We recently received the 2014 PSMJ Survey Report, which included data from 328 A&E firm participants. The results showed good improvement from the prior year, albeit not as good as pre-recession. As we have been witnessing firsthand in our business, most firms in the survey are improving their balance sheets and looking for opportunities to use this working capital to enhance their return on equity.
Many that have not recovered from the recession and have not improved their balance sheets are now looking at these ‘stronger’ firms as merger candidates. As such, we are seeing more merger and acquisition activity and we expect this to get stronger as we move into the third and fourth quarters of 2015.
Operating profits continued to increase over 2013. 2014 results are up 14 percent (pre-bonus). This is due to a combination of better pricing (direct labor multiplier increased from 3.04 to 3.14) and utilization, which increased from 61 percent to 64 percent.
After spiking to over 170 percent in 2010, operating overhead rates before incentive and bonus payments (total pre-bonus overhead/direct labor) are relatively stable at 160 percent. Total overhead increased slightly to about 187 percent, but we suspect this is because of the increased profitability that most firms experienced in 2014. For government contractor clients, the survey median FAR overhead rate was 182 percent - significantly more than we see for our A&E firms that work for the government.
Total hourly costs per direct labor (i.e. the amount that the average firm has to bill per direct labor to break even) increased slightly to approximately $90/hour.
Turning to the balance sheet, total debt to equity was fairly consistent with the prior year; however, in digging into the detail, those firms with over 100 employees increased their leverage (we would assume this is acquisition related) and those firms below 100 employees have decreased their leverage.
Line of credit borrowing on those that reported on the accrual basis was only 16 percent of total accounts receivable. Since most banks will lend up to 80 percent of eligible accounts receivable, this available credit (even without the acquiree’s assets) is an available source of working capital to fund acquisitions.
Given the low interest rate environment, the available working capital, and the banks becoming more lenient on loan terms, this creates a very good environment for firms with the stronger balance sheets to look for acquisitions. Because of this scenario, many are also warning that this is a seller’s environment, so sales prices are tending to inch up and overpaying for an acquisition becomes more of a risk.
In reading the survey results, we were surprised to learn that approximately 1 out every 6 firms surveyed were accrual basis taxpayers. If you are one of these privately-held firms and believe you don’t qualify for the cash-basis method for income tax reporting, please contact us. We recently received verbal approval from the IRS to change the method of a major engineering firm, which will result in a substantial deferral of income taxes.
Going forward, the following sectors expect to see strong growth: Commercial developers, manufacturing and pharmaceutical, energy/utilities/water/wastewater, healthcare, and housing. Government buildings and education continue to be weak. Overall, transportation is still being held back by the lack of long-term funding by the Feds, but Pennsylvania continues to be strong as a result of its recent funding improvements.
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