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Fluor 10-Q 2009
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the transition period from to
Commission File Number: 1-16129
FLUOR CORPORATION (Exact name of registrant as specified in its charter)
469-398-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 30, 2009, 178,989,282 shares of the registrant’s common stock, $0.01 par value, were outstanding.
FLUOR CORPORATION
FORM 10-Q
September 30, 2009
1
FLUOR CORPORATION CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
UNAUDITED
See Notes to Condensed Consolidated Financial Statements.
2
FLUOR CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET
UNAUDITED
See Notes to Condensed Consolidated Financial Statements.
3
FLUOR CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
UNAUDITED
See Notes to Condensed Consolidated Financial Statements.
4
FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
(1) The Condensed Consolidated Financial Statements do not include footnotes and certain financial information normally presented annually under accounting principles generally accepted in the United States and, therefore, should be read in conjunction with the company’s December 31, 2008 annual report on Form 10-K. Accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of results that can be expected for the full year.
The Condensed Consolidated Financial Statements included herein are unaudited; however, they contain all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are necessary to present fairly its consolidated financial position at September 30, 2009 and its consolidated results of operations and cash flows for the three and nine months ended September 30, 2009 and 2008. Management adopted Statement of Financial Accounting Standard (“SFAS”) No. 165, “Subsequent Events” (Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 855-10) during the second quarter of 2009 and, accordingly, has evaluated all material events occurring subsequent to the date of the financial statements up to the date and time this quarterly report is filed on Form 10-Q.
Certain 2008 amounts have been reclassified to conform with the 2009 presentation.
(2) Recent Accounting Pronouncements
In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amends certain guidance in ASC 605-25, “Revenue Recognition — Multiple Element Arrangements.” ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-13 is effective for annual reporting periods beginning on or after June 15, 2010 and should be applied on a prospective basis for revenue arrangements entered into or materially modified with early adoption permitted. Management is currently evaluating the impact on the company’s financial position, results of operations and cash flows.
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (ASC 105-10). ASC 105-10 establishes the “FASB Accounting Standards Codification” (“Codification”), which officially launched July 1, 2009 to become the source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities. ASC 105-10 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The company adopted ASC 105-10 during the third quarter of 2009. The adoption of ASC 105-10 did not have a material impact on the company’s financial position, results of operations or cash flows.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), which has not yet been codified in the ASC. SFAS 167 eliminates exceptions in FASB Interpretation No. 46 (Revised) “Consolidation of Variable Interest Entities” (“FIN 46(R)”) related to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. SFAS 167 is effective for interim and annual reporting periods beginning after November 15, 2009. Management is currently evaluating the impact on the company’s financial position, results of operations and cash flows.
In December 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (ASC 715-20). ASC 715-20 amends SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The additional disclosure requirements under ASC 715-20 include expanded disclosure about an entity’s investment policies and strategies, the categories of plan assets, concentrations of credit risk and fair value measurements of plan assets. This standard is effective for fiscal years ending after December 15, 2009. Management is currently evaluating the impact on the company’s financial position, results of operations and cash flows.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (ASC 805). ASC 805 replaces SFAS 141 and establishes principles and requirements for how an acquirer recognizes and measures the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired in its financial statements. This
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
standard is effective for fiscal years beginning after December 15, 2008. The company adopted this standard during the first quarter of 2009. The adoption of ASC 805 did not have a material impact on the company’s financial position, results of operations or cash flows.
During 2009, the company implemented several new accounting pronouncements that are discussed in the notes where applicable.
(3) The components of comprehensive income, net of related tax, are as follows:
(4) The effective tax rate, based on the company’s operating results for the three and nine months ended September 30, 2009 was 34.6 percent and 34.5 percent, respectively, compared to 37.2 percent and 37.5 percent for the corresponding periods of 2008. The lower effective tax rate for the three and nine month periods ending September 30, 2009 was due to the recognition of a deferred tax benefit associated with taxes on unremitted foreign earnings and increased earnings attributable to noncontrolling interests for which the taxes are not paid by the company.
The company conducts business globally and, as a result, the company or one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business the company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Canada, the Netherlands, South Africa, the United Kingdom and the United States. Although the company believes its reserves for its tax positions are reasonable, the final outcome of tax audits could be materially different, both favorably and unfavorably. With few exceptions, the company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2003.
