The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, the consolidated financial statements and accompanying notes. For purposes of reviewing this document “operating profit” is calculated as revenues less cost of revenues excluding: corporate administrative and general expense; interest expense; interest income; domestic and foreign income taxes; gain or loss on discontinued operations; the cumulative effect of a change in accounting principles; and certain other miscellaneous non-operating income and expense items which are immaterial.

Results of Operations

As a result of a strategic reorganization, during 1999 the company realigned its operating units into four business segments (which the company refers to as Strategic Business Enterprises): Fluor Daniel, Fluor Global Services, Coal and Fluor Signature Services. The Fluor Daniel segment provides design, engineering, procurement and construction services on a worldwide basis to an extensive range of industrial, commercial, utility, natural resources and energy clients. The Fluor Global Services segment, which includes American Equipment Company, TRS Staffing Solutions, Fluor Federal Services, Telecommunications, Operations & Maintenance and Consulting Services, provides outsourcing and asset management solutions to its customers. The Coal segment produces, processes and sells high-quality, low-sulfur steam coal for the utility industry as well as industrial customers, and metallurgical coal for the steel industry. Fluor Signature Services, which commenced operations on November 1, 1999, was created to provide business administration and support services for the benefit of the company and ultimately, to unaffiliated customers.

To implement the reorganization, the company recorded a special provision of $117.2 million – see Strategic Reorganization Costs elsewhere in Management’s Discussion and Analysis. The provision was not allocated to the business segments.

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Fluor Daniel Segment

Total 1999 new awards were $4.8 billion compared with $8.2 billion in 1998 and $10.4 billion in 1997. The following table sets forth new awards for each of the segment’s business units:

New awards in 1999 were lower compared with 1998, reflecting both the lingering impact of deferred capital spending by clients, primarily in the petrochemical and mining industries, and the company’s continuing emphasis on greater project selectivity. The large size and uncertain timing of complex, international projects can create variability in the company’s award pattern; consequently, future award trends are difficult to predict with certainty. However, given the improving global economic conditions, including significantly higher oil prices and the recent stabilizing of commodity prices, the company is optimistic about the level of new awards in 2000.

Since 1997 the trend in new awards activity within each business unit reflects the impact of the economic conditions and operating strategies noted above. There were no individual new awards in excess of $550 million in either 1999 or 1998. New awards for the Chemicals & Life Sciences business unit in 1997 included the $1.9 billion Yanpet project, a petrochemical complex in Saudi Arabia. The Mining business unit’s new awards are down significantly from 1997 primarily due to depressed commodity prices, thereby limiting new projects, as well as this unit’s focus on project selectivity. The decrease in new awards in 1999 compared with 1998 and 1997 for the Manufacturing business unit is primarily the result of an increased focus on projects electivity.

Backlog at October 31, 1999, 1998 and 1997 was $6.8 billion, $10.4 billion and $12.3 billion, respectively. (See Operating Statistics for information relating to backlog by business unit.) The decrease in total backlog is consistent with the downward trend in new awards. Work performed on existing projects has exceeded new awards in both 1999 and 1998. The decrease in backlog from projects located outside the United States at October 31, 1999, resulted from work performed on international projects such as a copper and gold mine in Indonesia and the aforementioned petrochemical project in Saudi Arabia, in addition to a 39 percent decrease in international-related new awards. Although backlog reflects business which is considered to be firm, cancellations or scope adjustments may occur. Backlog is adjusted to reflect any known project cancellations, deferrals and revised project scope and cost, both upward and downward.

Fluor Daniel revenues decreased to $8.4 billion in 1999 compared with $9.4 billion in 1998 and $10.2 billion in 1997, primarily due to a continuing decline in the volume of work performed. The decline in revenues is consistent with the downward trend in new awards, reflecting both deferred capital spending by clients as well as the company’s emphasis on project selectivity. Fluor Daniel operating profit was $160 million in 1999, $161 million in 1998 and $70 million in 1997. Despite a 14 percent decline in revenues, operating margins for the year ended October 31, 1999 improved over the same period in 1998, primarily due to improved project execution. Operating results for the year ended October 31, 1997, reflect provisions totaling $118.2 million recorded for estimated losses on certain contracts and adjustments to project-related investments and accounts receivable. Results for 1997 also included charges totaling $25.4 million related to implementation of certain cost reduction initiatives.

