom and Canada. With few exceptions, we are no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities in major tax jurisdictions.
|
(12) Restructuring and Related Charges
2016 Restructuring Plan. During the third quarter of 2016, the Company began a process to review the structure and resources within its business segments and formulate a restructuring plan to more fully align global operations with the Company’s client-centric strategy, including a simplified organization structure and streamlined delivery model to achieve higher levels of profitable growth (“2016 Restructuring Plan”). The restructuring activities primarily include workforce reductions and facilities consolidations. During the three months ended March 31, 2017, we incurred $13.1 million of costs for these restructuring activities related to the 2016 Restructuring Plan, which have been included in selling, general and administrative expense on the consolidated statements of operations. Overall, as of March 31, 2017, we have incurred aggregate costs of $55.3 million in total restructuring charges under the 2016 Restructuring Plan. We completed the 2016 Restructuring Plan in the first quarter of 2017, and we expect aggregate annual cost savings of approximately $100.0 million.
2014 Restructuring Plan. In September 2014, the Company commenced certain restructuring activities in order to achieve important business objectives, including reducing overhead costs, improving efficiency, and reducing risk (“2014 Restructuring Plan”). These restructuring activities, which continued into 2015, included such items as a voluntary retirement program, workforce reductions, facilities consolidations and closures, and evaluation of certain lines of business. The restructuring activities under the 2014 Restructuring Plan were substantially complete as of December 25, 2015, and as such no restructuring costs were incurred during the three months ended March 25, 2016.
The changes in the provision for the restructuring activities for the three months ended March 31, 2017 are as follows:
|
|
2014 Restructuring Plan |
|
2016 Restructuring Plan |
|
|
||||||||||||
($ in thousands) |
|
Employee Severance |
|
Facilities Cost |
|
Employee Severance |
|
Facilities Cost |
|
Other |
|
Consolidated Total |
||||||
Balance, December 30, 2016 |
|
$ |
1,015 |
|
$ |
13,995 |
|
$ |
6,041 |
|
$ |
15,090 |
|
$ |
30 |
|
$ |
36,171 |
Provision |
|
|
— |
|
|
— |
|
|
4,353 |
|
|
8,401 |
|
|
382 |
|
|
13,136 |
Cash payments |
|
|
— |
|
|
(820) |
|
|
(8,607) |
|
|
(2,756) |
|
|
(412) |
|
|
(12,595) |
Non-cash settlements |
|
|
— |
|
|
— |
|
|
— |
|
|
(453) |
|
|
— |
|
|
(453) |
Balance, March 31, 2017 |
|
$ |
1,015 |
|
$ |
13,175 |
|
$ |
1,787 |
|
$ |
20,282 |
|
$ |
— |
|
$ |
36,259 |
The remaining provisions for employee severance and termination benefits will be paid primarily over the next twelve months, and accruals for facilities costs will be paid over the remaining term of the exited leases which extend through 2032.
|
(13) Defined Benefit Plans and Other Postretirement Benefits
We sponsor several defined benefit pension plans primarily in the U.S. and the United Kingdom (“U.K”). In the U.S., we have three noncontributory defined benefit pension plans. Plan benefits are generally based on years of service and compensation during the span of employment. Benefits in two of the plans are frozen while one plan remains active, the CH2M HILL OMI Retirement Plan (“OMI Plan”). During the year ended December 30, 2016, the Company adopted an amendment to freeze future pay and benefit service accruals beginning in 2017 for non-union participants within the OMI Plan resulting in a gain on curtailment and a reduction in our projected benefit obligation.
In the U.K., we assumed several defined benefit plans as part of our acquisition of Halcrow on November 10, 2011, of which the largest is the Halcrow Pension Scheme. These Halcrow defined benefit plans have been closed to new entrants for many years. The information related to these plans is presented in the Non‑U.S. Pension Plans columns of the tables below. During the year ended December 30, 2016, a subsidiary of CH2M, effected a transaction to restructure the benefits provided to members of the Halcrow Pension Scheme which significantly reduced the Company’s projected benefit obligation under the scheme as well as improved our net periodic benefit through the recognition of prior service credits.
The components of the net periodic pension expense (income) for the three months ended March 31, 2017 and March 25, 2016 are detailed below:
|
|
Three Months Ended |
||||||||||
|
|
March 31, 2017 |
|
March 25, 2016 |
||||||||
|
|
U.S. |
|
Non-U.S. |
|
U.S. |
|
Non-U.S. |
||||
($ in thousands) |
|
Pension Plans |
|
Pension Plans |
|
Pension Plans |
|
Pension Plans |
||||
Service cost |
|
$ |
89 |
|
$ |
1,074 |
|
$ |
671 |
|
$ |
1,377 |
Interest cost |
|
|
2,733 |
|
|
6,059 |
|
|
2,954 |
|
|
10,477 |
Expected return on plan assets |
|
|
(3,017) |
|
|
(9,515) |
|
|
(2,921) |
|
|
(8,814) |
Amortization of prior service credits |
|
|
(13) |
|
|
(2,479) |
|
|
(188) |
|
|
— |
Recognized net actuarial loss |
|
|
1,908 |
|
|
2,594 |
|
|
1,629 |
|
|
693 |
Net expense (income) included in current income |
|
$ |
1,700 |
|
$ |
(2,267) |
|
$ |
2,145 |
|
$ |
3,733 |
We sponsor a medical benefit plan for retired employees of certain subsidiaries. The plan is contributory, and retiree premiums are based on years of service at retirement. The benefits contain limitations and a cap on future cost increases. We fund postretirement medical benefits on a pay‑as‑you‑go basis. Additionally, we have a frozen non‑qualified pension plan that provides additional retirement benefits to certain senior executives who remained employed and retired from CH2M on or after age 65.