(5) Cash paid for interest was $7.9 million and $10.5 million for the nine months ended September 30, 2009 and 2008, respectively. Income tax payments, net of receipts, were $319.2 million and $268.0 million during the nine month periods ended September 30, 2009 and 2008, respectively.
6
FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
(6) In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (ASC 260-10-45). ASC 260-10-45 clarified that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders. The company’s restricted stock units and restricted stock awards are considered participating securities since the share-based awards contain a nonforfeitable right to dividends irrespective of whether the awards ultimately vest. ASC 260-10-45 requires that the two-class method of computing basic EPS be applied. Under the two-class method, the company’s stock options are not considered to be participating securities. ASC 260-10-45 is effective for fiscal years beginning after December 15, 2008 and was adopted by the company during the first quarter of 2009. There was no impact of significance on basic or diluted EPS as a result of the adoption of ASC 260-10-45.
The calculation of the basic and diluted EPS for the three and nine months ended September 30, 2009 and 2008 are presented below:
The table below sets forth the calculation of the percentage of net earnings allocable to common shareholders under the two-class method:
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
(7) In April 2009, the FASB issued FSP SFAS No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASC 825-10-50). ASC 825-10-50 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” (ASC 825-10) to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. ASC 825-10-50 also amends Accounting Principles Board Opinion No. 28, “Interim Financial Reporting,” (ASC 270-10) to require those disclosures in summarized financial information at interim reporting periods. ASC 825-10-50 was effective for interim reporting periods ending after June 15, 2009. The company adopted this standard during the second quarter of 2009. The adoption of the provisions of ASC 825-10-50 did not have a material impact on the company’s financial position, results of operations or cash flows.
The estimated fair values of the company’s financial instruments that are not measured at fair value on a recurring basis are as follows as of September 30, 2009:
Fair values were determined as follows:
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
The following table presents, for each of the fair value hierarchy levels required under SFAS No. 157, “Fair Value Measurements” (ASC 820-10), the company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2009:
All of the company’s money market funds and investments carried at fair value are included in the table above and are available-for-sale securities. These available-for-sale securities are made up of the following security types as of September 30, 2009: money market funds of $141 million, U.S. agency securities of $207 million, U.S. Treasury securities of $65 million, corporate debt securities of $167 million and other securities of $1 million. As of December 31, 2008, available-for-sale securities consisted of $376 million in money market funds and $41 million in debt securities, of which no individual debt security type was material.
In April 2009, the FASB issued FSP SFAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (ASC 820-10). ASC 820-
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
10 provides additional guidance for estimating fair value in accordance with SFAS No. 157, “Fair Value Measurements,” and emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. ASC 820-10 was effective for interim reporting periods ending after June 15, 2009. The company adopted this standard during the second quarter of 2009. The adoption of ASC 820-10 did not have a material impact on the company’s financial position, results of operations or cash flows.
In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (ASC 320-10-35). ASC 320-10-35 provides guidance to determine whether the holder of an investment in a debt security for which changes in fair value are not regularly recognized in earnings should recognize a loss in earnings when the investment is impaired. ASC 320-10-35 also improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the consolidated financial statements. The amendment to ASC 320-10-35 was effective for interim reporting periods ending after June 15, 2009. The company adopted this standard during the second quarter of 2009. This adoption did not have a material impact on the company’s financial position, results of operations or cash flows.
(8) In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (ASC 815-10). ASC 815-10 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance and cash flows. This standard is effective for fiscal years beginning after December 15, 2008. The company adopted this standard during the first quarter of 2009.
The company mitigates certain financial exposures, including currency and commodity price risk associated with engineering and construction contracts by utilizing derivative instruments. These instruments are designated as either fair value or cash flow hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (ASC 815). The company formally documents its hedge relationships at the inception of the agreements, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. The company also formally assesses, both at inception and at least quarterly thereafter, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the fair value of the hedged items. The fair value of all derivative instruments are recognized as assets or liabilities at the balance sheet date. For fair value hedges, the effective portion of the change in the fair value of the derivative instrument is offset against the change in the fair value of the underlying asset through earnings. The effective portion of the contracts’ gains or losses due to changes in fair value, associated with the cash flow hedges, are initially recorded as a component of accumulated other comprehensive income (loss) (“OCI”) and are subsequently reclassified into earnings when the hedged items settle. Any ineffective portion of a derivative’s change in fair value is recognized in earnings immediately. The company does not enter into derivative transactions for speculative or trading purposes.