Results for the year ended October 31, 1999 for Fluor Daniel include a provision totaling $84 million for process design problems which arose on its Murrin Murrin Nickel Cobalt project in Western Australia. The company anticipates recovering a portion of this amount and, accordingly, has recorded $64 million in expected insurance recoveries. The result on operating profit was a negative $20 million impact which reflects costs in excess of contract maximums and which are not otherwise recoverable from any insurance coverage. During the fourth quarter of 1999, Fluor Daniel completed a more definitive estimate of costs required to address the design problems and potential insurance recoveries. As a result of this effort, both the estimated cost and expected insurance recovery amounts discussed above include an upward revision of $20 million.

The majority of Fluor Daniel’s engineering and construction contracts provide for reimbursement of costs plus a fixed or percentage fee. In the highly competitive markets served by this segment, there is an increasing trend for cost-reimbursable contracts with incentive-fee arrangements and fixed or unit price contracts. In certain instances, Fluor Daniel has provided guaranteed completion dates and/or achievement of other performance criteria. Failure to meet schedule or performance guarantees or increases in contract costs can result in non-recoverable costs, which could exceed revenues realized from the project. Fluor Daniel continues to focus on improving operating margins by enhancing selectivity in the projects it pursues, lowering overhead costs and improving project execution.

The Fluor Daniel segment made no significant business acquisitions during 1999, 1998 or 1997.

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Fluor Global Services Segment

Total 1999 new awards were $2.0 billion compared with $1.8 billion in both 1998 and 1997. The following table sets forth new awards for each of the segment’s business units:

New awards in 1999 were higher compared with 1998, as a result of an increase in telecommunications projects. New awards in 1998 were slightly higher than 1997 primarily due to the renewal of facility management service contracts for IBM at various facilities located throughout the United States. Because of the nature of the services performed by Fluor Global Services, primarily related to American Equipment Company (AMECO) and TRS Staffing Solutions, a significant portion of this segment’s activities are not includable in backlog.

Backlog at October 31, 1999, 1998 and 1997 was $2.4 billion, $2.2 billion and $2.1 billion, respectively. (See Operating Statistics for information relating to backlog by business unit.) The increase in total backlog is consistent with the increasing trend in new awards. The backlog of Fluor Global Services is concentrated in the United States, representing approximately 90 percent, 88 percent and 92 percent of the total backlog at the end of 1999, 1998 and 1997, respectively. Although backlog reflects business that is considered to be firm, cancellations or scope adjustments may occur. Backlog is adjusted to reflect any known project cancellations, deferrals and revised project scope and cost, both upward and downward.

Fluor Global Services revenues increased to $2.9 billion in 1999 compared with $2.6 billion in 1998, as the result of higher revenues in its AMECO, Fluor Federal Services and Telecommunications business units. The decline in Fluor Global Services revenues from $3.0 billion in 1997 to $2.6 billion in 1998 was primarily due to a reduction in revenues related to its environmental strategies business which was phased out during 1998. Operating profit for the segment was $92 million in 1999, $81 million in 1998 and $52 million in 1997. Gross margin in 1999 declined to 9.4 percent from 11.2 percent in 1998 primarily due to the AMECO business unit, which is being adversely impacted by the increasingly competitive equipment sale and rental industry. Despite the lower gross margin, operating profit increased in 1999 compared with 1998 primarily due to the elimination of certain unprofitable operations which negatively impacted 1998. The improvement in operating results in 1998 as compared with 1997 is due primarily to losses incurred during 1997 by various unprofitable business units that were eliminated in 1998.

The majority of Fluor Global Services’ contracts provide for reimbursement of costs plus a fixed or percentage fee. Due to intense competitive market conditions, there is an increasing trend for contracts with incentive-fee arrangements or fixed or unit price contracts. In certain instances, contracts provide guaranteed completion dates and/or achievement of other performance criteria. Failure to meet schedule or performance guarantees or increases in contract costs can result in non-recoverable costs, which could exceed revenues realized from the project.

