On April 7, 2006, we closed on the purchase of the remaining 51% interest in a special purpose joint venture company, dedicated to the development, construction and operation of wind farm projects in Italy. We now own 100% of the equity interest of the special purpose company. In accordance with the terms of the agreement, we are required to pay a purchase price of €16,393 (approximately $19,900), of which €12,580 (approximately $15,200) was paid at closing and €3,813 (approximately $4,600) is due upon start of construction of one of the three wind farms being developed by the special purpose company. The purchase price is also subject to adjustments based on receipt by the special purpose company of additional grants according to Italian law 488 and we are currently expecting to make an additional payment equal to €3,130 (approximately $3,800) corresponding to 51% of the expected grants. The special purpose company had €26,163 (approximately $31,700) of non-recourse project debt at closing and €16,727 (approximately $20,300) of cash as of the closing date. Beginning with our second quarter 2006 financial statements, we will fully consolidate the financial results of the special purpose company, including the non-recourse debt, in our condensed consolidated financial statements.
On April 26, 2006, we consummated the exchange of 1,277,900 of our common shares for $50,000 of outstanding aggregate principal amount of our 2011 senior notes. Under the terms of the exchange, the participating holders received 25.558 common shares for each thousand dollars of aggregate principal amount of 2011 senior notes, including accrued and unpaid interest, exchanged. In addition, we called for redemption of the remaining amount of 2011 senior notes and trust preferred securities. On May 25, 2006, we will redeem the remaining $61,468 of outstanding aggregate principal amount of our 2011 senior notes. The remaining $5,963 of outstanding aggregate principal amount of our trust preferred securities will be redeemed on May 26, 2006. The exchange and redemption transactions, which will be reflected in our second quarter 2006 financial statements, will reduce the carrying amount of our debt by approximately $121,100, will reduce the amount of unpaid accrued interest on the trust preferred securities by approximately $3,000, will improve consolidated shareholders’ deficit by approximately $46,300 and will reduce our cash by approximately $79,000. The improvement in consolidated shareholders’ deficit reflects the issuance of new common share equity of approximately $58,700 offset by a primarily non-cash charge to income of approximately $12,400. The charge reflects primarily the difference between the fair market value of the common shares to be issued and the book value of the 2011 senior notes exchanged.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (amounts in thousands of dollars, except share data and per share amounts)
The following is management’s discussion and analysis of certain significant factors that have affected our financial condition and results of operations for the periods indicated below. This management’s discussion and analysis and other sections of this quarterly report on Form 10-Q contain forward-looking statements that are based on our assumptions, expectations and projections about the various industries within which we operate. Such forward-looking statements by their nature involve a degree of risk and uncertainty. We caution that a variety of factors could cause business conditions and results to differ materially from what is contained in our forward-looking statements. For additional risk information, see Part II, Item 1A. “Risk Factors.”
This discussion and analysis should be read in conjunction with our financial statements and notes thereto included in this quarterly report on Form 10-Q and our annual report on Form 10-K for the year ended December 30, 2005, which we refer to as our 2005 Form 10-K.
Overview
We operate through two business groups – the Global Engineering & Construction Group, which we refer to as our Global E&C Group, and our Global Power Group. In addition, corporate center expenses, corporate debt expenses, restructuring expenses and certain legacy liabilities, such as asbestos, are reported independently in the Corporate and Finance Group, which we refer to as the C&F Group.
First Quarter 2006 Results
We reported net income of $14,600 on operating revenues of $645,800 in the first quarter of 2006, compared to net income of $1,200 on operating revenues of $523,100 in the comparable period of 2005.
We continued to experience solid growth in new orders and backlog during the first quarter of 2006. Our consolidated new orders for the first quarter of 2006 were $1,529,400, an increase of 232%, as compared to the same period of 2005. As a result, our consolidated backlog as of March 31, 2006 increased 23% to $4,553,400, from $3,692,300 as of December 30, 2005 and 138% from $1,914,500 as of April 1, 2005. This is our highest level of backlog since the fourth quarter of 2002. Our backlog measured in terms of Foster Wheeler scope (as defined below) as of March 31, 2006 also increased 15% to $2,485,400, from $2,159,700 as of December 30, 2005 and 62% from $1,531,400 as of April 1, 2005.
We continued to execute on our aggressive program of debt reduction. In January 2006, we completed two warrant offer transactions which increased the number of common shares to be delivered upon the exercise of our Class A and Class B common share purchase warrants during the offer period and raised $75,300 in net proceeds. Holders of approximately 95% of the Class A warrants and 57% of the Class B warrants participated in the offers resulting in the aggregate issuance of approximately 8,403,500 common shares. We will use the warrant proceeds to redeem the remaining amounts of our 2011 senior notes and trust preferred securities. On April 26, 2006, we consummated the exchange of 1,277,900 of our common shares for $50,000 of outstanding aggregate principal amount of our 2011 senior notes. Under the terms of the exchange, the participating holders received 25.558 common shares for each thousand dollars of aggregate principal amount of 2011 senior notes, including accrued and unpaid interest, exchanged. The redemption and exchange transactions, which will be reflected in our second quarter 2006 financial statements, will reduce the carrying amount of our debt by approximately $121,100.
In March 2006, we satisfied our obligations under a final modification to terminate on a no-fault basis a contract to construct a nuclear storage facility for a U.S. government agency that would have required us to fund or obtain third-party project financing in excess of $100,000 and to post a performance bond in excess of $100,000. Under the terms of the final modification, we are released from further obligations to perform the contract.
Challenges and Drivers
Our primary operating focus is booking quality backlog and executing contracts well. The global markets in which we operate are largely dependent on overall economic growth and the resultant demand for oil and gas, petrochemicals and refined products, which in turn stimulate an increase in investment in new and expanded plants. These markets continued to be strong in the first quarter of 2006.
The Global E&C Group’s new orders for the first quarter of 2006 were $1,115,200, an increase of 296% when compared to the comparable period of 2005. We expect that capital investments in the markets served by our Global E&C Group, including the chemical, petrochemical, oil refining, liquefied natural gas and upstream oil and
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gas industries, will remain strong throughout 2006. The Global Power Group’s new orders for the first quarter of 2006 were $414,200, an increase of 132% when compared to the first quarter of 2005. We believe that there are significant growth opportunities in the markets we serve in 2006, such as solid fuel-fired boilers, boiler services, boiler environmental products and boiler-related construction services. We believe that we are well positioned to address both our Global E&C Group and Global Power Group markets.
Proposed asbestos trust fund legislation has recently been considered in the U.S. Senate. This proposed legislation, should it become law in its present form, would alter our payment obligations. We would be required to fund approximately $19,250 per year for 30 years and thus such legislation could have a material adverse impact on our financial condition, results of operations and long-term cash flow.
Proposed pension legislation has been introduced in the United States and the United Kingdom, which, if enacted, could have an adverse impact on the amount and timing of our future cash contributions. Additionally, proposals to alter the accounting for pension obligations are being considered, which if enacted, could materially impact our financial condition and results of operations.
Liquidity
We forecast cash flow over a twelve-month period and project that sufficient cash will be available to fund our working capital needs through the end of such period. See “—Liquidity and Capital Resources” in this Form 10-Q for additional details. As with any forecast, there can be no assurance that the cash amounts realized and/or timing of the cash flows will match our forecast.
Results of Operations
Consolidated Operating Revenues:
| | Three Months Ended | |
| |
| |
| | March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
| |
| | $ | 645,800 | | $ | 523,100 | | $ | 122,700 | | 23.5 | % |
| | | | | | | | | | | | |
The first quarter 2006 change reflects higher revenues in both our Global E&C Group and our Global Power Group (see Note 10 to the condensed consolidated financial statements in this Form 10-Q). The increase is due largely to the significant increase in bookings that occurred in 2005 in both our Global E&C Group and our Global Power Group. Additionally, $35,800 of the increase relates to flow-through costs in our Global E&C Group on projects executed by our United Kingdom, Continental Europe and Asia-Pacific operations. Flow-through costs relate to projects where we purchase and install equipment on behalf of our customers with little or no mark-up. Therefore, while flow-though costs do not impact net earnings, higher flow-through costs have the effect of reducing our margins.
Consolidated Cost of Operating Revenues:
| | Three Months Ended | |
| |
| |
| | March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
| |
| | $ | 563,800 | | $ | 446,000 | | $ | 117,800 | | 26.4 | % |
| | | | | | | | | | | | |
The first quarter 2006 change reflects a higher cost of operating revenues in both our Global E&C Group and our Global Power Group. The increase in cost of operating revenues results primarily from the increase in operating revenues along with an increase in flow-through costs on projects executed by our United Kingdom, Continental Europe and Asia-Pacific operations.
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Consolidated Selling, General and Administrative (SG&A) Expenses:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 51,800 | | $ | 55,200 | | $ | (3,400 | ) | (6.2 | )% |
| | | | | | | | | | |
SG&A expenses include the costs associated with general management, sales pursuit, including proposal expenses, and research and development costs. The first quarter 2006 decrease results primarily from a decrease in sales pursuit costs of $5,500 and research and development costs of $500, which was partially offset by an increase in general overhead of $2,600. The increase in general overhead results primarily from non-cash equity-based compensation expense of $1,800 recorded in the first quarter of 2006 related to the adoption of SFAS No. 123R, “Share-Based Payment.”
Consolidated Other Income:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 15,800 | | $ | 12,500 | | $ | 3,300 | | 26.4 | % |
| | | | | | | | | | |
Other income for the first three months of 2006 consists primarily of $3,200 of interest income, $8,600 in equity earnings generated from our investments, primarily from minority ownership interests, in build, own, and operate projects in Italy and Chile, a $900 gain on the sale of a previously closed manufacturing facility in Dansville, New York, and $500 of investment income earned by our captive insurance company.
Other income for the first three months of 2005 consists primarily of $2,400 of interest income, $5,000 in equity earnings generated from our investments, primarily from minority ownership interests, in build, own, and operate projects in Italy and Chile, a $1,500 gain recognized in the U.K. on the sale of an investment, and $300 of investment income earned by our captive insurance company.
Consolidated Other Deductions:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 7,500 | | $ | 9,400 | | $ | (1,900 | ) | (20.2 | )% |
| | | | | | | | | | |
Other deductions for the first quarter of 2006 consists primarily of $1,500 of bank fees, $2,500 of legal fees, $1,900 of consulting fees, and $(700) of bad debt recovery.
Other deductions for the first quarter of 2005 consists primarily of $3,700 of bank fees associated with the previous senior credit facility, $4,300 of legal fees, $1,500 of exchange losses and $(2,800) of bad debt recovery.
Consolidated Interest Expense:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 7,900 | | $ | 14,700 | | $ | (6,800 | ) | (46.3 | )% |
| | | | | | | | | | |
The decrease in interest expense for the first quarter 2006 reflects the benefits from our equity-for-debt exchanges completed in August and November of 2005.
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Consolidated Minority Interest:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | (400 | ) | $ | 1,000 | | $ | (1,400 | ) | (140.0 | )% |
| | | | | | | | | | |
Minority interest reflects third-party ownership interests in the results of our Global Power Group’s Martinez, California gas-fired cogeneration facility, and manufacturing facilities in Poland and the People’s Republic of China. The change results primarily from higher gas prices and, to a lesser extent, maintenance at the Martinez cogeneration facility.
Consolidated Tax Provision:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 16,300 | | $ | 8,000 | | $ | 8,300 | | 103.8 | % |
| | | | | | | | | | |
The consolidated tax provision results from the fact that certain of our operating units in Europe and Asia are profitable and are recording a provision for national and/or local income taxes. The consolidated tax provision also includes certain domestic state taxes. Additionally, taxes may be due in countries where our operating units execute project-related works. The pretax earnings of these profitable operations cannot be offset against certain other operations generating losses both in the United States and in certain other international jurisdictions. Further, with regard to our domestic and certain of our foreign operating units, SFAS No. 109, “Accounting for Income Taxes,” requires us to reduce our deferred tax benefits by a valuation allowance when, based upon available evidence, it is more likely than not that these tax benefits will not be realized for these operations in the future. Accordingly, the tax provision represents primarily taxes from profits generated in Europe and Asia that cannot be used to reduce losses incurred in other tax jurisdictions and the effect of applying valuation allowances where required.
Our effective tax rate is dependent on the location and amount of our taxable earnings and the effects of valuation allowance. Our total provision for income taxes of $16,300 on income before income taxes of $30,900 yields an effective tax rate of 52.6%. This provision differs from the amount of income tax determined by applying the applicable statutory rate of 35% to income before income taxes primarily as a result of non-U.S. earnings being taxed at rates lower than the U.S. statutory rate, offset by a valuation allowance of $7,600 related to the U.S. losses resulting primarily from the expenses of the C&F Group. We continue to experience a negative impact in our effective tax rate due to a significant increase in our valuation allowance under SFAS No. 109, for losses generated in the U.S. This is partially offset by the positive impact of decreases to our valuation allowance under SFAS No. 109 in certain non-U.S. jurisdictions. If this positive earnings trend in these foreign jurisdictions for which valuation allowances against deferred tax assets were established in previous years continues, we will evaluate the need to reverse the valuation allowances with respect to the deferred tax assets of these jurisdictions. Such evaluation includes a review of all available evidence, both positive and negative, in determining whether a valuation allowance is necessary.
For statutory purposes, the majority of the domestic federal tax benefits, against which valuation reserves have been taken, do not expire until 2024 and beyond, based on current tax laws.
