Fluor Corporation - 10-Q quarterly report FY

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See Accompanying Notes

See Accompanying Notes

See Accompanying Notes

The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, the Condensed Consolidated Financial Statements and accompanying notes and the company’s December 31, 2004 annual report on Form 10-K. For purposes of reviewing this document, “operating profit” is calculated as revenues less cost of revenues.

Certain statements made herein, including statements regarding the company’s projected revenues and earnings levels, 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 costs or revenues anticipated by the company, some risks may relate to accruals that have already been reflected in results of operations. The company’s failure to receive payments of accrued amounts or if liabilities are incurred in excess of amounts previously recognized, a charge against future earnings could result.

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 1. Business-Company Risk Factors” in the company’s Form 10-K filed March 4, 2005. 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: (949) 349-3909. The company disclaims any intent or obligation to update its forward-looking statements, whether as a result of new information, future events or otherwise.

Results of operations in the three and six months ended June 30, 2005 were a net loss of $16.4 million or $0.19 per diluted share and net earnings of $31.0 million or $0.36 per diluted share, respectively. These results compare with net earnings of $44.8 million or $0.54 per diluted share and $91.5 million or $1.11 per diluted share, respectively for the corresponding periods of 2004. The results for the three months ended June 30, 2005 include a charge of $65 million ($0.77 per diluted share) resulting from the unfavorable impact of a jury award and an after-tax gain of $2.4 million ($0.03 per diluted share) from the sale of a real estate asset. The results for the six months ended June 30, 2004 include an after-tax gain of $4.9 million ($0.06 per diluted share) from the sale of three real estate assets during the first half of the year. Because of the net loss in the second quarter, shares used to calculate diluted earnings per share for the three months ended June 30, 2005 are the same as shares used to calculate basic earnings per share.

Revenues for the three and six months ended June 30, 2005 were $2.9 billion and $5.8 billion, respectively, compared with $2.2 billion and $4.3 billion, respectively for the 2004 comparison periods. The current year increase was primarily in the Oil & Gas and Industrial & Infrastructure segments, reflecting the work performed on the higher level of new awards received over the last two years.

During the second quarter ended June 30, 2005, a subsidiary of the company received an unexpected unfavorable jury verdict awarded to a client for a project in the Cayman Islands. The impact to the results of operations was a charge of approximately $65 million to pre-tax earnings, including estimated interest and attorneys’ fees. In addition to the jury award, the charge also includes a reversal of amounts previously billed to the client for work performed, including recognized project earnings. As a result of the charge, which represents a foreign loss, the company’s ability to absorb foreign taxes incurred in high tax jurisdictions was significantly diminished. Accordingly, certain foreign earnings are subject to both U.S. and foreign taxes without an offsetting foreign tax credit.

Consolidated new awards for the three and six months ended June 30, 2005 were $3.2 billion and $6.6 billion, respectively, compared with $3.3 billion and $6.4 billion, respectively, in the comparable 2004 periods. The Global Services and Power segments had significant increases in new awards, offset by lower new awards in the Industrial & Infrastructure segment.

Consolidated backlog at June 30, 2005 increased 21 percent to $15.7 billion from $12.9 billion at June 30, 2004. Approximately 68 percent of consolidated new awards for the six months ended June 30, 2005 were for projects located outside of the United States. As of June 30, 2005, approximately 65 percent of consolidated backlog relates to international projects. Although backlog reflects business which is considered to be firm, cancellations or scope adjustments may occur. Backlog is adjusted to reflect any known project cancellations, deferrals and revised project scope and cost, both upward and downward.

OIL & GAS

Revenues and operating profit for the Oil & Gas segment are summarized as follows:

In the first quarter of 2005, the chemicals business line, which had previously been part of the Industrial & Infrastructure segment, was realigned under the Oil & Gas segment. This change was made to better match the needs for the large number of petrochemical projects anticipated over the next few years with the Oil & Gas segment’s project support infrastructure. All prior periods have been restated to reflect this change.

Revenues increased by 64 percent and 76 percent in the three and six months ended June 30, 2005 due to the continued increase in global project execution activities that have been experienced over the past two years. Operating profit margin has decreased slightly to 4.1 percent and 4.3 percent for the three and six month periods ended June 30, 2005 compared with 4.4 percent and 4.5 percent for the corresponding periods of 2004.