In December 1996, TRS Staffing Solutions, the segment’s temporary personnel services business unit, acquired the ConSol Group; in May 1997, AMECO acquired the SMA Companies; and, in June 1997, AMECO acquired J.W. Burress, Inc. These businesses, in addition to other smaller acquisitions, were purchased for a total of $142 million.

All acquisitions have been accounted for under the purchase method of accounting and their results of operations have been included in the company’s consolidated financial statements from the respective acquisition dates. If these acquisitions had been made at the beginning of 1997, pro forma consolidated results of operations would not have differed materially from actual results.

In October 1998, the company entered into an agreement to sell its ownership interest in Fluor Daniel GTI, Inc. (“FD/GTI”), an environmental services company. Under terms of the agreement, the company sold its 4,400,000 shares in FD/GTI for $8.25 per share, or $36.3 million in cash, on December 3, 1998. This transaction did not have a material impact on the company’s results of operations or financial position. In August 1997, the company completed the sale of ACQUION, a global provider of supply chain management services, for $12 million in cash, resulting in a pre-tax gain of $7 million.

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Coal Segment

Revenues and operating profit from Coal operations in 1999 were $1.08 billion and $147 million, respectively, compared with $1.13 billion and $173 million in 1998. Revenues and operating profit in 1997 were $1.08 billion and $155 million, respectively.

Revenues decreased $44 million in 1999 compared with 1998 primarily due to the combination of a reduction in volume of the higher priced metallurgical coal and a decline in prices. Metallurgical coal volume decreased nearly 18 percent during 1999 compared with 1998. This decrease was more than offset by an increase in lower priced steam coal volume. Also contributing to the decline in coal revenues were lowered realized prices for both steam and metallurgical coal. Steam coal prices declined 4 percent while metallurgical coal prices declined 2 percent. The metallurgical coal market continues to be adversely affected by steel imports from outside the United States and a weak U.S. coal export market. The imports have reduced demand for steel produced in the U.S. and thereby reduced U.S. demand for metallurgical coal, which is used in steel production. Demand is weak for U.S. coal exported to foreign markets as the U.S. Dollar remains strong and the Asian economies slowly recover from their financial crises. Additionally, the market for steam coal, which is used to fire electric-generating plants, continues to be impacted by high customer inventory levels resulting from last year’s mild winter and competition from western coals, which continue to penetrate the traditional eastern coal market areas. Gross profit for the year ended October 31, 1999 is down slightly from the same period in 1998 as a result of lower metallurgical coal sales volume and lower prices for both metallurgical and steam coal. Operating profit for 1999 is lower than 1998 due to higher fixed costs, primarily depreciation, depletion and amortization, as volume levels have remained relatively flat.

The market conditions described above have placed pressure on both the sales volume and pricing outlook for 2000. The company continues to focus on reducing mining production costs through expansion of its surface mining capabilities and utilization of longwall mining.

Revenues increased $46 million in 1998 compared with 1997 primarily due to increased sales volume of metallurgical coal, partially offset by lower steam coal prices. Metallurgical coal revenues increased 11 percent primarily due to higher demand by steel producers. Steam coal revenues were flat on steady volume in 1998 as compared with 1997, while steam coal prices declined approximately 3 percent as overall demand was down due to both a mild winter and summer in 1998. Gross profit increased by 15 percent and operating profit increased by 12 percent in 1998 compared with 1997, primarily due to reduced production costs and an increased proportion of higher margin metallurgical coal sales, partially offset by lower steam coal prices.

Coal segment acquisitions during the three years ended October 31, 1999 were primarily focused on the purchase of additional low-sulfur coal reserves in areas adjacent to existing mine and mill operations. All acquisitions have been accounted for under the purchase method of accounting and their results of operations have been included in the company’s consolidated financial statements from the respective acquisition dates. If these acquisitions had been made at the beginning of the respective year acquired, pro forma consolidated results of operations would not have differed materially from actual results.

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Strategic Reorganization Costs

As noted above, during 1999 the company reorganized its engineering and construction operations. The company recorded a special provision of $117.2 million ($100.5 million after-tax) to cover direct and other reorganization related costs, primarily for personnel, facilities and asset impairment adjustments. The provision was initially recorded during the second quarter at the then estimated amount of $136.5 million ($119.8 million after-tax). Total estimated personnel costs associated with the reorganization were reduced during the fourth quarter as both the actual number of employee terminations as well as the cost per employee termination were lower than originally estimated.

