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 September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 1-8430
McDERMOTT INTERNATIONAL, INC.
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(Exact name of registrant as specified in its charter)
REPUBLIC OF PANAMA 72-0593134
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1450 Poydras Street, New Orleans, Louisiana 70112-6050
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (504) 587-5400
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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 October 26,
2001 was 61,683,001.
McDERMOTT INTERNATIONAL, INC.
INDEX - FORM 10-Q
<Table>
<Caption>
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 - Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
September 30, 2001 and December 31, 2000 3
Condensed Consolidated Statements of Income
Three and Nine Months Ended September 30, 2001 and 2000 5
Condensed Consolidated Statements of Comprehensive Income (Loss)
Three and Nine Months Ended September 30, 2001 and 2000 6
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2001 and 2000 7
Notes to Condensed Consolidated Financial Statements 9
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 28
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 41
Item 2 - Change in Securities and Use of Proceeds 41
Item 6 - Exhibits and Reports on Form 8-K 42
SIGNATURES 43
</Table>
Exhibit 3.3 - Amended and Restated Certificate of Designation of Series D
Participating Preferred Stock
2
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
(In thousands)
Current Assets:
Cash and cash equivalents $ 90,643 $ 84,620
Investments -- 34,440
Accounts receivable - trade, net 204,589 181,422
Accounts receivable from The Babcock & Wilcox Company 6,785 12,308
Accounts receivable - unconsolidated affiliates 83,843 31,155
Accounts receivable - other 40,744 54,662
Environmental liabilities recoverable - current 1,878 1,527
Contracts in progress 106,987 90,142
Inventories 7,949 11,733
Deferred income taxes 67,297 56,805
Other current assets 17,189 28,022
------------- ------------
Total Current Assets 627,904 586,836
------------- ------------
Property, Plant and Equipment 1,255,015 1,239,554
Less accumulated depreciation 893,455 874,198
------------- ------------
Net Property, Plant and Equipment 361,560 365,356
------------- ------------
Investments:
Government obligations 286,177 280,208
Other investments 44,623 46,547
------------- ------------
Total Investments 330,800 326,755
------------- ------------
Investment in The Babcock & Wilcox Company 186,966 186,966
------------- ------------
Accounts Receivable from The Babcock & Wilcox Company 18,193 18,193
------------- ------------
Goodwill less Accumulated Amortization of $65,368,000 at
September 30, 2001 and $50,579,000 at December 31, 2000 336,061 350,939
------------- ------------
Prepaid Pension Costs 152,205 134,307
------------- ------------
Other Assets 88,477 86,275
------------- ------------
TOTAL $ 2,102,166 $ 2,055,627
============= ============
</Table>
See accompanying notes to condensed consolidated financial statements.
3
LIABILITIES AND STOCKHOLDERS' EQUITY
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
(In thousands)
Current Liabilities:
Notes payable and current maturities of long-term debt $ 254,904 $ 96,346
Accounts payable 131,175 114,184
Accounts and notes payable to The Babcock & Wilcox Company 49,431 53,073
Environmental liabilities - current 4,766 6,162
Accrued employee benefits 65,330 57,578
Accrued contract costs 27,738 32,867
Advance billings on contracts 125,540 71,612
Other current liabilities 275,629 258,405
------------- ------------
Total Current Liabilities 934,513 690,227
------------- ------------
Long-Term Debt 96,589 323,157
------------- ------------
Accumulated Postretirement Benefit Obligation 28,261 28,276
------------- ------------
Environmental and Products Liabilities 14,483 10,294
------------- ------------
Other Liabilities 219,461 227,070
------------- ------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $1.00 per share, authorized
150,000,000 shares; issued 63,396,016 at September 30,
2001 and 62,582,382 at December 31, 2000 63,396 62,582
Capital in excess of par value 1,069,680 1,062,511
Accumulated deficit (208,032) (230,902)
Treasury stock at cost, 2,005,792 shares at September 30,
2001 and 2,005,042 at December 31, 2000 (62,736) (62,736)
Accumulated other comprehensive loss (53,449) (54,852)
------------- ------------
Total Stockholders' Equity 808,859 776,603
------------- ------------
TOTAL $ 2,102,166 $ 2,055,627
============= ============
</Table>
4
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
(Unaudited)
(In thousands, except per share amounts)
Revenues $ 591,169 $ 390,961 $ 1,519,718 $ 1,469,960
------------ ------------ ------------ ------------
Costs and Expenses:
Cost of operations 517,561 340,343 1,330,324 1,293,030
Selling, general and administrative expenses 51,242 43,561 152,791 142,022
------------ ------------ ------------ ------------
Total Costs and Expenses 568,803 383,904 1,483,115 1,435,052
------------ ------------ ------------ ------------
Equity in income (loss) of investees 11,246 5,692 24,124 (14,582)
------------ ------------ ------------ ------------
Operating Income 33,612 12,749 60,727 20,326
------------ ------------ ------------ ------------
Other Income (Expense):
Interest income 5,056 6,558 15,687 20,596
Interest expense (11,871) (12,871) (31,652) (32,672)
Other-net 753 272 (829) 5,534
------------ ------------ ------------ ------------
Total Other Expense (6,062) (6,041) (16,794) (6,542)
------------ ------------ ------------ ------------
Income before Provision for Income Taxes 27,550 6,708 43,933 13,784
Provision for Income Taxes 8,205 1,086 21,063 10,342
------------ ------------ ------------ ------------
Net Income $ 19,345 $ 5,622 $ 22,870 $ 3,442
============ ============ ============ ============
Earnings per Common Share:
Basic $ 0.32 $ 0.09 $ 0.38 $ 0.06
Diluted $ 0.31 $ 0.09 $ 0.37 $ 0.06
============ ============ ============ ============
Cash Dividends:
Per Common Share $ -- $ -- $ -- $ 0.10
============ ============ ============ ============
</Table>
See accompanying notes to condensed consolidated financial statements.
