Fluor Corporation - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

(Address of principal executive offices)

(Registrant’s telephone number, including area code)

Three Months Ended March 31, 2006 and 2005

March 31, 2006 and December 31, 2005

Three Months Ended March 31, 2006 and 2005

The provisions of SFAS 123-R generally apply to awards granted after the required effective date of the statement, which was January 1, 2006 for the company. The company has elected the modified prospective method of application and, accordingly, has not restated previously reported financial condition, operating results or cash flows. The elimination of additional capital associated with unvested restricted shares resulted in an offsetting reversal of unamortized executive stock plan expense upon implementation of SFAS 123-R. Additionally, the presentation of cash flows for 2006 has been modified to reflect the benefits of tax deductions for stock compensation in excess of recognized compensation cost as financing cash flows, as now required.

The company’s executive stock plans are described, and informational disclosures provided, in the Notes to the Consolidated Financial Statements included in the Form 10-K for the year ended December 31, 2005. The contractual lives of 2006 awards, which have included stock options and stock appreciation rights, are consistent with those of prior years. Restricted stock awards totaling 264,872 shares have been granted in 2006 at a per share price of $84.21, vesting over five years.

During the quarter ended March 31, 2006, the company recognized pretax compensation expense of $938,000 ($0.01 per diluted share after-tax) associated with stock options, including amounts arising from new stock option awards to purchase 259,175 shares at $84.21 per share, with annual vesting of 20 percent. The per share fair value of the options, determined using the Black-Scholes option-pricing model and assumptions of a 4.74 year average life, 4.6 percent risk-free interest rate, 1 percent expected dividend yield and 30 percent historical volatility, is $25.72. Previously under APB 25, no compensation cost was recognized for unvested stock options where the grant price was equal to the market price on the date of grant and the vesting provisions were based only on the passage of time. Had the company recorded compensation expense using the accounting method required by SFAS 123-R, net earnings and earnings per share for the three months ended March 31, 2005 would have been reduced to the pro forma amounts as follows:

The company has not historically considered retirement eligibility in determining stock-based compensation expense, including expense associated with stock options and restricted stock. The adoption of SFAS 123-R required the company to assume the first date on which an employee becomes eligible to retire in determining the amortization period for future stock-based awards. For example, if the employee is eligible for retirement two years from the date of grant, the amortization period will be no longer than two years rather than the specified service period over which awards normally vest. Retirement eligibility has been considered in the determination of periodic expense on a prospective basis for current year awards, and compensation expense associated with awards granted in prior periods have continued to be recognized using historical straight-line amortization practices.

The impact of using retirement eligibility in determining stock option expense would have been to decrease the pro forma adjustments by approximately 65 percent for the first quarter of 2005. The impact of using retirement eligibility to determine amortization periods for new stock options and restricted stock awards during the first quarter of 2006 was to increase pretax amortization expense by approximately $0.5 million and $1.5 million, respectively, for an aggregate after-tax impact of $0.02 per diluted share. The impact of using retirement eligibility to determine amortization

periods for previous restricted stock awards would have been to increase recorded restricted stock amortization expense of $4.8 million by approximately one-third during the 2005 period.

The average trading price of the company’s stock during the first quarter of 2006 was $83 per share. During the three months ended March 31, 2006, 342,000 stock options were exercised at a weighted average exercise price of $35 per share. As of March 31, 2006, there were 792,000 stock options outstanding with a weighted average exercise price of $49 per share, of which 528,000 were exercisable with a weighted average exercise price of $32 per share. As of December 31, 2005 and March 31, 2006, there were 1,498,000 and 1,310,000 unvested shares, respectively, of restricted stock outstanding. The balances of unamortized stock option and restricted stock expense at March 31, 2006 were $5.9 million and $53.6 million, respectively.

A reconciliation of the segment information to consolidated amounts for the three months ended March 31, 2006 and 2005 is as follows:

Corporate administrative and general expense includes non-operating expense of $1.0 million and $1.7 million for the three months ended March 31, 2006 and 2005, respectively.

Total assets in the Oil & Gas segment increased to $637 million at March 31, 2006 from $575 million at December 31, 2005 due to additional working capital associated with the higher level of project execution activities. Total assets in the Government segment increased to $1.3 billion at March 31, 2006 from $905 million at December 31, 2005 as the result of work being performed in support of the Federal Emergency Management Agency for hurricane relief efforts. Government segment assets include unbilled fees totaling $136 million on the Fernald project at March 31, 2006, of which $122 million are included in other current assets and $14 million are included in other assets in the accompanying Condensed Consolidated Balance Sheet.

The company currently expects to fund approximately $40 million to $60 million during 2006 compared with $89 million funded in 2005. During the three months ended March 31, 2006, contributions of approximately $7 million were made by the company.