At September 30, 2009, the company had total gross notional amounts of $156 million of foreign exchange forward contracts and $70 million of commodity swap forward contracts outstanding relating to engineering and construction contract obligations. The foreign exchange forward contracts are of varying duration, none of which extend beyond April 2011. The commodity swap forward contracts are of varying duration, none of which extend beyond four years. All existing hedges are determined to be highly effective. As a result, the impact to earnings due to hedge ineffectiveness was immaterial for the three and nine months ended September 30, 2009 and 2008, respectively.
10
FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
The fair values of derivatives designated as hedging instruments under ASC 815 as of September 30, 2009 were as follows:
The effect of derivative instruments on the Condensed Consolidated Statement of Earnings for the three and nine months ended September 30, 2009 was as follows:
11
FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
(9) Net periodic pension expense for defined benefit pension plans includes the following components:
The company currently expects to fund approximately $50 million to $70 million into its defined benefit pension plans during 2009, which is expected to be in excess of the minimum funding required. During the nine months ended September 30, 2009, contributions of approximately $30 million were made by the company.
Net periodic postretirement benefit cost includes the following components:
The preceding information does not include amounts related to benefit plans applicable to employees associated with certain contracts with the U.S. Department of Energy because the company is not responsible for the current or future funded status of these plans.
(10) In February 2004, the company issued $330 million of 1.5 percent Convertible Senior Notes (the “Notes”) due February 15, 2024 and received proceeds of $323 million, net of underwriting discounts. In December 2004, the company irrevocably elected to pay the principal amount of the Notes in cash. Notes are convertible if a specified trading price of the company’s common stock (the “trigger price”) is achieved and maintained for a specified period. The trigger price condition was satisfied during the fourth quarter of 2008 and third quarter of 2009 and the Notes were therefore classified as short-term debt. During the nine months ended September 30, 2009, holders converted $15 million of the Notes in exchange for the principal balance owed in cash plus 130,186 shares of the company’s common stock.
In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (ASC 470-20). ASC 470-20 requires the issuer of a convertible debt instrument to separately account for the liability and equity components in a manner that reflects the entity’s nonconvertible debt borrowing rate when interest expense is recognized in subsequent periods. ASC 470-20 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and is required to be applied retrospectively to all periods presented. The company adopted ASC 470-20 during the first quarter of 2009.
As a result of the adoption of ASC 470-20, the company recognized a cumulative-effect adjustment consisting of an increase to additional paid-in capital of $24.4 million, net of deferred taxes of $0.2 million, and a reduction of debt of $0.4 million for the equity component of the Notes. The December 31, 2008 balance of retained earnings was reduced by $24.2 million.
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
Additionally, interest expense as a result of debt discount amortization increased by $0.4 million for the nine months ended September 30, 2009, and $1.4 million and $5.6 million for the three and nine months ended September 30, 2008, respectively. There was no debt discount amortization for the three months ended September 30, 2009. The increase to interest expense resulted in a tax benefit of $0.2 million for the nine months ended September 30, 2009, and $0.7 million and $2.3 million for the three and nine months ended September 30, 2008, respectively. Net earnings attributable to Fluor Corporation for the three and nine months ended September 30, 2009 were increased by $0.7 million (less than $0.01 per share) and $2.1 million ($0.01 per share). Net earnings attributable to Fluor Corporation for three and nine months ended September 30, 2008 were reduced by $1.2 million (less than $0.01 per share) and $3.8 million ($0.02 per share), respectively.
The following table presents information related to the liability and equity components of the Notes:
The Notes are convertible into shares of the company’s common stock (par value $0.01 per share) at a conversion rate of 35.9104 shares per each $1,000 principal amount of Notes, subject to adjustment as described in the indenture. Interest expense for the three and nine months ended September 30, 2009 includes original coupon interest of $0.5 million and $1.5 million, respectively. Interest expense for the three and nine months ended September 30, 2008 includes original coupon interest of $0.9 million and $3.9 million, respectively. The effective interest rate on the liability component was 4.375 percent through February 15, 2009 at which time the discount on the liability was fully amortized. The if-converted value of $217 million is in excess of the principal value as of September 30, 2009.