Consolidated EBITDA:
Three Months Ended |
| |
March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
$ | 45,900 | | $ | 31,200 | | $ | 14,700 | | 47.1 | % |
| | | | | | | | | | |
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The increase in first quarter 2006 EBITDA reflects increased volumes of business at our Global E&C Group operations in the United Kingdom and Continental Europe. The markets served by our Global E&C Group remain strong and projects booked in 2005 are currently being executed. See the individual segment explanations below for additional details.
EBITDA is a supplemental, non-generally accepted accounting principle financial measure. EBITDA is defined as income before income taxes (and before goodwill charges), interest expense, depreciation and amortization. We have presented EBITDA because we believe it is an important supplemental measure of operating performance. EBITDA, after adjustment for unusual and infrequent items specifically excluded in the terms of the senior credit agreement, is used for certain covenants under the senior credit agreement. We believe that the line item on our condensed consolidated statement of operations and comprehensive income entitled “net income” is the most directly comparable generally accepted accounting principle (“GAAP”) financial measure to EBITDA. Since EBITDA is not a measure of performance calculated in accordance with GAAP, it should not be considered in isolation of, or as a substitute for, net income as an indicator of operating performance. EBITDA, as calculated by us, may not be comparable to similarly titled measures employed by other companies. In addition, this measure does not necessarily represent funds available for discretionary use, and is not necessarily a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income, the most directly comparable GAAP financial measure, users of this financial information should consider the type of events and transactions that are excluded. Our non-GAAP performance measure, EBITDA, has certain material limitations as follows:
| | • | It does not include interest expense. Because we have borrowed substantial amounts of money to finance some of our operations, interest is a necessary and ongoing part of our costs and has assisted us in generating revenue. Therefore, any measure that excludes interest has material limitations; |
| | • | It does not include taxes. Because the payment of taxes is a necessary and ongoing part of our operations, any measure that excludes taxes has material limitations; |
| | • | It does not include depreciation. Because we must utilize substantial property, plant and equipment in order to generate revenues in our operations, depreciation is a necessary and ongoing part of our costs. Therefore, any measure that excludes depreciation has material limitations. |
A reconciliation of EBITDA, a non-GAAP financial measure, to net income, a GAAP measure, is shown below.
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| | Total | | Global
E&C Group | | Global
Power Group | | C&F
Group |
(1)
|
| |
| |
| |
| |
| |
For the three months ended March 31, 2006 | | | | | | | | | | | | | |
Third-party revenues | | $ | 645,800 | | $ | 423,100 | | $ | 222,700 | | $ | — | |
| |
|
| |
|
| |
|
| |
|
| |
EBITDA | | $ | 45,900 | | $ | 55,000 | (2) | $ | 13,800 | (2) | $ | (22,900 | )(2) |
| | | | |
|
| |
|
| |
|
| |
Less: Interest expense | | | (7,900 | ) | | | | | | | | | |
Less: Depreciation and amortization | | | (7,100 | ) | | | | | | | | | |
| |
|
| | | | | | | | | | |
Income before income taxes | | | 30,900 | | | | | | | | | | |
Provision for income taxes | | | (16,300 | ) | | | | | | | | | |
| |
|
| | | | | | | | | | |
Net income | | $ | 14,600 | | | | | | | | | | |
| |
|
| | | | | | | | | | |
| | | | | | | | | | | | | |
For the three months ended April 1, 2005 | | | | | | | | | | | | | |
Third-party revenues | | $ | 523,100 | | $ | 330,700 | | $ | 192,400 | | $ | — | |
| |
|
| |
|
| |
|
| |
|
| |
EBITDA | | $ | 31,200 | | $ | 26,400 | (3) | $ | 29,600 | (3) | $ | (24,800 | ) (3) |
| | | | |
|
| |
|
| |
|
| |
Less: Interest expense | | | (14,800 | ) | | | | | | | | | |
Less: Depreciation and amortization | | | (7,200 | ) | | | | | | | | | |
| |
|
| | | | | | | | | | |
Income before income taxes | | | 9,200 | | | | | | | | | | |
Provision for income taxes | | | (8,000 | ) | | | | | | | | | |
| |
|
| | | | | | | | | | |
Net income | | $ | 1,200 | | | | | | | | | | |
| |
|
| | | | | | | | | | |
(1). | Includes general corporate income and expense, our captive insurance operation and eliminations. |
(2). | Includes in the three months ended March 31, 2006: the regular re-evaluation of contract profit estimates of $(100): $2,300 in our Global E&C Group and $(2,400) in our Global Power Group. |
(3). | Includes in the three months ended April 1, 2005: the regular re-evaluation of contract profit estimates of $14,800: $5,500 in our Global E&C Group and $9,300 in our Global Power Group; credit agreement costs associated with the previous senior credit facility of $(3,700) in our C&F Group; and charges for severance cost of $(100) in our Global E&C Group. |
Additional segment information is detailed in Note 10 to the condensed consolidated financial statements in this Form 10-Q.
Reportable Segments
We use several financial metrics to measure the performance of our business segments. EBITDA, as discussed and defined above, is the primary earnings measure used by our chief decision makers.
Global E&C Group
| | Three Months Ended | |
| |
| |
| | March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
| |
Third-party revenues | | $ | 423,100 | | $ | 330,700 | | $ | 92,400 | | 27.9 | % |
| |
|
| |
|
| |
|
| |
| |
EBITDA | | $ | 55,000 | | $ | 26,400 | | $ | 28,600 | | 108.3 | % |
| |
|
| |
|
| |
|
| |
| |
Results
The change in first quarter 2006 operating revenues primarily reflects increased volumes of work at our United Kingdom, Continental Europe and Asia-Pacific operating units. Projects in the Middle East, Australia and Italy in the oil and gas and chemical/petrochemical industries led the increase in activities.
The increase in first quarter 2006 EBITDA results primarily from strong operational performance on increased volumes of business at our European operations. The markets served by our Global E&C Group remains
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strong and we have added additional personnel in our United Kingdom and India offices to help capture the market growth. We plan to continue to expand our operational capacity throughout 2006.
Overview of Segment
Strong global economic growth continues to drive strong demand for oil and gas, petrochemicals and refined products, in turn stimulating an increase in investment in new and expanded plants. We expect global economic growth to remain strong throughout 2006.
Both oil and gas prices have remained at high levels for a prolonged period, which is leading to increased investment in oil and gas production facilities. This is expected to continue throughout 2006. We anticipate that oil and gas spending will increase in most regions, particularly West Africa, the Middle East, Russia and the Caspian states. We believe that rising demand for natural gas in Europe, Asia and the United States, combined with a shortfall in indigenous production, continues to act as a stimulant to the liquefied natural gas (“LNG”) business. We expect that investment will continue throughout 2006 for both LNG liquefaction plants and receiving terminals.
We believe that the global refining system is running at very high utilization rates, which combined with increasing global demand for transportation fuels and the current wide price differential between heavier higher-sulfur crudes and lighter, sweeter crudes, is stimulating refinery investment, particularly for heavier higher-sulfur crudes.
The aforementioned price differential also drives the strong economic case for upgrading refinery residue to higher value transportation fuels and we expect to see substantial investment in bottom-of-the-barrel upgrading projects in Europe, the United States and potentially Asia. We believe that several client refinery investment decisions will be made later this year and into 2007. We have considerable experience and expertise in this area including our proprietary delayed coking technology. We have seen an increase in the number of studies for potential delayed coking refinery units and our delayed coking technology, know-how, and experience designing and constructing delayed cokers places us in a good competitive position to address this market. We are currently working on several delayed coking projects.
Capacity constraints are generating an interest in additional refinery capacity, both greenfield and expansions. Companies have already announced several projects in the Middle East, and major expansion plans are being implemented for new facilities in Southeast Asia and China. We believe that the current cycle of investment at U.S. and European refineries to meet the demands of clean fuels legislation has now wound down. However, refineries in the Middle East, North Africa and Asia are now embarking on similar programs.
Investment in petrochemical plants rose sharply in 2004 and 2005 in response to strong demand growth. The majority of this investment has been centered in the Middle East. We believe that continued strong demand growth will support further new investment in the Middle East and Asia throughout 2006 and into 2007.
Although the pharmaceutical industry continues to grow rapidly, investment in new production facilities slowed in 2004 and 2005. We believe this was attributable to industry cost pressure and increased regulation. Investment has focused on plant upgrading and improvement projects rather than major new production facilities. There are now indications of some renewed interest in more significant plant investment in the key pharmaceutical investment hubs – Singapore, Ireland and Puerto Rico.
Global Power Group
| | Three Months Ended | |
| |
| |
| | March 31,
2006 | | April 1,
2005 | | $ Change | | % Change | |
| |
| |
| |
| |
| |
Operating revenue | | $ | 222,700 | | $ | 192,400 | | $ | 30,300 | | 15.7 | % |
| |
|
| |
|
| |
|
| |
| |
EBITDA | | $ | 13,800 | | $ | 29,600 | | $ | (15,800 | ) | (53.4 | )% |
| |
|
| |
|
| |
|
| |
| |
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Results
The increase in first quarter 2006 operating revenues primarily results from projects located in Western Europe and the United States.
The decrease in first quarter 2006 EBITDA was attributable primarily to a change in the contract portfolio, in terms of product mix and project cycle. The larger projects booked in the second half of 2005 are in the early phases of execution with correspondingly low levels of physical completion. The physical completion tends to be low during the early stages of these contracts. As a result, we anticipate increased levels of contract profit from these projects as we progress through the year. Secondly, a portion of this decrease resulted from under-performance during the first quarter of 2006 by our European operating unit on several contracts currently in execution. We have and continue to implement operational improvements in this unit the results of which are expected to enhance future performance.
Overview of Segment
Although the solid fuel-fired boiler market remains highly competitive, we believe that there are several continuing global market forces that will positively influence our Global Power Group. We believe that continued worldwide economic growth is driving power demand growth in most world regions. Global natural gas and oil supply concerns have driven gas and oil prices upwards to unprecedented levels. We expect natural gas fuel price volatility to remain high over the next 3-5 years due to declining domestic supplies in the world’s largest industrialized countries. In addition, we expect growth in sales of our environmental retrofit products due to further tightening of environmental regulations, including the development and growing acceptance of global greenhouse gas regulation. We believe that the combined effect of these factors will have a significant positive influence on the demand for our products and services, such as new utility and industrial solid fuel boilers, boiler services, boiler environmental products, and boiler-related construction services.
In North America, we believe the declining generating capacity reserves across the region coupled with persistent high oil and natural gas pricing is spurring market growth for large coal utility boilers. Given the uncertainty of future greenhouse gas regulation, we are seeing a growing market preference for supercritical utility boilers as well as investments by suppliers that may result in the entrance of gasification technology in the near term in the U.S. Plants that use these technologies operate more efficiently by producing the least amount of greenhouse gas per unit of electricity produced and also capture other pollutants to a higher level. We believe clients are selecting these technologies as a hedge against future greenhouse gas, mercury and other pollutant regulation that could occur in the near term. Due to this market direction, our Global Power Group is now actively marketing large-scale supercritical boiler technology as part of our utility boiler product portfolio to capitalize on this business opportunity. From the industrial sector, we are seeing growth in the solid fuel industrial boiler market, driven by high oil and gas pricing. These boilers allow industrial clients to utilize low cost biomass and other solid opportunity fuels, as an economic solution to supplying their energy needs. Many of these fuels also carry governmental tax credits and other financial incentives to encourage their use as renewable fuels making them more attractive to both the industrial and utility power sectors. We believe that our circulating fluidized-bed, or CFB, boiler technology is well positioned to serve this market segment due to its outstanding fuel flexibility and excellent environmental performance. The U.S. Environmental Protection Agency’s, or EPA’s, recent finalization of the Clean Air Interstate Rule and the implementation of earlier New Source Review lawsuit settlements brought against a number of utilities by the EPA continue to drive a strong retrofit pollution control market, including add-on pollution control systems, such as low NOx combustion systems, selective catalytic reduction systems and flue gas desulphurization systems. This market trend should benefit sales of our environmental products. Finally, we believe that due to reducing capacity margins, coal utility power plants are running harder to produce more electricity, which in turn is spurring maintenance investment by owners. We also think that owners are making larger capital investments in these plants to extend their lives. We believe these factors are helping to maintain a strong boiler service market, which should benefit our boiler service business.
In Europe, we believe that many of the same market forces discussed above are resulting in similar beneficial market trends for our European power business. We believe that declining power capacity reserves across the region coupled with persistent high oil and natural gas pricing is spurring market growth for large utility coal boilers. Due to Europe’s historical preference for high efficiency coal power plants and the emissions trading scheme regulation, supercritical boiler technology continues to be the preference in the utility boiler market sector. For this market segment, we believe that our supercritical CFB technology significantly increases our opportunity to take full advantage of the substantial domestic coal reserves held by many industrialized nations. In the fourth quarter of 2005, we were awarded a lump-sum turnkey contract for the design, supply and erection of the world’s largest CFB
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boiler and the world’s first supercritical CFB unit in Poland. From the industrial sector, driven by increasing power prices, and high oil and gas pricing, we are seeing growth in the solid fuel industrial power market, which is benefiting sales of our industrial boilers. The European Union, or EU, has established regulation and incentive programs to encourage the use of biomass and other waste fuels, which we believe is spurring growth both in the industrial and utility sectors for our CFB boilers market. We believe that the EU’s new landfill and waste recycling directives has opened a new market for our CFB boilers firing refuse derived fuels. The EU’s Large Combustion Plant Directive, or LCPD, is expected to drive growth in the retrofit pollution control market, which should benefit our environmental products business. Due to the LCPD’s relatively mild first step reduction goals, we do not expect to see significant growth until after 2008 in this sector. Finally, coal utility power plants in Europe are running harder to produce more electricity spurring maintenance and life extension investment by owners. Similar to the U.S., reduced capacity margins are driving this market, which is having a positive effect on the volume of our boiler service sales.