The components of the non-qualified pension benefit expense and postretirement benefit expense for the three months ended March 31, 2017 and March 25, 2016 are detailed below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
||||||||||
|
|
March 31, 2017 |
|
March 25, 2016 |
||||||||
|
|
Non-Qualified |
|
Postretirement |
|
Non-Qualified |
|
Postretirement |
||||
($ in thousands) |
|
Pension Plan |
|
Benefit Plans |
|
Pension Plan |
|
Benefit Plans |
||||
Service cost |
|
$ |
— |
|
$ |
163 |
|
$ |
— |
|
$ |
206 |
Interest cost |
|
|
10 |
|
|
405 |
|
|
13 |
|
|
497 |
Amortization of prior service (credits) costs |
|
|
— |
|
|
(96) |
|
|
— |
|
|
(96) |
Recognized net actuarial loss (gain) |
|
|
— |
|
|
(71) |
|
|
— |
|
|
(3) |
Net expense included in current income |
|
$ |
10 |
|
$ |
401 |
|
$ |
13 |
|
$ |
604 |
|
(14) Discontinued Operations
In connection with our 2014 Restructuring Plan, we elected to exit the fixed-price Power EPC business, which was a stand-alone operating segment. We intended to complete our remaining contracted fixed-price Power EPC contracts, the largest of which was a project in Australia through a consolidated joint venture partnership with an Australian construction contractor and a major U.S.-based gas power technology manufacturer (the “Consortium”) to engineer, procure, construct and start-up a combined cycle power plant that will supply power to a large liquefied natural gas facility in Australia. On January 24, 2017, the Consortium terminated its contract with its client the general contractor, JKC Australia LNG Pty (the “Contractor”) on the grounds that the Contractor had by its actions repudiated the contract. As a result of the termination of the contract, we substantially completed all of our operations in the fixed-price Power EPC business, and, therefore, have presented the results of operations, financial position, cash flows and disclosures related to the fixed-price Power EPC business as discontinued operations in our consolidated financial statements. The majority of the financial information presented in our discontinued operations in the consolidated financial statements for the first quarters of 2017 and 2016 relate to the Australian fixed-price Power EPC contract.
Additionally, because the substantive engineering and construction operations ceased on January 24, 2017 as a result of the contract termination, we determined that we no longer controlled the operations of the joint venture and deconsolidated the partnership from our consolidated financial statements. The negative book value of our 50% retained interest in the noncontrolling investment in the joint venture partnership as of January 24, 2017 was approximately $86.0 million, which approximated our evaluation of the potential future costs.
In connection with the contract termination, the Consortium, which includes the consolidated Australian joint venture partnership, expects to file arbitration claims against the Contractor during the first half of 2017. The Contractor has claimed that the Consortium’s termination was not valid, and we anticipate that the Contractor will file counter claims. We expect a lengthy, multi-year arbitration process and at this time we are unable to predict the timing of resolution or the outcome of disputes. Due to a variety of issues, the joint venture partnership experienced project losses of $280.0 million in 2014, of which our portion of the loss was $140.0 million, and $301.5 million in 2016, of which our portion of the loss was $154.1 million. These contract losses were previously accrued and recognized in the periods when known and estimable. The joint venture has demobilized from the site in the first quarter of 2017 and expects to continue to incur legal and other costs until the dispute is resolved. The Consortium continues to assess the expected future costs to close out the contract and terminate its current subcontractor obligations. It is possible that certain subcontractors could file claims against the Consortium as a result of our termination of their subcontract which could be material to our consolidated financial statements. Additionally, the joint venture’s performance on the project is secured by certain bonds totaling approximately $50.0 million, of which our portion is approximately $25.0 million, which could potentially be called by our client at some time in the future. If we are ultimately unsuccessful in our claim that the contract was repudiated by our client, the Consortium could be liable for the completion of the project by a separate contractor and other related damages. While we continue to assess the possible impacts to our financial statements, the ultimate outcome of the dispute will depend upon contested issues of fact and law. These additional costs could be materially adverse to our results of operations, cash flow and financial condition in the future. Management believes the existing accruals will be sufficient for any known or expected costs which can be estimated at this time.
The following table presents a reconciliation of the major classes of line items constituting the net income (loss) from discontinued operations related the fixed-price Power EPC business:
|
|
Three Months Ended |
||||
|
|
March 31, |
|
March 25, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Gross revenue |
|
$ |
7,836 |
|
$ |
56,398 |
Operating expenses: |
|
|
|
|
|
|
Direct cost of services |
|
|
(4,476) |
|
|
(55,327) |
Selling, general and administrative |
|
|
(2,807) |
|
|
(1,227) |
Income (loss) from discontinued operations before provision for income taxes |
|
|
553 |
|
|
(156) |
Provision (benefit) for income taxes related to discontinued operations |
|
|
(163) |
|
|
35 |
Net income (loss) from discontinued operations |
|
$ |
390 |
|
$ |
(121) |
The following table presents a reconciliation of the carrying amounts of the major classes of assets and liabilities included in discontinued operations related the fixed-price Power EPC business:
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Current assets: |
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
— |
|
$ |
9,664 |
Client accounts |
|
|
1,020 |
|
|
1,787 |
Unbilled revenue |
|
|
224 |
|
|
972 |
Other receivables, net |
|
|
— |
|
|
16 |
Prepaid expenses and other current assets |
|
|
— |
|
|
2,010 |
Current assets of discontinued operations |
|
|
1,244 |
|
|
14,449 |
Property, plant and equipment, net |
|
|
— |
|
|
1,836 |
Total assets of discontinued operations |
|
$ |
1,244 |
|
$ |
16,285 |
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
Accounts payable and accrued subcontractor costs |
|
$ |
— |
|
$ |
20,317 |
Billings in excess of revenue |
|
|
753 |
|
|
(933) |
Other accrued liabilities |
|
|
— |
|
|
188,721 |
Current liabilities of discontinued operations |
|
|
753 |
|
|
208,105 |
Investments in unconsolidated affiliates |
|
|
83,403 |
|
|
— |
Total liabilities of discontinued operations |
|
$ |
84,156 |
|
$ |
208,105 |
|
(15) Commitments and Contingencies
We are party to various legal actions arising in the normal course of business. Because a large portion of our business comes from U.S. federal, state and municipal sources, our procurement and certain other practices at times are subject to review and investigation by various agencies of the U.S. government 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 or alternatively could result in settlement. Damages assessed in connection with and the cost of defending any such actions could be substantial. While the outcomes of pending proceedings and legal actions are often difficult to predict, management believes that proceedings and legal actions that have not yet been terminated through settlement would not result in a material adverse effect on our results of operations or financial condition even if the final outcome is adverse to the Company.