A major project that has reached mechanical completion in the Oil & Gas segment is the Hamaca Crude Upgrader Project (“Hamaca”) located in Jose, Venezuela. Hamaca is a $1.1 billion lump sum project (including $92 million of approved change orders) of Grupo Alvica (“GA”), a joint venture including Fluor Daniel (80 percent) and Inelectra C.A. (20 percent), to design and build a petroleum upgrader for a consortium of owners called Petrolera Ameriven (“PA”) including Petroleos de Venezuela S.A., ChevronTexaco and ConocoPhillips.

The GA joint venture is pursuing cost and schedule relief through arbitration proceedings for the following three issues:

Arbitration proceedings were commenced by GA in late 2001. The site soil conditions issue was the subject of arbitration hearings in November 2002. There are no monetary cross-claims by PA in the arbitration. The amount of the claim for site soil conditions of $159 million includes the direct costs as well as significant delay-related and indirect costs. In April 2004, the arbitration panel awarded GA $36 million for direct cost of the site soil conditions remediation work, virtually all of the amounts sought by GA for this issue. The client had previously conditionally accepted responsibility relating to the soil conditions matter and $28 million had been paid. The balance of the award amount was received in April 2004. The award confirmed GA’s methodology for computing the amount of all change orders arising under the contract. In addition, the award also granted GA approximately 14 weeks of schedule relief. The delay and indirect costs were the subject of hearings in June 2004 and a decision is pending.

The hearings on the fundamental cost differences between the earlier 1998 labor agreement and the 2000 Acta Convenio were held in April 2003 and a decision on this issue is also expected shortly. The amount of the claim for Acta Convenio is $210 million and no payments have been made by the client relating to this matter.

In accordance with the contract, the joint venture is entitled to cost and schedule relief for the impact of the national strike in Venezuela. A change order relating to the national strike in the approximate amount of $340 million was submitted by GA. This action was followed by the filing of an arbitration claim relating to this issue in January 2004. Hearings on this issue are now scheduled for August and October 2005. Other force majeure incidents occurring prior to the national strike also were the subject of arbitration hearings in October 2003.

Incurred costs associated with delay and indirect costs related to the soil conditions, Acta Convenio, the national strike and other claims are probable of being recovered and thus are being deferred. These costs will be recognized in revenue when a change order is approved or payment is received. As of June 30, 2005, incurred costs amounting to $266 million have been deferred. Additional costs will be incurred as subcontractor close-outs are settled and remaining contract completion activities are concluded. The company believes that schedule relief awarded in connection with the direct costs of the site soil

conditions, along with other delay days requested on the other issues, will be sufficient to avoid the imposition of liquidated damages. If costs relating to Acta Convenio, soil conditions, the national strike or other claims are determined to be not recoverable or liquidated damages are assessed, the company could face materially reduced profits or losses on this project, along with lower levels of cash and additional borrowings.

New awards for the three months ended June 30, 2005 were $1.2 billion compared with $1.3 billion in the comparable period of 2004. Significant new awards in the 2005 period included a $665 million petrochemical complex in Saudi Arabia and a $172 million onshore production unit in Kazakhstan.

Backlog at June 30, 2005 increased 13 percent to $6.0 billion compared with $5.3 billion at June 30, 2004, reflecting the continued strength of new awards.

INDUSTRIAL & INFRASTRUCTURE

Revenues and operating profit (loss) for the Industrial & Infrastructure segment are summarized as follows:

In the first quarter of 2005, the chemicals business line, which had previously been part of the Industrial & Infrastructure segment, was realigned under the Oil & Gas segment. This change was made to better match the needs for the large number of petrochemical projects anticipated over the next few years with the Oil & Gas segment’s project support infrastructure. All prior periods have been restated to reflect this change.

Operating profit for the three and six months ended June 30, 2005 decreased significantly compared with the same periods in 2004. This decrease resulted primarily from a $65 million charge relating to an unfavorable jury award received during the second quarter of 2005 on a Cayman Islands project and a $9 million charge for disputed change orders on another project. In addition, in the first quarter of 2005, claim settlements totaling approximately $10 million were recognized.

On June 23, 2005, Fluor Daniel Caribbean, Inc. (“FD Caribbean”), a wholly owned subsidiary of the company, received an unexpected unfavorable jury verdict awarding $28.8 million to the developer of a resort hotel in the Caribbean. FD Caribbean was the general contractor on the project, which is located in the Cayman Islands.