In Asia, we believe that high economic growth continues to drive strong power demand growth and demand for new power capacity. The region’s historically high coal use, now coupled with high world oil and gas pricing, will likely continue to drive growth for coal-fueled utility and industrial boilers in the region. The region contains some of the world’s largest utility and industrial boiler markets, such as China and India, offering significant opportunity for our Global Power Group businesses. Due to the region’s growing environmental awareness, we see significant opportunity for our CFBs as well as our supercritical pulverized coal, or PC, boiler technologies, as well as biomass and opportunity fuel applications. We also see substantial opportunity for our CFB boilers in the potentially large Indian power market resulting from the country’s abundant low quality coals. Further, environmental awareness within China is driving growth in a potentially large retrofit pollution control market offering business opportunities for our environmental products. Finally, reduced capacity margins are also resulting in coal utility power plants being run harder to produce more electricity spurring maintenance and life extension investment by owners, offering further opportunity for our boiler services. Due to these market factors, the Global Power Group is actively marketing our PC and CFB boilers utilizing both conventional as well as supercritical steam designs, as well as our boiler maintenance services on a worldwide scale.
Liquidity and Capital Resources
First Quarter 2006 Activities
In January 2006, we completed transactions which increased the number of common shares to be delivered upon the exercise of our Class A and Class B common share purchase warrants during the offer period and raised $75,300 in net proceeds. The exercise price per warrant was not increased in the offers. Holders of approximately 95% of the Class A warrants and 57% of the Class B warrants participated in the offers resulting in the aggregate issuance of approximately 8,403,500 common shares. We will use the warrant proceeds to redeem the remaining amounts of our 2011 senior notes and trust preferred securities.
As of March 31, 2006, we had cash and cash equivalents on hand, short-term investments and restricted cash totaling $425,600, compared to $372,700 as of December 30, 2005. The increase includes the aforementioned $75,300 in proceeds from the warrant offers, partially offset by cash used in operations of $25,900. Of the $425,600 total at March 31, 2006, $303,000 was held by our foreign subsidiaries. See Note 1 to the condensed consolidated financial statements in this Form 10-Q for additional details on cash and restricted cash balances.
We used cash from operations of $25,900 in the first three months of 2006, compared to using $33,000 of cash from operations during the comparable period in 2005. Our operating cash flow during the first quarter of 2006 was impacted primarily by the funding of $16,400 for asbestos payments and the increased workload of our Global E&C Group. Our working capital varies from period to period depending on the mix, stage of completion and commercial terms and conditions of our contracts. Working capital in our Global E&C Group tends to rise as workload increases while working capital tends to decrease in our Global Power Group when the workload increases. The use of cash in the first quarter of 2005 was attributed primarily to the final phases of one of the legacy power projects in Europe.
Capital expenditures in the first quarter of 2006 were $4,300, compared to $1,000 for the comparable period of 2005. The capital expenditures were primarily related to information technology equipment and office equipment. The first quarter 2006 capital expenditures included approximately $500 of expenditures related to the expansion at
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one of our foreign manufacturing facilities. We anticipate spending an additional $2,700 on this expansion over the remainder of 2006, which we anticipate financing with a local debt facility.
Cash provided by financing activities in the first quarter of 2006 was $78,400, compared to using $19,100 of cash for financing activities in the comparable period in 2005. The cash provided by financing activities in the first quarter 2006 reflects primarily the aforementioned warrant offer proceeds and stock option proceeds. The cash used in financing activities in the first quarter 2005 results primarily from the payment of deferred financing costs of $12,900 in conjunction with the execution of the senior credit agreement.
Outlook
We closely monitor domestic and global liquidity and update our liquidity forecasts weekly. These forecasts cover, among other analyses, existing cash balances, cash flows from operations, cash repatriations from non-U.S. subsidiaries, proceeds from asset sales, working capital needs, unused credit line availability and claims recoveries, if any. Our liquidity forecasts extend over a twelve-month period and continue to indicate that sufficient liquidity will be available to fund our working capital needs through such period.
It is customary in the industries in which we operate to provide standby letters of credit, bank guarantees or performance bonds in favor of clients to secure obligations under contracts. We are required in certain circumstances to provide security to banks and the surety to obtain new standby letters of credit, bank guarantees and performance bonds. Certain of our European subsidiaries are required to and have cash collateralized $8,700 and $15,600 of their bonding requirements as of March 31, 2006 and December 30, 2005, respectively. Providing cash collateral increases working capital needs and limits our ability to repatriate funds from operating subsidiaries.
Our domestic operating entities do not generate sufficient cash flow to cover the costs related to our indebtedness, obligations to fund U.S. pension plans, asbestos-related liabilities and corporate overhead expenses. Consequently, we require cash repatriations from our non-U.S. subsidiaries in the normal course of our operations to meet our domestic cash needs and have successfully repatriated cash for many years. Our current 2006 forecast assumes total cash repatriation from our non-U.S. subsidiaries of approximately $107,500 from royalties, management fees, intercompany loans, debt service on intercompany loans and/or dividends. We repatriated $51,500 and $26,400 from our non-U.S. subsidiaries in the first three months of 2006 and 2005, respectively.
Our non-U.S. subsidiaries need to keep certain amounts available for working capital purposes, to pay known liabilities and for other general corporate purposes. In addition, certain of our non-U.S. subsidiaries are subject to statutory requirements in their jurisdictions of organization that restrict the amount of funds that such subsidiaries may distribute. These factors limit our ability to repatriate funds held by certain of our non-U.S. subsidiaries. However, we believe we could repatriate additional cash from certain other of our foreign subsidiaries should we desire and also have access to the domestic revolving credit facility.
We funded $16,400 of asbestos liabilities from our own cash flow in the first quarter 2006. While we expect active settlement negotiations with unsettled insurers to continue during 2006, we may determine that the appropriate course of action is to continue to fund a portion of our asbestos liabilities during 2006 while the coverage litigation and settlement negotiations continue. If we elect to continue this course of action, we may spend from our cash flow up to an additional $34,600 in the balance of 2006. This estimate assumes no additional settlements with insurance companies and is considered in our liquidity forecast. This forecast also assumes that the proposed asbestos trust fund legislation recently considered in the U.S. Senate will not become law. This proposed legislation, should it become law in its present form, would alter our payment obligations. We would be required to fund approximately $19,250 per year for 30 years and thus such legislation could have a material adverse impact on our financial condition, results of operations and long-term cash flow. (For further information, see risk factor entitled “Proposed national asbestos trust fund legislation could require us to pay amounts in excess of current estimates of our net asbestos liability, which could adversely affect our financial condition, results of operations and long-term cash flow”).
Our subsidiaries from time to time have entered into settlement and release agreements that resolved coverage litigation between them and certain asbestos insurance companies. These agreements generally restrict proceeds from the settlements for use by or on behalf of our subsidiaries for asbestos indemnity and defense costs. The proceeds remaining available to be collected under settlement agreements entered into in 2003 and 2004 can be used solely for such purposes.
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We have $29,700 in pending and to be submitted requests for equitable adjustment, or REAs, of which $11,900 was recorded in contracts in process on our condensed consolidated balance sheet as of March 31, 2006. The REAs, which relate to a project currently being executed for a U.S. government agency, include work performed and to be performed through 2008 over which time we expect to recover the total amount of the REAs. We are continuing to negotiate with the U.S government agency regarding these REAs as well as potentially restructuring the related contract.
We own a 50.5% interest in Martinez Cogen L.P., or MCLP, which owns and operates a natural gas fired cogeneration facility located at, and supplying most of its electrical and steam output to, an oil refinery in Martinez, California. MCLP’s financial condition, results of operations and cash flows are impacted by, among other things, the cost of natural gas and the electric tariffs upon which most of its revenues are based. The electric tariffs are set by independent regulatory agencies and are updated periodically. Over the last year, the cost of natural gas has risen sharply. The increase in the cost of natural gas has not yet been accompanied by a corresponding increase in one of the electric tariffs upon which most of MCLP’s electricity revenues are based. MCLP’s management is exploring ways to improve the foregoing situation, which include preliminary discussions with its refinery customer about the potential for restructuring the agreements between MCLP and the refinery. Further, the natural gas prices and electric tariffs in effect at March 31, 2006 are forecast to be sufficient to generate positive earnings and cash flow for MCLP in 2006. On a related matter, the previously reported equipment issue that led to the suspension of operations at the plant for several days in February 2006 was resolved in May 2006 without any material adverse impact on our results of operations or cash flow.
We maintain several defined benefit pension plans in the United States, United Kingdom, and Canada. Funding requirements for these plans are dependent, in part, on the performance of global capital markets and the discount rates used to calculate the present value of the liability. The poor performance of the global capital markets in the past and low interest rates significantly increased the funding requirements for these plans. The non-U.S. plans are funded from the local operating cash flows while funding for the U.S. plans is included within our U.S. working capital requirements. Our U.S. pension plans are frozen and our U.K. plan is closed to new entrants. The funding requirement for the U.S. plans will approximate $24,800 in 2006 and is projected to decline to essentially zero by 2010. Funding requirements for the foreign plans will approximate $30,100 in 2006 and will be required beyond 2010; however, contribution requirements subsequent to 2010 are not yet available. See Note 4 to the condensed consolidated financial statements in this Form 10-Q for additional information on our pensions.
Please refer to Note 3 to the condensed consolidated financial statements in this Form 10-Q for further information regarding our long-term debt obligations.
Under the terms of our debt and trust preferred securities, we have the ability to redeem or otherwise repurchase certain of our securities. We periodically evaluate whether to repurchase some of our outstanding debt and trust preferred securities. On April 26, 2006, we consummated the exchange of 1,277,900 of our common shares for $50,000 of outstanding aggregate principal amount of our 2011 senior notes. Under the terms of the exchange, the participating holders received 25.558 common shares for each thousand dollars of aggregate principal amount of 2011 senior notes, including accrued and unpaid interest, exchanged. In addition, we called for redemption of the remaining amount of 2011 senior notes and trust preferred securities. On May 25, 2006, we will redeem the remaining $61,468 of outstanding aggregate principal amount of our 2011 senior notes. The remaining $5,963 of outstanding aggregate principal amount of our trust preferred securities will be redeemed on May 26, 2006. The exchange and redemption transactions, which will be reflected in our second quarter 2006 financial statements, will reduce the carrying amount of our debt by approximately $121,100, will reduce the amount of unpaid accrued interest on the trust preferred securities by approximately $3,000, will improve consolidated shareholders’ deficit by approximately $46,300 and will reduce our cash by approximately $79,000. The improvement in consolidated shareholders’ deficit reflects the issuance of new common share equity of approximately $58,700 offset by a primarily non-cash charge to income of approximately $12,400. The charge reflects primarily the difference between the fair market value of the common shares to be issued and the book value of the 2011 senior notes exchanged.
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Holders of our 2011 senior notes have a security interest in the stock, debt and assets of certain Foster Wheeler subsidiaries.
Please refer to Note 13 to the condensed consolidated financial statements in this Form 10-Q for further information regarding our purchase of a special purpose joint venture company in April 2006.
The Board of Directors discontinued the payment of common share dividends in July 2001. We were prohibited from paying dividends under our prior senior credit facility and are prohibited under our new senior credit agreement. Therefore, we paid no dividends during the first three months of 2006 or the full year 2005 and do not expect to pay dividends on our common shares for the foreseeable future.
Capital Structure
We have the following common shares and common share equivalents as of May 3, 2006:
| | Units | | Common Share
Equivalents | |
| |
| |
| |
| | | | | |
Common shares outstanding | | 67,967,095 | | 67,967,095 | |
Convertible preferred shares outstanding | | 3,792 | | 246,945 | |
Stock options outstanding | | 2,687,370 | | 2,687,370 | |
Class A common share purchase warrants outstanding | | 208,618 | | 351,334 | |
Class B common share purchase warrants outstanding | | 14,917,780 | | 1,078,556 | |
Restricted stock units outstanding | | 351,849 | | 351,849 | |
| | | |
| |
Common shares and common share equivalents outstanding | | | | 72,683,149 | |
Common shares available for issuance | | | | 1,708,451 | |
| | | |
| |
Authorized common shares | | | | 74,391,600 | |
| | | |
| |
Off-Balance Sheet Arrangements
We have off-balance sheet financing arrangements in the form of operating leases, purchase commitments, standby letters of credit, bank guarantees and surety bonds. While these represent financial commitments, they are not required to be reported on our balance sheet under GAAP.
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Backlog and New Orders Booked
The backlog of unfilled orders includes amounts based on signed contracts as well as agreed letters of intent, which we have determined are legally binding and likely to proceed. Although backlog represents only business that is considered likely to be performed, cancellations or scope adjustments may occur. The elapsed time from the award of a contract to completion of performance may be up to four years. The dollar amount of backlog is not necessarily indicative of our future earnings related to the performance of such work due to factors outside our control, such as changes in project schedules or project cancellations. We cannot predict with certainty the portion of backlog to be performed in a given year. Backlog is adjusted quarterly to reflect project cancellations, deferrals, revised project scope and cost, and sale of subsidiaries, if any.