Many claims that are currently pending against us are covered by our professional liability insurance after we have exhausted our self-insurance requirement. Management estimates that the levels of insurance coverage (after retentions and deductibles) are generally adequate to cover our liabilities, if any, with regard to such claims. Any amounts that are probable of payment are accrued when such amounts are estimable. As of March 31, 2017 and December 30, 2016, accruals for potential estimated claim liabilities were $6.6 million and $8.9 million, respectively.
CH2M-WG Idaho, LLC (“CWI”), owned 50.5% by CH2M HILL Constructors, Inc., a wholly owned subsidiary of CH2M HILL Companies, Ltd., is a remediation contractor for the U.S. Department of Energy (“DOE”) at the Idaho National Laboratory site. The original remediation contract was to run from May 2005 through September 2012, and was extended through September 2015. CWI currently has a disagreement with DOE concerning what CWI’s final fee should be for the base contract period from May 2005 through September 2012. In December 2013, the DOE issued a final determination that was approximately $30.0 million less than CWI expected to receive in the fee determination. On March 6, 2014, CWI filed a Certified Claim with the Contracting Officer for a total fee owed of $40.1 million. Certified Claim was rejected through a Contracting Officer’s Final Decision in May 2014, and CWI filed its appeal to the Civilian Board of Contract Appeals on May 30, 2014. The trial was held on April 12 through 28, 2016, and the post-trial briefing phase is now complete. We are awaiting the decision from the Board. Based on information presently known to management, we believe that the outcome of this dispute will not have a material adverse effect on our financial condition, cash flows or results of operations.
In 2006, Halcrow Consulting Engineers & Architects, Ltd., Qatar Branch (“Halcrow”) entered into a Consulting Services Agreement with Qatari Diar Real Estate Investment Company (“QD”) to perform Pre and Post Contract Consultancy and Quantity Surveying Services for Lusail Development Primary Infrastructure, Marine, Earthworks, and Site Preparation Works (the “Project”) in Lusail, Qatar. The detailed design portion of the contract was extended from ten months to over seven years due primarily to employer delays and added scope, which were the responsibility of QD. On March 9, 2017, QD called Halcrow’s letter of credit for $6.7 million. On April 12, 2017, QD filed court proceedings in Qatari court (State of Qatar, Court of First Instance) against Halcrow. According to the court papers, QD’s claims are for (1) damages for loss and costs incurred resulting from the alleged negligent design of Bridges 8 and 9 on the Project (which bridge was designed by COWI – Halcrow’s subconsultant); and (2) compensation for alleged breach of contract relating to as yet unspecified infrastructure works. Further according to the court papers, the damages asserted by QD against Halcrow are as high as QAR 680.8 million, which is approximately $186.8 million. QD’s alternative damage amount for decennial liability under Qatari law (a form of strict liability) is for QAR 480.8 million, approximately $131.9 million. We intend to vigorously defend against QD’s claims, and to assert counterclaims against QD, including without limitation counterclaims for Halcrow’s entitlement to certified receivables of $4.0 million, delay claims of a minimum of approximately $20.0 million, and the wrongful calling of the letter of credit of $6.7 million. We will also assert the defense that the Agreement contains a limitation of liability provision capping any negligence damages against Halcrow at QAR 36.5 million, approximately $10.0 million.
|
(16) Subsequent Events
Second Lien Indenture
On April 28, 2017, we entered into a Second Lien Indenture through which we issued Senior Second Lien Notes with an aggregate principal amount of $200.0 million at an annual interest rate of 10% (the “Second Lien Notes”). The Second Lien Notes mature on April 28, 2020, and interest is payable on May 1 and November 1 of each year, commencing on November 1, 2017. The net proceeds of the Second Lien Notes are to be used to repay a portion of the outstanding revolving credit loans under our Credit Facility. The Second Lien Notes are unsubordinated, senior obligations of CH2M and are secured by second-priority liens on substantially all of CH2M’s and certain CH2M subsidiaries’ domestic assets.
The Second Lien Indenture also contains financial covenants that require CH2M to maintain a consolidated leverage ratio no greater than 4.50x and restricts CH2M’s ability to repurchase its common or preferred stock, pay cash dividends on or make certain other distributions on its common or preferred stock. Specifically, while the Second Lien Notes are outstanding, the amount CH2M may spend to repurchase its common stock in connection with its employee stock ownership program, other than legally required repurchases of common stock held in benefit plans, which are not restricted, will be limited to an aggregate of $75.0 million during the term of the Second Lien Notes plus a cumulative amount equal to 50% of CH2M’s consolidated net income, or minus 100% of any net loss, from April 1, 2017 to the date on which any such repurchase is to be made. The amount available to make repurchases of our common stock shall also be reduced to the extent that CH2M makes legally required repurchases of common stock held in benefit plans in excess of $50.0 million in any period of four consecutive quarters and that CH2M makes certain payments on subordinated indebtedness in accordance with the terms of the Second Lien Indenture.
The Second Lien Indenture contains affirmative and negative covenants and other terms that are customary for obligations similar to the Second Lien Notes, which include covenants that limit or restrict our ability to incur additional indebtedness, grant liens to secure their obligations, make certain kinds of investments, dispose of assets outside the ordinary course of business, create contractual restrictions on the ability to pay dividends or make certain other payments, merge or consolidate, sell all or substantially all of our assets, and enter into certain transactions with affiliates unless the transaction is comparable to an arm’s length transaction with a non-affiliate.
CH2M may, at its option, redeem the Second Lien Notes in whole at any time or from time to time in part, upon notice at a premium on the principal amount plus any accrued and unpaid interest to the date of redemption as shown below:
Redemption Period |
|
Redemption Price |
|
From April 28, 2017 (issue date) through April 28, 2018 |
|
110.0 |
% |
From April 29, 2018 through April 28, 2019 |
|
103.0 |
% |
From April 29, 2019 through October 28, 2019 |
|
101.5 |
% |
From October 29, 2019 through April 28, 2020 (maturity date) |
|
100.0 |
% |
Upon the occurrence of a change of control, any holder of Second Lien Notes will have the right to require CH2M to repurchase all or any portion of the holder’s Second Lien Notes at a purchase price in cash equal to 101% of the outstanding principal and accrued and unpaid interest, if any, through the date of repurchase.