During the course of the project, FD Caribbean ceased work on extra facilities that the developer added to the project scope without demonstrating the availability of funding to pay for such extra work. The company continued to perform the original contract base work. In January 2004, FD Caribbean filed suit to force collection of invoices for work that had been performed. Subsequent to the filing of the suit, the developer terminated the company, claiming that lack of progress constituted a material breach of the contract. The jury’s verdict awarded the developer damages in the amount referred to above. The company strongly believes that this verdict is not supported by the facts or by applicable law and will pursue all possible avenues of reconsideration or appeal.

The financial impact in the second quarter of 2005 was a charge of approximately $65 million including interest and attorneys’ fees. In addition to the jury award, the charge also includes a reversal of amounts previously billed to the client for work performed, including recognized project earnings. Efforts for reconsideration and appeal are ongoing.

The company participates in a 50/50 joint venture for a transportation infrastructure project located in California. In 2004, the company recorded a $28 million charge for its proportional share of estimated cost overruns on the project. The project continues to be subject to circumstances, such as owner-directed scope changes and delays that could result in additional charges in the future. The company continues to evaluate the impact of these circumstances on its estimated project costs, as well as any potential claims for recoveries or other contingencies on the project. At present, the company has determined that no such amounts are estimable based on information currently available to the company and thus no additional charges have been included in the second quarter.

Total assets for the Industrial & Infrastructure segment declined from $482.5 million at December 31, 2004 to $403.3 million at June 30, 2005 as the combined result of the recent strengthening of the U.S. dollar relative to the functional currencies in which many of the segment’s projects are transacted and adjustments associated with 2005 contract loss provisions. The segment realized no economic impact of the strengthening since its obligations are generally satisfied in the same functional currencies.

New awards for the three months ended June 30, 2005 were $348 million compared with an extremely strong $1.4 billion for the 2004 comparison period. Backlog decreased slightly to $4.5 billion at June 30, 2005 compared with $4.4 billion at June 30, 2004. During the second and first quarters of 2005, the segment experienced two life sciences project cancellations of $80 million and $282 million, respectively.

GOVERNMENT

Revenues and operating profit for the Government segment are summarized as follows:

The increase in revenues in the three and six months ended June 30, 2005 compared with the same periods in the prior year was primarily the result of increases in the level of work performed on projects in Iraq and higher fees on the Fernald project. Work performed in Iraq contributed approximately $202 million and $343 million, respectively, in revenue in the three and six months ended June 30, 2005 compared with $188 million and $342 million, respectively, in the comparable 2004 periods.

Operating profit for the three and six months ended June 30, 2005 includes the impact of provisions totaling $7 million and $38 million, respectively, recognized on four embassy projects which were adversely impacted by higher costs due to scope changes, unexpected execution problems and subcontractor difficulties. Total estimated cost overruns of $57 million on these projects were reduced by $19 million of recognized claim recoveries. Additional claim recoveries continue to be evaluated. The impact of the embassy provisions was largely offset by increased margin on the Fernald project. The segment has recognized unbilled fees totaling $118 million related to this project at June 30, 2005, including $7 million and $26 million, respectively, during the three and six months ended June 30, 2005, compared with $1 million and $7 million, respectively, in the same periods of 2004. Fees recognized in the 2005 period include the favorable impact of accelerated completion. These fees will be billed upon project completion in late 2006.

New awards of $350 million in the three months ended June 30, 2005 were approximately $110 million higher than new awards in the 2004 comparison period.

Backlog at June 30, 2005 increased to $1.2 billion from $915 million at the end of the second quarter of 2004, reflecting the favorable impact of increasing new awards levels.

GLOBAL SERVICES

Revenues and operating profit for the Global Services segment are summarized as follows:

Revenue increased 26 percent and 21 percent, respectively, in the three and six months ended June 30, 2005 compared with the same periods in 2004. The second quarter growth resulted primarily from an increase in customer-furnished materials. The operating profit margin declined to 6.1 percent in the second quarter of 2005 compared with 7.7 percent in the 2004 period, principally as the result of lower margin contribution on customer furnished materials. Operating results for the six months ended June 30, 2005 reflect the improved performance in all sectors that was achieved in the first quarter.