Under the reorganization plan, approximately 5,000 jobs are expected to be eliminated. The provision includes amounts for personnel costs for certain affected employees that are entitled to receive severance benefits under established severance policies or by government regulations. Additionally, outplacement services may be provided on a limited basis to some affected employees. The provision also reflects amounts for asset impairment, primarily for property, plant and equipment; intangible assets (goodwill); and certain investments. The asset impairments were recorded primarily because of the company’s decision to exit certain non-strategic geographic locations and businesses. The carrying values of impaired assets were adjusted to their current market values based on estimated sale proceeds, using either discounted cash flows or contractual amounts. Lease termination costs were also included in the special provision. The company anticipates closing 15 non-strategic offices worldwide as well as consolidating and downsizing other office locations. The closure or rationalization of these facilities is expected to be substantially complete by the end of fiscal year 2000.

As of October 31, 1999, the company has reduced headcount by approximately 5,000 employees and has closed 13 offices. The company anticipates closing two additional offices within the next six months. The special provision liability as of October 31, 1999 totaled $58.5 million. The remaining liability for personnel costs ($25.2 million) and asset impairments ($23.3 million) will be substantially utilized by April 30, 2000. The remaining liability associated with abandoned lease space ($9.7 million) will be amortized as an offset to lease expense over the remaining life of the respective leases starting on the date of abandonment.

Overhead beginning in 2000 is expected to be reduced by approximately $100 to $120 million annually as a result of the personnel reductions and office closures.

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Other

Net interest expense for 1999 increased by $8.4 million compared with 1998 primarily due to an increase in interest expense resulting from higher average outstanding short-term borrowings used to fund the company’s share repurchase program, which was completed in 1998. In addition, interest income declined as a result of lower average cash balances outstanding during the year. Net interest expense for 1998 increased compared with 1997 primarily due to an increase in short-term borrowings required to fund the company’s share repurchase program and a full year of interest related to the $300 million in long-term debt issued in March 1997.

Corporate administrative and general expense for the year ended October 31, 1999 was $55.4 million compared with $22.6 million for the same period in 1998. The increase is due to higher stock-based compensation plan expense and an increase in consulting costs related to the development and implementation of the company’s new strategic direction. Also included in corporate administrative and general expense for 1999 is approximately $8 million for the development of the company’s Enterprise Resource Management system, Knowledge@Work. In addition, the year ended October 31, 1998 included a credit of approximately $10 million related to a long-term incentive compensation plan. The company accrues for certain long-term incentive awards whose ultimate cost is dependent on attainment of various performance targets set by the Organization and Compensation Committee (the “Committee”) of the Board of Directors. Under the long-term incentive compensation plan referred to above, the performance target expired, without amendment or extension by the Committee, on December 31, 1997. Corporate administrative and general expense for the year ended October 31, 1998, increased as compared with 1997 due to costs associated with the company’s strategic business planning effort, executive severance and recruiting costs. Also included was the $10 million credit noted above.

The effective tax rate for year ended October 31, 1999 is significantly higher than the amount reported for the same period in 1998 primarily due to certain non-U.S. items included in the special provision which did not receive full tax benefit. The effective tax rate for the year ended October 31, 1998 was essentially the same as the U.S. federal statutory rate. In 1997, the effective tax rate was materially higher than the U.S. federal statutory tax rate primarily due to foreign-based project losses, other project-related investment losses and certain implementation costs for cost reduction initiatives incurred during the year which did not receive full tax benefit.

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Discontinued Operations

In October 1997, the company received $60 million representing a negotiated prepayment of the remaining amounts outstanding stemming from the 1994 sale of its Lead business. The amount received slightly exceeded the recorded discounted value of the receivable.