The Second Lien Indenture also contains customary events of default. If an event of default occurs, the holders of the Second Lien Notes may declare any outstanding principal, accrued and unpaid interest, and premium to be immediately due and payable. Additionally, certain events of bankruptcy or insolvency are events of default which shall result in the Second Lien Notes being due and payable immediately upon the occurrence of such events of default. Upon the occurrence of certain events of default, such as bankruptcy or insolvency, the Second Lien Notes become due and payable immediately.
Fourth Amendment to Our Credit Agreement
In connection with the issuance of the Second Lien Notes, on April 28, 2017 we entered into the Fourth Amendment (“Fourth Amendment”) to our Credit Agreement. The Fourth Amendment allows for the issuance and sale of the Second Lien Notes, as discussed above, lowers our maximum revolving credit facility to $875.0 million from $925.0 million, increases the maximum consolidated leverage ratio, as defined by the Fourth Amendment, to 4.00x from 3.00x, and modifies the definition of adjusted EBIDTA as used in the financial covenant calculation. Additionally, the Fourth Amendment requires that CH2M maintain, on a consolidated basis, a maximum consolidated first lien leverage ratio, as defined in the Fourth Amendment, no greater than 3.00x as well as maintain a minimum consolidated fixed charge coverage ratio, as defined in the Fourth Amendment, no less than 1.50x. The Fourth Amendment also requires that CH2M comply with the terms of the Second Lien Indenture limiting certain restricted payment and participation in the employee stock ownership program as described above.
The Fourth Amendment to our Credit Agreement continues to contain customary representations, warranties and conditions to borrowing including customary affirmative and negative covenants, which include covenants that limit or restrict our ability to incur indebtedness and other obligations, grant liens to secure their obligations, make investments, merge or consolidate, and dispose of assets, in each case subject to customary exceptions for credit facilities of this size and type. Additionally, the Fourth Amendment also makes other technical and operating changes.
The obligations of CH2M and its subsidiaries that are either borrowers or guarantors under the Fourth Amendment are secured by first-priority security interests in substantially all of the domestic assets of CH2M and such subsidiaries pursuant to Amended Credit Agreement dated as of September 30, 2016 and discussed in Note 10 – Line of Credit and Long-Term Debt. As a result of the Second Lien Notes and the Fourth Amendment, our remaining unused borrowing capacity under the Credit Facility was over $300.0 million as of March 31, 2017.
Intercreditor Agreement
Furthermore, on April 28, 2017 we entered into an Intercreditor Agreement with the agents of the Second Lien Notes and the lenders of the Fourth Amendment to our Credit Agreement that states that the liens on common collateral securing the claims of the Credit Agreement have priority over, and are senior to, the liens on the common collateral securing Second Lien Notes. The senior claims are defined in the Intercreditor Agreement to include, among other things, the principal amount of all indebtedness incurred under the Fourth Amendment and certain additional senior indebtedness permitted under the Intercreditor Agreement.
Amendment to Certificate of Designation of Series A Preferred Stock
In connection with the issuance of the Second Lien Notes and the Fourth Amendment, we obtained consent from our Series A Preferred Stockholder with respect to the incurrence of the notes and filed a Certificate of Amendment to the Certificate of Designation of Series A Preferred Stock which increases the annual rate at which dividends accrue on the Series A Preferred Stock from 5% to 7% beginning April 1, 2017. Dividends on the Series A Preferred Stock are cumulative and accrue quarterly in arrears on the sum of the original issue price of $62.22 per share plus all accumulated and unpaid accruing dividends, regardless of whether or not declared by the Board. The other terms of the Series A Preferred Stock set forth in the Certificate of Designation, and summarized in our Annual Report on Form 10-K for the year ended December 30, 2016, remain unchanged.
|
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 according to instructions to Form 10-Q and the provisions of Article 10 of Regulation S-X that are applicable to 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 annual audited 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.
In the opinion of 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 our Annual Report on Form 10-K for the year ended December 30, 2016.
Revenue Recognition
We earn revenue from different types of services performed under various types of contracts, including cost-plus, fixed-price and time-and-materials. We evaluate contractual arrangements to determine how to recognize revenue. We primarily perform engineering and construction related services and recognize 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 contract. In making such estimates, judgments are required to evaluate potential variances in schedule, the cost of materials and labor, productivity, subcontractor costs, liability claims, contract disputes, and achievement of contract performance standards. We record the cumulative effect of changes in contract revenue and cost at completion in the period in which the changed estimates are determined to be reliably estimable.
Below is a description of the four basic types of contracts from which we may earn revenue:
Cost-Plus Contracts. Cost-plus contracts can be cost plus a fixed fee or rate, or cost plus an award fee. Under these types of contracts, we charge our clients for our costs, including both direct and indirect costs, plus a fixed fee or an award fee. We generally recognize revenue based on the labor and non-labor costs we incur, plus the portion of the fixed fee or award fee we have earned to date.
Included in the total contract value for cost-plus fee arrangements is the portion of the fee for which receipt is determined to be probable. Award fees are influenced by the achievement of contract milestones, cost savings and other factors.
Fixed-Price Contracts. Under fixed-price contracts, our clients pay us an agreed amount negotiated in advance for a specified scope of work. For engineering and construction contracts, we recognize revenue on fixed-price contracts using the percentage-of-completion method where direct costs incurred to date are compared to total projected direct costs at contract completion. Prior to completion, our recognized profit margins on any fixed-price contract depend on the accuracy of our estimates and will increase to the extent that our actual costs are below the original estimated amounts. Conversely, if our costs exceed these estimates, our profit margins will decrease, and we may realize a loss on a project. The significance of these estimates varies with the complexity of the underlying project, with our large, fixed-price EPC projects being most significant.