New awards and backlog for Global Services reflect operations and maintenance activities only. The equipment, temporary staffing and global procurement operations do not report backlog due to the short turnaround between the receipt of new awards and the recognition of revenue. New awards for the three months ended June 30, 2005 were $748 million compared with $247 million for the 2004 comparison period, reflecting the addition of one new client and the renewal of agreements with three existing clients. Backlog for Global Services at June 30, 2005 was $3.1 billion compared with $1.9 billion at June 30, 2004, reflecting the impact of continued growth in the number of client sites served.

POWER

Revenues and operating profit for the Power segment are summarized as follows:

As the result of a shift in the markets served by and the types of projects awarded to ICA Fluor, commencing in the third quarter of 2004, its operating results, new awards and backlog are included in the Oil & Gas segment rather than the Power segment where it was previously reported.

The reduced operating profit in 2005 reflects the impact of lower levels of project execution activity, which are in the relatively early stages, where profit recognition is generally lower. Operating margin in 2004 reflects performance on projects that were either completed or nearing completion where profit recognition is strongest. Operating profit in the first half of 2004 also benefited from the receipt of a settlement for a dispute relating to a project that was completed in 2002.

New project awards in the second quarter of 2005 were $564 million compared with $85 million in the prior year comparison period. Demand for new power generation has increased modestly in recent quarters following a downturn in power plant construction activity. Backlog at June 30, 2005 was $934 million compared with $454 million at June 30, 2004. All projects in backlog will be performed 100 percent by Fluor.

In July 2003, the company jointly announced with Duke Energy Corporation the decision to dissolve the Duke/Fluor Daniel partnership (“D/FD”) as a result of the significant decline in the construction of new

power plants. The dissolution is not expected to have a material impact on results of operations or financial position of the company. The dissolution is in progress and is expected to be completed in 2005 as remaining project activities are concluded.

OTHER

Corporate general and administrative expense for the three and six months ended June 30, 2005 was $27.7 million and $65.7 million, respectively, compared with $33.0 million and $60.8 million in the corresponding periods of 2004. Gains on the sale of real estate assets are included in both years. Included in the second quarter of 2005 is a $4.2 million pre-tax gain from the sale of one real estate asset compared with a $7.4 million pre-tax gain from the sale of three real estate assets in the first quarter of 2004.

During the second quarter of 2005, net interest income was $1.4 million, compared with $0.7 million net interest expense reported in the same period of 2004. For the six months ended June 30, 2005 net interest income was $1.5 million compared to $0.1 million net interest expense in the same period of 2004.

On May 10, 2005, the company announced its decision to relocate its corporate headquarters from Southern California to the Dallas/Fort Worth metropolitan area. This move is expected to improve operational efficiency and position the company to more effectively serve its global client base. Of the approximately 390 headquarters staff presently located in Aliso Viejo, California, approximately 200 employees will either stay in Southern California or move to other U.S. office locations. Approximately 60 employees will relocate to the new Texas headquarters where approximately 120 additional employees are expected to be hired. Approximately 130 employees will leave the company as a result of the move.

The cost of employee displacements will be accrued ratably starting in the third quarter of 2005 through the anticipated date of the Southern California headquarters office closure in the second quarter of 2006. All other relocation and hiring costs will be charged to expense as incurred.

The existing corporate facility in Aliso Viejo is being sold, with an expected closing date in the third quarter of 2005. A short-term, market rate lease-back has been negotiated with the buyer that will allow the company to continue to occupy the facility for up to 18 months.

The accrual for employee displacement costs is expected to approximate $2 million during 2005. Employee relocation and hiring costs of approximately $2 million are expected to be incurred during the remainder of 2005, with additional amounts of approximately $18 million to be incurred during 2006. All employee relocation and hiring costs will be included in corporate general and administrative expense.

Income tax expense exceeded earnings before taxes for the three months ended June 30, 2005. The effective tax rate on the company’s operations for the six months ended June 30, 2005 was 64.1 percent compared with 33.5 percent in the 2004 comparison period. The higher 2005 effective tax rate is attributable to the Cayman Islands project jury award discussed under Industrial & Infrastructure above and the international embassy contract provisions discussed under Government above. Such foreign losses reduce the company’s ability to absorb excess foreign taxes incurred in high tax jurisdictions. The effective tax rate for the current year is projected to be between 40 and 45 percent compared with 33.6 percent for 2004.

ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (SFAS 123-R), which is a revision of SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123-R supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and amends SFAS 95, “Statement of Cash Flows.” Generally, the approach in SFAS 123-R is similar to the approach

described in SFAS 123. However, SFAS 123-R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Upon adoption of SFAS 123-R, pro forma disclosure of the impact of share-based payments to employees is no longer permitted.

The provisions of SFAS 123-R apply to awards granted after the required effective date of the statement, which is no later than January 1, 2006 for the company, with early adoption permitted in periods for which financial statements have not yet been issued. Initial application to existing unvested stock option awards may be based on either a modified prospective method or a modified retrospective method. The method of application selected by the company will determine which, if any, previously reported operating results will be restated. The company is required to adopt SFAS 123-R on January 1, 2006.

As permitted by SFAS 123, the company currently accounts for share-based payments to employees using the intrinsic value method pursuant to APB 25 and, as such, recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123-R’s fair value method will have an impact on results of operations, although it will have no impact on overall financial position. The impact of adoption of SFAS 123-R will not be material based on unvested options outstanding at June 30, 2005. Had SFAS 123-R been adopted in prior periods, the impact would be as presented in the disclosure of pro forma earnings and earnings per share in Note 5 in the Condensed Consolidated Financial Statements. Adoption of the new standard will also have an impact on the timing of expense recognition for new stock based awards, as discussed in Note 5 in the Condensed Consolidated Financial Statements.

SFAS 123-R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required. This requirement will generally impact cash provided or utilized by operating activities with equal offset in cash flows from financing activities in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amounts of operating cash flows recognized for such excess tax deductions were $9.2 million and $3.1 million in the six month periods ended June 30, 2005 and 2004, respectively.

Discussion of the status of this project is included above under Industrial & Infrastructure.

Without any admission of company liability, the company has consummated settlement of an action in which the plaintiffs alleged that certain Fluor officers and directors violated the Securities Exchange Act of 1934 by providing false or misleading statements about the company’s business and prospects. These complaints purported to be class action complaints brought on behalf of purchasers of the company’s stock during the period from May 22, 1996 through February 18, 1997. During the first quarter of 2005 the company, its insurer and the plaintiffs reached an agreement to settle this proceeding for $18 million without any admission of company liability, of which $16 million was paid by the company’s insurers. The remaining $2 million had been previously provided, and therefore, did not affect operating results for the first quarter of 2005. A hearing to confirm the settlement was held on June 27, 2005 and the court approved the settlement on June 29, 2005.

As of June 30, 2005, several matters relating to completed and in progress projects are in the dispute resolution process. The following discussion provides a background and current status of certain of these matters:

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 is pending.

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 the arbitration is scheduled to begin in October 2005.

Discussion of the status of the Hamaca project is included above under Oil & Gas.

The company filed for arbitration proceedings in February 2005 in connection with its London Connect Project, a $500 million lump sum project to design and install a telecommunications network that allows reception and transmissions throughout the London Underground system. The company is seeking relief through arbitration proceedings for two issues. The first is the overall delay and disruption related to the contract, which has hearings scheduled to commence in May 2006. The second is for scope disputes concerning the enabling of the various train stock to accept the new telecommunications network equipment. The company has not received a procedural order indicating when hearings will begin on the second issue.

During the first half of 2005, cash was generated primarily from operations, the issuance of common stock and the sale of certain real estate.

In the six months ended June 30, 2005, cash provided by operating activities was $176.8 million and primarily attributable to earnings sources and increases in advance billings on contracts in the Oil & Gas

and Government segments. Cash provided by operating activities during the first six months of 2004 was $17.5 million, which included reductions associated with progress on the Hamaca project of $41.9 million and a $30.9 million decrease in advances from D/FD as power projects were completed and advance payments previously received from clients on those projects were expended.

Cash utilized by investing activities was $73.7 million in the first half of 2005 compared with $13.8 million in the 2004 comparison period. During the second quarter of 2005 the company received $16.6 million in proceeds from the sale of one real estate property and $11.1 million from the disposal of other property and equipment. Investing cash flows in the six months ended June 30, 2004 included $50.2 million in proceeds from the sale of three real estate properties, which was partially offset by $33.0 million used to acquire Trend Western Technical Corporation. Capital expenditures, primarily for ongoing renewal and replacement in the construction equipment operations, including operations in Iraq and Eastern Europe were $86.2 million in the six months ended June 30, 2005 compared with $42.5 million in the same period of 2004. A joint-venture entity that will maintain telecommunications facilities for the London Underground was funded during the three months ended June 30, 2005, resulting in a cash investment of $13.6 million.