As of September 30, 2009, the company was in compliance with all of the financial covenants related to its debt agreements.
(11) The company’s director and executive stock plans are described, and informational disclosures are provided, in the notes to the Consolidated Financial Statements included in the Form 10-K for the year ended December 31, 2008. Restricted stock units and restricted stock awards of 622,653 and 434,201 were granted in the nine months ended September 30, 2009 and 2008, respectively, at weighted-average per share prices of $30.81 and $66.01, respectively. The awards for 2009 and 2008 vest ratably over three years. During the nine months ended September 30, 2009 and 2008, options for the purchase of 888,567 shares at a weighted average price of $30.65 per share and 548,538 shares at a weighted average price of $68.41 per share, respectively, were awarded. The option awards for 2009 and 2008 vest ratably over three years. The option awards expire ten years after the grant date.
(12) In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (ASC 810-10-45). ASC 810-10-45 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. This standard is effective for fiscal years beginning after December 15, 2008. The company adopted this standard during the first quarter of 2009.
As a result of the adoption of ASC 810-10-45, the company has separately disclosed on the face of the Condensed Consolidated Statement of Earnings for all periods presented the amount of net earnings attributable to the company and the amount of net earnings attributable to noncontrolling interests. For the three and nine months ended September 30, 2009, earnings attributable to noncontrolling interests were $12.6 million and $37.2 million, respectively, and the related tax effect was $0.7 million and $1.7 million, respectively. For the three and nine months ended September 30, 2008, earnings attributable to noncontrolling interests of $7.6 million and $26.1 million, respectively, and the related tax effects of $0.2 million and $1.1 million, respectively, were reclassified from total cost of revenue and income tax expense, respectively, to net earnings attributable to noncontrolling interests. Distributions paid to noncontrolling interests were $28.5 million and $42.7 million for the three and
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
nine months ended September 30, 2009, respectively, and $10.0 million and $18.7 million for the three and nine months ended September 30, 2008, respectively. Capital contributions from noncontrolling interests were $3.9 million for the nine months ended September 30, 2008.
(13) The company and certain of its subsidiaries are involved in litigation in the ordinary course of business. Additionally, the company and certain of its subsidiaries are contingently liable for commitments and performance guarantees arising in the ordinary course of business. The company and certain of its clients have made claims arising from the performance under its contracts. The company recognizes certain significant claims for recovery of incurred costs when it is probable that the claim will result in additional contract revenue and when the amount of the claim can be reliably estimated. Recognized claims against clients amounted to $199 million and $202 million at September 30, 2009 and December 31, 2008, respectively, and are primarily included in contract work in progress in the accompanying Condensed Consolidated Balance Sheet. Amounts ultimately realized from claims could differ materially from the balances included in the financial statements. The company does not expect that claim recoveries will have a material adverse effect on its consolidated financial position or results of operations.
As of September 30, 2009, several matters are in the litigation and dispute resolution process. The following discussion provides a background and current status of these matters:
Infrastructure Joint Venture Project
The company participated in a 50/50 joint venture for a fixed-price transportation infrastructure project in California. This joint venture project was adversely impacted by higher costs due to owner-directed scope changes leading to quantity growth, cost escalation, additional labor and schedule delays. The project opened to traffic in November 2007 and reached construction completion in the second quarter of 2009.
As of September 30, 2009, the company has recognized in cost and revenue its $52 million proportionate share of $104 million of costs relating to claims recognized by the joint venture. Total claims-related costs incurred, as well as claims submitted to the client by the joint venture, are in excess of the $104 million of recognized costs. As of September 30, 2009, the client had withheld liquidated damages totaling $51 million from amounts otherwise due the joint venture and has asserted additional claims against the joint venture. The company believes that the claims against the joint venture are without merit and that amounts withheld will ultimately be recovered by the joint venture and has therefore not recognized any reduction in project revenue for its $25.5 million proportionate share of the withheld liquidated damages. In addition, the client has drawn down $14.8 million against letters of credit provided by the company and its joint venture partner. The company believes that the amounts drawn down against the letters of credit will ultimately be recovered by the joint venture and, as such, has not reserved for the possible non-recovery of the company’s $7.4 million proportionate share.