Backlog measured in Foster Wheeler scope reflects the dollar value of backlog excluding third-party costs incurred by us on a reimbursable basis as agent or principal (i.e., flow-through costs). Foster Wheeler scope measures the component of backlog with mark-up and corresponds to our services plus fees for reimbursable contracts, and total selling price for lump-sum contracts.
| | Three Months Ended March 31, 2006 | | Three Months Ended April 1, 2005 | |
|
| |
| |
| Global
E&C
Group | | Global
Power
Group | | Total | | Global
E&C
Group | | Global
Power
Group | | Total | |
| |
| |
| |
| |
| |
| |
| |
NEW ORDERS BY PROJECT LOCATION: | |
North America | | $ | 56,300 | | $ | 266,200 | | $ | 322,500 | | $ | 8,800 | | $ | 80,500 | | $ | 89,300 | |
South America | | | 11,300 | | | 42,200 | | | 53,500 | | | 6,600 | | | 5,600 | | | 12,200 | |
Europe | | | 95,800 | | | 64,400 | | | 160,200 | | | 143,300 | | | 80,300 | | | 223,600 | |
Asia | | | 89,300 | | | 41,300 | | | 130,600 | | | 25,200 | | | 8,200 | | | 33,400 | |
Middle East | | | 838,400 | | | 100 | | | 838,500 | | | 86,000 | | | 3,600 | | | 89,600 | |
Australasia and other | | | 24,100 | | | — | | | 24,100 | | | 11,700 | | | 200 | | | 11,900 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 1,115,200 | | $ | 414,200 | | $ | 1,529,400 | | $ | 281,600 | | $ | 178,400 | | $ | 460,000 | |
| |
|
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|
| |
|
| |
|
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|
| |
|
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| | | | | | | | | | | | | | | | | | | |
NEW ORDERS BY INDUSTRY: | |
Power generation | | $ | 1,700 | | $ | 389,900 | | $ | 391,600 | | $ | 75,000 | | $ | 162,200 | | $ | 237,200 | |
Oil refining | | | 157,700 | | | — | | | 157,700 | | | 82,300 | | | — | | | 82,300 | |
Pharmaceutical | | | 44,300 | | | — | | | 44,300 | | | 19,500 | | | — | | | 19,500 | |
Oil and Gas | | | 49,000 | | | — | | | 49,000 | | | 70,400 | | | — | | | 70,400 | |
Chemical/petrochemical | | | 850,200 | | | — | | | 850,200 | | | 47,100 | | | — | | | 47,100 | |
Power plant operation | | | — | | | 25,200 | | | 25,200 | | | — | | | 25,000 | | | 25,000 | |
Environmental | | | 4,500 | | | — | | | 4,500 | | | 21,100 | | | — | | | 21,100 | |
Eliminations and others | | | 7,800 | | | (900 | ) | | 6,900 | | | (33,800 | ) | | (8,800 | ) | | (42,600 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 1,115,200 | | $ | 414,200 | | $ | 1,529,400 | | $ | 281,600 | | $ | 178,400 | | $ | 460,000 | |
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|
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|
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|
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| | March 31, 2006 | | April 1, 2005 | |
| |
| |
| |
| | Global
E&C
Group | | Global
Power
Group | | Total | | Global
E&C
Group | | Global
Power
Group | | Total | |
| |
| |
| |
| |
| |
| |
| |
BACKLOG (FUTURE REVENUES) BY CONTRACT TYPE: | |
Lump-sum turnkey | | $ | 340,900 | | $ | 274,400 | | $ | 615,300 | | $ | 409,600 | | $ | 36,400 | | $ | 446,000 | |
Other fixed-price | | | 258,100 | | | 687,400 | | | 945,500 | | | 166,600 | | | 549,200 | | | 715,800 | |
Reimbursable | | | 2,851,100 | | | 231,400 | | | 3,082,500 | | | 789,500 | | | 60,500 | | | 850,000 | |
Eliminations | | | (57,400 | ) | | (32,500 | ) | | (89,900 | ) | | (64,800 | ) | | (32,500 | ) | | (97,300 | ) |
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|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 3,392,700 | | $ | 1,160,700 | | $ | 4,553,400 | | $ | 1,300,900 | | $ | 613,600 | | $ | 1,914,500 | |
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| |
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| | | | | | | | | | | | | | | | | | | |
BACKLOG (FUTURE REVENUES) BY PROJECT LOCATION: | |
North America | | $ | 127,900 | | $ | 596,400 | | $ | 724,300 | | $ | 72,000 | | $ | 273,500 | | $ | 345,500 | |
South America | | | 104,800 | | | 53,800 | | | 158,600 | | | 23,400 | | | 13,000 | | | 36,400 | |
Europe | | | 388,000 | | | 375,500 | | | 763,500 | | | 611,500 | | | 163,200 | | | 774,700 | |
Asia | | | 275,800 | | | 131,500 | | | 407,300 | | | 182,600 | | | 155,300 | | | 337,900 | |
Middle East | | | 1,620,000 | | | 1,300 | | | 1,621,300 | | | 262,000 | | | 7,300 | | | 269,300 | |
Australasia and other | | | 876,200 | | | 2,200 | | | 878,400 | | | 149,400 | | | 1,300 | | | 150,700 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 3,392,700 | | $ | 1,160,700 | | $ | 4,553,400 | | $ | 1,300,900 | | $ | 613,600 | | $ | 1,914,500 | |
| |
|
| |
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|
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|
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|
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|
| |
| | | | | | | | | | | | | | | | | | | |
BACKLOG (FUTURE REVENUES) BY INDUSTRY: | |
Power generation | | $ | 128,800 | | $ | 1,033,700 | | $ | 1,162,500 | | $ | 281,400 | | $ | 534,100 | | $ | 815,500 | |
Oil refining | | | 884,300 | | | — | | | 884,300 | | | 342,500 | | | — | | | 342,500 | |
Pharmaceutical | | | 139,000 | | | — | | | 139,000 | | | 165,000 | | | — | | | 165,000 | |
Oil and Gas | | | 1,078,500 | | | — | | | 1,078,500 | | | 183,000 | | | — | | | 183,000 | |
Chemical/petrochemical | | | 1,062,100 | | | — | | | 1,062,100 | | | 186,500 | | | — | | | 186,500 | |
Power plant operation | | | — | | | 128,000 | | | 128,000 | | | — | | | 111,800 | | | 111,800 | |
Environmental | | | 17,600 | | | — | | | 17,600 | | | 107,900 | | | — | | | 107,900 | |
Eliminations and others | | | 82,400 | | | (1,000 | ) | | 81,400 | | | 34,600 | | | (32,300 | ) | | 2,300 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 3,392,700 | | $ | 1,160,700 | | $ | 4,553,400 | | $ | 1,300,900 | | $ | 613,600 | | $ | 1,914,500 | |
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Foster Wheeler scope in backlog | | $ | 1,339,000 | | $ | 1,146,400 | | $ | 2,485,400 | | $ | 930,700 | | $ | 600,700 | | $ | 1,531,400 | |
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| | | | | | | | | | | | | | | | | | | |
E&C man-hours in
backlog (in thousands) | | | 10,206 | | | | | | 10,206 | | | 5,337 | | | | | | 5,337 | |
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| |
The overall increase in consolidated backlog as of March 31, 2006, compared to April 1, 2005, is attributable primarily to our Global E&C Group, where we have won a number of significant contracts. In the first quarter of 2006, our Global E&C Group’s awards included an engineering, procurement and construction, or EPC, contract for the utilities and offsite work at a world-scale integrated refining and petrochemical complex in Rabigh, Saudi Arabia, an engineering, procurement and construction management, or EPCm, contract for a ethylene oxide/mono-ethylene glycol unit in Kuwait, and an EPC contract for safety automating services of the unheading and valve interlock systems on the delayed coking unit at a refinery in the United States. Our Global Power Group was awarded a design and supply, or D&S, contract to provide two CFB boilers to be used at a proposed solid-fuel generating unit at a power station in Louisiana, a D&S contract for two CFB boilers for an alumina refinery in South America, and a design, supply and erection contract for a peat and bio-mass-fired CFB boiler island unit for a heat and power plant in Finland.
The increase in consolidated new orders for the three months ended March 31, 2006 is attributable to both our Global E&C and Global Power Groups and reflects the awards noted above.
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Inflation
The effect of inflation on our revenues and earnings is minimal. Although a majority of our revenues are realized under long-term contracts, the selling prices of such contracts, established for deliveries in the future, generally reflect estimated costs to complete in these future periods. In addition, some contracts provide for price adjustments through escalation clauses.
Application of Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America. Management and the Audit Committee of the Board of Directors approve the critical accounting policies.
Highlighted below are the accounting policies that we consider significant to the understanding and operations of our business as well as key estimates that are used in implementing the policies. Several of the critical accounting policies and estimates are discussed in the notes to the condensed consolidated financial statements and in Management’s Discussion and Analysis of Financial Condition and Results of Operations as referenced below. A full discussion of our critical accounting policies and estimates is included in our 2005 Form 10-K. The only significant change to our application of critical accounting policies and estimates is our adoption of SFAS No. 123R, “Share Based Payment,” at the start of 2006, as discussed below.
Revenue Recognition
Refer to Note 1 to the condensed consolidated financial statements in this Form 10-Q, “Summary of Significant Accounting Policies – Revenue Recognition on Long-Term Contracts.”
Asbestos
Refer to Note 11 to the condensed consolidated financial statements in this Form 10-Q, “Litigation and Uncertainties.”
Pension and Postretirement Benefits
We have several defined benefit pension plans in the United States, the United Kingdom and Canada. We also have defined postretirement benefit plans for health care and life insurance benefits in the United States and Canada. The U.S. plans are frozen and the U.K. plan is closed to new entrants. Details of our pension and postretirement benefit plans are included in Note 4 to the condensed consolidated financial statements in this Form 10-Q.
The calculations of pension and postretirement benefit liabilities, annual service cost and cash contributions required rely heavily on estimates about future events often extending decades into the future. We are responsible for establishing the assumptions used for the estimates, which include:
| • | The discount rate used to present value the future obligations; |
| • | The expected long-term rate of return on plan assets; |
| • | The expected percentage of annual salary increases; |
| • | The selection of the actuarial mortality tables; and |
| • | The annual inflation percentage. |
We utilize our business judgment in establishing the estimates used in the calculations of pension and postretirement benefit liabilities, annual service cost and cash contributions. These estimates are updated on an annual basis at the beginning of each year or more frequently upon the occurrence of significant events. The estimates can vary significantly from the actual results and we cannot provide any assurance that the estimates used to calculate the pension and postretirement benefit liabilities included herein will approximate actual results. The volatility between the assumptions and actual results can be significant.
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Share-Based Compensation Plans
We have share-based compensation plans that reserve common shares for issuance to key employees and directors. Prior to December 31, 2005, we accounted for such share-based employee compensation plans under the measurement and recognition provisions of APB No. 25, “Accounting for Stock Issued to Employees,” as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” Accordingly, we used the intrinsic value method of accounting for our stock option awards and did not recognize compensation expense for stock options that were granted at an exercise price equal to or greater than the market price of our common stock on the date of grant. As a result, the recognition of share-based compensation expense was generally limited to the expense attributed to restricted stock awards. In accordance with SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” we provided pro forma net income or loss and net earnings or loss per common share disclosures for each period prior to December 31, 2005, as if we had applied the fair value-based method in measuring compensation expense for our share-based compensation plans, including stock options.
Effective December 31, 2005, we adopted the fair value provisions of SFAS No. 123R, “Share-Based Payment,” using the modified prospective transition method. Under this method, we will recognize share-based compensation expense for (i) all share-based payments granted prior to, but not yet vested as of, December 31, 2005, based on the grant date fair value originally estimated in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” and (ii) all future share-based payment awards based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Because we elected to use the modified prospective transition method, results for prior periods have not been restated.
The compensation cost that has been charged against income for our share-based compensation plans was $4,000 and $2,100 for the first three months of 2006 and 2005, respectively. The total income tax benefit recognized in the condensed consolidated statement of operations and comprehensive income was $80 and $87 for the first three months of 2006 and 2005, respectively. We received $5,900 in cash from option exercises under our share-based compensation plans for the three months ended March 31, 2006.
As of March 31, 2006, there was $4,800 and $6,000 of total unrecognized compensation cost related to stock options and restricted awards, respectively. Those costs are expected to be recognized over a weighted-average period of 9 months and 8 months, respectively.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model, which incorporates assumptions regarding a number of complex and subjective variables. We then recognize the fair value of each option as compensation cost ratably using the straight-line attribution method over the service period (generally the vesting period). The Black-Scholes model incorporates the following assumptions:
| | • | Expected volatility – we estimate the volatility of our common stock at the date of grant using a combination of unadjusted historical volatility, historical volatility adjusted for periods of unusual stock price activity, volatility of comparable companies and other factors. |
| | • | Expected term – we estimate the expected term of options granted based on a combination of vesting schedules, life of the option, historical experience and estimates of future exercise behavior patterns. |
| | • | Risk-free interest rate – we estimate the risk-free interest rate using the U.S. Treasury yield curve for periods equal to the expected life of the options in effect at the time of grant. |
| | • | Dividends – we use an expected dividend yield of zero since we are restricted from paying dividends under our senior credit agreement and, accordingly, we do not anticipate paying dividends in the foreseeable future. |
| | • | Forfeitures – we estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use a combination of historical data, demographic characteristics and other factors to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For purposes of calculating pro forma information under SFAS No. 123 for periods prior to December 31, 2005, we accounted for forfeitures as they occurred. The cumulative effect adjustment related to forfeitures upon adoption of SFAS No. 123R was immaterial. |
If factors change and we employ different assumptions in the application of SFAS No. 123R in future periods, the compensation expense that we record under SFAS No. 123R for future awards may differ significantly
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from what we have recorded in the current period. There is a high degree of subjectivity involved in selecting the option pricing model assumptions used to estimate share-based compensation expense under SFAS No. 123R. Option pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, existing valuation models may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration or forfeiture of those share-based payments in the future. Stock options may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that is significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements.