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Financial Position and Liquidity

The decrease in cash provided by operating activities in 1999, compared with 1998, is primarily due to lower net earnings (adjusted for the non-cash and unexpended amounts of the special provision in 1999) and an increase in project-related operating assets and liabilities. Also contributing to the decline was an increase in inventories, for both equipment for sale/rental and coal. The increase in inventories is the result of slowing markets. The receipt of a $30 million tax refund also positively impacted operating cash flow in 1998. The increase in cash provided by operating activities in 1998, compared with 1997, is primarily due to a net decrease in operating assets and liabilities (excluding the effects of business acquisitions and dispositions), primarily related to a decrease in the volume of work performed on engineering and construction contracts, and the aforementioned tax refund. Changes in operating assets and liabilities vary from year to year and are affected by the mix, stage of completion and commercial terms of engineering and construction projects.

Cash utilized by investing activities totaled $375.2 million in 1999 compared with $563.3 million in 1998. The decrease resulted primarily from lower capital expenditures and acquisitions, net of proceeds from the sale of property, plant and equipment. Capital expenditures in 1999 were primarily for the Fluor Global Services segment, specifically for AMECO and directed toward acquiring machinery and equipment for its rental business, and for the Coal segment, which were directed toward developing existing reserves. In addition, capital expenditures in 1999 include approximately $26 million of costs associated with Knowledge@Work. The company also completed the sale of its ownership interest in FD/GTI during 1999 and received proceeds totaling $36.3 million. The increase in cash utilized by investing activities in 1998 compared with 1997, is primarily attributable to monies received in 1997 from notes receivable related to the ongoing collection of deferred amounts associated with the company’s 1994 sale of its Lead business. Capital expenditures, net of proceeds from the sale of property, plant and equipment, increased in 1998 compared with 1997, primarily in the Fluor Global Services and Coal segments. Offsetting this increase was a significant decline in acquisitions, again primarily in the Fluor Global Services and Coal segments.

Cash utilized by financing activities totaled $220.6 million in 1999 compared with $98.0 million in 1998. During 1999 the company reduced commercial paper and loan notes by $299.2 million partially offset by the issuance of a $113.4 million note payable to an affiliate. In addition, the company became obligated with respect to $17.6 million in long-term municipal bonds. Cash utilized from financing activities totaled $98.0 million in 1998 compared with 1997 during which time the company provided cash by financing activities of $235.7 million. In 1998, the company had short-term borrowings of $341.8 million to fund its 1997/1998 share repurchase program. Under this program, the company repurchased 8.3 million shares of its common stock for a total of $379.0 million. In 1997, the company issued $300 million of 6.95 percent senior notes due March 1, 2007. Proceeds were used to fund operating working capital, capital expenditures and the company’s share repurchase program. During 1997, the company purchased .6 million shares of its common stock for a total of $34 million.

Cash dividends decreased in 1999 to $60.7 million ($.80 per share) from $63.5 million ($.80 per share) in 1998 and $63.8 million ($.76 per share) in 1997 as a consequence of the reduced number of shares outstanding that resulted from the company’s share repurchase program. In December 1999, the company announced an increase in its quarterly cash dividend from $.20 per share to $.25 per share in 2000.

The total debt to capitalization ratio at October 31, 1999, was 26.3 percent compared with 32.4 percent at October 31, 1998.

The company has on hand and access to sufficient sources of funds to meet its anticipated operating needs. Significant short- and long-term lines of credit are maintained with banks which, along with cash on hand, provide adequate operating liquidity. Liquidity is also provided by the company’s commercial paper program under which there was $113.7 million outstanding at October 31, 1999, compared with $245.5 million at October 31, 1998. In December 1998, the company expanded both its revolving credit facility and its commercial paper program from $400 million to $600 million. During January 1999, the company filed a shelf registration statement with the Securities and Exchange Commission for the sale of up to $500 million in debt securities.

Although the company is affected by inflation and the cyclical nature of the industry, its engineering and construction operations are generally protected by the ability to fix costs at the time of bidding or to recover cost increases in most contracts. Coal operations produce a commodity that is internationally traded at prices established by market factors outside the control of the company. However, commodity prices generally tend over the long term to correlate with inflationary trends, and the company’s substantial coal reserves provide a hedge against the long-term effects of inflation. Although the company has taken actions to reduce its dependence on external economic conditions, management is unable to predict with certainty the amount and mix of future business.

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Financial Instruments

In connection with its 1997/1998 share repurchase program, the company entered into a forward purchase contract for 1,850,000 shares of its common stock at a price of $49 per share. The contract matures in October 2000 and gives the company the ultimate choice of settlement option, either physical settlement or net share settlement. As of October 31, 1999, the contract settlement cost per share exceeded the current market price per share by $11.44.