Time-and-Materials Contracts. Under our time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we expend on a project. In addition, clients reimburse us for our actual out of pocket costs of materials and other direct expenditures that we incur in connection with our performance under the contract. Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared with the negotiated billing rate and markup on other direct costs. Some of our time-and-materials contracts are subject to maximum contract values, and accordingly, revenue under these contracts is recognized under the percentage-of-completion method where costs incurred to date are compared to total projected costs at contract completion. Revenue on contracts that is not subject to maximum contract values is recognized based on the actual number of hours we spend on the projects plus any actual out of pocket costs of materials and other direct expenditures that we incur on the projects.
Operations and Maintenance Contracts. A portion of our contracts are operations and maintenance type contracts. Revenue is recognized on operations and maintenance contracts on a straight-line basis over the life of the contract once we have an arrangement, service has begun, the price is fixed or determinable and collectability is reasonably assured.
For all contract types noted above, 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 when the change order can be estimated. Management evaluates when a change order is probable based upon its experience in negotiating change orders, the customer’s written approval of such changes or separate documentation of change order costs that are identifiable. Additional contract revenue related to claims is included in total estimated contract revenue when the amount can be reliably estimated, which is typically evidenced by a contract or other evidence providing a legal basis for the claim.
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.
Accounts Receivable
We reduce accounts receivable by estimating an allowance for amounts that may become uncollectible in the future. Management determines the estimated allowance for uncollectible amounts based on their judgments in evaluating the aging of the receivables and the financial condition of our clients, which may be dependent on the type of client and the client’s current financial condition.
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 work performed and revenue recognized on contracts in process using the percentage-of-completion method.
Fair Value Measurements
Fair value represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Assets and liabilities are valued based upon observable and non-observable inputs. Valuations using Level 1 inputs are based on unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date. Level 2 inputs utilize significant other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly; and valuations using Level 3 inputs are based on significant unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. There were no significant transfers between levels during any period presented.
Restructuring and Related Charges
An exit activity includes but is not limited to a restructuring, such as a sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations. The Company recognizes a current and long-term liability, within other accrued liabilities and other long term liabilities, respectively, and the related expense, within selling, general and administrative expense, for restructuring costs when the liability is incurred and can be measured. Restructuring accruals are based upon management estimates at the time they are recorded and can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded. Nonretirement postemployment benefits offered as special termination benefits to employees, such as a voluntary early retirement program, are recognized as a liability and a loss when the employee accepts the offer and the amount can be reasonably estimated.
Goodwill
Goodwill represents the excess of costs over fair value of the assets of businesses we have acquired. Goodwill acquired in a purchase business combination is not amortized, but instead, is tested for impairment at least annually. Our annual goodwill impairment test is conducted as of the first day of the fourth quarter of each year, however, upon the occurrence of certain triggering events, we are also required to test for impairment at dates other than the annual impairment testing date. In performing the impairment test, we evaluate our goodwill at the reporting unit level. We have the option to assess either quantitative or qualitative factors to determine whether it is more likely than not that the fair values of our reporting units are less than their carrying amounts. If after assessing the totality of events or circumstances, we determine that it is not more likely than not that the fair values of our reporting units are less than their carrying amounts, then the next step of the impairment test is unnecessary. If we conclude otherwise, then we are required to test goodwill for impairment by comparing the estimated fair value of each reporting unit to the unit’s carrying value, including goodwill. If the carrying value of a reporting unit does not exceed its fair value, the goodwill of the reporting unit is not considered impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
We determine the fair value of our reporting units using a combination of the income approach, the market approach, and the cost approach. The income approach calculates the present value of future cash flows based on assumptions and estimates derived from a review of our expected revenue growth rates, profit margins, business plans, cost of capital and tax rates for the reporting units. Our market based valuation method estimates the fair value of our reporting units by the application of a multiple to our estimate of a cash flow metric for each business unit. The cost approach estimates the fair value of a reporting unit as the net replacement cost using current market quotes.
Intangible Assets
We may acquire other intangible assets in business combinations. Intangible assets are stated at fair value as of the date they are acquired in a business combination. We amortize intangible assets with finite lives on a straight-line basis over their expected useful lives, currently up to ten years. We test our intangible assets for impairment in the period in which a triggering event or change in circumstance indicates that the carrying amount of the intangible asset may not be recoverable. If the carrying amount of the intangible asset exceeds the fair value, an impairment loss will be recognized in the amount of the excess. We determine the fair value of the intangible assets using a discounted cash flow approach.
Derivative Instruments
We primarily enter into derivative financial instruments to mitigate exposures to changing foreign currency exchange rates on our earnings and cash flows. We are primarily subject to this risk on long-term projects whereby the currency being paid by our client differs from the currency in which we incurred our costs, as well as intercompany trade balances among entities with differing currencies. We do not enter into derivative transactions for speculative or trading purposes. All derivatives are carried at fair value on the consolidated balance sheets in other receivables or other accrued liabilities as applicable. The periodic change in the fair value of the derivative instruments related to our business group operations is recognized in earnings within direct costs. The periodic change in the fair value of the derivative instruments related to our general corporate foreign currency exposure is recognized within selling, general and administrative expense
Retirement and Tax-Deferred Savings Plan
The Retirement and Tax Deferred Savings Plan is a retirement plan that includes a cash or deferred arrangement that is intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code and provides benefits to eligible employees upon retirement. The 401(k) Plan allows for matching contributions up to 58.33% of the first 6% of elective deferrals up to 3.5% of the employee’s quarterly base compensation, although specific subsidiaries may have different limits on employer matching. The matching contributions may be made in both cash and/or stock. Expenses related to matching contributions made in common stock for the 401(k) Plan for the three months ended March 31, 2017 were $2.6 million as compared to $5.5 million for the three months ended March 25, 2016.
Recently Adopted Accounting Standards
In March 2017, the FASB issued Accounting Standards Update ("ASU") 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The amendments in this ASU require that an employer disaggregate the service cost component from the other components of net benefit cost and report the service cost component in the same statement of income line item as other compensation costs for the relevant employees. Additionally, only the service cost component of net benefit cost would be eligible for capitalization. The ASU requires that the other components of net benefit cost be presented outside of income or loss from operations on the statement of income, separate from the service cost component. The amendments in this update should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic benefit cost and net periodic postretirement benefit in assets. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, and early adoption is permitted. Currently, the net periodic pension expense or income related to our defined pension benefit plans in the U.S. and internationally is presented within selling, general and administrative expense. Therefore, we anticipate the adoption of this ASU to impact the presentation of our statement of operations, including the subtotal of income or loss from operations. Refer to Note 13 – Defined Benefit Plans and Other Postretirement Benefits for detail of our net periodic pension expense or income by component.