The company continues to evaluate claims for recoveries and other contingencies on the project. The company continues to incur legal expenses associated with the claims and dispute resolution process.
London Connect Project
The company was involved in dispute resolution proceedings in connection with its London Connect Project, a $500 million lump-sum project to design and install a telecommunications network that allows transmission and reception throughout the London Underground system. In February 2005, the company sought relief through arbitration proceedings for two issues.
During the third quarter of 2009, the company settled the dispute, with no material change to segment profit. As a result of the settlement, the company is no longer reporting claim revenue for the project, which totaled $108 million at the end of the second quarter of 2009.
Greater Gabbard Offshore Wind Farm Project
The company is involved in a dispute in connection with the Greater Gabbard Offshore Wind Farm (“Greater Gabbard”) Project, a $1.5 billion lump-sum project to provide engineering, procurement and construction services for the client’s offshore wind farm project in the United Kingdom. The dispute relates to specifications for monopiles and transition pieces required under the contract. In the
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
third quarter of 2009, the company recorded $115 million of claim revenue related to this issue for costs incurred through the end of the quarter. Substantial additional costs arising from this dispute are expected to be incurred in future quarters. The company believes the ultimate recovery of incurred and future costs is probable.
Embassy Projects
The company has performed work on 11 embassy projects over the last five years for the United States Department of State under fixed-price contracts. These projects were adversely impacted by higher costs due to schedule extensions, scope changes causing material deviations from the Standard Embassy Design, increased costs to meet client requirements for additional security-cleared labor, site conditions at certain locations, subcontractor and teaming partner difficulties and the availability and productivity of construction labor. As of September 30, 2009, all embassy projects were complete, with some warranty items still pending.
As of September 30, 2009, aggregate costs totaling $33 million relating to claims on two of the embassy projects had been recognized in revenue. Total claims-related costs incurred to date, along with claims for equitable adjustment submitted or identified, exceed the amount recorded in claims revenue. As the first formal step in dispute resolution, all claims have been certified in accordance with federal contracting requirements. The company continues to periodically evaluate its position with respect to these claims.
Conex International v. Fluor Enterprises, Inc.
In November 2006, a Jefferson County, Texas, jury reached an unexpected verdict in the case of Conex International (“Conex”) v. Fluor Enterprises Inc. (“FEI”), ruling in favor of Conex and awarded $99 million in damages related to a 2001 construction project.
In 2001, Atofina (now part of Total Petrochemicals Inc.) hired Conex International to be the mechanical contractor on a project at Atofina’s refinery in Port Arthur, Texas. FEI was also hired to provide certain engineering advice to Atofina on the project. There was no contract between Conex and FEI. Later in 2001 after the project was complete, Conex and Atofina negotiated a final settlement for extra work on the project. Conex sued FEI in September 2003 alleging damages for interference and misrepresentation and demanding that FEI should pay Conex the balance of the extra work charges that Atofina did not pay in the settlement. Conex also asserted that FEI interfered with Conex’s contract and business relationship with Atofina. The jury verdict awarded damages for the extra work and the alleged interference.
The company appealed the decision and the judgment against the company was reversed in its entirety in December 2008 and remanded for a new trial. Based upon the present status of this matter, the company does not believe that there is a reasonable possibility that a loss will be incurred.
Fluor Corporation v. Citadel Equity Fund Ltd.
Citadel Equity Fund Ltd., a hedge fund and former investor in the company’s 1.5 percent Convertible Senior Notes (the “Notes”), and the company are disputing the calculation of the number of shares of the company’s common stock that were due to Citadel upon conversion of approximately $58 million of Notes. Citadel argues that it is entitled to an additional $28 million in value under its proposed calculation method. The company believes that the payout given to Citadel was proper and correct and that Citadel’s claims are without merit. The company’s loss could range from zero to $28 million plus interest, fees and costs. The company is vigorously defending its position and, based upon the present status of this matter, does not believe a loss will be incurred. The matter is presently set for trial in January 2010.