5
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
(Unaudited)
(In thousands)
Net Income $ 19,345 $ 5,622 $ 22,870 $ 3,442
---------- ---------- ---------- ----------
Other Comprehensive Income (Loss):
Currency translation adjustments:
Foreign currency translation adjustments (2,005) (11,158) (3,035) (14,490)
Unrealized losses on derivative financial instruments:
Unrealized losses on derivative financial
instruments (1,355) -- (2,289) --
Reclassification adjustment for losses included
in net income 113 -- 113
Unrealized gains on investments:
Unrealized gains arising during the period,
net of taxes (benefits) of $30,000 in the nine
months ended September 30, 2001 and
($111,000) and ($159,000), respectively, in the three
and nine months ended September 30, 2000 3,380 3,385 8,853 4,136
Reclassification adjustment for gains included
in net income, net of tax benefits of $162,000
in the nine months ended September 30, 2001 (3,351) (18) (2,239) (8)
---------- ---------- ---------- ----------
Other Comprehensive Income (Loss) (3,218) (7,791) 1,403 (10,362)
---------- ---------- ---------- ----------
Comprehensive Income (Loss) $ 16,127 $ (2,169) $ 24,273 $ (6,920)
========== ========== ========== ==========
</Table>
See accompanying notes to condensed consolidated financial statements.
6
McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
Nine Months Ended
September 30,
2001 2000
---------- ----------
(Unaudited)
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 22,870 $ 3,442
---------- ----------
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 48,069 47,290
Income or loss of investees, less dividends (3,668) 21,449
Gain on asset disposals and impairments - net (1,468) (2,213)
Provision for deferred taxes 8,792 6,820
Deconsolidation of The Babcock & Wilcox Company -- (19,424)
Other 4,945 6,196
Changes in assets and liabilities, net of effects
of acquisitions and divestitures:
Accounts receivable (58,090) 63,799
Net contracts in progress and advance billings 37,943 (27,587)
Accounts payable 13,982 (7,029)
Accrued and other current liabilities 12,887 (31,277)
Products and environmental liabilities 2,442 (11,157)
Other, net (24,115) (113,266)
Proceeds from insurance for products liability claims -- 26,427
Payments of products liability claims -- (23,782)
---------- ----------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 64,589 (60,312)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (27,644) (46,335)
Purchases of available-for-sale securities (929,393) (98,706)
Sales of available-for-sale securities 815,690 24,749
Maturities of available-for-sale securities 147,801 87,141
Proceeds from asset disposals 3,002 4,579
Other (645) 500
---------- ----------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES 8,811 (28,072)
---------- ----------
</Table>
7
CONTINUED
<Table>
<Caption>
Nine Months Ended
September 30,
2001 2000
---------- ----------
(Unaudited)
(In thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of long-term debt $ (239) $ (2)
Increase (decrease) in short-term borrowing (66,286) 42,278
Issuance of common stock 65 2
Dividends paid -- (8,972)
Other (90) 3,920
---------- ----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (66,550) 37,226
---------- ----------
EFFECTS OF EXCHANGE RATE CHANGES ON CASH (827) (434)
---------- ----------
NET INCREASE (DECREASE ) IN CASH AND CASH EQUIVALENTS 6,023 (51,592)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 84,620 162,734
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 90,643 $ 111,142
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 33,249 $ 37,989
Income taxes - net $ 7,014 $ 6,198
========== ==========
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES
Deconsolidation of The Babcock & Wilcox Company debt $ -- $ 4,760
========== ==========
</Table>
See accompanying notes to condensed consolidated financial statements.
8
McDERMOTT INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
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 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 over which we have significant influence. 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- and nine-month periods ended September 30,
2001.
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 and nine months ended September 30, 2001 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2001. For further information, refer to the consolidated financial
statements and related footnotes included in MII's annual report on Form 10-K
for the year ended December 31, 2000.
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. B&W and its
subsidiaries are committed to operating their businesses as normal, delivering
products and services as usual and pursuing new contracts and growth
opportunities. However, 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.
9
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 facts and circumstances at that 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 investment in
B&W, which was $186,966,000 at September 30, 2001, and is subject to periodic
reviews for recoverability. At September 30, 2001, the underlying net assets of
B&W exceeded MII's investment by $2,018,000. See Notes 4 and 8 for recent events
regarding the bankruptcy proceedings and other risk issues. See Note 8 for the
condensed consolidated financial information of B&W.
Effective January 1, 2001, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138, which adds to the guidance related to
accounting for derivative instruments and hedging activities. SFAS No. 133
requires us to recognize all derivatives on our consolidated balance sheet at
their fair values. Our initial adoption of SFAS No. 133, as amended by SFAS No.
138, had no material effect on our consolidated financial position or results of
operations.
On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that all business combinations be
accounted for under the purchase method. SFAS No. 141 also establishes criteria
for the separate recognition of intangible assets acquired in a business
combination. The adoption of SFAS No. 141 will have no effect on our
consolidated financial position or results of operations. SFAS No. 142 requires
that goodwill no longer be amortized to earnings, but instead be subject to
periodic testing for impairment. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. For the nine months ended September 30, 2001,
we had amortized approximately $14,787,000 of goodwill. We are reviewing the
effect SFAS No. 142 will have on our consolidated financial position or results
of operations.
In June 2001, the FASB 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 or results
of operations.
10
In August 2001, the FASB issued 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. SFAS No. 144 is effective for fiscal
years beginning after December 15, 2001. We have not yet determined the effect
SFAS No. 144 will have on our consolidated financial position or results of
operations.