In January 2017, the FASB issued Accounting Standard Update ("ASU") 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment. This ASU was issued with the objective of simplifying the subsequent measurement of goodwill for public business entities and not-for-profit entities by eliminating the second step of the goodwill impairment test. As a result, an entity would perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. During the three months ended March 31, 2017, we early adopted this standard which will be effective for our annual goodwill impairment test to be conducted as of the first day of the fourth quarter of 2017. We do not believe this ASU will have a material impact on our financial statements.
In January 2017, the FASB issued Accounting Standard Update ("ASU") 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business). This ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU will be effective for fiscal years beginning after December 15, 2017, and should be applied prospectively. Once effective, we will apply this guidance to determine if certain transactions are acquisitions (or disposals) of assets or businesses, but we do not believe this ASU will materially change how we currently evaluate similar transactions.
In October 2016, the FASB issued Accounting Standard Update ("ASU") 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. This standard amends the guidance issued with ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis in order to make it less likely that a single decision maker would individually meet the characteristics to be the primary beneficiary of a Variable Interest Entity ("VIE"). When a decision maker or service provider considers indirect interests held through related parties under common control, they perform two steps. The second step was amended with this ASU to say that the decision maker should consider interests held by these related parties on a proportionate basis when determining the primary beneficiary of the VIE rather than in their entirety as was called for in the previous guidance. The adoption of this standard in the current reporting period did not have a material impact on our consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU was issued with the objective to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The new standard will require companies to recognize the income tax consequences of an intra-entity transfer of non-inventory assets when the transfer occurs. This ASU will be effective for fiscal years beginning after December 15, 2017, and early adoption is permitted. We are currently evaluating the impact of the adoption of this ASU on our financial position and results of operations.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance for eight specific changes with respect to how certain cash receipts and cash payments are classified within the statement of cash flows in order to reduce existing diversity in practice. This ASU will be effective for fiscal years beginning after December 15, 2017, and early adoption is permitted, and it should be applied using a retroactive transition method to each period presented. We are currently evaluating the impacts the adoption of this standard will have on our consolidated statements of cash flows, focusing on the impact our cash flows related to distributions received from equity method investees and contingent consideration payments made subsequent to business combinations. We anticipate that approximately $15.9 million of the acquisition related payments within our investing cash flows for the year ended December 30, 2016, of which zero occurred in the three months ended March 25, 2016, will be reclassified to financing cash flows as a result of adopting this ASU.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payments Accounting. During the three months ended September 30, 2016, the Company elected to early adopt ASU 2016-09 with an effective date of December 26, 2015. As a result, the Company recognized the excess tax benefit of $1.3 million within income tax benefit on the consolidated statements of income for the three months ended March 31, 2017, and, upon adoption, previously unrecognized excess tax benefits of $11.1 million resulted in a cumulative-effect adjustment to retained earnings for the year ended December 30, 2016. The adoption did not impact the existing classification of awards. Excess tax benefits from stock-based compensation of $2.1 million for the three months ended March 25, 2016 were restated into cash flows from operating activities from cash flows from financing activity. Additionally, adopted retrospectively, the Company reclassified $1.9 million and $2.0 million of employee withholding taxes paid from operating activities into financing activities for the three months ended March 31, 2017 and March 25, 2016, respectively. Following the adoption of the standard, the Company elected to continue estimating the number of awards expected to be forfeited and adjust its estimate on an ongoing basis.
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU is a comprehensive new leases standard that was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We continue to assess the impact of adopting ASU 2016-02, but expect to record a significant amount of right-of-use assets and corresponding liabilities. Based upon our operating leases as of December 30, 2016, we expect to have in excess of $500.0 million of undiscounted future minimum lease payments upon adoption of this standard.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments issued with this ASU require equity securities (including other ownership interests, such as partnerships, unincorporated joint ventures, and limited liability companies) to be measured at fair value with changes in the fair value recognized through net income. An entity’s equity investments that are accounted for under the equity method of accounting or result in consolidation of an investee are not included within the scope of this update. This ASU will be effective for annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods, with early adoption permitted. We believe this standard’s impact on CH2M will be limited to equity securities currently accounted for under the cost method of accounting, which as of March 31, 2017 are valued at $3.4 million within investments in unconsolidated affiliates on the consolidated balance sheet. We do not expect the adoption of this standard to have a material impact on our consolidated statements of operations.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and subsequently modified with various amendments and clarifications. This ASU is a comprehensive new revenue recognition model that is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU also requires additional quantitative and qualitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU, as amended, is effective for annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods. Companies may use either a full retrospective or a modified retrospective approach to adopt this ASU. CH2M is currently evaluating the impact of this ASU, the subsequently issued amendments, and the transition alternatives on its financial position and results of operations. Currently, we have identified various revenue streams by contract billing type, client type, and type of contracted services. We are reviewing our contracts in the various revenue streams in order to isolate those that will be significantly impacted as well as to identify the relevant revenue streams for disaggregated disclosure. After our assessment is complete, we can begin estimating the potential financial impacts of the new standard as well as identify necessary controls, processes and information system changes.