(14) In the ordinary course of business, the company enters into various agreements providing financial or performance assurances to clients on behalf of certain unconsolidated partnerships, joint ventures and other jointly executed contracts. These agreements are entered into primarily to support the project execution commitments of these entities. The guarantees have various expiration dates ranging from mechanical completion of the facilities being constructed to a period extending beyond contract completion in certain circumstances. The maximum potential payment amount of an outstanding performance guarantee is the remaining cost of work to be performed by or on behalf of third parties under engineering and construction contracts. Performance guarantees outstanding as of September 30, 2009 amounted to $3.3 billion. Amounts that may be required to be paid in excess of estimated costs to complete contracts in progress are not estimable. For cost reimbursable contracts, amounts
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
that may become payable pursuant to guarantee provisions are normally recoverable from the client for work performed under the contract. For lump-sum or fixed-price contracts, this amount is the cost to complete the contracted work less amounts remaining to be billed to the client under the contract. Remaining billable amounts could be greater or less than the cost to complete. In those cases where costs exceed the remaining amounts payable under the contract the company may have recourse to third parties, such as owners, co-venturers, subcontractors or vendors for claims.
Financial guarantees, provided in the ordinary course of business to clients and others in certain limited circumstances, are entered into with financial institutions and other credit grantors and generally obligate the company to make payment in the event of a default by the borrower. Most arrangements require the borrower to pledge collateral in the form of property, plant and equipment which is deemed adequate to recover amounts the company might be required to pay. As of September 30, 2009, there were no material guarantees outstanding.
(15) In the normal course of business, the company forms partnerships or joint ventures primarily for the execution of single contracts or projects. Applying the guidance of FIN 46(R) (ASC 810), the company evaluates qualitative and quantitative information for each partnership or joint venture at inception to determine, first, whether the entity formed is a variable interest entity (“VIE”) and, second, if the company is the primary beneficiary and needs to consolidate the entity. Upon the occurrence of certain events outlined in ASC 810, the company reassesses its initial determination of whether the entity is a VIE and whether consolidation is still required.
A partnership or joint venture is considered a VIE if either (a) the total equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) characteristics of a controlling financial interest are missing (either the ability to make decisions through voting or other rights, the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity), or (c) the voting rights of the equity holders are not proportional to their obligations to absorb the expected losses of the entity and/or their rights to receive the expected residual returns of the entity, and substantially all of the entity’s activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights.
The company is deemed to be the primary beneficiary of the VIE and consolidates the entity if the company will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns or both. The company considers all parties that have direct or implicit variable interests when determining if it is the primary beneficiary. The majority of the partnerships and joint ventures that are formed for the execution of the company’s projects are VIEs because the total equity investment is typically nominal and not sufficient to permit the entity to finance its activities without additional subordinated financial support. However, often the VIE does not meet the consolidation requirements of ASC 810. The contractual agreements that define the ownership structure and equity investment at risk, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights and board representation of the respective parties are used to determine if the entity is a VIE and if the company is the primary beneficiary and must consolidate the entity.
The partnerships or joint ventures of the company are typically characterized by a 50 percent or less, non-controlling, ownership or participation interest, with decision making and distribution of expected gains and losses typically being proportionate to the ownership or participation interest. As such and as noted above, even when the partnership or joint venture is determined to be a VIE, the company is frequently not the primary beneficiary. Should losses occur in the execution of the project for which the VIE was established, the losses would be absorbed by the partners of the VIE. The majority of the partnership and joint venture agreements provide for capital calls to fund operations, as necessary. Such funding is infrequent and is not anticipated to be material. Some of the company’s VIEs have debt, but the debt is typically non-recourse in nature. At times, the company’s participation in VIEs requires agreements to provide financial or performance assurances to clients. Refer to Note 14 for a further discussion of such agreements.
As of September 30, 2009 the company had a number of entities that were determined to be VIEs, with the majority not meeting the consolidation requirements of ASC 810. Most of the unconsolidated VIEs are proportionately consolidated, though the equity and cost methods of accounting for the investments are also used, depending on the company’s respective participation rights, amount of influence in the VIE and other factors. The aggregate investment carrying value of the unconsolidated VIEs was $138 million at September 30, 2009 and was classified under “Investments and goodwill” in the Condensed Consolidated Balance Sheet. The company’s maximum exposure to loss as a result of its investments in unconsolidated VIEs is typically
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
limited to the aggregate of the carrying value of the investment and future funding commitments. Future funding commitments at September 30, 2009 for the unconsolidated VIEs were $22 million.