NOTE 2 - INVENTORIES
Inventories are as follows:
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
(In thousands)
Raw Materials and Supplies $ 5,482 $ 7,412
Work in Progress 763 1,895
Finished Goods 1,704 2,426
------------- ------------
Total Inventories $ 7,949 $ 11,733
============= ============
</Table>
NOTE 3 - ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss included in stockholders'
equity are as follows:
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
(In thousands)
Currency Translation Adjustments $ (50,124) $ (47,089)
Net Unrealized Gain (Loss) on Investments 1,772 (4,842)
Net Unrealized Loss on Derivative Financial Instruments (2,176) --
Minimum Pension Liability (2,921) (2,921)
------------- ------------
Accumulated Other Comprehensive Loss $ (53,449) $ (54,852)
============= ============
</Table>
NOTE 4 - INVESTIGATIONS AND LITIGATION
On March 12, 2001, the plaintiffs' motion for rehearing en banc was denied by
the U.S. Fifth Circuit Court of Appeals 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 have
filed a petition for writ of certiorari to the United States Supreme Court. By
order issued October 1, 2001, the
11
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 December 15, 2000, lawsuits were filed by a number of Norwegian oil companies
against MII, Heeremac, Heerema and Saipem S.p.A. for violations of the Norwegian
Pricing Act of 1953 in connection with projects in Norway. Plaintiffs include
Norwegian affiliates of various of the plaintiffs in the Shell civil case
pending in Houston. Most of the projects were performed by Saipem S.p.A. or its
affiliates, with some by Heerema/HeereMac and none by JRM. We understand that
the conduct alleged by plaintiffs is the same conduct which plaintiffs allege in
the U.S. civil cases. The cases were heard by the Conciliation Boards in Norway
during the first week of October 2001. In all instances, the Boards referred the
cases to the court of first instance for further proceedings. The plaintiffs
have one year to proceed with the cases.
In 1998, B&W settled all pending and future punitive damage claims in the
lawsuit filed against B&W and Atlantic Richfield by Donald F. Hall, Mary Ann
Hall and others (the "Hall Litigation") for $8,000,000 for which B&W seeks
reimbursement from other parties. There is a controversy between B&W and its
insurers as to the amount of coverage available under the liability insurance
policies covering the facilities. B&W filed a declaratory judgment action in a
Pennsylvania State Court seeking a judicial determination as to the amount of
coverage available under the policies. On April 28, 2001, in response to
cross-motions for partial summary judgment, the Pennsylvania State Court issued
its ruling regarding: (1) the applicable trigger of coverage under the Nuclear
Energy Liability Policies issued by B&W's nuclear insurers; and (2) the scope of
the nuclear insurers' defense obligations to B&W under these policies. With
respect to the trigger of coverage, the Pennsylvania State Court held that a
"manifestation" trigger applied to the underlying claims at issue. Although the
Court did not make any determination of coverage with respect to any of the
underlying claims, we believe the effect of its ruling is to increase the amount
of coverage potentially available to B&W under the policies at issue to
$320,000,000. With respect to the nuclear insurers' duty to defend B&W, the
Court held that B&W is entitled to separate and independent counsel funded by
the nuclear insurers. On May 21, 2001, the Court granted the insurers' motion
for reconsideration of the April 25, 2001 order. On October 1, 2001, the Court
entered its order reaffirming its original substantive insurance coverage
rulings and further certified the order for immediate appeal by any party. The
plaintiffs' remaining claims against B&W in the Hall Litigation have been
automatically stayed as a result of the B&W bankruptcy filing. B&W filed a
complaint for declaratory and injunctive relief with the Bankruptcy Court
seeking to stay the pursuit of the Hall Litigation against ARCO during the
pendency of B&W's bankruptcy proceeding due to common insurance coverage and the
risk to B&W of issue or claim preclusion, which stay the Bankruptcy Court denied
in October 2000. B&W appealed the Bankruptcy Court's Order and on May 18, 2001,
the United States District Court for the Eastern District of Louisiana affirmed
the Bankruptcy Court's Order. B&W has appealed the decision to the United States
Fifth Circuit Court of Appeals. We believe that all claims under
12
the Hall Litigation will be resolved within the limits of coverage of our
insurance policies; however, our insurance coverage may not be adequate and we
may be materially adversely impacted if our liabilities exceed our coverage. B&W
transferred the two facilities subject to the Hall Litigation to BWXT in June
1997 in connection with BWXT's formation and an overall corporate restructuring.
On April 25, 2001, the plaintiffs-appellants in the class action complaints
against MII and two of its executive officers alleging violation of federal
securities laws filed a motion to voluntarily dismiss their appeal, and the
appeal was dismissed by the U.S. Fifth Circuit Court on April 26, 2001.
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 U.S.
Bankruptcy Court for the Eastern District of Louisiana, which actions have been
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 a settlement 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 has 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. The consolidated
actions have been set for trial on
13
April 15, 2002. Discovery is proceeding in the consolidated actions, and the
Court has permitted the asbestos claimants committee and the future claimants'
representative to intervene in the litigation as parties. 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. The Court has not yet ruled on these motions. We
believe the Plaintiff Insurers' complaints and the substantive allegations they
contain are without merit. MII and B&W intend to contest and defend against
these actions vigorously. We believe the Plaintiff Insurers' complaints will not
have a material adverse effect on our consolidated financial position or results
of operations. However, if the Plaintiff Insurers are successful, our financial
position and our investment in B&W will be adversely affected.
On April 30, 2001, B&W filed a declaratory judgment action in its Chapter 11
proceeding against MI, BWICO, BWXT, Hudson Products Corporation and McDermott
Technologies, 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 Technologies, 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 has permitted the asbestos
claimants committee and the future claimants' representative in the Chapter 11
proceeding to intervene and proceed as plaintiff-intervenors and has realigned
B&W as a defendant in this action. The asbestos claimants committee and the
future claimants' representative 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 has ruled that Louisiana law
will apply to the solvency issue in this action. Trial commenced on October 22,
2001 to determine B&W's solvency at the time of the corporate reorganization
and concluded on November 2, 2001, following which the Bankruptcy Court
requested written briefing and has taken the matter under consideration. We
believe that B&W was solvent at the time of the transfers and that the transfers
are not voidable. However, if the transferred asset action is decided against us
by the Bankruptcy Court, it could have a material adverse effect on our
consolidated financial position and results of operations. It could also have a
material adverse effect on MI's ability to repay its 9.375%, $225,000,000 notes
due March 15, 2002 described in Part I, Section K - Risk Factors of MII's annual
report on Form 10-K for the year ended December 31, 2000. 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 January 15, 2002.
14
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, 2000:
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 JRM's arbitration proceedings against Texaco Exploration and
Production, Inc. ("Texaco") concerning Texaco's withheld payment of
$23,000,000 due under an installation contract.