There are significant differences among valuation models. This may result in a lack of comparability with other companies that use different models, methods and assumptions. There is also a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and may materially affect the fair value estimate of share-based payments.
Goodwill and Intangible Assets
Each year, we evaluate goodwill for potential impairment, as prescribed by SFAS No. 142, “Goodwill and Other Intangible Assets.” We test for impairment at the reporting unit level as defined in SFAS No. 142. This test is a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value, which is based on future cash flows, exceeds the carrying amount, goodwill is not considered impaired. If the carrying amount exceeds the fair value, the second step must be performed to measure the amount of the impairment loss, if any. The second step compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. In the fourth quarter of each year, we evaluate goodwill on a separate reporting unit basis to assess recoverability, and impairments, if any, are recognized in earnings. An impairment loss would be recognized in an amount equal to the excess of the carrying amount of the goodwill over the implied fair value of the goodwill. SFAS No. 142 also requires that intangible assets with determinable useful lives be amortized over their respective estimated useful lives and reviewed annually for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” In 2005, the evaluation indicated that no adjustment to the carrying value of goodwill was required.
Income Taxes
Refer to Note 1 to the condensed consolidated financial statements in this Form 10-Q, “Summary of Significant Accounting Policies – Income Taxes.”
Liquidity Forecasting
Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in this Form 10-Q.
Accounting Developments
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments,” which amends SFAS No. 133 and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FW PREFERRED CAPITAL TRUST I
(amounts in thousands of dollars)
FW Preferred Capital Trust I, or the Capital Trust, is a 100% indirectly-owned finance subsidiary of Foster Wheeler Ltd. In 1999, the Capital Trust issued $175,000 of trust preferred securities. The Capital Trust invested the proceeds from the trust preferred securities in an equal principal amount of 9% junior subordinated deferrable interest debentures, or the debentures, of Foster Wheeler LLC.
Prior to December 27, 2003 the Capital Trust was consolidated in our financial statements. In 2004, we adopted FIN No. 46, “Consolidation of Variable Interest Entities,” which we refer to as FIN No. 46, for variable interest entities formed prior to February 1, 2003. In accordance with the provisions of FIN No. 46, we determined that although the Capital Trust is a variable interest entity, Foster Wheeler Ltd. is not the primary beneficiary. Accordingly, we de-consolidated the Capital Trust as of December 27, 2003. Our condensed consolidated financial statements reflect Foster Wheeler LLC’s obligations to the Capital Trust as subordinated deferrable interest debentures and deferred accrued interest on subordinated deferrable interest debentures. The interest expense on the debentures is reported as interest expense in the condensed consolidated statement of operations and comprehensive income.
The following is management’s discussion and analysis of certain significant factors that have affected the financial condition and results of operations of the Capital Trust for the periods indicated below. This management’s discussion and analysis and other sections of this quarterly report on Form 10-Q contain forward-looking statements that are based on management’s assumptions, expectations and projections about the Capital Trust. Such forward-looking statements by their nature involve a degree of risk and uncertainty.
Overview – The Capital Trust
The financial condition and results of operations of the Capital Trust are dependent on the financial condition and results of operations of Foster Wheeler Ltd. and Foster Wheeler LLC since the Capital Trust’s only assets are the debentures. The Capital Trust’s only source of income and cash is the interest income on the debentures. These debentures have essentially the same terms as the trust preferred securities. Therefore, the Capital Trust can only make payments on the trust preferred securities if Foster Wheeler LLC first makes payments on the debentures.
Since January 15, 2002, Foster Wheeler LLC has exercised its right to defer payments on the debentures. The previous senior credit facility required Foster Wheeler LLC to defer the payment of the dividends on the trust preferred securities; while the new senior credit agreement requires the approval of the lenders to make payments on the trust preferred securities to the extent such payments are not contractually required by the underlying trust preferred securities agreements. Accordingly, no dividends were paid during the first three months of 2006 or the full year 2005.
In September 2004, Foster Wheeler Ltd. completed an equity-for-debt exchange offer in which it issued common shares, preferred shares and common share purchase warrants of Foster Wheeler Ltd. in exchange for trust preferred securities. In conjunction with the exchange, the Capital Trust recorded a $103,800 reduction in the trust preferred securities and a $31,100 reduction in deferred accrued mandatorily redeemable preferred security distributions payable. The Capital Trust also recorded a corresponding reduction in the debentures and accrued interest receivable.
In August 2005, Foster Wheeler Ltd. completed another equity-for-debt exchange in which it issued common shares of Foster Wheeler Ltd. in exchange for the remaining portion of the trust preferred securities. In conjunction with the exchange, the Capital Trust recorded a $65,200 reduction in the aggregate liquidation amount of existing trust preferred securities and a $26,100 reduction in deferred accrued mandatorily redeemable preferred security distributions payable. The Capital Trust also recorded a corresponding decrease in the debentures and accrued interest receivable.
On May 26, 2006, we will redeem the remaining $5,963 of outstanding aggregate principal amount of trust preferred securities.
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Results of Operations – The Capital Trust
| | Three Months Ended |
| |
|
| | March 31,
2006 | | April 1,
2005 | | $
Change | | % Change | |
| |
| |
| |
| |
| |
| | | | | | | | | |
Interest income | | — | | — | | — | | N/M | |
| | | | | | | | | |
(Increase)/decrease in valuation allowance | | (300 | ) | 13,900 | | (14,200 | ) | (102.2 | )% |
| | | | | | | | | |
Preferred security distributions expense | | 200 | | 2,100 | | (1,900 | ) | (90.5 | )% |
| | | | | | | | | |
N/M - not meaningful. | | | | | | | | | |
SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” states that “a loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.” SFAS No. 114 requires that the measurement of impairment be based on one of several methods including the loan’s observable market price. The Capital Trust has established a valuation allowance on the interest income receivable based on the market price of the trust preferred securities, which is deemed a proxy for the debentures’ observable market price. Accordingly, the Capital Trust has not recorded interest income in the first three months of 2006 and 2005. Changes in the valuation allowance result from changes in the market price of the trust preferred securities. The market price per security of the trust preferred securities was $35.25 as of March 31, 2006, $37.20 as of December 30, 2005, $31.92 as of April 1, 2005 and $27.05 as of December 31, 2004.
The preferred security distributions expense represents the accrual for cash distributions due on the trust preferred securities. Distributions accrue at an annual rate of 9% on the outstanding liquidation amount of the trust preferred securities, compounded quarterly. Additionally, deferred distributions accrue interest at an annual rate of 9%, compounded quarterly, as well. The decrease in preferred security distributions expense in the first three months of 2006 results primarily from the reduction in the amount of trust preferred securities outstanding as a result of the equity-for-debt exchanges. As noted previously, the Capital Trust has deferred the distributions on the trust preferred securities in conjunction with Foster Wheeler LLC’s decision to defer interest payments on the debentures since January 15, 2002.
Financial Condition – The Capital Trust
The investment in subordinated deferrable interest debentures was $6,000 as of March 31, 2006 and December 30, 2005. The accrued interest receivable on the subordinated deferrable interest debentures, net of the valuation allowance, decreased from $2,700 as of December 30, 2005 to $2,400 as of March 31, 2006, as a result of the increase in the valuation allowance. The deferred accrued mandatorily redeemable preferred security distributions payable increased from $2,700 as of December 30, 2005 to $2,900 as of March 31, 2006, as a result of the accrual of interest expense.
Liquidity and Capital Resources – The Capital Trust
The Capital Trust’s ability to continue is dependent on Foster Wheeler Ltd.’s and Foster Wheeler LLC’s financial condition as the Capital Trust’s only asset is the debentures. Foster Wheeler LLC, an indirect wholly owned subsidiary of Foster Wheeler Ltd., is essentially a holding company that owns the stock of various subsidiary companies, and is included in our condensed consolidated financial statements.
Safe Harbor Statement
This management’s discussion and analysis of financial condition and results of operations, other sections of this quarterly report on Form 10-Q and other reports and oral statements made by Foster Wheeler representatives from time to time may contain forward-looking statements that are based on our assumptions, expectations and projections about Foster Wheeler and the various industries within which we operate. These include statements
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regarding our expectation about revenues (including as expressed by our backlog), our liquidity, the outcome of litigation and legal proceedings and recoveries from customers for claims, and the costs of current and future asbestos claims and the amount and timing of insurance recoveries. Such forward-looking statements by their nature involve a degree of risk and uncertainty. We caution that a variety of factors, including but not limited to the factors described under Part II, Item 1A. “Risk Factors” and the following, could cause business conditions and results to differ materially from what is contained in forward-looking statements:
| • | changes in the rate of economic growth in the United States and other major international economies; |
| • | changes in investment by the power, oil & gas, pharmaceutical, chemical/petrochemical and environmental industries; |
| • | changes in the financial condition of our customers; |
| • | changes in regulatory environment; |
| • | changes in project design or schedules; |
| • | changes in our estimates of costs to complete projects; |
| • | changes in trade, monetary and fiscal policies worldwide; |
| • | war and/or terrorist attacks on facilities either owned or where equipment or services are or may be provided; |
| • | outcomes of pending and future litigation, including litigation regarding our liability for damages and insurance coverage for asbestos exposure; |
| • | protection and validity of our patents and other intellectual property rights; |
| • | increasing competition by foreign and domestic companies; |
| • | compliance with our debt covenants; |
| • | recoverability of claims against our customers and others; and |
| • | changes in estimates used in our critical accounting policies. |
Other factors and assumptions not identified above were also involved in the formation of these forward-looking statements and the failure of such other assumptions to be realized, as well as other factors, may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described above in connection with any forward-looking statements that may be made by us.
We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any additional disclosures we make in proxy statements, quarterly reports on Form 10-Q, annual reports on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(amounts in thousands of dollars)
Our strategy for managing transaction risks associated with currency fluctuations is for each operating unit to enter into derivative transactions, such as foreign currency forward exchange contracts, to hedge its exposure on contracts into the operating unit’s functional currency. We utilize all such financial instruments solely for hedging. Our company policy prohibits the speculative use of such instruments. The counterparties to such financial instruments expose us to credit loss in the event of nonperformance. To minimize this risk, we enter into these financial instruments with financial institutions that are primarily rated “BBB+” or better by Standard & Poor’s (or the equivalent by other recognized credit rating agencies).
Interest Rate Risk — We are exposed to changes in interest rates primarily as a result of our borrowings, if any, under our senior credit agreement (there were no such borrowings as of March 31, 2006) and our variable rate project debt. If market rates average 1% more in 2006 than in 2005, our interest expense for the next twelve months would increase, and income before tax would decrease by approximately $50. This amount has been determined by considering the impact of the hypothetical interest rates on our variable-rate balances as of March 31, 2006.
Foreign Currency Risk — We operate on a worldwide basis with substantial operations in Europe that subject us to translation risk on the Euro and British pound sterling. All significant activities of our non-U.S. affiliates are recorded in their functional currency, which is typically the country of domicile of the affiliate. While this mitigates the potential impact of earnings fluctuations as a result of changes in foreign currency exchange rates, our affiliates do enter into transactions through the normal course of operations in currencies other than their functional currency. We seek to minimize the resulting exposure to foreign currency fluctuations by matching the revenues and expenses in the same currency for our long-term contracts. We further mitigate these foreign currency exposures through the use of foreign currency forward exchange contracts to hedge the exposed item, such as anticipated purchases or revenues, back to their functional currency.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the interim period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Disclosure Committee and management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) pursuant to Exchange Act Rule 13a-15. Based on this evaluation, and as of March 31, 2006, our chief executive officer and our chief financial officer concluded, at the reasonable assurance level, that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including the chief executive officer and the chief financial officer, we conducted an evaluation
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of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 30, 2005.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting in the first quarter of 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. | OTHER INFORMATION |
Refer to Note 11 to the condensed consolidated financial statements in this Form 10-Q for a discussion of legal proceedings, which is incorporated by reference in this Part II.
Risk Factors Relating to Our Business
Our business is subject to a number of risks and uncertainties, including those described below. If any of these events occur, our business could be harmed and the trading price of our securities could decline. The following discussion of risks relating to our business should be read carefully in connection with evaluating our business, prospects and the forward-looking statements contained in this report on Form 10-Q. For additional information regarding forward-looking statements, see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Safe Harbor Statement.”
Our domestic operating entities do not generate sufficient cash flow to cover the costs related to our indebtedness, obligations to fund U.S. pension plans, asbestos-related liabilities and corporate overhead expenses. Consequently, we require cash repatriations from our non-U.S. subsidiaries in the normal course of our operations to meet our domestic cash needs. Our ability to repatriate funds from our non-U.S. subsidiaries is limited by a number of factors. Accordingly, we are limited in our ability to use the funds held by our non-U.S. subsidiaries for working capital purposes, to repay debt or to satisfy other obligations.