Net periodic postretirement benefit cost includes the following components:

The company is involved in arbitration proceedings in connection with its London Connect Project (“LUL”), a $500 million lump sum project to design and install a telecommunications network that allows reception and transmissions throughout the London Underground system. In February 2005, the company sought relief through arbitration proceedings for two issues. First, the company is seeking relief for the overall delay and disruption to the project that relates to the contract time period of 2001 through 2003. The arbitration hearing on this matter is scheduled to commence in May 2006. A claim for delay and disruption subsequent to 2003 will be submitted to the dispute resolution process shortly. Costs incurred of $51 million relating to delay and disruption for the entire contract period have been recognized as claims. The second issue concerns the responsibility for enabling the various train stock to accept the new telecommunication network equipment. Hearings involving LUL, the company and Motorola, a subcontractor, are completed and the parties await the arbitration decision.

The company has 11 embassy projects that are in various stages of completion under fixed-priced contracts with the United States Department of State. Several of these projects have been adversely impacted by higher costs due to scope changes, unexpected execution problems, increases in material cost and subcontractor difficulties. Claims for equitable adjustment on seven of these projects totaling approximately $77.5 million have been submitted to date and, as the first formal step in dispute resolution, the majority of these claims have now been certified in accordance with federal contracting requirements, with the balance expected to be certified in the near future. As of March 31, 2006, $45.5 million in costs relating to these claims have been incurred and recognized in revenue. Additional claim recoveries continue to be evaluated.

In October 1998, Fluor Daniel International and Fluor Arabia Ltd. filed a complaint in the United States District Court for the Southern District of New York against General Electric Company and certain operating subsidiaries as well as Saudi American General Electric, a Saudi Arabian corporation. The complaint seeks damages in connection with the procurement, engineering and construction of the Rabigh Combined Cycle Power Plant in Saudi Arabia. Subsequent to a motion to compel arbitration of the matter, the company initiated arbitration proceedings in New York under the American Arbitration Association international rules. The evidentiary phase of the arbitration has been concluded. In January 2005 the arbitration panel indicated that it would be rendering its decision in two phases; the first to be a decision on entitlement and second, a decision on damages. On May 4, 2005 the arbitration panel issued a partial award on entitlement issues which confirmed Fluor’s entitlement to recovery of certain of its claims for costs incurred in construction of the plant. A decision determining the amount recoverable has yet to be issued by the arbitration panel.

The Dearborn Industrial Project (the “Project”) started as a co-generation combined cycle power plant project in Dearborn, Michigan. The initial Turnkey Agreement, dated November 24, 1998, consisted of three phases. Commencing shortly after Notice to Proceed, the owner/operator, Dearborn Industrial Generation (“DIG”), issued substantial change orders enlarging the scope of the project.

The Project was severely delayed with completion of Phase II. DIG unilaterally took over completion and operation of Phase II and commissioned that portion of the plant. Shortly thereafter, DIG drew upon a $30 million letter of credit which Duke/Fluor Daniel (“D/FD”) expects to recover upon resolution of the dispute. D/FD retains lien rights (in fee) against the project. In October 2001, D/FD commenced an action in Michigan State Court to foreclose on the lien interest.

In December 2001, DIG filed a responsive pleading denying liability and simultaneously served a demand for arbitration to D/FD claiming, among other things, that D/FD is liable to DIG for alleged construction delays and defective engineering and construction work at the Dearborn plant. The court has ordered the matter to arbitration. The lien action remains stayed pending completion of the arbitration of D/FD’s claims against DIG and DIG’s claims against D/FD. An arbitration panel has been appointed and arbitration is underway.

During 2005 the company’s Industrial & Infrastructure segment was awarded a $544 million project by a joint venture, GeneSYS Telecommunications Limited (“GeneSYS”), which is consolidated in the company’s consolidated financial statements. The project was entered into with the United Kingdom Secretary of State for Transport (the “Highways Agency”) to design, build, maintain and finance a new integrated transmission network throughout England’s motorways. The project will be executed by GeneSYS in which the company owns a 45 percent interest and HSBC Infrastructure Fund Management Limited, which owns a 55 percent interest. GeneSYS will finance the engineering and construction (“E&C”) of upgraded telecommunications infrastructure with approximately $240 million (£140 million) of non-recourse debt (the “term loan facility”) from a consortium of lenders (the “Banks”) along with joint venture member capital contributions totaling approximately $37 million (£22 million). The equity contributions by the joint venture members have been provided through equity bridge loans from the Banks. The loans have been guaranteed or secured in proportion to each member’s equity participation. The equity bridge loans are repayable upon completion of the upgrade at which time the equity members are required to fund their contributions to the joint venture.