For a detailed description of these proceedings please refer to Note 11 to the
consolidated financial statements included in Part I of MII's annual report on
Form 10-K for the year ended December 31, 2000. Also, see Note 8 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 5 - SEGMENT REPORTING
There are no differences from our last annual report in our basis of
segmentation or in our basis of measurement of segment profit or loss, except
for the inclusion of income from over-funded pension plans of discontinued
operations in Corporate. An analysis of our operations by segment is as follows:
15
Segment Information for the Three and Nine Months Ended September 30, 2001 and
2000.
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
(Unaudited)
(In thousands)
REVENUES
Marine Construction Services $ 262,776 $ 161,922 $ 602,605 $ 614,699
Government Operations 118,475 95,949 356,349 322,712
Industrial Operations 198,007 120,961 527,714 365,674
Power Generation Systems - B&W -- -- -- 155,774
Power Generation Systems 12,059 14,829 33,486 14,975
Adjustments and Eliminations(1) (148) (2,700) (436) (3,874)
------------ ------------ ------------ ------------
$ 591,169 $ 390,961 $ 1,519,718 $ 1,469,960
============ ============ ============ ============
</Table>
(1) Segment revenues are net of the following intersegment transfers and other
adjustments:
<Table>
Marine Construction Services
Transfers $ 107 $ 224 $ 237 $ 805
Government Operations Transfers 37 226 184 657
Industrial Operations Transfers 4 78 15 181
Power Generation Systems
Transfers - B&W -- -- -- 59
Adjustments and Eliminations -- 2,172 -- 2,172
-------- -------- -------- --------
$ 148 $ 2,700 $ 436 $ 3,874
======== ======== ======== ========
</Table>
16
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
(Unaudited)
(In thousands)
OPERATING INCOME:
Segment Operating Income:
Marine Construction Services $ 17,581 $ (9,142) $ 15,526 $ (16,930)
Government Operations 3,814 8,175 22,813 30,043
Industrial Operations 4,009 4,689 9,773 9,723
Power Generation Systems - B&W -- -- -- 7,172
Power Generation Systems (1,010) (2,055) (2,787) (2,419)
---------- ---------- ---------- ----------
$ 24,394 $ 1,667 $ 45,325 $ 27,589
========== ========== ========== ==========
Gain (Loss) on Asset Disposal and Impairments - Net:
Marine Construction Services $ (43) $ 1,087 $ 672 $ 2,028
Government Operations 14 9 776 208
Industrial Operations 9 -- 20 10
Power Generation Systems - B&W -- -- -- (33)
---------- ---------- ---------- ----------
$ (20) $ 1,096 $ 1,468 $ 2,213
========== ========== ========== ==========
Income (Loss) from Investees:
Marine Construction Services $ 4,762 $ 3,143 $ 6,048 136
Government Operations 6,110 4,483 16,868 7,762
Industrial Operations 11 80 127 151
Power Generation Systems - B&W -- -- -- 812
Power Generation Systems 363 (2,014) 1,081 (23,443)
---------- ---------- ---------- ----------
$ 11,246 $ 5,692 $ 24,124 $ (14,582)
========== ========== ========== ==========
SEGMENT INCOME (LOSS):
Marine Construction Services $ 22,300 $ (4,912) $ 22,246 $ (14,766)
Government Operations 9,938 12,667 40,457 38,013
Industrial Operations 4,029 4,769 9,920 9,884
Power Generation Systems - B&W -- -- -- 7,951
Power Generation Systems (647) (4,069) (1,706) (25,862)
---------- ---------- ---------- ----------
35,620 8,455 70,917 15,220
Corporate (2,008) 4,294 (10,190) 5,106
---------- ---------- ---------- ----------
TOTAL $ 33,612 $ 12,749 $ 60,727 $ 20,326
========== ========== ========== ==========
</Table>
17
NOTE 6 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
(Unaudited)
(In thousands, except shares and per share amounts)
Basic:
Net income $ 19,345 $ 5,622 $ 22,870 $ 3,442
------------ ------------ ------------ ------------
Weighted average common shares 60,832,878 59,908,646 60,499,071 59,657,556
------------ ------------ ------------ ------------
Basic earnings per common share $ 0.32 $ 0.09 $ 0.38 $ 0.06
------------ ------------ ------------ ------------
Diluted:
Net income $ 19,345 $ 5,622 $ 22,870 $ 3,442
------------ ------------ ------------ ------------
Weighted average common shares (basic) 60,832,878 59,908,646 60,499,071 59,657,556
Effect of dilutive securities:
Stock options and restricted stock 1,645,429 1,280,288 2,099,995 894,244
------------ ------------ ------------ ------------
Adjusted weighted average common shares
and assumed conversions 62,478,307 61,188,934 62,599,066 60,551,800
------------ ------------ ------------ ------------
Diluted earnings per common share $ 0.31 $ 0.09 $ 0.37 $ 0.06
============ ============ ============ ============
</Table>
NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS
Our worldwide operations give rise to exposure to market risks from changes in
foreign exchange rates. We use derivative financial instruments, primarily
forward contracts, to reduce the impact of changes in foreign exchange rates on
our operating results. We use these instruments primarily to hedge our exposure
associated with revenues or costs on our long-term contracts which are
denominated in currencies other than our operating entities' functional
currencies. We do not hold or issue derivative financial instruments for trading
or other speculative purposes.
We enter into forward contracts primarily as hedges of certain firm purchase and
sale commitments denominated in foreign currencies. We record these contracts at
fair value on our consolidated balance sheet. Depending on the hedge designation
at the inception of the contract, the related gains and losses on these
contracts are either offset against the change in fair value of the hedged firm
commitment through earnings or deferred in stockholders' equity (as a component
of accumulated other comprehensive loss) until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value is
immediately recognized in earnings. The gain or loss on a derivative financial
instrument not designated as a hedging instrument is also immediately recognized
in earnings. Gains and losses on forward contracts that require
18
immediate recognition are included as a component of other-net in our condensed
consolidated statement of income.
We are exposed to credit-related losses in the event of nonperformance by
counterparties to derivative financial instruments. We mitigate this risk by
using major financial institutions with high credit ratings.
NOTE 8 - 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 these claims are similar in nature, the
primary 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 to reorganize under Chapter 11 of the U.S.