As of March 31, 2006, we had corporate debt of $151,500, limited recourse project specific debt of $96,100, and capital lease obligations of $64,800. The corporate debt must be serviced with cash repatriations from our operating subsidiaries and/or from the proceeds of financings. In addition, as of March 31, 2006, we had $598,900 of undrawn letters of credit, bank guarantees and surety bonds issued and outstanding, $9,200 of which were cash collateralized. As of March 31, 2006, we had cash, cash equivalents, short-term investments and restricted cash of $425,600, of which $303,000 was held by our non-U.S. subsidiaries. Our current 2006 forecast assumes total cash repatriation from our non-U.S. subsidiaries of $107,500 from royalties, management fees, intercompany loans, debt service on intercompany loans and/or dividends. There can be no assurance that the forecasted foreign cash repatriation will occur as our non-U.S. subsidiaries need to keep certain amounts available for working capital purposes, to pay known liabilities, and for other general corporate purposes. Such amounts exceed, and are not directly comparable to, the foreign component of restricted cash. In addition, certain of our non-U.S. subsidiaries are parties to loan, bank guarantee and other agreements that contain covenants, and are subject to statutory requirements in their jurisdictions of organization that restrict the amount of funds that such subsidiaries may distribute. The repatriation of funds may also subject those funds to taxation. As a result of these factors, we may not be able to repatriate and utilize funds held by our non-U.S. subsidiaries in the amount forecasted above.
If we have a material weakness in our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected.
Although we had no material weaknesses as of December 30, 2005, we have reported material weaknesses in our internal control over financial reporting in the past. We cannot assure that we will avoid a material weakness in the future. If we have another material weakness in our internal control over financial reporting in the future, it could adversely impact our ability to report our financial results in a timely and accurate manner.
Our international operations involve risks that may limit or disrupt operations, limit repatriation of cash, increase foreign taxation or otherwise have a material adverse effect on our business, financial condition, results of operations and cash flow.
We have substantial international operations that are conducted through foreign and domestic subsidiaries, as well as through agreements with foreign joint-venture partners. Our international operations accounted for approximately 80% of our fiscal year 2005 operating revenues and substantially all of our operating cash flow. We have international operations in Europe, Asia, Africa and South America. Our foreign operations are subject to risks that could materially adversely affect our business, financial condition, results of operations and cash flow, including:
| • | uncertain political, legal and economic environments; |
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| • | potential incompatibility with foreign joint venture partners; |
| • | foreign currency controls and fluctuations; |
| • | energy prices and availability; |
| • | the imposition of additional governmental controls and regulations; |
| • | war and civil disturbances; and |
Because of these risks, our international operations may be limited, or disrupted; we may lose contract rights; our foreign taxation may be increased; or we may be limited in repatriating earnings. In addition, in some cases, applicable law and joint venture or other agreements may provide that each joint venture partner is jointly and severally liable for all liabilities of the venture. These potential events and liabilities could have a material adverse effect on our business, financial condition, results of operations and cash flow.
Our debt levels and significant interest payment obligations could limit the funds we have available for working capital, capital expenditures, dividend payments, acquisitions and other business purposes, which could adversely impact our business.
As of March 31, 2006, we had corporate debt of $151,500, limited recourse project specific debt of $96,100, and capital lease obligations of $64,800. We may not have sufficient funds available to pay all of the debt upon maturity.
Over the last five years, we have been required to allocate a significant portion of our cash flow to pay interest on debt. After paying interest on debt, we have fewer funds available for working capital, capital expenditures, acquisitions and other business purposes. This could limit our ability to respond to changing market conditions, limit our ability to expand through acquisitions, increase our vulnerability to adverse economic and industry conditions and place us at a competitive disadvantage compared to our competitors that have less indebtedness. Our estimated 2006 cash requirements for interest and principal debt service are approximately $50,700.
Certain of our various debt agreements impose significant financial covenants, which may prevent us from capitalizing on business opportunities and taking certain corporate actions, which could materially adversely affect our business, financial condition, results of operations and cash flow.
Our senior credit agreement imposes significant financial covenants on us. These covenants limit our ability to incur indebtedness, pay dividends or make other distributions, make investments and sell assets. Failure to comply with these covenants may allow lenders to elect to accelerate the repayment dates under this debt. We may not be able to repay such obligations if accelerated. Our failure to repay such obligations under our senior credit agreement and our other debt obligations would have a material adverse effect on our business, financial condition, results of operations and cash flow and result in defaults under the terms of our other indebtedness.
We face limitations on our ability to obtain new letters of credit, bank guarantees and performance bonds from banks and surety on the same terms as we have historically. If we were unable to obtain letters of credit, bank guarantees, or performance bonds on reasonable terms, our business, financial condition, results of operations and cash flow would be materially adversely affected.
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It is customary in the industries in which we operate to provide letters of credit, bank guarantees or performance bonds in favor of clients to secure obligations under contracts.
We may not be able to continue obtaining new letters of credit, bank guarantees, and performance bonds in sufficient quantities to match our business requirements. If our financial condition deteriorates, we may also be required to provide cash collateral or other security to maintain existing letters of credit, bank guarantees and performance bonds. If this occurs, our ability to perform under existing contracts may be adversely affected.
Our current and future lump-sum or fixed-price contracts and other shared risk contracts may result in significant losses if costs are greater than anticipated.
Some of our contracts are lump-sum contracts and other shared-risk contracts that are inherently risky because we agree to the selling price of the project at the time we enter into the contracts. The selling price is based on estimates of the ultimate cost of the contract and we assume substantially all of the risks associated with completing the project, as well as the post-completion warranty obligations.
We assume the project’s technical risk, meaning that we must tailor products and systems to satisfy the technical requirements of a project even though, at the time the project is awarded, we may not have previously produced such a product or system. We also assume the risks related to revenue, cost and gross profit realized on such contracts that can vary, sometimes substantially, from the original projections due to changes in a variety of other factors, including but not limited to:
| • | unanticipated technical problems with the equipment being supplied or developed by us, which may require that we spend our own money to remedy the problem; |
| • | changes in the costs of components, materials or labor; |
| • | difficulties in obtaining required governmental permits or approvals; |
| • | changes in local laws and regulations; |
| • | changes in local labor conditions; |
| • | project modifications creating unanticipated costs; |
| • | delays caused by local weather conditions; and |
| • | our suppliers’ or subcontractors’ failure to perform. |
These risks are exacerbated as most projects are long-term that result in increased risk that the circumstances upon which we based our original bid will change in a manner that increases our costs. In addition, we sometimes bear the risk of delays caused by unexpected conditions or events. Long-term, fixed-price projects often make us subject to penalties if portions of the project are not completed in accordance with agreed-upon time limits. Therefore, significant losses can result from performing large, long-term projects on a lump-sum basis. These losses may be material and could negatively impact our business, financial condition, results of operations and cash flow.
We may increase the size and number of lump-sum turnkey contracts, sometimes in countries where we have limited previous experience.
We may bid for and enter into such contracts through partnerships or joint ventures with third parties that have greater bonding capacity than we do. This would increase our ability to bid for the contracts. Entering into these partnerships or joint ventures will expose us to credit and performance risks of those third-party partners, which could have a negative impact on our business and our results of operations if these parties fail to perform under the arrangements.
We also perform government contracts containing fixed labor rates that are subject to audit by governmental agencies. These audits can occur several years after completion of the project and could result in claims for reimbursement from us. These reimbursement amounts could be materially different than estimated, which could have a negative impact on our results of operations and cash flow.
We may have high working capital requirements in the near term and we may have difficulty obtaining financing, which could have a negative impact on our business, financial condition, results of operations and cash flow.
Our business requires a significant amount of working capital and our U.S. operations do not generate sufficient cash flow to cover the costs related to our indebtedness, obligations to fund U.S. pension plans, asbestos-related liabilities and corporate overhead expenses. In some cases, significant amounts of working capital are required to finance the purchase of materials and performance of engineering, construction and other work on
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projects before payment is received from customers. In some cases, we are contractually obligated to our customers to fund working capital on our projects. Moreover, we may need to incur additional indebtedness in the future to satisfy our working capital needs. As a result, we are subject to risks associated with debt financing, including insufficient cash flow to meet our required debt payments and the inability to meet our credit facility covenants.
Our working capital requirements may increase if we are required to give our customers more favorable payment terms under contracts in order to compete successfully for certain projects. These terms may include reduced advance payments from customers and payment schedules from customers that are less favorable to us. In addition, our working capital requirements have increased in recent years because we have had to advance funds to complete projects under lump-sum contracts and have been involved in lengthy arbitration or litigation proceedings to recover these amounts from our customers. All of these factors may result, or have resulted, in increases in the amount of contracts in process and receivables and short-term borrowings. Continued increases in working capital requirements would have a material adverse effect on our business, financial condition, results of operations and cash flow.
Projects included in our backlog may be delayed or cancelled, which could materially harm our financial condition, results of operations and cash flow.
The dollar amount of backlog does not necessarily indicate future earnings related to the performance of that work. Backlog refers to expected future revenues under signed contracts and legally binding letters of intent that we have determined are likely to be performed. Backlog projects represent only business that is considered firm, although cancellations or scope adjustments may occur. Most contracts require our clients to pay for work performed to the point of contract cancellation. Due to changes in project scope and schedule, we cannot predict with certainty when or if backlog will be performed. In addition, even where a project proceeds as scheduled, it is possible that contracted parties may default and fail to pay amounts owed to us. Any material delay, cancellation or payment default could materially harm our financial condition, results of operations and cash flow.
Backlog as of March 31, 2006 increased 23% as compared to year-end 2005. However, backlog may decline in the future.
The number and cost of our current and future asbestos claims in the United States could be substantially higher than we have estimated and the timing of payment of claims could be sooner than we have estimated, which could materially adversely affect our financial condition, results of operations and cash flow.
Some of our subsidiaries are named as defendants in numerous lawsuits and out-of-court administrative claims pending in the United States in which the plaintiffs claim damages for alleged bodily injury or death arising from exposure to asbestos in connection with work performed, or heat exchange devices assembled, installed and/or sold, by our subsidiaries. We expect these subsidiaries to be named as defendants in similar suits and claims brought in the future. For purposes of our financial statements, we have estimated the indemnity and defense costs to be incurred in resolving pending and forecasted domestic claims through year-end 2020. Although we believe our estimates are reasonable, the actual number of future claims brought against us and the cost of resolving these claims could be substantially higher than our estimates. Some of the factors that may result in the costs of these claims being higher than our current estimates include:
| • | the rate at which new claims are filed; |
| • | the number of new claimants; |
| • | changes in the mix of diseases alleged to be suffered by the claimants, such as type of cancer, asbestosis or other illness; |
| • | increases in legal fees or other defense costs associated with these claims; |
| • | increases in indemnity payments; |
| • | decreases in the proportion of claims dismissed with zero indemnity payments; |
| • | indemnity payments being required to be made sooner than expected; |
| • | bankruptcies of other asbestos defendants, causing a reduction in the number of available solvent defendants and thereby increasing the number of claims and the size of demands against our subsidiaries; |
| • | adverse jury verdicts requiring us to pay damages in amounts greater than we expect to pay in settlement; |
| • | changes in legislative or judicial standards that make successful defense of claims against our subsidiaries more difficult; or |
| • | enactment of legislation requiring us to contribute amounts to a national settlement trust in excess of our expected net liability, after insurance, in the tort system. |
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The total liability recorded on our balance sheet is based on estimated indemnity and defense costs expected to be incurred through year-end 2020. We believe that it is likely that there will be new claims filed after 2020, but in light of uncertainties inherent in long-term forecasts, we do not believe that we can reasonably estimate the indemnity and defense costs that might be incurred after 2020. Our forecast contemplates that the number of new claims requiring indemnity will decline from year to year. Failure of future claims to decline as we expect may result in our aggregate liability for asbestos claims being higher than estimated.
Since year-end 2004, we have worked with Analysis Research Planning Corporation (“ARPC”), nationally recognized consultants in projecting asbestos liabilities, to estimate the amount of asbestos-related indemnity and defense costs for the following 15-year period. ARPC reviews our asbestos indemnity payments, defense costs and claims activity during the previous year and compares them to our 15-year forecast prepared at the previous year-end. We reduced our estimated year-end 2005 liability for payments and settlements made during the quarter ended March 31, 2006.
In 2005, the number of mesothelioma claims filed against us was significantly higher than forecast. In addition, the average indemnity amounts we paid for both mesothelioma and non-mesothelioma claims were significantly higher than forecast. These factors increase indemnity costs but were partially offset by significantly higher than forecasted rates of dismissals of claims with zero indemnity payments.
Based on their review of 2005 activity, ARPC recommended that the assumptions used to estimate our future asbestos liability over the next 15 years be updated as of year-end 2005. Accordingly, we worked with ARPC to develop a revised estimate of our indemnity and defense costs through 2020. At year-end 2005, we increased our liability for domestic asbestos indemnity and defense costs through 2020 to $516,000, which brought our liability to a level consistent with ARPC’s reasonable best estimate. In connection with updating our estimated asbestos liability and related asset, we recorded a loss of $113,700 in the fourth quarter of 2005. Our liability for asbestos indemnity and defense costs was $497,600 as of March 31, 2006.
Our forecast of the number of future claims is based, in part, on a regression model, which employs the statistical analysis of our historical claims data to generate a trend line for future claims and, in part, on an analysis of future disease incidence. Although we believe this forecast method is reasonable, other forecast methods that attempt to estimate the population of living persons who could claim they were exposed to asbestos at worksites where our subsidiaries performed work or sold equipment, could also be used and might project higher numbers of future claims than our forecast.