In some cases, the company is required to consolidate VIEs. The carrying value of the assets and liabilities associated with the operations of the consolidated VIEs at September 30, 2009 was $441 million and $236 million, respectively.
None of the VIEs are individually material to the company’s results of operations, financial position or cash flows. As of September 30, 2009, there were no material changes to the VIEs reported in the company’s annual report on Form 10-K.
(16) Operating information by segment is as follows:
Segment profit for Industrial & Infrastructure for the nine months ended September 30, 2008 included a pre-tax gain of $79.2 million from the sale of a joint venture interest in the Greater Gabbard Project. External revenue and segment profit for Global Services for both the three months and nine months ended September 30, 2009 included the impact of a $45 million provision for the potential lack of collectability of a client receivable for a paper mill where the company’s scope of work was to recommission, start up and operate the facility.
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FLUOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNAUDITED
A reconciliation of the segment information to consolidated amounts is as follows:
Total assets in the Industrial & Infrastructure segment increased to $712 million at September 30, 2009 from $536 million at December 31, 2008 due to the Greater Gabbard Project and increased volume across all business lines. Total assets in the Government segment were $506 million at September 30, 2009 compared to $326 million at December 31, 2008. The increase in total assets corresponded to an increase in working capital to support project execution activities.
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FLUOR CORPORATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, the Condensed Consolidated Financial Statements and notes and the company’s December 31, 2008 annual report on Form 10-K. For purposes of reviewing this document, “segment profit” is calculated as revenue less cost of revenue and earnings attributable to noncontrolling interests excluding: corporate administrative and general expense; interest expense; interest income; domestic and foreign income taxes; and other non-operating income and expense items.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements made herein, including statements regarding the company’s projected revenue and earnings levels, cash flow and liquidity, new awards and backlog levels and the implementation of strategic initiatives and organizational changes are forward-looking in nature. These forward-looking statements reflect current analysis of existing information and are subject to various risks and uncertainties. As a result, caution must be exercised in relying on forward-looking statements. Due to known and unknown risks, the company’s actual results may differ materially from its expectations or projections. Factors potentially contributing to such differences include, among others:
While most risks affect only future cost or revenue anticipated by the company, some risks may relate to accruals that have already been reflected in earnings. The company’s failure to receive payments of accrued amounts or incurrence of liabilities in excess of amounts previously recognized could result in a charge against future earnings.
Additional information concerning these and other factors can be found in our press releases as well as our periodic filings with the Securities and Exchange Commission, including the discussion under the heading “Item 1A. Risk Factors” in this Form
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10-Q as well as the company’s Form 10-K filed February 25, 2009. These filings are available publicly on the SEC’s website at http://www.sec.gov, on Fluor’s website at http://investor.fluor.com or upon request from Fluor’s Investor Relations Department at (469) 398-7220. Except as otherwise required by law, the company undertakes no obligation to publicly update or revise its forward-looking statements, whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONSConsolidated revenue for the three months ended September 30, 2009 was $5.4 billion, reflecting a 4 percent decrease when compared to the $5.7 billion of revenue for the corresponding three months in 2008, primarily as the result of reduced revenue contributions from the Oil & Gas and Power segments. Consolidated revenue for the nine months ended September 30, 2009 increased slightly to $16.5 billion compared to $16.3 billion for the first nine months of the prior year, primarily driven by revenue increases in the Industrial & Infrastructure and Government segments, partially offset by revenue declines in Global Services and Power.
Net earnings attributable to Fluor Corporation were $162 million, or $0.89 per diluted share, and $536 million, or $2.93 per diluted share, for the three and nine months ended September 30, 2009, compared to net earnings attributable to Fluor Corporation of $182 million, or $1.00 per diluted share, and $527 million, or $2.86 per diluted share, for the corresponding periods of 2008. The decrease in net earnings attributable to Fluor Corporation for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 was primarily due to lower contributions from the Oil & Gas and Global Services segments, partially offset by earnings increases in the other segments. The 2009 results for Global Services included a $45 million provision in the current quarter for the potential lack of collectability of a client receivable. The increase in net earnings attributable to Fluor Corporation for the nine months ended September 30, 2009 when compared to the nine months ended September 30, 2008 was primarily due to improved contributions from the Oil & Gas, Government and Power segments and a 20 percent decrease in corporate administrative and general expense in the 2009 period, partially offset by decreased contributions from the Industrial & Infrastructure and Global Services segments and lower net interest income. Earnings for the Industrial & Infrastructure segment declined for the nine months ended September 30, 2009 compared to the corresponding period of the prior year because the results in 2008 included the favorable impact of a pre-tax gain of $79.2 million from the sale a joint venture interest in a wind farm project. The global recession continues to impact the near-term capital investment plans of many of the company’s clients across all of the company’s segments except Government.