Bankruptcy Code as a means to determine and comprehensively resolve all pending
and future asbestos liability claims against them. Included in the filing are
B&W and its subsidiaries Americon, Inc., Babcock & Wilcox Construction Co., Inc.
and Diamond Power International, Inc. On February 20, 2001, the Bankruptcy Court
appointed a mediator to facilitate negotiations among the debtors and the
committee representing the asbestos claimants to reach a final determination of
the debtors' ultimate liability for asbestos-related claims. The mediator's
appointment is authorized through January 31, 2002.
On February 22, 2001, B&W and its debtors filed a plan of reorganization and a
disclosure statement. The plan of reorganization contemplates a resolution under
either the settlement process or a strategy of litigating asbestos claims. Under
the settlement process, there would be a consensual agreement of 75% of the
asbestos personal injury claimants. A trust would be formed and assigned all of
B&W's and its filing subsidiaries' insurance rights with an aggregate products
liability value of approximately $1,150,000,000. In addition, $50,000,000 cash
and a $100,000,000 subordinated 10-year note payable would be transferred into
the trust. The debtors and non-debtor affiliates would consent to the assignment
of the insurance and would release and void any right that they have to the
insurance, with the non-debtor defendants receiving a full release and
protection under the Bankruptcy Code against future asbestos products liability
claims relating to B&W. The trust's rights to the insurance would be protected
and could be dedicated solely to the resolution of the asbestos claims. As a
result of the creation of the trust, B&W and all its affiliates would be
released and discharged from all present and future liability for asbestos
claims arising out of exposure to B&W's products.
19
Under the litigation strategy of the proposed plan, if B&W is not able to reach
a consensual agreement with the plaintiffs, a cram-down option is available. The
claims would still be channeled through a trust with $50,000,000 cash and a
$100,000,000 subordinated 10-year note payable, but the debtors and their
affiliates would not transfer their insurance rights. The debtors would manage
the insurance rights, and claims would be handled through the litigation process
by the trust. Funding of the trust would be from the insurance, the cash, the
note payable, and equity of the debtors, if necessary. The period of exclusivity
for filing a plan of reorganization extends through January 31, 2002.
Prior to its bankruptcy filing, B&W and its subsidiaries had engaged in a
strategy of negotiating and settling asbestos products liability claims brought
against them and billing the settled amounts to insurers for reimbursement. The
average amount per settled claim over the three calendar years prior to the
Chapter 11 filing was approximately $7,900. Reimbursed amounts are subject to
varying insurance limits based on the year of coverage, insurer solvency and
collection delays (due primarily to agreed payment schedules with specific
insurers delaying reimbursement for three months or more). No claims have been
paid since the bankruptcy filing. Claims paid during the year ended December 31,
2000, prior to the bankruptcy filing, aggregated $23,640,000 of which
$20,121,000 has been recovered or is due from insurers. At September 30, 2001,
receivables of $28,991,000 were due from insurers for reimbursement of settled
claims and approximately $1,152,500,000 was recorded as an insurance recoverable
for unasserted claims. Currently, certain insurers are refusing to reimburse B&W
for settled claims until B&W's assumption, in bankruptcy, of its pre-bankruptcy
filing contractual reimbursement arrangements with those insurers. To date, this
has not had a material adverse impact on B&W's liquidity or the conduct of its
business, and we do not expect it to in the future. We anticipate that B&W 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 settled asbestos claims and a July 30, 2001 bar date
was set 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 B&W and its filing subsidiaries. As of the March 29, 2001 bar date, over
49,000 allegedly settled claims had been filed. B&W has accepted approximately
7,600 as settled claims at this time and is in the process of challenging a
significant number of claims. If the Bankruptcy Court determines these claims
were not settled prior to the filing of the Chapter 11, these claims may be
refiled as unsettled claims. As of July 30, 2001, approximately 220,000
additional asbestos personal injury claims, 168 property damage claims, 212
derivative asbestos claims and 524 claims relating to the Apollo Parks Township
facilities, had been filed. As set forth in the proposed Litigation Protocol
filed with the District Court on October 18, 2001, we intend to challenge all
unsupported claims and believe that a significant number may be disallowed by
the Bankruptcy Court. While we continue to review the filed claims and the
ultimate asbestos liability of B&W and its subsidiaries remains uncertain,
20
we believe that the $1,307,725,000 that B&W has provided for asbestos products
liability claims at September 30, 2001 continues to represent our best estimate
of its ultimate liability for asbestos claims. While the B&W Chapter 11
reorganization proceedings continue to progress, there are a number of issues
and matters related to B&W's asbestos liability to be resolved prior to its
emergence from the proceedings. In addition to the solvency issue relating to
the reorganization we completed in the fiscal year ended March 31, 1999,
remaining issues and matters to be resolved include, but are not limited to:
o the ultimate asbestos liability of B&W and its subsidiaries;
o the outcome of negotiations with the asbestos claimants committee,
the future claimants representative and other participants in the
Chapter 11, 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 the declaratory judgment actions filed by certain
insurers and negotiations with our insurers as to additional amounts
of coverage of B&W and its subsidiaries 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;
o the possible need for an extension of the three-year term of the
$300,000,000 debtor-in-possession revolving credit and letter of
credit facility ("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 B&W intends to bid; and
o the continued ability of our insurers to reimburse us for payments
made to asbestos claimants.
For information regarding ongoing investigations and litigation involving B&W,
see Note 4. For further information concerning B&W and its bankruptcy filing,
refer to Note 20 to the consolidated financial statements included in MII's
annual report on Form 10-K for the year ended December 31, 2000.
Debtor-In-Possession Financing
In connection with the bankruptcy filing, B&W and its filing subsidiaries
entered into the DIP Credit facility with Citibank, N.A. and Salomon Smith
Barney Inc. with a three-year term. There were no borrowings under this facility
at September 30, 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
21
$172,000,000 (the "Pre-existing LCs"). MII, MI and BWICO have agreed to
indemnify and reimburse B&W and its filing subsidiaries 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 September 30, 2001,
approximately $111,100,000 in letters of credit have been issued under the DIP
Credit Facility of which approximately $60,700,000 were to replace or backstop
pre-existing LCs.
Financial Results and Reorganization Items
The B&W condensed consolidated financial statements are set forth below.