Cash provided by financing activities in the first six months of 2005 included the issuance of 758,367 shares of common stock, resulting in net proceeds of $41.8 million. Offsetting this cash inflow was the utilization of $30.0 million for debt reduction. During the first quarter of 2004, net proceeds of $323.1 million were realized from the issuance of convertible senior notes. A portion of the proceeds from this issuance was used to repay $100 million of outstanding debt on the company’s Aliso Viejo, California facilities and $121.5 million of commercial paper. Also impacting cash flows in the first half of both 2005 and 2004 was $34.6 million and $20.4 million, respectively, in cash received from the exercise of stock options. Cash utilized for the payment of dividends ($0.32 per share) in the six months ended June 30, 2005 and 2004 was $27.6 million and $26.6 million, respectively. The company’s total debt to total capitalization (“debt-to-capital”) ratio at June 30, 2005 was 24.3 percent compared with 26.3 percent at December 31, 2004.

Liquidity is provided by cash generated from operations, advance billings on contracts in progress and access to financial markets. As customer advances are reduced through use in project execution and if not replaced by advances on new projects, the company’s cash position would be reduced. The requirements for operating liquidity could result in the need for short-term borrowings. For the next 12 months, cash generated from operations supplemented as necessary by borrowings under credit facilities and the issuance of debt or equity securities are expected to be sufficient to fund operations. The cost of acquisition and construction of the new corporate headquarters in the Dallas/Fort Worth metropolitan area are expected to be approximately $55 million, and will be funded from available cash resources, including proceeds from the pending sale of the existing headquarters facility, over the next nine to twelve months.

Off-Balance Sheet Arrangements

The company maintains a variety of commercial commitments that are generally made available to provide support for various commercial provisions in its engineering and construction contracts. The company has $833 million in committed and uncommitted lines of credit to support letters of credit. Letters of credit are provided to clients in the ordinary course of business in lieu of retention or for performance and completion guarantees on engineering and construction contracts. The company also posts surety bonds primarily on state and local government projects to guarantee its performance on contracts.

In the ordinary course of business, the company enters into various agreements providing financial or performance assurances to clients on behalf of certain unconsolidated subsidiaries, joint ventures and for 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. In most cases any amounts expended on behalf of a partner or joint venture participant pursuant to performance guarantees would be recovered from the client

or other third party for work performed in the ordinary course of contract execution. As of June 30, 2005, the amount of guarantees outstanding measured on this basis increased to $2.5 billion compared with $1.8 billion as of December 31, 2004 as the principal result of a new transportation infrastructure joint-venture project.

The company has a joint venture arrangement that will design, build, finance and maintain an aircraft refueling facility at a United States Air Force base in Qatar for the Defense Energy Support Center, an agency of the Department of Defense. The company has a 27.5 percent interest in the joint venture company. On April 29, 2005, the joint venture entered into an agreement for project financing which includes a joint and several project completion guarantee by the members of the joint venture. The maximum potential amount of future payments that could be required under the guarantee is $76.5 million, the maximum principal amount available under the financing arrangement, plus any accrued interest.

Financial guarantees, made in the ordinary course of business on behalf of 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 June 30, 2005, no material changes to financial guarantees of the debt of third parties had occurred since the filing of the company’s December 31, 2004 annual report on Form 10-K.

Financial Instruments

The company utilizes forward exchange contracts to hedge foreign currency transactions entered into in the ordinary course of business and not to engage in currency speculation. At June 30, 2005, the company had forward foreign exchange contracts of less than 20 months duration to exchange major world currencies for U.S. dollars. The total gross notional amount of these contracts at June 30, 2005 was $73 million.

There have been no material changes on this matter in the first half of 2005. Accordingly, the disclosures provided in the Annual Report on Form 10-K for the year ended December 31, 2004 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 six 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.

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.

In addition to the matters described above, we are involved in disputes with respect to the Hamaca Crude Upgrader project located in Jose, Venezuela. We are part of a joint venture which is actively proceeding on a number of issues under binding arbitration to recover amounts that are due as change orders to the project. For additional information on the Hamaca dispute, see the section entitled “Results of Operations – Oil & Gas” in Part I, Item 2 in Management’s Discussion and Analysis of Financial Condition and Results of Operations, above.

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