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|
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|
|
|
|
Three Months Ended March 31, 2017 |
|
Three Months Ended March 25, 2016 |
||||||||||||||
|
|
Gross |
|
Equity in |
|
Operating |
|
Gross |
|
Equity in |
|
Operating |
||||||
($ in thousands) |
|
Revenue |
|
Earnings |
|
Income |
|
Revenue |
|
Earnings |
|
Income |
||||||
National Governments |
|
$ |
475,679 |
|
$ |
4,494 |
|
$ |
10,666 |
|
$ |
446,724 |
|
$ |
6,308 |
|
$ |
763 |
Private |
|
|
289,280 |
|
|
(131) |
|
|
9,271 |
|
|
348,097 |
|
|
287 |
|
|
14,496 |
State & Local Governments |
|
|
475,474 |
|
|
2,998 |
|
|
9,514 |
|
|
492,189 |
|
|
2,458 |
|
|
25,763 |
Total |
|
$ |
1,240,433 |
|
$ |
7,361 |
|
$ |
29,451 |
|
$ |
1,287,010 |
|
$ |
9,053 |
|
$ |
41,022 |
|
|
|
Common |
|
Preferred |
|
|
|
(in thousands) |
|
Shares |
|
Shares |
|
Amount |
|
Stockholders’ equity, December 30, 2016 |
|
25,148 |
|
4,822 |
|
$ |
445,538 |
Shares purchased and retired |
|
(512) |
|
— |
|
|
(24,028) |
Shares issued in connection with stock-based compensation and employee benefit plans |
|
133 |
|
— |
|
|
5,587 |
Net income attributable to CH2M |
|
— |
|
— |
|
|
13,959 |
Other comprehensive income, net of tax |
|
— |
|
— |
|
|
15,585 |
Other comprehensive income attributable to noncontrolling interest, net of tax |
|
|
|
|
|
|
(136) |
Deconsolidation of a subsidiary's noncontrolling interest |
|
— |
|
— |
|
|
87,838 |
Income attributable to noncontrolling interests from continuing operations |
|
— |
|
— |
|
|
4,257 |
Loss attributable to noncontrolling interests from discontinued operations |
|
|
|
|
|
|
(60) |
Investment in affiliates, net |
|
— |
|
— |
|
|
2,806 |
Stockholders’ equity, March 31, 2017 |
|
24,769 |
|
4,822 |
|
$ |
551,346 |
|
The following table presents the changes in goodwill by segment during the three months ended March 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands) |
|
National Governments |
|
Private |
|
State & Local Governments |
|
Consolidated Total |
||||
Balance as of December 30, 2016 |
|
$ |
12,753 |
|
$ |
146,913 |
|
$ |
318,086 |
|
$ |
477,752 |
Foreign currency translation |
|
|
225 |
|
|
906 |
|
|
5,278 |
|
|
6,409 |
Balance as of March 31, 2017 |
|
$ |
12,978 |
|
$ |
147,819 |
|
$ |
323,364 |
|
$ |
484,161 |
The following table presents the changes in intangible assets by segment during the three months ended March 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands) |
|
National Governments |
|
Private |
|
State & Local Governments |
|
Consolidated Total |
||||
Balance as of December 30, 2016 |
|
$ |
433 |
|
$ |
23,988 |
|
$ |
13,603 |
|
$ |
38,024 |
Amortization |
|
|
(121) |
|
|
(621) |
|
|
(3,474) |
|
|
(4,216) |
Foreign currency translation |
|
|
7 |
|
|
17 |
|
|
537 |
|
|
561 |
Balance as of March 31, 2017 |
|
$ |
319 |
|
$ |
23,384 |
|
$ |
10,666 |
|
$ |
34,369 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
Net finite-lived |
||
($ in thousands) |
|
Cost |
|
Amortization |
|
intangible assets |
|||
March 31, 2017 |
|
|
|
|
|
|
|
|
|
Customer relationships |
|
$ |
174,641 |
|
$ |
(140,272) |
|
$ |
34,369 |
Total finite-lived intangible assets |
|
$ |
174,641 |
|
$ |
(140,272) |
|
$ |
34,369 |
December 30, 2016 |
|
|
|
|
|
|
|
|
|
Customer relationships |
|
$ |
172,880 |
|
$ |
(134,856) |
|
$ |
38,024 |
Total finite-lived intangible assets |
|
$ |
172,880 |
|
$ |
(134,856) |
|
$ |
38,024 |
|
|
|
|
|
|
Amortization |
|
($ in thousands) |
|
Expense |
|
2017 (nine months remaining) |
|
$ |
11,559 |
2018 |
|
|
4,251 |
2019 |
|
|
3,518 |
2020 |
|
|
3,518 |
2021 |
|
|
3,518 |
2022 |
|
|
3,518 |
Thereafter |
|
|
4,487 |
|
|
$ |
34,369 |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Land |
|
$ |
5,021 |
|
$ |
5,021 |
Building and land improvements |
|
|
106,354 |
|
|
107,140 |
Furniture and fixtures |
|
|
25,586 |
|
|
26,009 |
Computer and office equipment |
|
|
158,441 |
|
|
157,542 |
Field equipment |
|
|
130,616 |
|
|
130,681 |
Leasehold improvements |
|
|
76,803 |
|
|
75,492 |
|
|
|
502,821 |
|
|
501,885 |
Less: Accumulated depreciation |
|
|
(263,252) |
|
|
(255,289) |
Net property, plant and equipment |
|
$ |
239,569 |
|
$ |
246,596 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2017 |
|
December 30, 2016 |
||||||||
|
|
Carrying |
|
Fair |
|
Carrying |
|
Fair |
||||
($ in thousands) |
|
Amount |
|
Value |
|
Amount |
|
Value |
||||
Equipment financing |
|
$ |
7,631 |
|
$ |
7,195 |
|
$ |
8,152 |
|
$ |
7,662 |
Note payable by consolidated joint venture |
|
$ |
2,485 |
|
$ |
2,295 |
|
$ |
2,483 |
|
$ |
2,284 |
|
|
Three Months Ended |
||||
|
|
March 31, |
|
March 25, |
||
(in thousands) |
|
2017 |
|
2016 |
||
Unrealized gain (loss) from changes in derivative fair values |
|
$ |
394 |
|
$ |
(598) |
Realized loss from changes in derivative fair values |
|
$ |
(1,705) |
|
$ |
(774) |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Revolving Credit Facility, average rate of interest of 3.7% |
|
$ |
507,822 |
|
$ |