THE BABCOCK & WILCOX COMPANY
DEBTOR-IN-POSSESSION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
(Unaudited)
(In thousands)
Revenues $ 304,575 $ 250,385 $ 1,026,350 $ 821,198
------------ ------------ ------------ ------------
Costs and Expenses:
Cost of operations 261,227 217,045 875,595 717,819
Selling, general and administrative
expenses 30,208 28,382 87,280 84,163
Reorganization charges 11,364 4,834 22,628 12,799
------------ ------------ ------------ ------------
Total Costs and Expenses 302,799 250,261 985,503 814,781
------------ ------------ ------------ ------------
Equity in income of investees 783 1,217 2,001 3,914
------------ ------------ ------------ ------------
Operating Income 2,559 1,341 42,848 10,331
------------ ------------ ------------ ------------
Other Income (Expense):
Interest income 1,893 2,761 6,259 5,553
Interest expense (1,073) (1,107) (5,146) (2,497)
Other-net 387 1,280 (5,469) 327
------------ ------------ ------------ ------------
Total Other Income (Expense) 1,207 2,934 (4,356) 3,383
------------ ------------ ------------ ------------
Income before Provision for Income Taxes 3,766 4,275 38,492 13,714
Provision for Income Taxes 830 5,532 16,765 8,717
------------ ------------ ------------ ------------
Net Income (Loss) $ 2,936 $ (1,257) $ 21,727 $ 4,997
============ ============ ============ ============
</Table>
22
THE BABCOCK & WILCOX COMPANY
DEBTOR-IN-POSSESSION
CONDENSED CONSOLIDATED BALANCE SHEET
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
(In thousands)
Assets:
Current Assets $ 547,149 $ 553,937
Property, Plant and Equipment 75,996 80,459
Products Liabilities Recoverable from Insurers 1,152,489 1,153,761
Goodwill 75,452 77,093
Prepaid Pension Costs 19,444 20,369
Other Assets 158,104 128,043
------------- ------------
Total Assets $ 2,028,634 $ 2,013,662
============= ============
Liabilities:
Current Liabilities $ 380,771 $ 364,977
Liabilities Subject to Compromise(1) 1,443,301 1,456,313
Accrued Postretirement Benefit Obligation 773 566
Other long-term liabilities 14,805 18,589
Stockholder's Equity:
Common Stock 1,001 1,001
Capital in Excess of Par Value 134,737 134,733
Retained Earnings 82,551 60,824
Accumulated Other Comprehensive Loss (29,305) (23,341)
------------- ------------
Total Liabilities and Stockholder's Equity $ 2,028,634 $ 2,013,662
============= ============
(1)Liabilities subject to compromise
consist of the following:
Accounts payable $ 2,963 $ 3,113
Provision for warranty 17,870 21,742
Other current liabilities 21,890 25,302
Products liabilities 1,307,725 1,307,725
Accumulated postretirement benefit obligation 70,891 75,910
Other long-term liabilities 21,962 22,521
------------- ------------
$ 1,443,301 $ 1,456,313
============= ============
</Table>
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.
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 September 30, 2001, the total value of B&W's and its subsidiaries'
customer contracts yet to be completed covered by such indemnity arrangements
was approximately $174,000,000 of which approximately $92,000,000 relates to
bonds issued after February 21, 2000.
23
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 (1) whose
financial statements were previously consolidated with those of its parent (as
B&W's were with ours) and (2) 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 $166,234,000, as
of February 21, 2000, increased to $186,966,000 due to post-bankruptcy filing
adjustments to the net assets of B&W and is subject to periodic reviews for
recoverability. When B&W emerges from the jurisdiction of the Bankruptcy Court,
the subsequent accounting will be determined based upon the applicable facts and
circumstances at that time, including the terms of any plan of 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, the ability of B&W 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. 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 our
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 periods ended December 31, 2000 and 1999
includes an explanatory paragraph indicating that these issues raise substantial
doubt about B&W's ability to continue as a going concern.
Following is our condensed Pro Forma Consolidated Statement of Loss, assuming
the deconsolidation of B&W, for the nine months ended September 30, 2000:
24
Assumes deconsolidation as of the beginning of the period presented:
<Table>
<Caption>
Nine Months
Ended September 30, 2000
(Unaudited)
(In thousands)
Revenues $ 1,314,245
Operating Income $ 3,850
Income before Benefit from Income Taxes $ 4,490
Net Loss $ (2,063)
Loss per Common Share:
Basic $ (0.03)
Diluted $ (0.03)
</Table>
Liquidity
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 remains unchanged at B. This downgrade by Moody's Investor Service has
impacted our cost of capital and could impact our access to capital.
We expect to meet capital expenditure, working capital and debt maturity
requirements for the remainder of 2001 from cash and cash equivalents and
short-term borrowings.
MI and its subsidiaries are unable to incur additional long-term debt
obligations under one of MI's public debt indentures, other than in connection
with certain extension, renewal or refunding transactions (including an
extension or refinancing of MI's 9.375% notes).
As a result of its bankruptcy filing, B&W and its filing subsidiaries are
precluded from paying dividends to stockholders 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
Inter-company Payables") and other creditors during the pendency of the
bankruptcy case, without the Bankruptcy Court's approval.
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. 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.
25
As a result of the impact of the September 11, 2001, terrorist attacks on the
insurance industry, 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 will be available only at rates that we consider uneconomical. We
do not expect this situation to impact our liquidity negatively for the
foreseeable future.
MI's 9.375% notes with an aggregate principal amount of $225,000,000 are
scheduled to mature on March 15, 2002. MI currently has insufficient cash and
other liquid resources on hand to fund the repayment of its 9.375% notes.
However, we have generated a significant amount of cash flow in the June and
September 2001 quarters which gives us some confidence that our fourth quarter
cash flow from operations will also be positive. We completed the sale of
McDermott Engineers & Constructors (Canada) Ltd. on October 29, 2001, which
generated additional cash that we may use to pay down debt (see Note 9 to the
condensed consolidated financial statements). We are also exploring other
alternatives including further asset sales, early bond redemptions and potential
refinancing or extension of these notes. MI's ability to satisfy, extend or
refinance these notes will be significantly influenced by the results of the
litigation involving our corporate reorganization completed in the fiscal year
ended March 31, 1999. If the action in this litigation is decided against us by
the Bankruptcy Court, it could have a material adverse effect on MI's ability to
satisfy, extend or refinance these notes.