Although the ultimate choice of settlement option resides with the company, if the price of the company’s common stock falls to certain levels, as defined in the contract, the holder of the contract has the right to require the company to settle the contract.

The company’s investment securities and substantially all of its debt instruments carry fixed rates of interest over their respective maturity terms. The company does not currently use derivatives, such as swaps, to alter the interest characteristics of its investment securities or its debt instruments. The company’s exposure to interest rate risk on its $300 million senior notes, due in 2007, is not material given the company’s strong balance sheet and creditworthiness which provides the ability to refinance.

The company utilizes forward exchange contracts to hedge foreign currency transactions entered into in the ordinary course of business and not to engage in currency speculation. At October 31, 1999 and 1998, the company had forward foreign exchange contracts of less than eighteen months duration, to exchange principally Australian Dollars, Canadian Dollars, Korean Won, Dutch Guilders and German Marks for U.S. Dollars. In addition, the company has a forward foreign currency contract to exchange U.S. Dollars for British Pounds Sterling to hedge annual lease commitments which expired December 1999. The total gross notional amount of these contracts at October 31, 1999 and 1998 was $124 million and $106 million, respectively. Forward contracts to purchase foreign currency represented $122 million and $102 million and forward contracts to sell foreign currency represented $2 million and $4 million, at October 31, 1999 and 1998, respectively.

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The Year 2000 Issue — Readiness Disclosure

The Year 2000 issue is the result of computer systems and other equipment with processors that use only two digits to identify a year rather than four. If not corrected, many computer applications and date sensitive equipment could fail or create erroneous results before, during and after the Year 2000. The company utilizes information technology (“IT”) systems, such as computer networking systems and non-IT devices, which may contain embedded circuits, such as those which may be found in building security equipment. Both IT systems and non-IT devices are subject to potential failure due to the Year 2000 issue.

The company has developed and implemented a plan to achieve Year 2000 readiness (the “Y2K Program”). Progress reports on the Y2K Program are presented regularly to the company’s senior management and periodically to the Audit Committee of the company’s Board of Directors.

The company identified and assigned priority to certain mission critical systems. The company defines mission critical systems as those that might have a significant adverse effect in one or more of the following areas: safety, environmental, legal or financial exposure and company credibility and image.

The company’s Y2K Program has been implemented in the following three phases: (1) Identification Phase – includes the identification and assessment of Year 2000 problems requiring systems modifications or replacements; (2) Remediation Phase – includes the remediation and testing of systems having Year 2000 problems and the identification of compliant systems’ installation scheduled during 1999; and (3) Contingency Planning Phase – includes the development of contingency and business continuity plans to mitigate the effect of any system or equipment failure. The timeframe for each phase of the Y2K Program are represented in the following table:

As of October 31, 1999, the company’s software applications are Year 2000 compliant, although a small number of systems have a November installation date to accommodate user system schedules. As of October 31, 1999, the company’s hardware is Year 2000 compliant with the exception of the phone system at one business unit where a compliant system is scheduled for installation in early December. Transitioning into Year 2000, the company did not experience any material issues and all of its computer systems are operating normally. The company will continue to monitor its systems on an ongoing basis for the immediate future. As of January 13, 2000, the company has not been made aware of any Year 2000 disruptions for which it is responsible at any of its various project sites throughout the world.

With respect to systems acquired by the company for its own account or the account of customers, the company uses standard compliance processes to certify Year 2000 compliance. The company requires that all suppliers certify and, where appropriate, guarantee that the systems and equipment they provide to the company for its own account and the account of its customers are Year 2000 compliant. In addition to requiring such certifications, the company also has completed a process of reviewing the Year 2000 compliance of critical suppliers. Actions included the review of remediation and testing of specific equipment, review of suppliers’ corporate Year 2000 progress and confirmation of electronic exchange formats. Where appropriate, the company has followed up its review of supplier information with telephone interviews and on-site visits. Where a supplier has not, or cannot, satisfy the company’s Year 2000 requirements, the company has sought alternate suppliers, subject to customer requirements and contract specifications. Although initial reviews and the results following the company’s transition into Year 2000 indicate that Year 2000 compliance by the company’s suppliers should not have a material adverse affect on the company’s operations, there can be no assurance that all Year 2000 issues have been resolved in a timely manner.

With respect to Engineering Systems, the company has retired approximately 38 percent of its engineering applications software to streamline its operations, reduce support costs and avoid costs of Year 2000 remediation. The cost of such software, to the extent originally capitalized, has been fully amortized and the company does not expect any significant write off as the result of such retirement. The implementation of compliant versions of all remaining Engineering Systems is complete, with the remediation of those remaining applications largely being addressed via upgrades.

All Project Site Specific Systems are Year 2000 ready, including the Department of Energy’s projects and the control systems in use at the company’s coal plants.

With respect to Customer Systems and current customer projects generally, the company has evaluated those systems and projects to determine whether or not any action is required to ensure Year 2000 readiness. The company has reviewed projects where it has ongoing warranty or performance obligations for Year 2000 issues. It targeted approximately 1,600 projects for additional Year 2000 assessment, all of which have been reviewed. At those projects where Year 2000 issues may exist, the company has evaluated what further action is required and any required remediation and contingency planning is complete. The company relies directly and indirectly on external systems utilized by its suppliers and on equipment and materials provided by those suppliers and used for the company’s business. As discussed above, the company has implemented a procedure for reviewing Year 2000 compliance by its suppliers, which will be ongoing into year 2000.

With respect to systems and equipment provided to clients, the company does not control the upgrades, additions and/or changes made by its clients, or by others for its clients, to those systems and equipment. Accordingly, the company does not provide any assurances, nor current information about Year 2000 capabilities, nor potential Year 2000 problems, with respect to past projects. Each project is performed under an agreement with the company’s client. Those agreements specifically outline the extent of the company’s obligations and warranties and the limitations that may apply.

The company has investments in various joint ventures and has monitored the Year 2000 efforts of such joint ventures. Based on available information, the company believes business systems used in such joint ventures are Year 2000 ready.

The company uses both internal and external resources in its Y2K Program. The company estimates that, from 1996 to date, it has spent approximately $25 million on the Year 2000 issue. It anticipates spending an additional $.6 million during the first quarter of fiscal year 2000. The estimate of additional spending was derived utilizing numerous assumptions, including the assumption that the company has already identified and completed its most significant Year 2000 issues and that plans of its third party suppliers will be fulfilled in a timely manner without cost to the company.

The company estimates that 44 percent of the total costs incurred for the Y2K Program have been incurred to remediate systems (including software upgrades); the remaining 56 percent of the total costs incurred have been incurred to replace systems and equipment. The company estimates its direct costs for the Y2K Program (costs necessary to assess and remediate existing systems) are approximately $14 million. In addition to the direct costs of the Y2K Program, the company has accelerated its program of replacing out-of-date personal computers and operating systems, regardless of whether or not such computers and systems were Year 2000 compliant. All replacement equipment and systems are Y2K compliant. The costs associated with those replacements are estimated at $11 million. The company estimates it has spent $14 million to date and will spend an additional $.3 million in connection with replacing equipment and systems.

The Y2K Program has been funded under the company’s general IT and operating budgets. In 1999, Y2K Program costs were 11 percent of the IT budget. The Year 2000 expenditures have been and will continue to be expensed and deducted from income when incurred, except for costs incurred to acquire new software developed or obtained to replace old software which may be capitalized and amortized under generally accepted accounting principles. No significant internal systems projects were deferred due to the Y2K Program efforts. The above amounts are the company’s best estimate given other systems initiatives that were ongoing irrespective of the Y2K Program (such as the migration to Windows NT and related hardware upgrades). However, there can be no guarantee that these assumptions are accurate, and actual results could differ materially from those anticipated.

The company has developed contingency plans to address the Year 2000 issues that may pose a significant risk to its ongoing operations and existing projects, including an early warning system developed for the millennium transition. Such plans include the implementation of alternate procedures to compensate for any system and equipment malfunctions or deficiencies with the company’s internal systems and equipment, with systems and equipment utilized at the company’s project sites, with systems and equipment provided to clients and with systems and equipment supplied by third parties. Due to the large number of variables involved with estimating resultant lost revenues should there be a third party failure, the company cannot provide an estimate of damage if any of the scenarios were to occur. There can be no assurance that any contingency plans implemented by the company would be adequate to meet the company’s needs without materially impacting its operations, that any such plan would be successful or that the company’s results of operations would not be materially and adversely affected by the delays and inefficiencies inherent in conducting operations in an alternative manner.

The company’s Y2K Program is subject to a variety of risks and uncertainties, some of which are beyond the company’s control. Those risks and uncertainties include, but are not limited to, the Year 2000 readiness of third parties and the Year 2000 compliance of systems and equipment provided by suppliers.

The company believes that its most reasonably likely worst case Year 2000 scenarios would relate to problems with the systems of third parties, rather than with the company’s internal systems. At this time, the company believes that risks are greatest in the area of third party system and equipment suppliers. Each of the company’s locations relies on suppliers for basic utility service as well as the timely provision of project services and equipment. If the supply of such necessary services and equipment were to fail at any location, the company’s operations at that location, whether consisting of engineering, design or construction activities, maintenance services or coal mining and processing, would essentially be shut down or disrupted until such services and equipment deliveries were restored. Depending on the location, the company could suffer delays in performing contracts and in otherwise fulfilling its commitments. Such delays could materially adversely impact the company’s receipt of payments due from customers upon its tender of contract deliverables or upon achievement of contract milestones. The company believes that the geographical dispersion of the company’s facilities mitigates the risk that such failures in any locale or at any project site will result in the simultaneous closure of, or sustained suspension of operations at, multiple company facilities or at project sites. Consequently, to the extent practical, the company expects to mitigate any interruption in its business operations in one location by shifting the performance of the constrained activity to a functioning office or facility. There may be instances, however, where the activity cannot be performed elsewhere or on a timely basis given the disruption caused by the Year 2000 problems in any location. In such instances, the company will assess the relevant provisions of its contracts and, where it deems appropriate, work with its customers to resolve performance and schedule delays and any resulting financial consequences on a mutually satisfactory basis to the extent possible under then prevailing circumstances.

No assurance can be given that the company will achieve all aspects of Year 2000 readiness. Further, there is the possibility that significant litigation may occur due to business and equipment failures caused by the Year 2000 issue. It is uncertain whether, or to what extent, the company may be affected by such litigation. The failure of the company, its clients (including governmental agencies), suppliers of computer systems and equipment, joint venture partners and other third parties upon whom the company relies, to achieve Year 2000 readiness could materially and adversely affect the company’s results from operations.

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Euro Conversion

Given the nature and size of the company’s European operations, the company does not perceive the conversion to the Euro as a significant risk. The company’s businesses operate under long-term contracts, typically denominated in U.S. Dollars, compared with more traditional retail or manufacturing environments. If required, the company is currently able to bid, price and negotiate contracts using the Euro. The company’s treasury function is also capable of operating with the Euro. Specifically, the company is able to: establish bank accounts; obtain financing; obtain bank guarantees or letters of credit; trade foreign currency; and hedge transactions. The company’s ongoing Euro conversion effort will be primarily concentrated in the systems area.

Conversion to the Euro impacts the company’s subsidiaries in The Netherlands, Germany, Belgium and Spain. All subsidiaries use a standard accounting system and all reside in the same database. The company’s conversion plan is to maintain the legacy database for historical reference and to create a new database with the Euro as the base currency. The new database will permit transactions to take place in both legacy currencies and the Euro as well as perform prescribed rounding calculations. The new Euro-based database is available and testing is in progress. Full conversion is anticipated to be complete by the start of fiscal year 2001.

The company has not incurred and it does not expect to incur any significant costs from the continued conversion to the Euro, including any currency risk, which could significantly affect the company’s business, financial condition and results of operations.

The company has not experienced any significant operational disruptions to date and does not currently expect the continued conversion to the Euro to cause any significant operational disruptions, including the impact of systems operated by others.

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New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133). SFAS No. 133 establishes new standards for recording derivatives in interim and annual financial statements. This statement, as amended, is effective for the company’s fiscal year 2001. Management does not anticipate that the adoption of the new statement will have a significant impact on the results of operations or the financial position of the company.