As occurred in 2005, the actual number of future claims, the mix of disease types and the amounts of indemnity and defense costs may exceed our current estimates. We annually update our forecasts to take into consideration recent claims experience and other developments, such as legislation, that may affect our estimates of future asbestos-related costs. The announcement of increases to asbestos liabilities as a result of revised forecasts, adverse jury verdicts or other negative developments involving asbestos litigation or insurance recoveries may cause the value or trading prices of our securities to decrease significantly. These negative developments could also negatively impact our liquidity, cause us to default under covenants in our indebtedness, cause our credit ratings to be downgraded, restrict our access to capital markets or otherwise have a material adverse effect on our financial condition, results of operations and cash flow.
The amount and timing of insurance recoveries of our asbestos-related costs in the United States is uncertain. The failure to obtain insurance recoveries could cause a material adverse effect on our financial condition, results of operations and cash flow.
We believe that a significant portion of our subsidiaries’ liability and defense costs for asbestos claims will be covered by insurance. Since year-end 2005, we have worked with Peterson Risk Consulting, nationally recognized experts in the estimation of insurance recoveries, to review our estimate of the value of the unsettled insurance asset and assist in the estimation of our primary and unsettled asbestos insurance asset. Based on insurance policy data, historical claim data, future liability estimate, and allocation methodology assumptions we provided them, Peterson Risk Consulting provided an analysis of the unsettled insurance asset as of year-end 2005. We utilized that analysis to determine our estimate of the value of the unsettled insurance asset. As of March 31, 2006, we reduced our estimated year-end 2005 asbestos insurance asset for insurance settlement proceeds paid to third parties during the quarter.
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Our condensed consolidated balance sheet as of March 31, 2006, includes as an asset an aggregate of $318,000, which represents our best estimate of actual and probable insurance recoveries relating to our domestic liability for pending and estimated future asbestos claims through year-end 2020, $25,100 of this asset is recorded in accounts and notes receivable and $292,900 is recorded as asbestos-related insurance recovery receivable. The amount recorded within accounts and notes receivable reflects amounts due in the next 12 months under executed settlement agreements with insurers and does not include any estimate for future settlements. The amount recorded as asbestos-related insurance recovery receivable includes an estimate of recoveries from unsettled insurers, based upon assumptions relating to cost allocation, the application of New York law, and other factors as well as an estimate of the amount of recoveries under existing settlements with other insurers. On February 13, 2001, litigation was commenced against certain of our subsidiaries by certain of our insurers seeking to recover from other insurers amounts previously paid by them and to adjudicate their rights and responsibilities under our subsidiaries’ insurance policies. As of March 31, 2006, we estimate the value of our asbestos insurance asset contested by our subsidiaries’ insurers in ongoing litigation as $115,000. While this litigation is pending, we have had to cover a substantial portion of our settlement payments and defense costs out of our cash flow.
Our subsidiaries have entered into several settlement agreements calling for certain insurers to make lump-sum payments, as well as payments over time, for use by our subsidiaries to fund asbestos-related indemnity and defense costs and, in certain cases, for reimbursement for portions of out-of-pocket costs previously incurred. We intend to continue to attempt to negotiate additional settlements where achievable on a reasonable basis in order to minimize the amount of future costs that we would be required to fund out of our cash flow. If we cannot achieve settlements in amounts necessary to cover our future costs, we may continue to fund a portion of future costs, which may reduce our cash flow and our working capital, and may adversely affect our liquidity.
If we cannot achieve settlements through negotiations, the ability of our subsidiaries to ultimately recover a substantial portion of asbestos-related costs from insurance is dependent on successful resolution of outstanding coverage issues in the insurance litigation described above related to their insurance policies. These issues include:
| • | the law applicable to the subsidiaries’ insurance policies; |
| • | disputes regarding allocations of liabilities among our subsidiaries and the insurers; |
| • | the effect of deductibles and policy limits on available insurance coverage; |
| • | the characterization of asbestos claims brought against our subsidiaries as product related or non-product related; and |
| • | other defenses raised by one or more of the insurers either to the scope of their obligations under the policies or timing of their payments. |
An adverse outcome in the pending insurance litigation described above could significantly limit our insurance recoveries. However, a favorable outcome in all or part of the litigation could significantly increase available insurance recoveries above our current estimate. In this regard, on January 10, 2005, a New York state trial court entered an order finding that New York, rather than New Jersey, law applies in the litigation described above regarding the allocation of liability for asbestos-related personal injury claims among our subsidiaries and their various insurers. Prior to entry of the New York court order, we had calculated estimated insurance recoveries applying New Jersey law. The application of New York, rather than New Jersey, law would result in our subsidiaries realizing lower insurance recoveries. Thus, as a result of this decision and other factors, we estimated our insurance asset assuming application of New York law and we recorded a charge to earnings in the fourth quarter of 2004 of $75,800 and reduced the year-end 2004 carrying value of our probable insurance recoveries by a similar amount. Unless this decision is reversed, we expect that we will be required to fund a larger portion of our asbestos liabilities from our own cash. The amount and timing of these funding requirements will be dependent upon, among other things, litigated or negotiated resolution of the various disputes with our insurers with whom we have not yet settled. On February 16, 2005, our subsidiaries filed an appeal of this decision to a higher court. Our appeal is currently pending and there can be no assurances as to the timing or the outcome.
Even if the coverage litigation is resolved in a manner favorable to us, our recoveries may be limited by insolvencies among our insurers. We have not assumed recovery in the estimate of our asbestos insurance recovery asset from any of our currently insolvent insurers. Other insurers may become insolvent in the future and our insurers also may fail to reimburse amounts owed to us on a timely basis. Any failure to realize expected insurance recoveries, and any delays in receiving from our insurers amounts owed to our subsidiaries, will have a material adverse effect on our financial condition, results of operations, and cash flow.
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The pending coverage litigation and active negotiations with our insurers is continuing. We funded $16,400 of asbestos liabilities from our cash flow during the first three months of 2006. While we expect active settlement negotiations with unsettled insurers to continue during 2006, we may determine that the appropriate course of action is to continue to fund a portion of our asbestos liabilities during 2006 while the coverage litigation and settlement negotiations continue. If we elect to continue this course of action, we may spend from our cash flow up to an additional $34,600 in the balance of 2006. This estimate assumes no additional settlements with insurance companies and is considered in our liquidity forecast.
Proposed national asbestos trust fund legislation could require us to pay amounts in excess of current estimates of our net asbestos liability, which could adversely affect our financial condition, results of operations and long-term cash flow.
Although no specific federal legislation has been enacted by the United States Congress, a possibility exists that a bill entitled Fairness in Asbestos Injury Resolution Act of 2005, which has been introduced in both houses of Congress in Washington D.C., may become law. This bill was reported out of the Senate Judiciary Committee and was brought to the Senate floor in February 2006, but was defeated on a procedural issue without a vote on the merits. Because we have been named as a defendant in a significant number of asbestos-related bodily injury claims we would be a “defendant participant” in a proposed national trust fund should such enabling legislation become law. If this proposed legislation is enacted into law in its current form, substantially all current and future asbestos claims will be removed from the tort system and claimants’ exclusive remedy will be payment from a national trust fund. This proposed legislation, should it become law in its present form, would alter our payment obligations. We, as a defendant participant in the fund, would be required to make annual contributions to this fund for a period of up to 30 years. While the exact amount that we may be required to pay over this period of time is unknown, under the form of the bill in which it was debated in the Senate, the amount would be at least $19,250 per year for 30 years, none of which would be covered by insurance. This amount significantly exceeds costs that we expect to incur, net of insurance, to defend and resolve claims in the tort system. This proposed legislation, should it become law in its present form, could have a material adverse impact on our financial condition, results of operations and long-term cash flow.
The number of asbestos-related claims received by our subsidiaries in the United Kingdom has recently increased. These claims are covered by insurance policies and proceeds from the policies are paid directly to the plaintiffs. The timing and amount of asbestos claims that may be made in the future, the financial solvency of the insurers, and the amount that may be paid to resolve the claims, are uncertain. The insurance carriers’ failure to make payments due under the policies could have a material adverse effect on our financial condition, results of operations and cash flow.
Some of our subsidiaries in the United Kingdom have received claims alleging personal injury arising from exposure to asbestos in connection with work performed, or heat exchange devices assembled, installed and/or sold, by our subsidiaries. The total number of claims received to date in the United Kingdom is 783 of which 325 remained open at March 31, 2006. We expect these subsidiaries to be named as defendants in similar suits and claims brought in the future. To date, insurance policies have provided coverage for substantially all of the costs incurred in connection with resolving asbestos claims in the United Kingdom. Our ability to continue to recover under these insurance policies is dependant upon, among other things, the timing and amount of asbestos claims that may be made in the future, the financial solvency of our insurers, and the amount that may be paid to resolve the claims. These factors could significantly limit insurance recoveries, which could have a material adverse effect on our financial condition, results of operations and cash flows.
Failure by us to successfully defend against claims made against us by project owners or by our project subcontractors, or failure by us to recover adequately on claims made against project owners, could have a material adverse effect upon our financial condition, results of operations and cash flow.
In the ordinary course of business, claims involving project owners and subcontractors are brought against us and by us in connection with our project contracts. Claims brought against us include back charges for alleged defective or incomplete work, breaches of warranty and/or late completion of the project work, and claims for canceled projects. The claims and back charges can involve actual damages, as well as contractually agreed upon liquidated sums. If we were found to be liable on any of the project claims against us, we would have to incur a write-down or charge against earnings, to the extent a reserve had not been established for the matter in our accounts. Claims brought by us against project owners include claims for additional costs incurred in excess of current contract provisions arising out of project delays and changes in the initial scope of work. Claims between us and our
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subcontractors and vendors include claims like any of those described above. These project claims, if not resolved through negotiation, are often subject to lengthy and expensive litigation or arbitration proceedings. We have used significant additional working capital in projects with cost overruns pending the resolution of our claims against project owners. Amounts ultimately realized on project claims by us could differ materially from the balances included in our financial statements, resulting in a charge against earnings to the extent profit has already been accrued on a project contract. Charges and write-downs associated with claims brought against us and by us could have a material adverse impact on our financial condition, results of operations and cash flow.
Because operations are concentrated in four particular industries, we may be adversely impacted by economic or other developments in these industries.
We derive a significant amount of revenues from services provided to corporations that are concentrated in four industries: power, oil and gas, chemical/petrochemical and pharmaceuticals. Unfavorable economic or other developments in one or more of these industries could adversely affect our clients and could have a material adverse effect on our financial condition, results of operations and cash flow.
Our failure to successfully manage geographically diverse operations could impair our ability to react quickly to changing business and market conditions and comply with industry standards and procedures.
We operate in more than 50 countries around the world, with approximately 8,400, or 87%, of our employees located outside of the United States. In order to manage our day-to-day operations, we must overcome cultural and language barriers and assimilate different business practices. In addition, we are required to create compensation programs, employment policies and other administrative programs that comply with the laws of multiple countries. Failure to successfully manage geographically-diverse operations could impair our ability to react quickly to changing business and market conditions and comply with industry standards and procedures.
We may lose business to competitors who have greater financial resources.
We are engaged in highly competitive businesses in which customer contracts are often awarded through bidding processes based on price and the acceptance of certain risks. We compete with other general and specialty contractors, both foreign and domestic, including large international contractors and small local contractors. Some competitors have greater financial and other resources than we do and may have significantly more favorable leverage ratios. Because financial strength is a factor in deciding whether to grant a contract, our competitors’ more favorable leverage ratios give them a competitive advantage and could prevent us from obtaining contracts for which we have bid.
A failure by us to attract and retain qualified personnel, joint venture partners, advisors and subcontractors could have an adverse effect on our business, financial condition, results of operations and cash flow.
Our ability to attract and retain qualified engineers and other professional personnel, as well as joint-venture partners, advisors and subcontractors, will be an important factor in determining our future success. The market for these professionals, joint-venture partners, advisors and subcontractors is competitive, and we may not be successful in efforts to attract and retain these professionals, joint-venture partners, advisors and subcontractors. In addition, success depends in part on our ability to attract and retain skilled laborers. Failure to attract or retain these workers could have a material adverse effect on our business, financial condition, results of operations and cash flow.
We are subject to various environmental laws and regulations in the countries in which we operate. If we fail to comply with these laws and regulations, we may have to incur significant costs and penalties that could adversely affect our financial condition, results of operations and cash flow.
Our operations are subject to U.S., European and other laws and regulations governing the generation, management, and use of regulated materials, the discharge of materials into the environment, the remediation of environmental contamination, or otherwise relating to environmental protection. These laws include U.S. federal statutes, such as the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, or CERCLA, the Clean Water Act, the Clean Air Act and similar state and local laws, and European laws and regulations including those promulgated under the Integrated Pollution Prevention and Control Directive issued by the European Union in 1996, and the 1991 directive dealing with waste and hazardous waste and laws and regulations similar to those in other countries in which we operate. Both our Global E&C Group and Global Power Group make use of and produce as wastes or byproducts substances that are considered to be hazardous under the laws and regulations referred to above. We may be subject to liabilities for
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environmental contamination as an owner or operator of a facility or as a generator of hazardous substances without regard to negligence or fault, and we are subject to additional liabilities if we do not comply with applicable laws regulating such hazardous substances, and, in either case, such liabilities can be substantial.