MI owns substantial subsidiaries outside the B&W Chapter 11 filing, including
BWXT, which comprises our Government Operations segment, and Hudson Products
Corporation, which operates our heat exchanger business. BWXT and Hudson
Products Corporation are defendants in the action brought in the Chapter 11
proceeding concerning our corporate reorganization completed in the fiscal year
ended March 31, 1999, and our alternatives regarding these subsidiaries may be
limited until, and depending upon, a resolution in our favor of the action
seeking to void the transfers by B&W of the capital stock of BWXT and Hudson
Products Corporation to BWICO (the parent of B&W) in connection with the
reorganization. In addition, MI has a financial asset pursuant to a stock
purchase and sale agreement with MII (the "Intercompany Agreement"). For the
2001 year, MI would be entitled to $249,637,000 on the exercise of all of its
rights under that agreement, which would generate a tax liability of
$87,338,000. MI does not currently intend to exercise its right to sell under
the Intercompany Agreement (although it may in the future elect to do so). Since
MI is not expected to generate sufficient operating cash flow to repay the
9.375% notes at maturity, and if its extension or refinancing alternatives do
not materialize, MI will have to consider exercising its rights under the
Intercompany Agreement, selling all or a part of one or more of its operating
subsidiaries, requesting a capital contribution or loan from MII or some
combination of these and other alternatives. As a result, MI's inability to
successfully refinance or repay these notes could have a material adverse impact
on MII's liquidity, financial
26
position and results of operations. MI's level of indebtedness and its lack of
liquidity pose substantial risks to the holders of its debt securities and to
its ability to continue as a going concern.
NOTE 9 -SUBSEQUENT EVENTS
On October 29, 2001, we sold McDermott Engineers & Constructors (Canada) Ltd.
("MECL") to a unit of Jacobs Engineering Group Inc. MECL provides engineering,
construction and maintenance services to customers in a wide range of industries
including upstream oil and gas, petroleum refining, petrochemicals and
chemicals. The consolidated net assets of MECL included in our results at
September 30, 2001 totaled approximately $25,000,000. MECL, which is included in
our Industrial Operations segment, had revenues of approximately $452,000,000
and segment income of approximately $7,000,000 for the nine months ended
September 30, 2001. We expect to record a gain on the sale of MECL. The cash
proceeds will be used to pay down debt.
On October 17, 2001, our board of directors adopted a Stockholder Rights Plan
and declared a dividend of one right to purchase preferred stock for each
outstanding share of our common stock to stockholders of record at the close of
business on November 1, 2001. Each right initially entitles the registered
holder to purchase from us a fractional share consisting of one one-thousandth
of a share of our Series D Participating Preferred Stock, par value $1.00 per
share, at a purchase price of $35.00 per fractional share, subject to
adjustment. The rights generally will not become exercisable until ten days
after a public announcement that a person or group has acquired 15% or more of
our common stock (thereby becoming an "Acquiring Person") or the tenth business
day after the commencement of a tender or exchange offer that would result in a
person or group becoming an Acquiring Person (we refer to the earlier of those
dates as the "Distribution Date"). The rights are attached to all certificates
representing our currently outstanding common stock and will attach to all
common stock certificates we issue prior to the Distribution Date. Until the
Distribution Date, the rights will be evidenced by the certificates representing
our common stock and will be transferable only with our common stock. Generally,
if any person or group becomes an Acquiring Person, each right, other than
rights beneficially owned by the Acquiring Person (which will thereupon become
void), will thereafter entitle its holder to purchase, at the rights' then
current exercise price, shares of our common stock having a market value of two
times the exercise price of the right. If, after there is an Acquiring Person,
and we or a majority of our assets is acquired in certain transactions, each
right not owned by an Acquiring Person will entitle its holder to purchase, at a
discount, shares of common stock of the acquiring entity (or its parent) in the
transaction. At any time until ten days after a public announcement that the
rights have been triggered, we will generally be entitled to redeem the rights
for $.01 per right and to amend the rights in any manner other than to reduce
the redemption price. Certain subsequent amendments are also permitted. Until a
right is exercised, the holder thereof, as such, will have no rights to vote or
receive dividends or any other rights of a stockholder. As adopted by our board
of directors, the stockholder rights plan includes a provision that requires us
to put the plan up for a vote at our 2002 annual meeting of stockholders. If the
resolution in favor of the stockholder rights plan is defeated, the plan
provides that the board
27
of directors will redeem the rights or terminate the plan, except in the case of
certain disclosed acquisition plans or proposals. If our stockholders approve
the plan, it is scheduled to expire on the fifth anniversary of the date of its
adoption.
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, 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;
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;
28
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;
o the potential impact on available insurance due to the recent increases
in bankruptcy filings by asbestos-troubled companies;
o changes in existing environmental regulatory matters;
o rapid technological changes;
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 specifically in the Middle East based upon the September 11,
2001 terrorist attacks;
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 due
to the impact of the September 11, 2001 terrorist attacks on the
insurance industry.
We believe the items we have outlined above are important factors that could
cause our actual results to differ materially from 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,
2000. 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.
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.
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 the timing of the award of many marine construction projects remains
uncertain, we believe this segment's backlog should continue to increase for the
remainder of 2001.
The revenues of our Government Operations segment are largely a function of
capital spending by the U.S. Government. As a result of reductions in the
defense budget over the past several years, we do not expect this
29
segment to experience any significant growth in the next three years. We expect
this segment's backlog to remain relatively constant since it is the sole
supplier to the U.S. Navy of nuclear fuel assemblies and major nuclear reactor
components for the Naval Reactors Program. We currently expect the 2001
operating activity of this segment will be about the same as in 2000.
The revenues of our Industrial Operations segment are affected by variations in
the business cycles in its customers' industries and the overall economy.
Legislative and regulatory issues such as environmental regulations and
fluctuations in U.S. Government funding patterns also affect this segment. With
the sale of MECL completed, we expect the 2001 operating activity of this
segment to be below the level of 2000.
We expect a sequential decrease in earnings next quarter, due to seasonal
weakness in JRM's marine business.