The effective tax rate, based on the company’s operating results for the three and nine months ended September 30, 2009 was 34.6 percent and 34.5 percent, respectively compared to 37.2 percent and 37.5 percent for the corresponding periods of 2008. The lower effective tax rate for the three and nine month periods ending September 30, 2009 was primarily attributable to the recognition of a deferred tax benefit associated with taxes on unremitted foreign earnings and increased earnings attributable to noncontrolling interests for which the taxes are not paid by the company.
Consolidated new awards for the three and nine months ended September 30, 2009 were $2.9 billion and $15.1 billion, respectively, compared to new awards of $8.8 billion and $20.9 billion for the three and nine months ended September 30, 2008. The Oil & Gas and Government segments were the major contributors to the new award activity for the third quarter of 2009, and the Oil & Gas and Industrial & Infrastructure segments were the principal drivers of new award activity for the nine months ended September 30, 2009. Approximately 74 percent of consolidated new awards for the nine months ended September 30, 2009 were for projects located outside of the United States.
Consolidated backlog at September 30, 2009 was $28.0 billion compared to $36.5 billion at September 30, 2008. The decline in backlog is primarily due to project cancellations, scope reductions and lower 2009 new award bookings in the Oil & Gas segment. As of September 30, 2009, approximately 61 percent of consolidated backlog relates to international projects. Although backlog reflects business which is considered to be firm, cancellations, scope adjustments or deferrals may occur. Backlog is adjusted to reflect any known project cancellations, revisions to project scope and cost, and deferrals, as appropriate.
OIL & GAS
Revenue and segment profit for the Oil & Gas segment are summarized as follows:
Revenue for the three months ended September 30, 2009 decreased 11 percent when compared to the same quarter of 2008 due
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to reduced project execution activities as a number of large projects within the segment near completion. Revenue for the nine months ended September 30, 2009 was up only slightly compared to the first nine months of 2008, as the growth experienced by the segment over the last several years has slowed.
Segment profit for the three months ended September 30, 2009 decreased 8 percent when compared to the third quarter of 2008, primarily driven by the reduced revenue volume. Segment profit for the nine months ended September 30, 2009 increased 11 percent compared to the same period of 2008 primarily due to the net positive impact of forecast adjustments for certain projects nearing completion, which were primarily due to the approval of change orders and successful resolution of disputed items.
New awards for the three months ended September 30, 2009 were $1.2 billion, compared to $5.1 billion for the corresponding period of 2008. Current quarter awards included a European underground gas storage facility and two clean gasoline projects in Mexico. New awards for the nine months ended September 30, 2009 were $6.1 billion, compared to $12.4 billion for the first nine months of 2008. Backlog at September 30, 2009 decreased 43 percent to $13.1 billion compared to $22.8 billion at September 30, 2008. The decrease in backlog is the result of cancellations and scope reductions of certain projects, primarily in the first quarter of 2009, along with lower new award bookings in 2009. In addition, during the third quarter of 2009, the company reduced backlog by $1.2 billion for a gas processing project in Russia that has been delayed indefinitely by the client. Though the project has not been formally canceled, there is significant uncertainty as to whether it will proceed.
The segment has been a participant in an expanding market that includes very large projects in diverse geographical locations, which are well suited to the company’s global execution and project management capabilities and strong financial position. However, the global credit crisis and recession have resulted in some clients reassessing their capital spending plans for 2009 and beyond, with others delaying projects or attempting to renegotiate commercial terms for awarded projects in an attempt to obtain lower capital costs. As such, the high growth and operating profit margins recently experienced by the segment will be increasingly difficult to sustain.
INDUSTRIAL & INFRASTRUCTURE
Revenue and segment profit for the Industrial & Infrastructure segment are summarized as follows:
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