487,009 |
Equipment financing, due in monthly installments to September 2021, secured by equipment. These notes bear interest ranging from 0.22% to 3.29% |
|
|
7,631 |
|
|
8,152 |
Note payable by consolidated joint venture, due July 2019. This note bears interest at 6-month LIBOR plus 2.5% |
|
|
2,485 |
|
|
2,483 |
Other notes payable |
|
|
194 |
|
|
230 |
Total debt |
|
|
518,132 |
|
|
497,874 |
Less: current portion of debt |
|
|
2,233 |
|
|
2,242 |
Total long-term portion of debt |
|
$ |
515,899 |
|
$ |
495,632 |
|
|
|
2014 Restructuring Plan |
|
2016 Restructuring Plan |
|
|
||||||||||||
($ in thousands) |
|
Employee Severance |
|
Facilities Cost |
|
Employee Severance |
|
Facilities Cost |
|
Other |
|
Consolidated Total |
||||||
Balance, December 30, 2016 |
|
$ |
1,015 |
|
$ |
13,995 |
|
$ |
6,041 |
|
$ |
15,090 |
|
$ |
30 |
|
$ |
36,171 |
Provision |
|
|
— |
|
|
— |
|
|
4,353 |
|
|
8,401 |
|
|
382 |
|
|
13,136 |
Cash payments |
|
|
— |
|
|
(820) |
|
|
(8,607) |
|
|
(2,756) |
|
|
(412) |
|
|
(12,595) |
Non-cash settlements |
|
|
— |
|
|
— |
|
|
— |
|
|
(453) |
|
|
— |
|
|
(453) |
Balance, March 31, 2017 |
|
$ |
1,015 |
|
$ |
13,175 |
|
$ |
1,787 |
|
$ |
20,282 |
|
$ |
— |
|
$ |
36,259 |
|
|
|
Three Months Ended |
||||||||||
|
|
March 31, 2017 |
|
March 25, 2016 |
||||||||
|
|
U.S. |
|
Non-U.S. |
|
U.S. |
|
Non-U.S. |
||||
($ in thousands) |
|
Pension Plans |
|
Pension Plans |
|
Pension Plans |
|
Pension Plans |
||||
Service cost |
|
$ |
89 |
|
$ |
1,074 |
|
$ |
671 |
|
$ |
1,377 |
Interest cost |
|
|
2,733 |
|
|
6,059 |
|
|
2,954 |
|
|
10,477 |
Expected return on plan assets |
|
|
(3,017) |
|
|
(9,515) |
|
|
(2,921) |
|
|
(8,814) |
Amortization of prior service credits |
|
|
(13) |
|
|
(2,479) |
|
|
(188) |
|
|
— |
Recognized net actuarial loss |
|
|
1,908 |
|
|
2,594 |
|
|
1,629 |
|
|
693 |
Net expense (income) included in current income |
|
$ |
1,700 |
|
$ |
(2,267) |
|
$ |
2,145 |
|
$ |
3,733 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
||||||||||
|
|
March 31, 2017 |
|
March 25, 2016 |
||||||||
|
|
Non-Qualified |
|
Postretirement |
|
Non-Qualified |
|
Postretirement |
||||
($ in thousands) |
|
Pension Plan |
|
Benefit Plans |
|
Pension Plan |
|
Benefit Plans |
||||
Service cost |
|
$ |
— |
|
$ |
163 |
|
$ |
— |
|
$ |
206 |
Interest cost |
|
|
10 |
|
|
405 |
|
|
13 |
|
|
497 |
Amortization of prior service (credits) costs |
|
|
— |
|
|
(96) |
|
|
— |
|
|
(96) |
Recognized net actuarial loss (gain) |
|
|
— |
|
|
(71) |
|
|
— |
|
|
(3) |
Net expense included in current income |
|
$ |
10 |
|
$ |
401 |
|
$ |
13 |
|
$ |
604 |
|
The following table presents a reconciliation of the major classes of line items constituting the net income (loss) from discontinued operations related the fixed-price Power EPC business:
|
|
Three Months Ended |
||||
|
|
March 31, |
|
March 25, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Gross revenue |
|
$ |
7,836 |
|
$ |
56,398 |
Operating expenses: |
|
|
|
|
|
|
Direct cost of services |
|
|
(4,476) |
|
|
(55,327) |
Selling, general and administrative |
|
|
(2,807) |
|
|
(1,227) |
Income (loss) from discontinued operations before provision for income taxes |
|
|
553 |
|
|
(156) |
Provision (benefit) for income taxes related to discontinued operations |
|
|
(163) |
|
|
35 |
Net income (loss) from discontinued operations |
|
$ |
390 |
|
$ |
(121) |
The following table presents a reconciliation of the carrying amounts of the major classes of assets and liabilities included in discontinued operations related the fixed-price Power EPC business:
|
|
|
|
|
|
|
|
|
March 31, |
|
December 30, |
||
($ in thousands) |
|
2017 |
|
2016 |
||
Current assets: |
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
— |
|
$ |
9,664 |
Client accounts |
|
|
1,020 |
|
|
1,787 |
Unbilled revenue |
|
|
224 |
|
|
972 |
Other receivables, net |
|
|
— |
|
|
16 |
Prepaid expenses and other current assets |
|
|
— |
|
|
2,010 |
Current assets of discontinued operations |
|
|
1,244 |
|
|
14,449 |
Property, plant and equipment, net |
|
|
— |
|
|
1,836 |
Total assets of discontinued operations |
|
$ |
1,244 |
|
$ |
16,285 |
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
Accounts payable and accrued subcontractor costs |
|
$ |
— |
|
$ |
20,317 |
Billings in excess of revenue |
|
|
753 |
|
|
(933) |
Other accrued liabilities |
|
|
— |
|
|
188,721 |
Current liabilities of discontinued operations |
|
|
753 |
|
|
208,105 |
Investments in unconsolidated affiliates |
|
|
83,403 |
|
|
— |
Total liabilities of discontinued operations |
|
$ |
84,156 |
|
$ |
208,105 |
|
Redemption Period |
|
Redemption Price |
|
From April 28, 2017 (issue date) through April 28, 2018 |
|
110.0 |
% |
From April 29, 2018 through April 28, 2019 |
|
103.0 |
% |
From April 29, 2019 through October 28, 2019 |
|
101.5 |
% |
From October 29, 2019 through April 28, 2020 (maturity date) |
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
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|