During construction, the availability of the existing telecommunications network will be maintained for the Highways Agency by GeneSYS. Upon completion of the upgrade, operating availability of the network will be provided to the Highways Agency and the system will be fully maintained by GeneSYS. Under this arrangement, GeneSYS is entitled to payments from the Highways Agency for network availability, operations and maintenance (“O&M”) plus fees for on-demand maintenance services. The company has been engaged by GeneSYS to provide design engineering and construction of the network as well as O&M and on-demand services for the existing and upgraded facilities under a subcontract extending through 2016.

Based on a qualitative analysis of the operations of GeneSYS and the variable interests of all parties to the arrangement, under the provisions of FIN 46-R the company has been determined to be the primary beneficiary of the joint venture. The company’s financial statements include the accounts of GeneSYS, and, accordingly, the non-recourse debt provided by the Banks totaling $71.6 million and $57.6 million at March 31, 2006 and December 31, 2005, respectively.

The term loan facility provides for interest only at LIBOR plus a margin of 95 basis points during construction of the upgraded facilities reducing to a margin of 90 basis points after completion of construction and continuing until fully repaid. Commitment fees are payable on unused portions of the facility. Payments are due in installments over the term of the services period ending in 2016.

The term loan facility is an obligation of GeneSYS and will never be a debt obligation of the company because it is non-recourse to the joint venture members. Accordingly, in the event of a default on the term loans, the lenders may only look to the resources of GeneSYS for repayment. The debt will never be repayable from assets of the company beyond its gross $17 million equity investment plus any un-remitted profits in the venture.

The contract has been segmented between the E&C and O&M portions of the work to be performed. The E&C portion of the work will be accounted for using contract accounting revenue recognition principles. Revenue in connection with O&M services including on-demand services will be recognized as earned through the life of the contract.

new telephone number is 469-398-7000. The relocation is being accomplished in phases through June 2006 as all personnel and functions move from the existing Aliso Viejo facility and other locations.

Approximately 130 employees in Southern California that will not be relocating to Texas have already left or will leave the company in the next two months. The cost of these employee displacements has been accrued ratably starting in the third quarter of 2005 through the actual or anticipated date of the Southern California headquarters office closure in the second quarter of 2006. All other relocation and hiring costs are charged to expense as incurred.

For the quarter ended March 31, 2006, corporate administrative expenses include $2.5 million for relocation costs, which comprises the accrual of employee displacement costs and other direct expenses. Additional employee relocation and hiring costs and facility relocation costs totaling approximately $16 million are expected to be incurred during the remainder of 2006, which will also be included in corporate administrative and general expense.

The existing corporate facility in Aliso Viejo was sold in September 2005. A short-term, market rate lease-back has been negotiated with the buyer that will terminate on June 30, 2006. The cost of the new Texas headquarters is expected to approximate $60 million and is being funded from available cash resources including proceeds from the sale of the current headquarters facility.

There have been no material changes on this matter in the first quarter of 2006. Accordingly, the disclosures provided in the Annual Report on Form 10-K for the year ended December 31, 2005 remain current.

As of the end of the period covered by this report, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in alerting them on a timely basis to information relating to the company that is required to be included in our periodic reports filed with the SEC.

To maintain a cost-effective controls structure, management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can only provide reasonable assurance that our management’s control objectives are met. In addition, the design of any system of control is based upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all future events, no matter how remote.

There were no changes to our internal control over financial reporting that occurred during the three months ended on the date of this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The new corporate office in Irving, Texas was officially opened on April 24, 2006. In connection with the relocation we have hired a number of new employees and outsourced certain functions. The company is pleased with the progress on the relocation. See Item 1A. “Risk Factors – Our continued success requires us to hire and retain qualified personnel” in the Annual Report on Form 10-K for the year ended December 31, 2005.

Three Months Ended March 31, 2006 and 2005

Fluor and its subsidiaries, incidental to their normal business activities, are parties to a number of legal proceedings and other matters in various stages of development. While we cannot predict the outcome of these proceedings, in our opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate are not expected to have a material adverse effect upon the consolidated financial position, or the results of operations of the company, after giving effect to provisions already recorded.

Our Annual Report on Form 10-K for the year ended December 31, 2005, under Item 1A. “Risk Factors” includes a detailed discussion of our risk factors. The information presented below updates, and should be read in conjunction with, the risk factor information disclosed in the Form 10-K.

     To the extent that cash flow from operations, together with available borrowings under our credit facility, is insufficient to make future investments, make acquisitions or provide needed additional working capital, we may require additional financing from other sources. Our ability to obtain such additional financing in the future will depend in part upon prevailing capital market conditions, as well as conditions in our business and our operating results; and those factors may affect our efforts to arrange additional financing on terms that are satisfactory to us. If adequate funds are not available, or are not available on acceptable terms, we may not be able to make future investments, take advantage of acquisitions or other opportunities, or respond to competitive challenges.

Finally, the following proposal presented by a shareholder was not approved: