UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the period ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________to______________
Commission File No. 1-8430
McDERMOTT INTERNATIONAL, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
REPUBLIC OF PANAMA 72-0593134
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1450 Poydras Street, New Orleans, Louisiana 70112-6050
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (504) 587-5400
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the Company's Common Stock at April 30, 2002
was 63,022,339.
McDERMOTT INTERNATIONAL, INC.
INDEX - FORM 10-Q
<Table>
<Caption>
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 - Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
March 31, 2002 and December 31, 2001 4
Condensed Consolidated Statements of Loss
Three Months Ended March 31, 2002 and 2001 6
Condensed Consolidated Statements of Comprehensive Income (Loss)
Three Months Ended March 31, 2002 and 2001 7
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2002 and 2001 8
Notes to Condensed Consolidated Financial Statements 10
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 33
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 44
Item 6 - Exhibits and Reports on Form 8-K 44
SIGNATURES 45
</Table>
2
PART I
McDERMOTT INTERNATIONAL, INC.
FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
3
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<Table>
<Caption>
March 31, December 31,
2002 2001
------------ ------------
(Unaudited)
(In thousands)
Current Assets:
Cash and cash equivalents $ 146,235 $ 196,912
Investments -- 158,000
Accounts receivable - trade, net 192,916 139,598
Accounts receivable from The Babcock & Wilcox Company 7,201 3,681
Accounts receivable - unconsolidated affiliates 38,308 69,368
Accounts receivable - other 37,373 34,833
Contracts in progress 93,249 97,326
Inventories 1,760 1,825
Deferred income taxes 60,649 59,370
Other current assets 52,886 52,490
------------ ------------
Total Current Assets 630,577 813,403
------------ ------------
Property, Plant and Equipment 1,224,121 1,218,650
Less accumulated depreciation 868,106 864,751
------------ ------------
Net Property, Plant and Equipment 356,015 353,899
------------ ------------
Investments in Debt Securities 171,629 173,003
------------ ------------
Investment in The Babcock & Wilcox Company 186,966 186,966
------------ ------------
Accounts Receivable from The Babcock & Wilcox Company 18,202 17,489
------------ ------------
Goodwill 330,579 330,705
------------ ------------
Prepaid Pension Costs 150,557 152,510
------------ ------------
Other Assets 80,509 75,865
------------ ------------
TOTAL $ 1,925,034 $ 2,103,840
============ ============
</Table>
See accompanying notes to condensed consolidated financial statements.
4
LIABILITIES AND STOCKHOLDERS' EQUITY
<Table>
<Caption>
March 31, December 31,
2002 2001
------------ ------------
(Unaudited)
(In thousands)
Current Liabilities:
Notes payable and current maturities of long-term debt $ 1,322 $ 209,506
Accounts payable 106,868 118,811
Accounts and notes payable to The Babcock & Wilcox Company 37,920 34,098
Accrued employee benefits 67,985 91,596
Accrued contract costs 24,565 26,367
Advance billings on contracts 232,056 170,329
U.S. and foreign income taxes payable 101,183 123,985
Other current liabilities 202,900 203,695
------------ ------------
Total Current Liabilities 774,799 978,387
------------ ------------
Long-Term Debt 100,114 100,393
------------ ------------
Accumulated Postretirement Benefit Obligation 27,373 23,536
------------ ------------
Environmental Liabilities 11,997 15,083
------------ ------------
Self-Insurance 77,067 67,878
------------ ------------
Other Liabilities 154,993 148,453
------------ ------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $1.00 per share, authorized
150,000,000 shares; issued 64,662,126 at
March 31, 2002 and 63,733,257 at December 31, 2001 64,662 63,733
Capital in excess of par value 1,085,969 1,077,148
Accumulated deficit (251,517) (250,924)
Treasury stock at cost, 2,045,792 shares at March 31,
2002 and 2,005,792 at December 31, 2001 (62,776) (62,736)
Accumulated other comprehensive loss (57,647) (57,111)
------------ ------------
Total Stockholders' Equity 778,691 770,110
------------ ------------
TOTAL $ 1,925,034 $ 2,103,840
============ ============
</Table>
5
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF LOSS
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
----------- -----------
(Unaudited)
(In thousands, except per share amounts)
Revenues $ 399,192 $ 410,524
----------- -----------
Costs and Expenses:
Cost of operations 366,579 369,315
Selling, general and
administrative expenses 42,169 41,247
----------- -----------
408,748 410,562
----------- -----------
Equity in Income of Investees 7,534 4,921
----------- -----------
Operating Income (Loss) (2,022) 4,883
----------- -----------
Other Income (Expense):
Interest income 3,480 5,848
Interest expense (7,165) (10,131)
Other-net 1,698 (2,211)
----------- -----------
Total Other Expense (1,987) (6,494)
Loss from Continuing Operations before
Provision for (Benefit from) Income Taxes
and Extraordinary Item (4,009) (1,611)
Provision for (Benefit from) Income Taxes (2,249) 3,558
----------- -----------
Loss from Continuing Operations
before Extraordinary Item (1,760) (5,169)
Income from Discontinued Operations 826 736
----------- -----------
Loss before Extraordinary Item (934) (4,433)
Extraordinary Item, net of taxes of $184,000 341 --
----------- -----------
Net Loss $ (593) $ (4,433)
=========== ===========
Loss per Common Share:
Basic
Loss from Continuing Operations
before Extraordinary Item $ (0.03) $ (0.09)
Net Loss $ (0.01) $ (0.07)
Diluted
Loss from Continuing Operations
before Extraordinary Item $ (0.03) $ (0.09)
Net Loss $ (0.01) $ (0.07)
=========== ===========
</Table>
See accompanying notes to condensed consolidated financial statements.
6
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands)
Net Loss $ (593) $ (4,433)
---------- ----------
Other Comprehensive Income (Loss):
Currency translation adjustments:
Foreign currency translation adjustments (493) 120
Unrealized gains (losses) on derivative financial instruments:
Unrealized gains (losses) on derivative financial instruments 1,192 (1,200)
Reclassification adjustment for losses included in net income 192 --
Unrealized gains (losses) on investments:
Unrealized gains (losses) arising during the period,
net of taxes (benefits) of $30,000 at March 31, 2001 (512) 4,077
Reclassification adjustment for (gains) losses
included in net income, net of tax benefit of
$162,000 at March 31, 2001 (915) 1,955
---------- ----------
Other Comprehensive Income (Loss) (536) 4,952
---------- ----------
Comprehensive Income (Loss) $ (1,129) $ 519
========== ==========
</Table>
See accompanying notes to condensed consolidated financial statements.
7
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (593) $ (4,433)
---------- ----------
Adjustments to reconcile net loss to net
cash provided by (used) in operating activities:
Depreciation and amortization 9,103 14,286
Income or loss of investees, less dividends (5,558) (3,551)
Gain on asset disposals and impairments - net (76) (525)
Provision for deferred taxes 9,537 799
Extraordinary gain (341) --
Other 3,726 4,690
Changes in assets and liabilities, net of effects
of acquisitions and divestitures:
Accounts receivable (32,343) (12,862)
Net contracts in progress and advance billings 65,931 16,947
Accounts payable (7,965) (4,358)
Accrued and other current liabilities (2,125) (19,427)
Products and environmental liabilities (308) (1,651)
Other, net (35,964) (2,728)
---------- ----------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES 3,024 (12,813)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (10,558) (7,764)
Purchases of available-for-sale securities (646,992) (348,883)
Sales of available-for-sale securities 737,819 355,875
Maturities of available-for-sale securities 67,103 33,026
Proceeds from asset disposals 76 543
Other -- (1,366)
---------- ----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 147,448 31,431
========== ==========
</Table>
8
CONTINUED
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of long-term debt $ (208,309) $ (27)
Increase (decrease) in short-term borrowing 667 (48,838)
Issuance of common stock 1,672 180
Other 4,856 3,101
---------- ----------
NET CASH USED IN FINANCING ACTIVITIES (201,114) (45,584)
---------- ----------
EFFECTS OF EXCHANGE RATE CHANGES ON CASH (35) (617)
---------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (50,677) (27,583)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 196,912 84,620
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 146,235 $ 57,037
---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 11,540 $ 14,317
Income taxes - net $ 15,132 $ 2,146
========== ==========
</Table>
See accompanying notes to condensed consolidated financial statements.
9
McDERMOTT INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
NOTE 1 - BASIS OF PRESENTATION
We have presented our condensed consolidated financial statements in U.S.
Dollars in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information.
Accordingly, they do not include all of the information and GAAP footnotes
required for complete financial statements. We have included all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation. These condensed consolidated financial statements include the
accounts of McDermott International, Inc. and its subsidiaries and controlled
joint ventures. We use the equity method to account for investments in joint
ventures and other entities we do not control, but have significant influence
over. We have eliminated all significant intercompany transactions and accounts.
We have reclassified certain amounts previously reported to conform with the
presentation at and for the three-month period ended March 31, 2002.
McDermott International, Inc. ("MII") is the parent company of the McDermott
group of companies, which includes:
o J. Ray McDermott, S.A. ("JRM"), a Panamanian subsidiary of MII, and
its consolidated subsidiaries;
o McDermott Incorporated ("MI"), a Delaware subsidiary of MII, and its
consolidated subsidiaries;
o Babcock & Wilcox Investment Company ("BWICO"), a Delaware subsidiary
of MI;
o BWX Technologies, Inc. ("BWXT"), a Delaware subsidiary of BWICO, and
its consolidated subsidiaries; and
o The Babcock & Wilcox Company ("B&W"), an unconsolidated Delaware
subsidiary of BWICO.
Operating results for the three months ended March 31, 2002 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2002. For further information, refer to the consolidated financial statements
and footnotes thereto included in MII's annual report on Form 10-K for the year
ended December 31, 2001.
On February 22, 2000, B&W and certain of its subsidiaries filed a voluntary
petition in the U.S. Bankruptcy Court for the Eastern District of Louisiana in
New Orleans (the "Bankruptcy Court") to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. B&W and these subsidiaries took this action as a means to
determine and comprehensively resolve their asbestos liability. As of February
22, 2000, B&W's operations are subject to the jurisdiction of the Bankruptcy
Court and, as a result, our access to cash flows of B&W and its subsidiaries is
restricted.
10
Due to the bankruptcy filing, beginning on February 22, 2000, we no longer
consolidate B&W's financial results in our condensed consolidated financial
statements, and we present our investment in B&W on the cost method. When B&W
emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting
will be determined based on the applicable circumstances and facts at such time,
including the terms of any plan of reorganization. The filing results in
increased uncertainty with respect to the amounts, means and timing of the
ultimate settlement of asbestos claims and the recovery of MII's net investment
in B&W which was $186,966,000 at March 31, 2002. We monitor B&W's Chapter 11
reorganization proceedings for developments that could result in material
adjustments to, including the write-off of, the carrying value of MII's
investment in B&W during any fiscal quarter or year. At March 31, 2002, the book
value of the underlying net assets of B&W exceeds MII's investment by
$2,052,000. See Note 9 for the condensed consolidated financial information of
B&W.
Effective January 1, 2002, based on a review performed by the company and
independent consultants, we changed our estimate of the useful lives of new
major marine vessels from 12 years to 25 years to better reflect the service
lives of our assets and industry norms. Consistent with this change, we also
extended the lives of major upgrades to existing vessels. We continue to
depreciate our major marine vessels using the units-of-production method, based
on the utilization of each vessel. The change in estimated useful lives improved
our operating income by approximately $429,000 for the three months ended March
31, 2002.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that we no longer amortize goodwill, but instead perform periodic
testing for impairment. We have not yet completed the first step of our
transitional goodwill impairment test for the goodwill associated with The
Babcock & Wilcox Company; however, we do not currently expect to incur a
material transition goodwill impairment charge as of January 1, 2002. See Note 8
for a reconciliation of reported net income to adjusted net income, which
excludes goodwill amortization expense for all periods presented.
Effective January 1, 2002, we also adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets. It
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of Accounting Pronouncements Bulletin No. 30, "Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. See Note 2 for information on our
discontinued operations.
11
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred. When the liability is initially recorded, the
entity capitalizes a cost by increasing the carrying amount of the related
long-lived asset. Over time, the liability is accreted to its present value each
period, and the capitalized cost is depreciated over the useful life of the
related asset. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss upon settlement.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We are
reviewing the effect SFAS No. 143 will have on our consolidated financial
position and results of operations.
NOTE 2 - DISCONTINUED OPERATIONS
As of March 31, 2002, we have classified our subsidiary Hudson Products
Corporation ("HPC"), a component of our Industrial Operations segment, as an
asset held for sale in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which we adopted on January 1,
2002. Accordingly, we have reported the results of operations for HPC in
discontinued operations. The condensed consolidated statement of loss for the
three months ended March 31, 2001 has been restated for consistency to reflect
the current year treatment of HPC as a discontinued operation. Condensed
financial information for our operations reported in discontinued operations
follows:
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands)
Revenues $ 16,065 $ 22,211
Income before Provision for Income Taxes $ 1,171 $ 1,113
</Table>
We have reported the assets and liabilities of HPC in our condensed consolidated
balance sheets as held for sale, as follows:
<Table>
<Caption>
March 31, December 31,
2002 2001
------------ ------------
(Unaudited)
(In thousands)
Other current assets $ 33,244 $ 31,426
Other current liabilities $ 9,488 $ 8,902
</Table>
12
NOTE 3 - INVENTORIES
Inventories are summarized below:
<Table>
<Caption>
March 31, December 31,
2002 2001
------------- ------------
(Unaudited)
(In thousands)
Raw Materials and Supplies $ 1,603 $ 1,733
Work in Progress $ 157 $ 92
------------ -------------
Total Inventories $ 1,760 $ 1,825
============ =============
</Table>
NOTE 4 - ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss included in stockholders'
equity are as follows:
<Table>
<Caption>
March 31, December 31,
2002 2001
----------- ------------
(Unaudited)
(In thousands)
Currency Translation Adjustments $ (50,895) $ (50,402)
Net Unrealized Gain (Loss) on Investments (126) 1,301
Net Unrealized Loss on Derivative Financial Instruments (856) (2,240)
Minimum Pension Liability (5,770) (5,770)
----------- -----------
Accumulated Other Comprehensive Loss $ (57,647) $ (57,111)
=========== ===========
</Table>
NOTE 5 - INVESTIGATIONS AND LITIGATION
On March 12, 2001, the plaintiffs' motion for rehearing en banc was denied by
the U.S. Court of Appeals for the Fifth Circuit in the December 1998 lawsuit
filed by Den norske stats oljeselskap a.s. and several related entities against
MII, JRM and others arising from alleged anti-competitive activities. The
plaintiffs filed a petition for writ of certiorari to the U.S. Supreme Court. By
order issued October 1, 2001, the Supreme Court invited the Solicitor General of
the United States to file a brief expressing the view of the United States on
the issues presented in the writ application. On February 20, 2002, the U.S.
Supreme Court denied the petition for certiorari. The plaintiffs filed a motion
for rehearing by the U.S. Supreme Court. On April 15, 2002, the U.S. Supreme
Court denied the motion for rehearing. On April 23, 2002, British Gas, Heerema
and MII executed an agreement to settle the British Gas anti-trust claims
against Heerema and MII, which claims were previously included in the Phillips
and Shell litigations.
In December 1998, a subsidiary of JRM (the "Operator Subsidiary") was in the
process of installing the south deck module on a compliant tower in the Gulf of
Mexico for Texaco Exploration and Production, Inc. ("Texaco") when the main
hoist load line failed, resulting in the loss of the module. In December 1999,
Texaco filed a lawsuit seeking consequential damages for delays resulting from
the incident, as well as costs incurred to complete the project with another
contractor and uninsured losses. This lawsuit was filed in the
13
U. S. District Court for the Eastern District of Louisiana against a number of
parties, some of which brought third-party claims against the Operator
Subsidiary and another subsidiary of JRM, the owner of the vessel which
attempted the lift of the deck module (the "Owner Subsidiary"). Both the Owner
Subsidiary and the Operator Subsidiary were subsequently tendered as direct
defendants to Texaco. In addition to Texaco's claims in the federal court
action, damages for the loss of the south deck module have been sought by
Texaco's builder risk insurers in claims against the Owner Subsidiary and the
other defendants, excluding the Operator Subsidiary, which was an additional
insured under the policy. Total damages sought by Texaco and its builder risk
insurers in the federal court proceeding approximate $250 million. Texaco's
federal court claims against the Operator Subsidiary were stayed in favor of a
pending binding arbitration proceeding between them required by contract, which
the Operator Subsidiary initiated to collect $23 million due for work performed
under the contract, and in which Texaco also sought consequential damages and
uninsured losses. The federal court trial, on the issue of liability only,
commenced in October 2001. On March 27, 2002, the Court orally found that the
Owner Subsidiary was liable to Texaco, specifically finding that Texaco had
failed to sustain its burden of proof against all named defendants except the
Owner Subsidiary relative to liability issues, and, alternatively, that the
Operator Subsidiary's highly extraordinary negligence served as a superceding
cause of the loss. The finding was subsequently set forth in a written order
dated April 5, 2002, which found against the Owner Subsidiary on the claims of
Texaco's builder risk insurers in addition to the claims of Texaco. The judge
has neither entered a final judgment nor issued a written opinion on this
matter. On May 6, 2002, the Owner Subsidiary filed a notice of appeal of the
April 5, 2002 order, which we believe is unsupported under the applicable law
and facts. The matter has recently been transferred to a new district court
judge and no trial date has yet been set for damages and certain insurance
issues. The trial in the arbitration proceeding, which was set to begin in
January 2002, was delayed for procedural reasons. We expect a new date will be
set for the arbitration trial. Although the Owner Subsidiary is not a party to
the arbitration, we believe that the claims against the Owner Subsidiary, like
those against the Operator Subsidiary, are governed by the contractual
provisions which require arbitration and waive the recovery of consequential
damages against the Operator Subsidiary and its affiliates. We plan to
vigorously pursue the arbitration proceeding and any appeals process in the
federal court action, and we do not believe that a material loss with respect to
these matters is likely. In addition, we are evaluating our insurance coverage
in the event of any liability. However, the ultimate outcome of the proceedings
is uncertain, and an adverse ruling in either proceeding could have a material
adverse impact on our consolidated financial position, results of operations and
cash flow.
In early April 2001, a group of insurers (the "Plaintiff Insurers") who have
previously provided insurance to B&W under our excess liability policies filed
(1) a complaint for declaratory judgment and damages against MII in the B&W
Chapter 11 proceeding in the U.S. District Court for the Eastern District of
Louisiana and (2) a declaratory judgment complaint against B&W in the Bankruptcy
Court, which actions have been
14
consolidated before the U.S. District Court for the Eastern District of
Louisiana, which has jurisdiction over portions of the B&W Chapter 11
proceeding. The insurance policies at issue in this litigation provide a
significant portion of B&W's excess liability coverage available for the
resolution of the asbestos-related claims that are the subject of the B&W
Chapter 11 proceeding. The consolidated complaints contain substantially
identical factual allegations. These include allegations that, in the course of
settlement discussions with the representatives of the asbestos claimants in the
B&W bankruptcy proceeding, MII and B&W breached the confidentiality provisions
of an agreement they entered into with these Plaintiff Insurers relating to
insurance payments by the Plaintiff Insurers as a result of asbestos claims.
They also allege that MII and B&W have wrongfully attempted to expand the
underwriters' obligations under that settlement agreement and the applicable
policies through the filing of a plan of reorganization in the B&W bankruptcy
proceeding that contemplates the transfer of rights under that agreement and
those policies to a trust that will manage the pending and future
asbestos-related claims against B&W and certain of its affiliates. The
complaints seek declarations that, among other things, the defendants are in
material breach of the settlement agreement with the Plaintiff Insurers and that
the Plaintiff Insurers owe no further obligations to MII and B&W under that
agreement. With respect to the insurance policies, if the Plaintiff Insurers
should succeed in terminating the settlement agreement, they seek to litigate
issues under the policies in order to reduce their coverage obligations. The
complaint against MII also seeks a recovery of unspecified compensatory damages.
B&W filed a counterclaim against the Plaintiff Insurers which asserts a claim
for breach of contract for amounts owed and unpaid under the settlement
agreement, as well as a claim for anticipatory breach for amounts that will be
owed in the future under the settlement agreement. B&W seeks a declaratory
judgment as to B&W's rights and the obligations of the Plaintiff Insurers and
other London Market insurers under the settlement agreement and under their
respective insurance policies with respect to asbestos claims. On October 2,
2001, MII and B&W filed dispositive motions with the Court seeking dismissal of
the Plaintiff Insurers' claim that MII and B&W had materially breached the
settlement agreement at issue. In a ruling issued January 4, 2002, the U.S.
District Court for the Eastern District of Louisiana granted MII's and B&W's
motion for summary judgment and dismissed the declaratory judgment action filed
by the Plaintiff Insurers. The ruling concluded that the Plaintiff Insurers'
claims lacked a factual or legal basis. Our agreement with the underwriters went
into effect in April 1990 and has served as the allocation and payment mechanism
to resolve many of the asbestos claims against B&W. We believe this ruling
reflects the extent of the underwriter's contractual obligations and underscores
that this coverage is available to settle B&W's asbestos claims. As a result of
the January 4, 2002 ruling, the only claims that remained in the litigation were
B&W's counterclaims against the Plaintiff Insurers and against other London
Market insurers. The parties have recently agreed to dismiss without prejudice
those of B&W's counterclaims seeking a declaratory judgment regarding the
parties' respective rights and obligations under the settlement agreement. B&W's
counterclaim seeking a money judgment for approximately $6,500,000 due and owing
by London Market Insurers under the settlement agreement remains pending. A
trial of this counterclaim is scheduled for June 17, 2002.
15
Following the resolution of this remaining counterclaim, the Plaintiff Insurers
will have an opportunity to appeal the January 4, 2002 ruling. At this point,
the Plaintiff Insurers have not indicated whether they intend to pursue an
appeal.
On or about November 5, 2001, The Travelers Indemnity Company and Travelers
Casualty and Surety Company (collectively, "Travelers") filed an adversary
proceeding against B&W and related entities in the U.S. Bankruptcy Court for the
Eastern District of Louisiana seeking a declaratory judgment that Travelers is
not obligated to provide any coverage to B&W with respect to so-called
"non-products" asbestos bodily injury liabilities on account of previous
agreements entered into by the parties. On or about the same date, Travelers
filed a similar declaratory judgment against MI and MII in the U.S. District
Court for the Eastern District of Louisiana. The cases filed against MI and MII
have been consolidated before the District Court and the Asbestos Claimants
Committee ("ACC") and the Future Claimants Representative ("FCR") have
intervened in the action. On February 4, 2002, B&W and MII filed answers to
Travelers' complaints, denying that previous agreements operate to release
Travelers from coverage responsibility for asbestos "non- products" liabilities
and asserting counterclaims requesting a declaratory judgment specifying
Travelers' duties and obligations with respect to coverage for B&W's asbestos
liabilities. The Court has bifurcated the case into two phases, with Phase I
addressing the issue of whether previous agreements between the parties serve to
release Travelers from any coverage responsibility for asbestos "non-products"
claims. Discovery has commenced on Phase I issues, and the Court has set June
21, 2002 as the close of Phase I discovery. No trial date has been scheduled.
This insurance, if available, would be in addition to the amounts already
included in B&W's financial statements as of March 31, 2002.
On April 30, 2001, B&W filed a declaratory judgment action in its Chapter 11
proceeding in the U.S. Bankruptcy Court for the Eastern District of Louisiana
against MI, BWICO, BWXT, Hudson Products Corporation and McDermott Technology,
Inc. seeking a judgment, among other things, that (1) B&W was not insolvent at
the time of, or rendered insolvent as a result of, a corporate reorganization
that we completed in the fiscal year ended March 31, 1999, which included, among
other things, B&W's cancellation of a $313,000,000 note receivable and B&W's
transfer of all the capital stock of Hudson Products Corporation, Tracy Power,
BWXT and McDermott Technology, Inc. to BWICO, and (2) the transfers are not
voidable. As an alternative, and only in the event that the Bankruptcy Court
finds B&W was insolvent at a pertinent time and the transactions are voidable
under applicable law, the action preserved B&W's claims against the defendants.
The Bankruptcy Court permitted the ACC and the FCR in the Chapter 11 proceedings
to intervene and proceed as plaintiff-intervenors and realigned B&W as a
defendant in this action. The ACC and the FCR are asserting in this action,
among other things, that B&W was insolvent at the time of the transfers and that
the transfers should be voided. The Bankruptcy Court ruled that Louisiana law
applied to the solvency issue in this action. Trial commenced on October 22,
2001 to determine B&W's solvency at the
16
time of the corporate reorganization and concluded on November 2, 2001. In a
ruling filed on February 8, 2002, the Bankruptcy Court found B&W solvent at the
time of the corporate reorganization. On February 19, 2002, the ACC and FCR
filed a motion with the District Court seeking leave to appeal the February 8,
2002 ruling. On February 20, 2002, MI, BWICO, BWXT, Hudson Products Corporation
and McDermott Technology, Inc. filed a motion for summary judgment asking that
judgment be entered on a variety of additional pending counts presented by the
ACC and FCR that we believe are resolved by the February 8, 2002 ruling. On
March 20, 2002, at a hearing in the Bankruptcy Court, the judge granted this
motion and dismissed all claims asserted in complaints filed by the ACC and the
FCR regarding the 1998 transfer of certain assets from B&W to its parent, which
ruling was memorialized in an Order and Judgment dated April 17, 2002 that
dismissed the proceeding with prejudice. On April 26, 2002, the ACC and FCR
filed a notice of appeal of the April 17, 2002 Order and Judgment. In addition,
an injunction preventing asbestos suits from being brought against non-filing
affiliates of B&W, including MI, JRM and MII, and B&W subsidiaries not involved
in the Chapter 11 extends through July 15, 2002.
Additionally, due to the nature of our business, we are, from time to time,
involved in routine litigation or subject to disputes or claims related to our
business activities, including performance or warranty related matters under our
customer and supplier contracts and other business arrangements. In our
management's opinion, none of this litigation or disputes and claims will have a
material adverse effect on our consolidated financial position, results of
operations or cash flows.
Other than as noted above, the following legal proceedings have had no change in
status from that disclosed in Item 3 - "Legal Proceedings," included in Part I
of MII's annual report on Form 10-K for the year ended December 31, 2001:
o The Department of Justice investigation into allegations of wrongdoing
by a limited number of former employees of MII and JRM concerning the
heavy-lift business of JRM's Heeremac joint venture with Heerema
Offshore Construction Group, Inc. and the heavy-lift business of JRM.
o The Department of Justice investigation into possible anti-competitive
activity in the marine construction business of McDermott-ETPM East,
Inc., one of the operating companies within JRM's former McDermott-ETPM
joint venture with ETPM, S.A., a French company.
o The June 1998 lawsuit filed by Phillips Petroleum Company and several
related entities against MII and others, referred to as the "Phillips
Litigation" in our annual report.
o The June 1998 lawsuit filed by Shell Offshore, Inc. and several related
entities against MII and others, referred to as the "Shell Litigation"
in our annual report.
o The December 2000 lawsuits filed by a number of Norwegian oil companies
against MII and others alleging violations of the Norwegian Pricing Act
of 1953 in connection with projects in Norway.
17
o The lawsuit filed by Donald F. Hall, Mary Ann Hall and others against
B&W and Atlantic Richfield Company, referred to as the "Hall
Litigation" in our annual report, as well as the controversy between
B&W and its insurers as to the amount of coverage available under the
liability policies covering the facilities involved in this litigation.
For a detailed description of these proceedings, please refer to Note 11 to the
consolidated financial statements included in Part II of MII's annual report on
Form 10-K for the year ended December 31, 2001. Also, see Note 9 to the
condensed consolidated financial statements regarding B&W's potential liability
for non-employee asbestos claims and additional information concerning the
Chapter 11 reorganization proceedings commenced by B&W and certain of its
subsidiaries on February 22, 2000.
NOTE 6 - SEGMENT REPORTING
For the three months ended March 31, 2002, we have reported the results of
operations for HPC in discontinued operations. In addition, we have included the
results of McDermott Technology, Inc. ("MTI") in Government Operations. HPC and
MTI were previously included in our Industrial Operations segment.
Segment information for the three months ended March 31, 2001 has been restated
to reflect these changes in our reportable segments. We have not changed our
basis of measurement of segment profit or loss from our last annual report. An
analysis of our operations by segment is as follows:
Segment Information for the Three Months Ended March 31, 2002 and 2001.
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
------------ ------------
(Unaudited)
(In thousands)
REVENUES
Marine Construction Services $ 264,171 $ 134,680
Government Operations 121,791 125,368
Industrial Operations -- 142,097
Power Generation Systems 13,242 8,434
Adjustments and Eliminations(1) (12) (55)
------------ ------------
$ 399,192 $ 410,524
============ ============
</Table>
(1) Segment revenues are net of the following intersegment transfers and other
adjustments:
<Table>
Marine Construction Services Transfers $ 12 $ 34
Government Operations Transfers -- 21
------------ ------------
$ 12 $ 55
============ ============
</Table>
18
OPERATING INCOME (LOSS):
<Table>
Segment Operating Income (Loss):
Marine Construction Services $ (10,209) $ (10,416)
Government Operations 11,847 10,853
Industrial Operations -- 1,318
Power Generation Systems (568) (585)
--------- ---------
$ 1,070 $ 1,170
========= =========
Gain on Asset Disposal and Impairments - Net:
Marine Construction Services $ 75 $ 522
Government Operations 1 3
--------- ---------
$ 76 $ 525
========= =========
Income (Loss) from Investees:
Marine Construction Services $ 1,594 $ (46)
Government Operations 5,910 4,702
Industrial Operations -- 30
Power Generation Systems 30 235
--------- ---------
$ 7,534 $ 4,921
========= =========
OPERATING INCOME (LOSS):
Marine Construction Services $ (8,540) $ (9,940)
Government Operations 17,758 15,558
Industrial Operations -- 1,348
Power Generation Systems (538) (350)
--------- ---------
8,680 6,616
Corporate (10,702) (1,733)
--------- ---------
TOTAL $ (2,022) $ 4,883
========= =========
</Table>
19
NOTE 7 - EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted loss per
share:
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
------------ ------------
(Unaudited)
(In thousands, except shares and
per share amounts)
Basic and Diluted:
Loss from Continuing Operations $ (1,760) $ (5,169)
Income from Discontinued Operations 826 736
Extraordinary Item 341 --
------------ ------------
Net Loss $ (593) $ (4,433)
------------ ------------
Weighted Average Common Shares 61,024,612 60,144,541
============ ============
Basic and Diluted Loss per Common Share:
Loss from Continuing Operations $ (0.03) $ (0.09)
Income from Discontinued Operations $ 0.01 $ 0.01
Extraordinary Item $ 0.01 $ --
Net Loss $ (0.01) $ (0.07)
</Table>
Due to rounding, for the quarter ended March 31, 2001, the net loss per share
does not equal the sum of the per share amounts for the individual components of
the net loss.
At March 31, 2002 and 2001, incremental shares of 2,199,012 and 2,426,431,
respectively, related to stock options and restricted stock were excluded from
the diluted share calculation as their effect would have been anti-dilutive.
NOTE 8 - GOODWILL
On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, we no longer amortize goodwill to earnings, but
instead we periodically test for impairment. Following is our reconciliation of
reported net income to adjusted net income, which excludes goodwill amortization
expense (including related tax effects), for the periods presented:
20
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands, except
per share amounts)
Loss before extraordinary item $ (934) $ (4,433)
Add back: goodwill amortization -- 4,940
---------- ----------
Adjusted income (loss) before extraordinary item $ (934) $ 507
========== ==========
Net loss $ (593) $ (4,433)
Add back: goodwill amortization -- 4,940
---------- ----------
Adjusted net income (loss) $ (593) $ 507
========== ==========
Basic and diluted earnings (loss) per share before
extraordinary item:
Loss before extraordinary item $ (0.02) $ (0.07)
Add back: goodwill amortization -- 0.08
---------- ----------
Adjusted earnings (loss) per share before
extraordinary item $ (0.02) $ 0.01
========== ==========
Basic and diluted earnings (loss) per share:
Net loss $ (0.01) $ (0.07)
Add back: goodwill amortization -- 0.08
---------- ----------
Adjusted earnings (loss) per share $ (0.01) $ 0.01
========== ==========
</Table>
Changes in the carrying amount of goodwill for the three months ended March 31,
2002 are as follows:
<Table>
<Caption>
Marine Power
Construction Government Generation
Services Operations Systems
Segment Segment Segment Total
------------ ------------ ------------ ------------
(in thousands)
Balance as of January 1, 2002 $ 313,008 $ 12,926 $ 4,771 $ 330,705
Currency Translation Adjustment -- -- (126) (126)
------------ ------------ ------------ ------------
Balance as of March 31, 2002 $ 313,008 $ 12,926 $ 4,645 $ 330,579
============ ============ ============ ============
</Table>
NOTE 9 - THE BABCOCK & WILCOX COMPANY
General
As a result of asbestos-containing commercial boilers and other products B&W and
certain of its subsidiaries sold, installed or serviced in prior decades, B&W is
subject to a substantial volume of non-employee liability claims asserting
asbestos-related injuries. All of the personal injury claims are similar in
nature, the primary
21
difference being the type of alleged injury or illness suffered by the plaintiff
as a result of the exposure to asbestos fibers (e.g., mesothelioma, lung cancer,
other types of cancer, asbestosis or pleural changes).
On February 22, 2000, B&W and certain of its subsidiaries filed a voluntary
petition in the Bankruptcy Court for the U.S. District Court for the Eastern
District of Louisiana to reorganize under Chapter 11 of the U.S. Bankruptcy
Code. Included in the filing are B&W and its subsidiaries Americon, Inc.,
Babcock & Wilcox Construction Co., Inc. and Diamond Power International, Inc.
(the "Debtors"). The Debtors took this action as a means to determine and
comprehensively resolve all pending and future asbestos liability claims against
them. Following the filing, the Bankruptcy Court issued a preliminary injunction
prohibiting asbestos liability lawsuits and other actions for which there is
shared insurance from being brought against non-filing affiliates of the
Debtors, including MI, JRM and MII. The preliminary injunction is subject to
periodic hearings before the Bankruptcy Court for extension. Currently, the
preliminary injunction runs through July 15, 2002.
Insurance Coverage and Pending Claims
Prior to its bankruptcy filing, the Debtors had engaged in a strategy of
negotiating and settling asbestos personal injury claims brought against them
and billing the settled amounts to insurers for reimbursement. At March 31,
2002, receivables of $27,288,000 were due from insurers for reimbursement of
settled claims paid by the Debtors prior to the Chapter 11 filing. Currently,
certain insurers are refusing to reimburse the Debtors for these receivables
until the Debtors' assumption, in bankruptcy, of its pre-bankruptcy filing
contractual reimbursement arrangements with such insurers. To date, this has not
had a material adverse impact on the Debtors' liquidity or the conduct of their
business and we do not expect it to in the future. We anticipate that the
Debtors will eventually recover these insurance reimbursements.
Pursuant to the Bankruptcy Court's order, a March 29, 2001 bar date was set for
the submission of allegedly unpaid pre-Chapter 11 settled asbestos claims and a
July 30, 2001 bar date for all other asbestos personal injury claims, asbestos
property damage claims, derivative asbestos claims and claims relating to
alleged nuclear liabilities arising from the operation of the Apollo Parks
Township facilities against the Debtors. As of the March 29, 2001 bar date, over
49,000 allegedly settled claims had been filed. The Debtors have accepted
approximately 8,100 as pre-Chapter 11 binding settled claims at this time with
an approximate value of $49,000,000. The Bankruptcy Court has disallowed
approximately 19,000 claims as settled claims and the Debtors are in the process
of challenging virtually all of the remaining claims. If the Bankruptcy Court
determines these claims were not settled prior to the filing of the Chapter 11
petition, these claims may be refiled as unsettled personal injury claims. As of
July 30, 2001, approximately 220,000 additional asbestos personal injury claims,
60,000 related party claims, 168 property damage claims, 212 derivative asbestos
claims and 524 claims relating to the Apollo Parks Township facilities had been
filed. Since the July 30, 2001 bar date, approximately 4,224 additional personal
injury claims were filed. The estimated total alleged value, as
22
asserted by the claimants in the Chapter 11 proceeding and in filed proofs of
claim, of the asbestos-related claims, including the alleged settled claims,
exceeds the combined value of the Debtors and certain assets transferred by B&W
to its parent in a corporate reorganization completed in fiscal year 1999 and
the known available products liability and property damage coverages. As set
forth in the proposed Litigation Protocol filed with the U. S. District Court on
October 18, 2001, the Debtors intend to challenge all unsupported claims and
believe that a significant number may be disallowed by the Bankruptcy Court. The
ACC and FCR filed briefs opposing the Litigation Protocol and requesting an
estimation of pending and future claims.
Amended Plan of Reorganization
On February 22, 2001, the Debtors filed a plan of reorganization and a
disclosure statement. On May 7, 2002, the Debtors filed an amended plan of
reorganization and an amended disclosure statement (collectively, the "Amended
Plan"), which supercede the plan and disclosure statement filed in February
2001.
The Amended Plan contemplates a resolution of the cases based on the principle
that all creditors with valid claims, including, but not limited to, valid
asbestos-related claims, will be paid in full. If the Amended Plan is approved,
all of the shares of B&W will be transferred to a new corporation (the "Funding
Facility"), which will be owned by BWICO, B&W's present shareholder. Payments
under the Amended Plan will generally be funded from three sources: (1)
available cash on the effective date of the Amended Plan generated from the
Debtors' operations and available financing; (2) available cash generated from
the reorganized Debtors, after reserves for letter of credit and working capital
needs; and (3) insurance proceeds. The Funding Facility would (a) pay directly
claims for which it is responsible under the Amended Plan, including
administrative claims not arising in the ordinary course of the Debtors'
businesses, general unsecured claims, asbestos personal injury claims based on
pre-chapter 11 binding settlement agreements ("Settled Asbestos Claims"), and
any valid asbestos property damage claims; (b) provide an initial $2.8 million
(which we believe to be covered by insurance) and an assignment of certain
insurance rights to a trust ("Apollo/Parks Township Litigation Facility Trust")
established to pay certain claims arising from alleged nuclear radiation
exposure at two of the Debtors' former facilities in Western Pennsylvania (the
"Apollo/Parks Township Claims"); and (c) provide a trust (the "Asbestos PI
Trust") established to resolve asbestos personal injury claims, with annual
payments of up to $150 million from the three sources described above to satisfy
such claims in full. All asbestos personal injury claims against the Debtors
would be channeled to the Asbestos PI Trust.
With respect to the insurance proceeds described above, on the effective date of
the Amended Plan, the Debtors would assign to the Funding Facility their rights
against their insurance coverage that relate to asbestos personal injury and
property damage claims against the Debtors. The Debtors' affiliates would also
waive their rights against that insurance to the extent that those rights would
deplete the available $1.15 billion face value products liability coverage,
except that MI, JRM and Hudson Products Corporation would
23
retain the right to pursue claims for coverage on account of asbestos
liabilities, if any, relating to their own operations. The Amended Plan
contemplates that the Debtors will receive a full release and discharge from all
present and future liability for asbestos personal injury claims, asbestos
property damage claims, the Apollo/Parks Township Claims, and any other claims
against them in their Chapter 11 proceedings (with the exception of certain
ordinary course obligations and other obligations of the Debtors not related to
the impaired claims discussed above, which would remain as unimpaired
obligations of the reorganized Debtors). In addition, in consideration of their
waiver of insurance rights, the Debtors' affiliates would be protected by a
channeling injunction against present and future liability for asbestos personal
injury claims arising from the Debtors' operations. If resources later become
depleted, and the Asbestos PI Trust can no longer pay claims that are due and
owing, the Amended Plan contemplates that the injunction may be lifted as to MI,
MII and certain other affiliates. The Amended Plan also provides for a release
of the affiliates from claims related to transactions with the Debtors that were
generally outside the ordinary course of business and did not include the
operations or management of the Debtors' present businesses, assets or
obligations.
The Amended Plan provides that, under certain conditions involving a continuing
uncured adjudicated payment default of the Funding Facility's obligations to
fund the Asbestos PI Trust, the Funding Facility would be required to transfer
to the Asbestos PI Trust all of the shares of The Babcock & Wilcox Company. If
that should occur, we would lose our ownership interest in The Babcock & Wilcox
Company, resulting in a write-off of the carrying value, if any at that time, of
MII's investment ($186,996,000 at March 31, 2002). The Amended Plan also
contemplates that, commencing in the fifth year after the effective date of the
Amended Plan, and on an annual basis thereafter, the Funding Facility would have
the opportunity to make a lump-sum payment to the Asbestos PI Trust in an
amount, approved by the Bankruptcy Court, of the then estimated present and
future liability on account of Asbestos PI Claims, and upon making such payment
would have no further obligation to fund the Asbestos PI Trust. If that should
occur, the financial results of B&W would be reconsolidated with MII and MII
would have access to the cash flows of B&W. A third possible alternative would
be the satisfaction of all claims against the Debtors by the Funding Facility,
which would also result in the financial results of B&W being reconsolidated
with MII and MII having access to the cash flows of B&W.
We have considered the impact of the Amended Plan on our estimate of the
Debtors' ultimate asbestos liability and on our investment in B&W. We continue
to believe that the $1,307,725,000 that B&W provided for asbestos products
liability claims at March 31, 2002 represents our best estimate of the Debtors'
minimum liability for asbestos claims under a settlement strategy. It is not
possible to estimate the range of loss under the strategy proposed in the
Amended Plan. However, amounts claimed by the asbestos claimants are in a wide
range and exceed the value of B&W and certain assets transferred by B&W to its
parent in a corporate reorganization completed in fiscal year 1999 and our known
available products liability and property damage coverages.
24
Specific Treatment of the Debtors' Claims Under the Amended Plan
Asbestos Personal Injury Claims and Derivative PI Claims. The Amended Plan would
establish a mechanism to channel all asbestos personal injury claims against the
Debtors to the Asbestos PI Trust. Further, the Amended Plan would establish
three classes of asbestos personal injury claims: a malignant class, a
nonmalignant class, and an administrative convenience class. The administrative
convenience class would be required to irrevocably elect, in connection with
voting on the plan, to accept a single lump sum payment of $400 from the
Asbestos PI Trust. The malignant and non-malignant claims that do not elect the
$400 lump sum payment would be processed, liquidated and paid in full by the
Asbestos PI Trust pursuant to the trust's distribution procedures ("TDP"). The
TDP will provide claimants who meet criteria respecting exposure, an existing
cause of action and a compensable medical condition an offer of payment provided
on an established schedule or grid. If a claimant fails to meet such criteria,
or is not satisfied with the proposed payment under the grid, the claimant would
be permitted to elect to commence a mediation to settle the claim with the
Asbestos PI Trust; and, if mediation proves to be unsuccessful, then the
claimant would have the option to litigate the claim in the Eastern District of
Louisiana. Derivative personal injury claims (claims for contribution or
indemnity) would be paid by the Asbestos PI Trust only if the derivative
claimant's aggregate liability for the direct claimant's claim has been fixed,
liquidated and paid by the derivative claimant by settlement or final order. In
no event would the Asbestos PI Trust be required to pay more to a derivative
claimant than its liability or obligation to the direct claimant.
Asbestos Property Damage Claims, Settled Asbestos Claims, Derivative Property
Damage Claims, General Unsecured Claims, and certain other claims. These claims
would be resolved by the Funding Facility. The Funding Facility would have all
the Debtors' defenses and pending objections relating to any of these claims and
would pay claims that are allowed by the Bankruptcy Court in full. These allowed
claims would generally be paid 75% of the amount of their claim within 30 days
from the time the claim becomes allowed, and the remaining 25% eighteen months
from the effective date of the Amended Plan.
Apollo/Parks Township Claims. The Apollo/Parks Township Litigation Facility
Trust would be established to process, litigate and pay Apollo/Parks Township
Claims. Through the Funding Facility, on the effective date of the Amended Plan,
the Debtors would contribute $2.8 million (which we believe to be covered by
insurance) and assign approximately $1.2 million in insurance reimbursement
claims due the Debtors. The Amended Plan further contemplates that the Atlantic
Richfield Company ("ARCO"), a codefendant of B&W in litigation involving these
claims, would contribute up to $4 million to the Apollo/Parks Township
Litigation Facility Trust, and the Debtors and ARCO would assign to the
Apollo/Parks Township Litigation Facility Trust approximately $300 million in
insurance coverage that is specifically available to cover present and future
Apollo/Parks Township Claims.
25
Intercompany Claims. Ordinary course claims between the Debtors and their
affiliates would either be resolved through a process of setoff, or will be left
unimpaired under the Amended Plan.
Termination of The Debtors' Exclusive Right to File a Plan
The Debtors maintained the exclusive right to file a plan of reorganization in
their cases (the "exclusive period") from February 2000 through May 8, 2002, at
which time the Bankruptcy Court terminated the exclusive period and permitted
other parties in the Chapter 11 proceeding to file competing plans of
reorganization. The ACC and FCR have indicated that they intend to file a joint
plan of reorganization within sixty days of May 8, 2002. Should such a plan be
submitted, litigation may ensue regarding objections by the Debtors and others
to the ACC/FCR plan, objections by the ACC/FCR to the Debtors' plan and related
issues concerning the confirmation and effectuation of either plan, or some
other alternative that may emerge in those proceedings. Confirmation of the
Debtors' plan of reorganization or any plan which may be submitted by the ACC
and/or FCR will require a finding that such plan satisfies all the conditions
set forth in the Bankruptcy Code as well as the conditions specified in the
plan. We cannot assure that either of these requirements will be met with
respect to the Debtors' plan or any other plan. In the event the Bankruptcy
Court were to find that more than one submitted plan meets the tests set forth
in the Bankruptcy Code for confirmation, the Court may confirm only one plan
and, in exercising its discretion to do so, is required to consider the
preferences of creditors and equity security holders. We cannot assure the
confirmation of the Debtors' plan.
While the Chapter 11 reorganization proceedings continue to progress, there are
a number of issues and matters related to the Debtors' asbestos liability to be
resolved prior to its emergence from the proceedings. Remaining issues and
matters to be resolved include, but are not limited to:
o the ultimate asbestos liability of the Debtors;
o the outcome of negotiations with the ACC, the FCR and other
participants in the Chapter 11 proceedings, concerning, among other
things, the size and structure of a trust to satisfy the asbestos
liability and the means for funding that trust;
o the outcome of negotiations with our insurers as to additional amounts
of coverage of the Debtors and their participation in a plan to fund
the settlement trust;
o the Bankruptcy Court's decisions relating to numerous substantive and
procedural aspects of the Chapter 11 proceedings, including the
Court's periodic determinations as to whether to extend the existing
preliminary injunction that prohibits asbestos liability lawsuits and
other actions for which there is shared insurance from being brought
against non-filing affiliates of B&W, including MI, JRM and MII;
26
o the anticipated need for an extension of the three-year term of the
$300,000,000 debtor-in-possession revolving credit and letter of
credit facility (the "DIP Credit Facility"), which is scheduled to
expire in February 2003, to accommodate the issuance of letters of
credit expiring after that date in connection with new construction
and other contracts on which the Debtors intend to bid;
o the continued ability of our insurers to reimburse us for payments
made to asbestos claimants; and
o the ultimate resolution of the ruling issued by the Bankruptcy Court
on February 8, 2002 which found B&W solvent at the time of a corporate
reorganization completed in the fiscal year ended March 31, 1999 and
the related ruling issued on April 17, 2002 (collectively, the
"Transfer Case"), and the appeals from these rulings. See Note 5 for
further information.
Any changes in (1) the estimates of the Debtors' nonemployee asbestos liability
and insurance, (2) the differences between the proportion of those liabilities
covered by insurance and that experienced in the past and (3) the ultimate
resolution of the Transfer Case could result in material adjustments to B&W's
financial statements and negatively impact our ability to realize our net
investment in B&W and certain assets transferred by B&W to its parent in the
corporate reorganization.
Debtor-In-Possession Financing
In connection with the bankruptcy filing, the Debtors entered into the DIP
Credit facility with Citibank, N.A. and Salomon Smith Barney Inc. with a
three-year term. The Bankruptcy Court approved the full amount of this facility,
giving all amounts owed under the facility a super-priority administrative
expense status in bankruptcy. The Debtors' obligations under the facility are
(1) guaranteed by substantially all of B&W's other domestic subsidiaries and B&W
Canada Ltd. and (2) secured by a security interest on B&W Canada Ltd.'s assets.
Additionally, B&W and substantially all of its domestic subsidiaries granted a
security interest in their assets to the lenders under the DIP Credit Facility
upon the defeasance or repayment of MI's public debt. The DIP Credit Facility
generally provides for borrowings by the Debtors for working capital and other
general corporate purposes and the issuance of letters of credit, except that
the total of all borrowings and non-performance letters of credit issued under
the facility cannot exceed $100,000,000 in the aggregate. The DIP Credit
Facility also imposes certain financial and non-financial covenants on B&W and
its subsidiaries. There were no borrowings under this facility at March 31, 2002
or December 31, 2001. A permitted use of the DIP Credit Facility is the issuance
of new letters of credit to backstop or replace pre-existing letters of credit
issued in connection with B&W's and its subsidiaries' business operations, but
for which MII, MI or BWICO was a maker or guarantor. As of February 22, 2000,
the aggregate amount of all such pre-existing letters of credit totaled
approximately $172,000,000 (the "Pre-existing LCs"), $19,024,000 of which remain
outstanding at March 31, 2002. MII, MI and BWICO have agreed to indemnify and
reimburse the Debtors
27
for any customer draw on any letter of credit issued under the DIP Credit
Facility to backstop or replace any Pre-existing LC for which it already has
exposure and for the associated letter of credit fees paid under the facility.
As of March 31, 2002, approximately $112,282,000 in letters of credit have been
issued under the DIP Credit Facility of which approximately $55,434,000 were to
replace or backstop Pre-existing LCs. At December 31, 2001, B&W was in violation
of a covenant under the DIP Credit Facility caused by the acquisition of 80% of
the common stock of a company for approximately $90,000. B&W received a consent
from the lenders that remedied this covenant violation on March 18, 2002.
Financial Results and Reorganization Items
The B&W condensed consolidated financial statements set forth below have been
prepared in conformity with the American Institute of Certified Public
Accountants' Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code," issued November 19, 1990 ("SOP
90-7"). SOP 90-7 requires a segregation of liabilities subject to compromise by
the Bankruptcy Court as of the bankruptcy filing date and identification of all
transactions and events that are directly associated with the reorganization.
Liabilities subject to compromise include prepetition unsecured claims, which
may be settled at amounts which differ from those recorded in the B&W condensed
consolidated financial statements.
28
THE BABCOCK & WILCOX COMPANY
DEBTOR-IN-POSSESSION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
Three Months Ended
March 31,
2002 2001
---------- ----------
(Unaudited)
(In thousands)
Revenues $ 378,957 $ 355,859
---------- ----------
Costs and Expenses:
Cost of operations 325,033 301,789
Selling, general and administrative
expenses 29,413 28,601
Reorganization charges 6,378 4,943
---------- ----------
Total Costs and Expenses 360,824 335,333
---------- ----------
Equity in income of investees 880 367
---------- ----------
Operating Income 19,013 20,893
---------- ----------
Other Income (Expense):
Interest income 1,440 2,364
Interest expense (1,266) (1,475)
Other-net (234) (3,248)
---------- ----------
(60) (2,359)
---------- ----------
Income before Provision for Income Taxes 18,953 18,534
Provision for Income Taxes 8,415 7,869
---------- ----------
Net Income $ 10,538 $ 10,665
========== ==========
Effect of no longer amortizing goodwill:
Net Income $ 10,665
Add back: goodwill amortization (net of tax) 1,126
----------
Adjusted Net Income $ 11,791
==========
</Table>
29
THE BABCOCK & WILCOX COMPANY
DEBTOR-IN-POSSESSION
CONDENSED CONSOLIDATED BALANCE SHEET
<Table>
<Caption>
March 31, December 31,
2002 2001
----------- ------------
(Unaudited)
(In thousands)
Assets:
Current Assets $ 608,419 $ 592,968
Property, Plant and Equipment 78,526 77,185
Products Liabilities Recoverable 1,152,489 1,152,489
Goodwill 76,301 74,394
Prepaid Pension Costs 11,575 12,411
Other Assets 160,597 159,692
----------- -----------
Total Assets $ 2,087,907 $ 2,069,139
=========== ===========
Liabilities:
Current Liabilities $ 443,490 $ 431,702
Liabilities Subject to Compromise(A) 1,438,901 1,441,869
Accrued Postretirement Benefit Obligation 771 897
Other long-term liabilities 15,727 14,693
Stockholder's Equity:
Common Stock 1,001 1,001
Capital in Excess of Par Value 134,717 134,729
Retained Earnings 88,861 78,323
Accumulated Other Comprehensive Loss (35,561) (34,075)
----------- -----------
Total Liabilities and Stockholder's Equity $ 2,087,907 $ 2,069,139
=========== ===========
(A) Liabilities subject to compromise consist of the following:
Accounts payable $ 3,703 $ 3,720
Provision for warranty 14,463 16,346
Other current liabilities 25,673 25,758
Products liabilities 1,307,725 1,307,725
Accumulated postretirement benefit obligation 70,319 70,909
Other long-term liabilities 17,018 17,411
----------- -----------
$ 1,438,901 $ 1,441,869
=========== ===========
</Table>
Liabilities subject to compromise include pre-petition unsecured claims, which
may be settled at amounts which differ from those recorded in the B&W condensed
consolidated financial statements.
In the course of the conduct of B&W's and its subsidiaries' business, MII and MI
have agreed to indemnify two surety companies for B&W's and its subsidiaries'
obligations under surety bonds issued in connection with their customer
contracts. At March 31, 2002, the total value of B&W's and its subsidiaries'
customer contracts yet to be completed covered by such indemnity arrangements
was approximately $136,000,000 of which approximately $58,000,000 relates to
bonds issued after February 21, 2000.
30
B&W's financial results are included in our consolidated results through
February 21, 2000, the day prior to B&W's Chapter 11 filing. However, generally
accepted accounting principles specifically require that any entity whose
financial statements were previously consolidated with those of its parent (as
B&W's were with ours) that files for protection under the U.S. Bankruptcy Code,
whether solvent or insolvent, must be prospectively deconsolidated from the
parent and presented on the cost method. The cost method requires us to present
the net assets of B&W at February 22, 2000 as an investment and not recognize
any income or loss from B&W in our results of operations during the
reorganization period. This investment of $186,966,000 is subject to periodic
reviews for recoverability. The results of our assessment of recoverability are
dependent on our expected resolution of the overall asbestos liability, timing
of cash flow distributions from B&W as contemplated under the Amended Plan and
market conditions. When B&W emerges from the jurisdiction of the Bankruptcy
Court, the subsequent accounting will be determined based upon the applicable
circumstances and facts at such time, including the terms of any plan of
reorganization. It is possible that a material adjustment to our financial
statements will be required in the course of or on the completion of the B&W
reorganization.
We have assessed B&W's liquidity position as a result of the bankruptcy filing
and believe that B&W can continue to fund its and its subsidiaries' operating
activities and meet its debt and capital requirements for the foreseeable
future. However, B&W's ability to continue as a going concern depends on its
ability to settle its ultimate asbestos liability from its net assets, future
profits and cash flow and available insurance proceeds, whether through the
confirmation of a plan of reorganization or otherwise. The B&W condensed
consolidated financial information set forth above has been prepared on a going
concern basis which contemplates continuity of operations, realization of assets
and liquidation of liabilities in the ordinary course of business. As a result
of the bankruptcy filing and related events, there is no assurance that the
carrying amounts of assets will be realized or that liabilities will be
liquidated or settled for the amounts recorded. In addition, a rejection of the
Amended Plan of reorganization could change the amounts reported in the B&W
financial statements and cause a material decrease in the carrying amount of our
investment. The independent accountant's report on the separate consolidated
financial statements of B&W for the years ended December 31, 2001 and 2000
includes an explanatory paragraph indicating that these issues raise substantial
doubt about B&W's ability to continue as a going concern.
NOTE 10 - LIQUIDITY
As a result of the B&W bankruptcy filing, our access to the cash flows of B&W
and its subsidiaries has been restricted. In addition, MI and JRM and their
respective subsidiaries are limited, as a result of covenants in debt
instruments, in their ability to transfer funds to MII and its other
subsidiaries through cash dividends or through unsecured loans or investments.
As a result, we have assessed our ability to continue as a going
31
concern and have concluded that we can continue to fund our operating activities
and capital requirements for the foreseeable future. In this regard, management
will be required to address several significant issues:
o MI's Negative Cash Flows. We expect MI to experience negative cash
flows in 2002, primarily due to tax payments on the exercise of MI's
rights under an Intercompany Agreement referred to below. MI expects
to meet its cash needs through short-term borrowings by BWXT on the
MII Credit Facility, sale of assets, obtaining loans from either JRM
or MII, a capital contribution from MII or some combination of those
sources. While we expect MI's cash flow to improve considerably in
2003, MI's lack of liquidity poses substantial risk in the short term.
o Reduction in Surety Bond Capacity. Two of our surety companies
notified us in the first quarter of 2001 that they are no longer
willing to issue bonds on our behalf. We obtain surety bonds in the
ordinary course of business of several of our operations to secure
contract bids and to meet the bonding requirements of various
construction and other contracts with customers. We are currently
canvassing the surety market to obtain additional bonding capacity.
Since we received the notice from our surety companies, we have been
satisfying most of our bonding requirements by letters of credit and
enhanced contract terms and conditions. However, if we fail to obtain
replacement bonding capacity, our ability to secure customer contracts
and pursue additional projects in the future may be materially
adversely affected. As of March 31, 2002, MII guaranteed previously
issued surety bonds of $147,000,000, $136,000,000, of which were
issued in connection with business operations of B&W and its
subsidiaries. We do not believe that either MII or any of its
subsidiaries, including B&W, have ever had a surety bond called.
However, MII does not currently have sufficient cash or other liquid
resources available if contract defaults require it to fund a
significant amount of its surety bonds.
o Credit Rating Downgrade. In September 2001, Moody's Investor Service
lowered MI's credit rating from BA3 to B2. JRM's credit rating
remained unchanged at BA3. Our rating by Standard & Poors remained
unchanged at B. This downgrade by Moody's Investor Service has
impacted our cost of capital and could impact our access to capital.
o Upcoming Maturity of our Credit Facilities. The MII, JRM and B&W DIP
Credit Facilities are scheduled to expire in February 2003. We plan to
renegotiate these facilities. However, if we are unable to renegotiate
these facilities, this could impact our access to capital as we may
not be able to obtain alternative financing.
During the three months ended March 31, 2002, MI repurchased or repaid the
remaining $208,808,000 in aggregate principal amount of its 9.375% Notes due
March 15, 2002 for aggregate payments of $208,283,000, resulting in an
extraordinary net after tax gain of $341,000. In order to repay the remaining
notes, MI exercised its right pursuant to a stock purchase and sale agreement
with MII (the "Intercompany Agreement"), under which MI had the right to sell to
MII and MII had the right to buy from MI, 100,000 units, each of which consisted
of one share of MII common stock and one share of MII Series A Participating
Preferred Stock. MI held this financial asset since prior to
32
the 1982 reorganization transaction under which MII became the parent of MI. The
price was based on (1) the stockholders' equity of MII at the close of the
fiscal year preceding the date on which the right to sell or buy, as the case
may be, was exercised and (2) the price-to-book value of the Dow Jones
Industrial Average. At January 1, 2002, the aggregate unit value of MI's right
to sell all of its 100,000 units to MII was approximately $243,000,000. MI
received this amount from the exercise of the Intercompany Agreement. MII funded
that payment by (1) receiving dividends of $80,000,000 from JRM and of
$20,000,000 from one of our captive insurance companies and (2) reducing its
short-term investments and cash and cash equivalents. The proceeds paid to MI
were subject to U.S. federal, state and other applicable taxes, and we recorded
a tax provision totaling approximately $85,400,000 at December 31, 2001. Payment
of this amount may put a strain on our liquidity.
Item 2. Management's Discussion And Analysis Of Financial Condition and Results
Of Operations
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
We are including the following discussion to inform our existing and potential
security holders generally of some of the risks and uncertainties that can
affect our company and to take advantage of the "safe harbor" protection for
forward-looking statements that applicable federal securities law affords.
From time to time, our management or persons acting on our behalf make
forward-looking statements to inform existing and potential security holders
about our company. These statements may include projections and estimates
concerning the timing and success of specific projects and our future backlog,
revenues, income and capital spending. Forward-looking statements are generally
accompanied by words such as "estimate," "project," "predict," "believe,"
"expect," "anticipate," "plan," "goal" or other words that convey the
uncertainty of future events or outcomes. In addition, sometimes we will
specifically describe a statement as being a forward-looking statement and refer
to this cautionary statement.
In addition, various statements this Quarterly Report on Form 10-Q contains,
including those that express a belief, expectation or intention, as well as
those that are not statements of historical fact, are forward-looking
statements. These forward-looking statements speak only as of the date of this
report, we disclaim any obligation to update these statements unless required by
securities law, and we caution you not to rely on them unduly. We have based
these forward-looking statements on our current expectations and assumptions
about future events. While our management considers these expectations and
assumptions to be reasonable, they are inherently subject to significant
business, economic, competitive, regulatory and other risks, contingencies and
uncertainties, most of which are difficult to predict and many of which are
beyond our control. These risks, contingencies and uncertainties relate to,
among other matters, the following:
o general economic and business conditions and industry trends;
o the continued strength of the industries in which we are involved;
33
o decisions about offshore developments to be made by oil and gas
companies;
o the deregulation of the U.S. electric power market;
o the highly competitive nature of our businesses;
o our future financial performance, including availability, terms and
deployment of capital;
o the continued availability of qualified personnel;
o operating risks normally incident to offshore exploration, development
and production operations;
o changes in, or our failure or inability to comply with, government
regulations and adverse outcomes from legal and regulatory
proceedings, including the results of ongoing governmental
investigations and related civil lawsuits involving alleged
anticompetitive practices in our marine construction business;
o estimates for pending and future nonemployee asbestos claims against
B&W and potential adverse developments that may occur in the Chapter
11 reorganization proceedings involving B&W and certain of its
subsidiaries, which could result in material adjustments to, including
the write-off of, the $186,966,000 carrying value of MII's investment
in B&W;
o the potential impact on available insurance due to the recent
increases in bankruptcy filings by asbestos-troubled companies;
o the potential impact on our insurance subsidiaries of B&W
asbestos-related claims under policies issued by those subsidiaries;
o changes in existing environmental regulatory matters;
o rapid technological changes;
o realization of deferred tax assets;
o consequences of significant changes in interest rates and currency
exchange rates;
o difficulties we may encounter in obtaining regulatory or other
necessary approvals of any strategic transactions;
o social, political and economic situations in foreign countries where
we do business, including among others, countries in the Middle East;
o effects of asserted and unasserted claims;
o our ability to obtain surety bonds and letters of credit;
o the continued ability of our insurers to reimburse us for payments
made to asbestos claimants; and
o our ability to maintain builder's risk, liability and property
insurance in amounts we consider adequate at rates that we consider
economical, particularly after the impact on the insurance industry of
the September 11, 2001 terrorist attacks.
We believe the items we have outlined above are important factors that could
cause estimates in our financial statements to differ materially from actual
results and those expressed in a forward-looking statement made in this report
or elsewhere by us or on our behalf. We have discussed many of these factors in
more detail elsewhere in this report and in our annual report on Form 10-K for
the year ended December 31, 2001. These factors are not necessarily all the
important factors that could affect us. Unpredictable or unknown factors we have
not discussed in this report could also have material adverse effects on actual
results of matters that are the subject of our forward-looking statements. We do
not intend to update our description of important factors each time a potential
important factor arises, except as required by applicable securities laws and
regulations. We advise our security holders that they should (1) be aware that
important factors not referred to above could affect the accuracy of our
forward-looking statements and (2) use caution and common sense when considering
our forward-looking statements.
34
GENERAL
The amount of revenues we generate from our Marine Construction Services segment
largely depends on the level of oil and gas development activity in the world's
major hydrocarbon producing regions. Our revenues from this segment reflect the
variability associated with the timing of significant development projects.
Although oil and gas prices remain lower than we anticipated for 2002, we expect
revenues to increase at our Marine Construction Services segment for 2002,
primarily for deepwater projects. We believe the oil and gas industry is focused
on deepwater projects, and that the deepwater floater market will be robust over
the next several years, with around 70 prospects worldwide. JRM's future is tied
to the deepwater market. However, timing of award of many marine construction
projects is uncertain. In addition, the Marine Construction Services market
remains competitive, which may have a significant impact on our anticipated
segment income in future periods.
The revenues of our Government Operations segment are largely a function of
capital spending by the U.S. Government. As the sole supplier of nuclear fuel
assemblies and major nuclear components for certain U.S. Government programs,
BWXT is a significant participant in the defense industry. Additionally, with
BWXT's unique capability of full life-cycle management of special nuclear
materials, facilities and technologies, BWXT is poised to participate in the
continuing cleanup and management of the Department of Energy's nuclear sites
and weapons complexes.
The results of operations of our Industrial Operations segment include only the
results of McDermott Engineers & Constructors (Canada) Ltd., which we sold in
October 2001. The results of our Hudson Products Corporation ("HPC") subsidiary
are reported in discontinued operations. We expect to sell our interest in HPC
in 2002. See Note 2 to the condensed consolidated financial statements for
further information on discontinued operations. In addition, we have included
the results of McDermott Technology, Inc. ("MTI") in Government Operations. MTI
was previously included in our Industrial Operations segment.
Effective February 22, 2000 and until B&W and its filing subsidiaries emerge
from the Chapter 11 reorganization proceedings and the subsequent accounting is
determined, we no longer consolidate B&W's and its subsidiaries' results of
operations in our condensed consolidated financial statements and our investment
in B&W is presented on the cost method.
In general, our business segments are composed of capital-intensive businesses
that rely on large contracts for a substantial amount of their revenues.
Effective January 1, 2002, based on a review performed by the company and
independent consultants, we changed our estimate of the useful lives of new
major marine vessels from 12 years to 25 years to better reflect the service
lives of our assets and industry norms. Consistent with this change, we also
extended the
35
lives of major upgrades to existing vessels. We continue to depreciate our major
marine vessels using the units-of-production method, based on the utilization of
each vessel. The change in estimated useful lives improved our operating income
by approximately $429,000 for the three months ended March 31, 2002.
For a summary of our accounting policies that we believe are important to an
understanding of our financial statements, please refer to Item 7 included in
Part II of our annual report on Form 10-K for the year ended December 31, 2001.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2002 VS. THREE MONTHS ENDED
MARCH 31, 2001
Marine Construction Services
Revenues increased $129,491,000 to $264,171,000. The increase is a result of new
offshore construction projects, primarily for the deepwater market. Fabrication
hours in the current quarter were 3.7 million hours versus 1.5 million in the
quarter ended March 31, 2001. However, in offshore construction activities, we
recorded 379 marine days, 19% fewer than in the quarter ended March 31, 2001.
The decline in marine days is attributable to reduced time charters to our
Mexican joint venture. Pemex, the national oil company of Mexico, is the primary
customer of this joint venture.
Segment operating loss, which is before income from investees, decreased
$207,000 to $10,209,000, primarily due to increased activity in the current
quarter and the elimination of goodwill amortization. These improvements were
offset by cost overruns on our first EPIC spar contract and difficulties setting
a topside. On the topside, we recorded a charge of $1,400,000, primarily due to
equipment problems and weather delays in the Gulf of Mexico. On the EPIC spar
contract, which we estimated to be approximately 53% complete at March 31, 2002
, we recorded a $9,500,000 charge in the current quarter primarily due to
engineering and scope changes, which resulted in productivity deterioration. We
have two other EPIC spar contracts in our backlog. At March 31, 2002, we
estimate one to be approximately 22% complete, and work has just begun on the
other contract.
Income (loss) from investees improved $1,640,000 to income of $1,594,000,
primarily due to improved operating results from our Mexican joint venture.
Government Operations
Revenues decreased $3,577,000 to $121,791,000, primarily due to lower volumes
from management and operating contracts for U.S. Government-owned facilities,
nuclear fuel assemblies and reactor components for the U.S. Government and
commercial nuclear environmental services. Higher volumes from other government
operations and commercial work partially offset these decreases.
36
Segment operating income, which is before income from investees, increased
$994,000 to $11,847,000, primarily due to higher volumes and margins from other
government operations and commercial work and higher margins from management and
operating contracts for U.S. Government-owned facilities. In addition, we
received an insurance settlement relating to environmental restoration costs.
Lower volumes and margins from nuclear fuel assemblies and reactor components
for the U.S. Government, higher general and administrative expenses and
increased spending on fuel cell research and development partially offset these
increases.
Income from investees increased $1,208,000 to $5,910,000, primarily due to
improved operating results from the Pantex joint venture.
Power Generation Systems
Revenues increased $4,808,000 to $13,242,000, primarily due to higher volumes
from the fabrication of utility and industrial boilers and from after-market
service activities.
Corporate
Corporate expenses increased $8,969,000 to $10,702,000, primarily due to the
recognition of expense from our over-funded pension plans in the current quarter
compared to income from these plans in the quarter ended March 31, 2001. Also,
variable stock-based compensation expense increased due to increases in our
stock price.
Other Income Statement Items
Interest income decreased $2,368,000 to $3,480,000, primarily due to decreases
in investments and prevailing interest rates.
Interest expense decreased $2,966,000 to $7,165,000, primarily due to reduced
interest rates and borrowings on our credit lines and the repayment of MI's
remaining 9.375% Notes due March 15, 2002.
Other-net improved $3,909,000 from expense of $2,211,000 to income of
$1,698,000. The improvement is primarily attributable to gains on sales of
investment securities and foreign currency transaction gains.
For the three months ended March 31, 2002, income earned in low tax
jurisdictions contributed to the effective tax rate of approximately a 56%
benefit on our pre-tax loss. The provision for income taxes for the three months
ended March 31, 2001 reflects non-deductible amortization of goodwill of
$4,940,000, of which $4,502,000 was attributable to the premium we paid on the
acquisition of the minority interest in JRM in June 1999. Income taxes for the
three months ended March 31, 2001 also includes a tax benefit relating to
favorable tax settlements in foreign jurisdictions totaling $2,300,000. We
operate in many different tax jurisdictions. Within these jurisdictions, tax
provisions vary because of nominal rates, allowability of deductions, credits
and
37
other benefits and tax bases (for example, revenue versus income). These
variances, along with variances in our mix of income from these jurisdictions,
are responsible for shifts in our effective tax rate.
Backlog
<Table>
<Caption>
3/31/02 12/31/01
---------- ----------
(Unaudited)
(In thousands)
Marine Construction Services $2,053,527 $1,800,491
Government Operations 1,101,493 1,025,400
Power Generation Systems 38,888 49,970
---------- ----------
TOTAL BACKLOG $3,193,908 $2,875,861
========== ==========
</Table>
Backlog for the Marine Construction Services segment increased primarily because
of recent awards of new offshore construction projects in the Gulf of Mexico,
Southeast Asia and the Middle East.
At March 31, 2002, Government Operations' backlog with the U. S. Government was
$1,021,421,000 (of which $25,304,000 had not been funded).
Liquidity and Capital Resources
During the three months ended March 31, 2002, our cash and cash equivalents
decreased $50,677,000 to $146,235,000, and our total debt decreased $208,463,000
to $101,436,000, primarily due to payments of long-term debt of $208,309,000.
During this period, we received cash of $804,922,000 from sales and maturities
of investments, $3,024,000 from operating activities, $1,672,000 from the
issuance of common stock pursuant to our employee stock plans and $76,000 from
the sale of assets. We used cash of $646,992,000 for the purchase of investments
and $10,558,000 for additions to property, plant and equipment.
At March 31, 2002 and December 31, 2001, we had available various uncommitted
short-term lines of credit from banks totaling $8,685,000 and $8,885,000,
respectively. We had borrowings of $693,000 against these lines at March 31,
2002 and no borrowings against these lines at December 31, 2001.
On February 21, 2000, B&W and certain of its subsidiaries entered into the DIP
Credit Facility to satisfy their working capital and letter of credit needs
during the pendency of their bankruptcy case. As a condition to borrowing or
obtaining letters of credit under the DIP Credit Facility, B&W must comply with
certain financial covenants. At December 31, 2001, B&W was in violation of a
covenant under the DIP Credit Facility caused by the acquisition of 80% of the
common stock of a company for approximately $90,000. B&W received a consent from
the lenders that remedied this covenant violation on March 18, 2002. B&W had no
borrowings outstanding under this facility at March 31, 2002 or December 31,
2001. Letters of credit outstanding under the DIP Credit Facility at March 31,
2002 totaled approximately $112,282,000. This facility is scheduled to expire in
February 2003. We plan to renegotiate this facility and expect to be successful.
See Note 9 to the condensed consolidated financial statements for further
information on the DIP Credit Facility.
38
At March 31, 2002, MII was a maker or guarantor on $19,024,000 of letters of
credit issued in connection with B&W operations prior to its Chapter 11 filing.
In addition, MII, MI and BWICO have agreed to indemnify B&W for any customer
draw on $55,435,000 in letters of credit which have been issued under the DIP
Facility to replace or backstop letters of credit on which MII, MI and BWICO
were makers or guarantors as of B&W's Chapter 11 filing. We believe that B&W has
never had a letter of credit drawn on by a customer. However, MII, MI and BWICO
do not currently have sufficient cash or other liquid resources available,
either individually or combined, to satisfy their maker, guarantor or indemnity
obligations to letter of credit issuers of B&W should customer draws occur on a
significant amount of these letters of credit.
On the day before B&W's Chapter 11 filing, February 21, 2000, we also entered
into other financing arrangements providing financing to the balance of our
operations. This financing, as amended on April 24, 2000, consisted of a
$200,000,000 credit facility for MII, BWXT and Hudson Products Corporation (the
"MII Credit Facility") and a $200,000,000 credit facility for JRM and its
subsidiaries (the "JRM Credit Facility"). Each facility is with a group of
lenders, for which Citibank, N.A. is acting as the administrative agent. These
facilities are scheduled to expire in February 2003. We plan to renegotiate
these facilities and expect to be successful.
On March 26, 2002, the MII Credit Facility was reduced to $100,000,000. This
facility serves as a revolving credit and letter of credit facility. Borrowings
under this facility may be used for working capital and general corporate
purposes. The aggregate amount of loans and amounts available for drawing under
letters of credit outstanding under the MII Credit Facility may not exceed
$100,000,000. This facility is secured by a collateral account funded with
various U.S. government securities with a minimum marked-to-market value equal
to 105% of the aggregate amount available for drawing under letters of credit
and revolving credit borrowings outstanding. We had no borrowings against this
facility at March 31, 2002 or December 31, 2001. Letters of credit outstanding
at March 31, 2002 were approximately $57,928,000.
The JRM Credit Facility consists of two tranches. One is a revolving credit
facility that provides for up to $100,000,000 for advances to borrowers.
Borrowings under this facility may be used for working capital and general
corporate purposes. The second tranche provides for up to $200,000,000 of
letters of credit. The aggregate amount of loans and amounts available for
drawing under letters of credit outstanding under the JRM Credit Facility may
not exceed $200,000,000. The facility is subject to certain financial and
non-financial covenants. We had no borrowings against this facility at March 31,
2002 or December 31, 2001. Letters of credit outstanding under the JRM Credit
Facility at March 31, 2002 totaled approximately $95,894,000.
At March 31, 2002, we had total cash, cash equivalents and investments of
$317,864,000. Our investment portfolio consists primarily of government
obligations and other investments in debt securities. The fair value of our
investments at March 31, 2002 was $171,629,000. As of March 31, 2002, we had
pledged approximately
39
$46,069,000 fair value of these investments to secure a letter of credit in
connection with certain reinsurance agreements. In addition, as of March 31,
2002, we had pledged investment portfolio assets having a fair market value of
approximately $111,000,000 to secure our obligations under the MII Credit
Facility. We had free cash available totaling approximately $94,000,000 at March
31, 2002.
During the three months ended March 31, 2002, MI repurchased or repaid the
remaining $208,808,000 in aggregate principal amount of its 9.375% Notes due
March 15, 2002 for aggregate payments of $208,283,000, resulting in an
extraordinary net after tax gain of $341,000. In order to repay the remaining
notes, MI exercised its right pursuant to a stock purchase and sale agreement
with MII (the "Intercompany Agreement"). Under this agreement, MI had the right
to sell to MII and MII had the right to buy from MI, 100,000 units, each of
which consisted of one share of MII Common Stock and one share of MII Series A
Participating Preferred Stock held by MI since prior to the 1982 reorganization
transaction under which MII became the parent of MI. MI received approximately
$243,000,000 from the exercise of the Intercompany Agreement. MII funded that
payment by (1) receiving dividends of $80,000,000 from JRM and of $20,000,000
from one of our captive insurance companies and (2) reducing its short-term
investments and cash and cash equivalents. The proceeds paid to MI were subject
to U.S. federal, state and other applicable taxes, and we recorded a tax
provision totaling approximately $85,400,000 at December 31, 2001. Payment of
this amount may put a strain on our liquidity.
As of March 31, 2002, our projected liquidity position for 2002 has not changed
significantly from that disclosed in Part II of MII's annual report on Form 10-K
for the year ended December 31, 2001. We anticipate incurring negative cash
flows in 2002. We expect to meet capital expenditure, working capital and debt
maturity requirements from cash and cash equivalents, short-term borrowings and
the sale of HPC. We also expect MI to experience negative cash flows in 2002,
primarily due to tax payments on the exercise of MI's rights under the
Intercompany Agreement. MI expects to meet its cash needs through short-term
borrowings by BWXT on the MII Credit Facility, sale of assets, obtaining loans
from either JRM or MII, a capital contribution from MII or some combination of
those sources. While we expect MI's cash flow to improve in 2003, MI's lack of
liquidity poses substantial risk to us and to the holders of its outstanding
debt securities in the short term.
MI and JRM and their respective subsidiaries are restricted, as a result of
covenants in debt instruments, in their ability to transfer funds to MII and its
other subsidiaries through cash dividends or through unsecured loans or
investments. At March 31, 2002, substantially all the net assets of MI were
subject to those restrictions. At March 31, 2002, JRM and its subsidiaries could
make unsecured loans to or investments in MII and its other subsidiaries of
approximately $71,000,000.
Our two surety companies notified us in the first quarter of 2001 that they are
no longer willing to issue bonds on our behalf. We obtain surety bonds in the
ordinary course of business of several of our operations to secure contract bids
and to meet the bonding requirements of various construction and other contracts
with customers.
40
We are currently canvassing the surety market to obtain additional bonding
capacity. Since we received the notice from our surety companies, we have been
satisfying most of our bonding requirements by letters of credit and enhanced
contract terms and conditions. However, if we fail to obtain replacement bonding
capacity, our ability to secure customer contracts and pursue additional
projects in the future may be materially adversely affected. As of March 31,
2002, MII guaranteed previously issued surety bonds of $147,000,000,
$136,000,000 of which were issued in connection with business operations of B&W
and its subsidiaries. We do not believe that either MII or any of its
subsidiaries, including B&W, have ever had a surety bond called. However, MII
does not currently have sufficient cash or other liquid resources available if
contract defaults require it to fund a significant amount of its surety bonds.
As a result of its bankruptcy filing, B&W and its filing subsidiaries are
precluded from paying dividends to shareholders and making payments on any
pre-bankruptcy filing accounts or notes payable that are due and owing to any
other entity within the McDermott group of companies (the "Pre-Petition
Intercompany Payables") and other creditors during the pendency of the
bankruptcy case, without the Bankruptcy Court's approval.
As a result of the B&W bankruptcy filing, our access to the cash flows of B&W
and its subsidiaries has been restricted. In addition, MI and JRM and their
respective subsidiaries are limited, as a result of covenants in debt
instruments, in their ability to transfer funds to MII and its other
subsidiaries through cash dividends or through unsecured loans or investments.
As a result, we have assessed our ability to continue as a going concern and
have concluded that we can continue to fund our operating activities and capital
requirements for the foreseeable future.
In September 2001, Moody's Investor Service lowered MI's credit rating from BA3
to B2. JRM's credit rating remained unchanged at BA3. Our rating by Standard &
Poors remained unchanged at B. This downgrade by Moody's Investor Service has
impacted our cost of capital and could impact our access to capital.
As a result of the impact of the September 11, 2001 terrorist attacks, our
insurers have indicated that we will incur higher costs, higher deductibles and
more restrictive terms and conditions as we renew our historical insurance
coverages in the future. We expect to continue to maintain coverage that we
consider adequate at rates that we consider economical. However, some previously
insured risks may no longer be insurable, or insurance to cover them may be
available only at rates that we consider uneconomical.
We have evaluated and expect to continue evaluating possible strategic
acquisitions. At any given time, we may be engaged in discussions or
negotiations or enter into agreements relating to potential acquisition
transactions.
41
The Babcock & Wilcox Company
B&W and its subsidiaries conduct substantially all of the operations of our
Power Generation Systems segment. The amount of revenues we generate from our
Power Generation Systems segment primarily depends on capital spending by
customers in the electric power generation industry. The economy of the U.S.
slowed down in late 2001, easing demand for electricity and for new generating
capacity. This slowdown also resulted in a slowing of inquiries for new power
plants and plant upgrades. Current U.S. emissions requirements continue to
prompt some customers to place orders for environmental equipment. Domestic
demand for electrical power generation industry services and replacement nuclear
steam generators continues at strong levels. The international markets remain
unsettled. Economic and political instability in Asia has caused projects there
to be delayed, suspended or cancelled. We currently expect this segment's 2002
revenues to be about the same as 2001.
B&W's financial results are included in our consolidated results through
February 21, 2000, the day prior to B&W's Chapter 11 filing. However, generally
accepted accounting principles specifically require that any entity whose
financial statements were previously consolidated with those of its parent (as
B&W's were with ours) that files for protection under the U.S. Bankruptcy Code,
whether solvent or insolvent, must be prospectively deconsolidated from the
parent and presented on the cost method. The cost method requires us to present
the net assets of B&W at February 22, 2000 as an investment and not recognize
any income or loss from B&W in our results of operations during the
reorganization period. This investment of $186,966,000 as of March 31, 2002 is
subject to periodic reviews for recoverability. The results of our assessment of
recoverability are dependent on our expected resolution of the overall asbestos
liability, timing of cash flow distributions from B&W as contemplated under the
amended plan of reorganization and market conditions. When B&W emerges from the
jurisdiction of the Bankruptcy Court, the subsequent accounting will be
determined based upon the applicable circumstances and facts at such time,
including the terms of any plan of reorganization. It is possible that a
material adjustment to our financial statements will be required in the course
of or on the completion of the B&W reorganization. See Note 9 to the condensed
consolidated financial statements for B&W's financial information at March 31,
2002.
In the three months ended March 31, 2002:
B&W's revenues increased $23,098,000 to $378,957,000, primarily due to
higher volumes from the fabrication, repair and retrofit of existing
facilities, replacement nuclear steam generators, boiler cleaning
equipment and nuclear services. Lower volumes from the fabrication and
erection of fossil fuel steam and environmental control systems and
replacement parts partially offset these increases.
B&W's operating income decreased $1,880,000 to $19,013,000, primarily
due to (1) lower volumes and margins from the fabrication and erection
of fossil fuel steam and environmental control systems and operation
and maintenance contracts and (2) higher reorganization expenses
associated with the
42
Chapter 11 filing. Higher volumes and margins from nuclear services and
higher volumes from the fabrication, repair and retrofit of existing
facilities partially offset these decreases.
Other-net expense decreased $3,014,000. Other-net expense for the three
months ended March 31, 2001 included an impairment loss of $3,000,000
relating to available-for-sale securities whose decline in value had
been judged to be other than temporary.
B&W's backlog at March 31, 2002 and December 31, 2001 was
$1,334,562,000 and $1,379,736,000, respectively.
Our outlook for B&W in 2002 remains positive, despite the significant decline in
natural gas prices towards the end of 2001, and subsequent drop in interest in
coal-fired power generation. We expect our U.S. construction and service
business to remain strong with overall revenues remaining flat for B&W in 2002.
We expect operating income to increase in 2002 due to lower bankruptcy related
expenses and improved results in our original equipment manufacturers' ("OEM")
business. The OEM market outlook has changed dramatically from the summer of
2001. Energy prices are low, and our prior outlook for the potential of new
coal-fired base load power plants has diminished. We believe this is a viable
long-term market for new capacity and electric generating capacity only if
energy prices rise, and only if we experience a lasting recovery that
fundamentally affects the demand for electricity itself.
Presently, the Chapter 11 proceedings have not fundamentally affected B&W's
business due to its current mix of work. However, if B&W remains in Chapter 11,
and an OEM market does not return, B&W would be affected because of the lack of
surety capacity and related factors.
In connection with the bankruptcy filing, B&W and its filing subsidiaries
entered into the DIP Credit Facility with a group of lenders, with Citibank,
N.A. as administrative agent, for a three-year term. The facility requires
compliance with certain financial and non-financial covenants. At December 31,
2001, B&W was in violation of a covenant under the DIP Credit Facility. B&W
received a consent from the lenders that remedied this covenant violation on
March 18, 2002. See Note 9 to the condensed consolidated financial statements
for further information on the DIP Credit Facility.
We have assessed B&W's liquidity position as a result of the bankruptcy filing
and believe that B&W can continue to fund its and its subsidiaries' operating
activities and meet its debt and capital requirements for the foreseeable
future. However, B&W's ability to continue as a going concern is dependent upon
its ability to settle its ultimate asbestos liability from its net assets,
future profits and cash flow and available insurance proceeds, whether through
the confirmation of a plan of reorganization or otherwise. As a result of the
bankruptcy filing and related events, there is no assurance that the carrying
amounts of assets will be realized or that liabilities will be liquidated or
settled for the amounts recorded. In addition, a rejection of B&W's
43
amended plan of reorganization or any amendment thereto could change the amounts
reported in the B&W financial statements and cause a material decrease in the
carrying amount of our investment in B&W. See Note 9 to the condensed
consolidated financial statements for more information.
See Note 1 to the condensed consolidated financial statements for information on
new accounting standards.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding ongoing investigations and litigation, see Note 5 to
the condensed consolidated financial statements in Part I of this report, which
we incorporate by reference into this Item. In addition, see Note 9 to the
condensed consolidated financial statements included in this report regarding
B&W's potential liability for non-employee asbestos claims and the Chapter 11
reorganization proceedings commenced by B&W and certain of its subsidiaries on
February 22, 2000, which we incorporate by reference into this Item.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 3.1* - McDermott International, Inc.'s Articles of
Incorporation, as amended (incorporated by reference to Exhibit 3.1 to
McDermott International, Inc.'s Form 10-K for the fiscal year ended
March 31, 1996 (File No. 1-08430)).
Exhibit 3.2 - Amended and Restated By-Laws of McDermott International,
Inc.
Exhibit 3.3* - Amended and Restated Certificate of Designation of
Series D Participating Preferred Stock (incorporated by reference
herein to Exhibit 3.1 to McDermott International, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001 (File No.
1-08430)).
(b) Reports on Form 8-K
On March 27, 2002, we filed a report on Form 8-K dated March 20, 2002.
Our report included Item 5 - Other Events.
- ----------
* Incorporated by reference to the filing indicated.
44
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.
McDERMOTT INTERNATIONAL, INC.
/s/ Francis S. Kalman
---------------------------------------------------
By: Francis S. Kalman
Executive Vice President and Chief Financial
Officer (Principal Financial and Accounting Officer
and Duly Authorized Representative)
May 13, 2002
45
EXHIBIT INDEX
<Table>
<Caption>
Exhibit Description
- ------- -----------
3.1* McDermott International, Inc.'s Articles of Incorporation, as
amended (incorporated by reference to Exhibit 3.1 to McDermott
International, Inc.'s Form 10-K for the fiscal year ended March 31,
1996 (File No. 1-08430)).
3.2 Amended and Restated By-Laws of McDermott International, Inc.
3.3* Amended and Restated Certificate of Designation of Series D
Participating Preferred Stock (incorporated by reference herein to
Exhibit 3.1 to McDermott International, Inc.'s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2001 (File No.
1-08430)).
</Table>
- ----------
* Incorporated by reference to the filing indicated.