We may be subject to significant costs, fines and penalties and/or compliance orders if we do not comply with environmental laws and regulations including those referred to above. Some environmental laws, including CERCLA, provide for joint and several strict liabilities for remediation of releases of hazardous substances, which could result in a liability for environmental damage without regard to negligence or fault. These laws and regulations and common laws principles could expose us to liability arising out of the conduct of current and past operations or conditions, including those associated with formerly owned or operated properties caused by us or others, or for acts by us or others which were in compliance with all applicable laws at the time the acts were performed. In some cases, we have assumed contractual indemnification obligations for environmental liabilities associated with some formerly owned properties. Additionally, we may be subject to claims alleging personal injury, property damage or natural resource damages as a result of alleged exposure to or contamination by hazardous substances. The ongoing costs of complying with existing environmental laws and regulations can be substantial. Changes in the environmental laws and regulations, remediation obligations, enforcement actions or claims for damages to persons, property, natural resources or the environment, could result in material costs and liabilities.
You should read Note 11 to the condensed consolidated financial statements in this Form 10-Q for a summary of our material environmental proceedings and litigation.
We rely on our information systems in our operations. Failure to protect these systems against security breaches could adversely affect our business and results of operations. Additionally, if these systems fail or become unavailable for any significant period of time, our business could be harmed.
The efficient operation of our business is dependent on computer hardware and software systems. We rely on our information systems to communicate and store customer and project information, to track new bookings and inventory, to procure materials and equipment for projects, to perform computerized design and engineering drawings, to perform project scheduling and cost tracking, to maintain Internet and extranet web sites, to maintain our proprietary research and development data and to effectively manage accounting and financial functions. Our information systems are comprised of multiple networks.
Information systems are vulnerable to security breaches by computer hackers and cyber terrorists. We rely on industry accepted security measures and technology to securely maintain confidential and proprietary information maintained on our information systems. However, these measures and technology may not always be adequate to properly prevent security breaches. Moreover, advances in computing capabilities or other developments may result in a compromise or breach of the technology used by us to protect our systems.
In February 2005, we experienced a security breach in our computer systems that service our North American operations. Although it does not appear that our primary financial information system was accessed, or that the integrity of our financial information was compromised, we cannot ensure that this is the case. Although we believe we have taken the steps needed to resolve this breach, compromises of our security systems could expose us to a risk of loss or litigation and possible liability, which could substantially harm our business and results of operations. Further, anyone who is able to circumvent our security measures could misappropriate proprietary or confidential information, which could adversely affect our ability to effectively compete for new business or could cause interruptions in our operations. Because of the nature and magnitude of our projects, we may be the target of cyber terrorists or be the subject of industrial espionage. Although we maintain property and liability insurance, the insurance may not cover potential losses and/or claims of this type or may not be adequate to cover all related costs or liability that may be incurred. As a part of our ongoing efforts to protect our systems against future breaches, we have hired a full-time information technology security manager.
In addition, the unavailability of the information systems or the failure of these systems to perform as anticipated could disrupt our business and could result in decreased performance and increased overhead costs, causing our business and results of operations to suffer. Our information systems are vulnerable to damage or interruption from:
| • | earthquake, fire, flood and other natural disasters; |
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| • | the failure to properly integrate our various networks that comprise our global information systems; and |
| • | computer systems, Internet, or data network failure. |
Any significant interruption or failure of our information systems or any significant breach of security could adversely affect our business and results of operations.
We may lose market share to our competitors and be unable to operate our business profitably if our patents and other intellectual property rights do not adequately protect our proprietary products.
Our success depends significantly on our ability to protect our intellectual property rights to the technologies and know-how used in our proprietary products. We rely on patent protection, as well as a combination of trade secret, unfair competition and similar laws and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our issued patents and those that may be issued in the future may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products. Although we have taken steps to protect our intellectual property and proprietary technology, there is no assurance that third parties will not be able to design around the patents. We also rely on unpatented proprietary technology. We cannot provide assurance that we can meaningfully protect all our rights in our unpatented proprietary technology or that others will not independently develop substantially equivalent proprietary products or processes or otherwise gain access to our unpatented proprietary technology. We seek to protect our trade secrets, know-how and other unpatented proprietary technology, in part with confidentiality agreements and intellectual property assignment agreements with our employees, independent distributors and consultants. However, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements or in the event that our competitors discover or independently develop such trade secrets or other proprietary information.
Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. If we cannot adequately protect our intellectual property rights in these foreign countries, our competitors may be able to compete more directly with us, which could adversely affect our competitive position and business.
We also hold licenses from third parties that are necessary to utilize certain technologies used in the design and manufacturing of some of our products. The loss of such licenses would prevent us from manufacturing and selling these products, which could harm our business.
We have anti-takeover provisions in our bye-laws that may discourage a change of control.
Our bye-laws contain provisions that could make it more difficult for a third-party to acquire us without the consent of our board of directors. These provisions provide for:
| • | The board of directors to be divided into three classes serving staggered three-year terms. Directors can be removed from office only for cause, by the affirmative vote of the holders of two-thirds of the issued shares generally entitled to vote. The board of directors does not have the power to remove directors. Vacancies on the board of directors may only be filled by the remaining directors. Each of these provisions can delay a shareholder from obtaining majority representation on the board of directors. |
| • | Any amendment to the bye-law limiting the removal of directors to be approved by the board of directors and the affirmative vote of the holders of three quarters of the issued shares entitled to vote at general meetings. |
| • | The board of directors to consist of not less than three nor more than 20 persons, the exact number to be set from time to time by a majority of the whole board of directors. Accordingly, the board of directors, and not the shareholders, has the authority to determine the number of directors and could delay any shareholder from obtaining majority representation on the board of directors by enlarging the board of directors and filling the new vacancies with its own nominees until a general meeting at which directors are to be appointed. |
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| • | Restrictions on the time period in which directors may be nominated. A shareholder notice to nominate an individual for election as a director must be received no less than 120 calendar days prior to the anniversary of the date on which Foster Wheeler Ltd. first mailed its proxy materials for the preceding year’s annual meeting. |
| • | Restrictions on the time period in which shareholder proposals may be submitted. To be timely for inclusion in Foster Wheeler Ltd.’s proxy statement, a shareholder’s notice for a shareholder proposal must be received not less than 120 days prior to the first anniversary of the date on which Foster Wheeler Ltd. first mailed its proxy materials for the preceding year’s annual general meeting. To be timely for consideration at the annual meeting of shareholders, a shareholder’s notice must be received no less than 45 days prior to the anniversary of the date on which Foster Wheeler Ltd. first mailed its proxy materials for the preceding year’s annual meeting. |
| • | The board of directors to determine the powers, preferences and rights of preference shares and to issue the preference shares without shareholder approval. The board of directors could authorize the issuance of preference shares with terms and conditions that could discourage a takeover or other transaction that holders of some or a majority of the common shares might believe to be in their best interests or in which holders might receive a premium for their shares over the then market price of the shares. |
| • | A general prohibition on “business combinations” between Foster Wheeler Ltd. and an “interested member.” Specifically, “business combinations” between an interested member and Foster Wheeler Ltd. are prohibited for a period of five years after the time the interested member acquires 20% or more of the outstanding voting shares, unless the business combination or the transaction resulting in the person becoming an interested member is approved by the board of directors prior to the date the interested member acquires 20% or more of the outstanding voting shares. |
“Business combinations” is defined broadly to include amalgamations or consolidations with Foster Wheeler Ltd. or its subsidiaries, sales or other dispositions of assets having an aggregate value of 10% or more of the aggregate market value of the consolidated assets, aggregate market value of all outstanding shares, consolidated earning power or consolidated net income of Foster Wheeler Ltd., adoption of a plan or proposal for liquidation and most transactions that would increase the interested member’s proportionate share ownership in Foster Wheeler Ltd.
“Interested member” is defined as a person who, together with any affiliates and/or associates of that person, beneficially owns, directly or indirectly, 20% or more of the issued voting shares of Foster Wheeler Ltd.
| • | Any matter submitted to the shareholders at a meeting called on the requisition of shareholders holding not less than one-tenth of the paid-up voting shares of Foster Wheeler Ltd. to be approved by the affirmative vote of all of the shares eligible to vote at such meeting. |
These provisions could make it more difficult for a third-party to acquire us, even if the third-party’s offer may be considered beneficial by many shareholders. As a result, shareholders may be limited in their ability to obtain a premium for their shares.
We are a Bermuda company and it may be difficult for you to enforce judgments against us or our directors and executive officers.
Foster Wheeler Ltd. is a Bermuda exempted company. As a result, the rights of shareholders will be governed by Bermuda law and our memorandum of association and bye-laws. The rights of shareholders under Bermuda law may differ from the rights of shareholders of companies incorporated in other jurisdictions. A substantial portion of our assets are located outside the United States. It may be difficult for investors to enforce in the United States judgments obtained in U.S. courts against us or our directors based on the civil liability provisions of the U.S. securities laws. Uncertainty exists as to whether courts in Bermuda will enforce judgments obtained in other jurisdictions, including the United States, under the securities laws of those jurisdictions or entertain actions in Bermuda under the securities laws of other jurisdictions.
Our bye-laws restrict shareholders from bringing legal action against our officers and directors.
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Our bye-laws contain a broad waiver by our shareholders of any claim or right of action, both individually and on our behalf, against any of our officers or directors. The waiver applies to any action taken by an officer or director, or the failure of an officer or director to take any action, in the performance of his or her duties, except with respect to any matter involving any fraud or dishonesty on the part of the officer or director. This waiver limits the right of shareholders to assert claims against our officers and directors unless the act or failure to act involves fraud or dishonesty.
ITEM 6. EXHIBITS
Exhibit No. | Exhibits |
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3.1 | Memorandum of Association of Foster Wheeler Ltd. (Filed as Annex II to Foster Wheeler Ltd.’s Form S-4/A (File No. 333-52468) filed on March 9, 2001, and incorporated herein by reference.) |
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3.2 | Memoranda of Reduction of Share Capital and Memorandum of Increase in Share Capital each dated December 1, 2004. (Filed as Exhibit 99.2 to Foster Wheeler Ltd.’s Form 8-K, filed on December 2, 2004, and incorporated herein by reference.) |
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3.3 | Certificate of Designation relating to Foster Wheeler Ltd.’s Series B Convertible Preferred Shares, adopted on September 24, 2004. (Filed as Exhibit 3.1 to Foster Wheeler Ltd.’s Form 10-Q for the quarter ended September 24, 2004, and incorporated herein by reference.) |
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3.4 | Bye-Laws of Foster Wheeler Ltd., amended November 30, 2004. (Filed as Exhibit 99.3 to Foster Wheeler Ltd.’s Form 8-K, dated November 29, 2004 and filed on December 2, 2004, and incorporated herein by reference.) |
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10.1 | Waiver of the Registration Rights Agreement, dated as of February 2, 2006, by and among Foster Wheeler Ltd., Foster Wheeler LLC, on behalf of themselves and the subsidiary guarantors and Citigroup Global Capital Markets Inc. (Filed as Exhibit 10.13 to Foster Wheeler Ltd.’s Form 10-K for the fiscal year ended December 30, 2005, filed on March 3, 2006, and incorporated herein by reference.) |
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10.2 | Waiver of the Registration Rights Agreement, dated as of February 2, 2006, by and among Foster Wheeler Ltd., Foster Wheeler LLC, on behalf of themselves and the subsidiary guarantors and Merrill Lynch Global Allocation Fund, Inc., Merrill Lynch International Investment Fund-MLIIF Global Allocation Fund, Merrill Lynch Variable Series Fund, Inc.-Merrill Lynch Global Allocation V.I. Fund, and Merrill Lynch Series Funds, Inc.-Global Allocation Strategy Portfolio. (Filed as Exhibit 10.14 to Foster Wheeler Ltd.’s Form 10-K for the fiscal year ended December 30, 2005, filed on March 3, 2006, and incorporated herein by reference.) |
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10.3 | Preliminary Agreement for the Sale of Quotas, dated January 31, 2006, between Foster Wheeler Italiana S.p.A., Fineldo S.p.A. and MPE S.p.A. (Filed as Exhibit 10.29 to Foster Wheeler Ltd.’s Form 10-K for the fiscal year ended December 30, 2005, filed on March 3, 2006, and incorporated herein by reference.) |
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10.4 | Third Amendment to Loan Agreement and Guaranty, dated as of April 19, 2006, in respect of and to the Loan Agreement and Guaranty, dated as of March 24, 2005, among Foster Wheeler LLC, Foster Wheeler USA Corporation, Foster Wheeler North America Corp., Foster Wheeler Energy Corporation and Foster Wheeler Inc., the Guarantors party thereto, the Lenders party thereto, Morgan Stanley & Co. Incorporated, as Collateral Agent, Wells Fargo Foothill Inc., as Administrative Agent, Sole Lead Arranger and Sole Lead Bookrunner. (Filed as Exhibit 99.1 to Foster Wheeler Ltd.’s Form 8-K, filed on April 25, 2006, and incorporated herein by reference.) |
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12.1 | Statement of Computation of Consolidated Ratio of Earnings to Fixed Charges |
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31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Raymond J. Milchovich |
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31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of John T. La Duc |
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32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Raymond J. Milchovich |
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32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of John T. La Duc |
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SIGNATURES
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.
| | | | FOSTER WHEELER LTD.
(Registrant) |
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Date: May 10, 2006 | | |
/S/ RAYMOND J. MILCHOVICH
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| | | | RAYMOND J. MILCHOVICH
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER |
Date: May 10, 2006 | | |
/S/ JOHN T. LA DUC
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| | | | JOHN T. LA DUC
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934