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. Through February 21, 2000, B&W's and its
subsidiaries' results are included in our segment results under Power Generation
Systems - B&W (see Note 5 to the condensed consolidated financial statements).
B&W and its consolidated subsidiaries' pre-bankruptcy filing revenues of
$155,774,000 and operating income of $9,410,000 are included in our consolidated
financial results for the nine months ended September 30, 2000.
In general, each of our business segments is composed of capital-intensive
businesses that rely on large contracts for a substantial amount of their
revenues.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2001 VS. THREE MONTHS
ENDED SEPTEMBER 30, 2000
Marine Construction Services
Revenues increased $100,854,000 to $262,776,000, primarily due to higher volumes
in North American activities, including the deepwater markets of the Gulf of
Mexico, and fabrication operations in the Eastern Hemisphere.
Segment operating income (loss) increased $26,723,000 from a loss of $9,142,000
to income of $17,581,000, primarily due to higher volumes and margins in North
American activities and fabrication operations in the Eastern Hemisphere. Higher
general and administrative expenses partially offset these increases.
30
Income from investees increased $1,619,000 to $4,762,000, primarily due to
favorable contract closeout adjustments from our U.K. joint venture that was
terminated in June 2001. Lower operating results in our SPARS joint venture
partially offset this increase.
Government Operations
Revenues increased $22,526,000 to $118,475,000, primarily due to higher volumes
from nuclear fuel assemblies and reactor components for the U.S. Government.
Segment operating income decreased $4,361,000 to $3,814,000, primarily due to
lower margins from nuclear fuel assemblies and reactor components for the U.S.
Government and lower volumes and margins from management and operating contracts
for U.S. Government-owned facilities.
Income from investees increased $1,627,000 to $6,110,000, primarily due to
higher operating results from the start-up of our Pantex and Y-12 joint
ventures. Lower operating results from a joint venture in Colorado partially
offset these increases.
Industrial Operations
Revenues increased $77,046,000 to $198,007,000, primarily due to higher volumes
from engineering, construction and plant maintenance activities in Canadian
operations.
Segment operating income decreased $680,000 to $4,009,000, primarily due to
lower margins from plant maintenance activities in Canadian operations and
higher selling, general and administrative expenses. Higher volumes from
engineering and construction activities in Canadian operations partially offset
these decreases.
Power Generation Systems
Revenues decreased $2,770,000 to $12,059,000, primarily due to lower volumes
from the fabrication of utility and industrial boilers. Higher volumes from
after-market service activities partially offset these decreases.
Segment operating loss decreased $1,045,000 to $1,010,000, primarily due to
lower selling, general and administrative expenses.
Income (loss) from investees increased $2,377,000 from a loss of $2,014,000 to
income of $363,000, primarily due to charges to exit and impair certain foreign
joint ventures in the prior year.
Corporate
Corporate expenses increased $6,302,000 from income of $4,294,000 to expense of
$2,008,000, primarily due to lower income from our over-funded pension plans,
legal and professional fees relating to the
31
declaratory action with respect to the assets transferred out of B&W, higher
insurance expenses and costs associated with the termination of our information
technology arrangement with AT&T Solutions. Lower employee-related costs,
including severance, lower net general and administrative expenses and legal
fees related to claims in the prior year partially offset these increases.
Other Income Statement Items
Interest income decreased $1,502,000 to $5,056,000, primarily due to a decrease
in investments.
Other-net included a loss of $4,000,000 related to the curtailment of a foreign
pension plan and gains of approximately $3,300,000 on the sale of securities.
The provision for income taxes for the three months ended September 30, 2001 and
2000 reflected nondeductible amortization of goodwill of $4,502,000. The
goodwill was created by the premium we paid on the acquisition of the minority
interest in JRM in June 1999. The provision for income taxes for the three
months ended September 30, 2001 included a tax benefit of $1,500,000, primarily
related to favorable tax settlements in foreign jurisdictions and a provision
for proposed IRS tax deficiencies. In addition, the income before provision for
income taxes for the three months ended September 30, 2000 included losses and
charges of $2,340,000 to exit certain foreign joint ventures which had no
associated tax benefits. We operate in many different tax jurisdictions. Within
these jurisdictions, tax provisions vary because of nominal rates, allowability
of deductions, credits and 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.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2001 VS. NINE MONTHS
ENDED SEPTEMBER 30, 2000
Marine Construction Services
Revenues decreased $12,094,000 to $602,605,000, primarily due to lower volume in
offshore activities in the Far East relating to the West Natuna project. Higher
volumes in North American activities, including the deepwater markets of the
Gulf of Mexico, and in the Eastern Hemisphere fabrication operations partially
offset this decrease.
Segment operating income (loss) increased $32,456,000 from a loss of $16,930,000
to income of $15,526,000, primarily due to higher volumes and margins in North
American activities and in the Eastern Hemisphere fabrication operations. Lower
volumes on the West Natuna project and higher general and administrative
expenses partially offset these increases.
32
Income from investees increased $5,912,000 to $6,048,000, primarily due to
favorable contract closeout adjustments from our U.K. joint venture that was
terminated in June 2001. In addition, the prior year included higher losses
associated with our U.K. joint venture.
Government Operations
Revenues increased $33,637,000 to $356,349,000, primarily due to higher volumes
from nuclear fuel assemblies and reactor components for the U.S. Government and
commercial work. Lower volumes from management and operating contracts for U.S.
Government-owned facilities and other government operations partially offset
these increases.
Segment operating income decreased $7,230,000 to $22,813,000, primarily due to
lower volume and margins from management and operating contracts for U.S.
Government-owned facilities and higher general and administrative expenses.
Higher volume and margins from commercial work partially offset these decreases.
Income from investees increased $9,106,000 to $16,868,000, primarily due to
higher operating results from a joint venture in Idaho and the start-up of our
Pantex and Y-12 joint ventures. Lower operating results from a joint venture in
Colorado partially offset these increases.
Industrial Operations
Revenues increased $162,040,000 to $527,714,000, primarily due to higher volumes
from engineering, construction and plant maintenance activities in Canadian
operations and from air-cooled heat exchangers.
Power Generation Systems
Revenues increased $18,511,000 to $33,486,000, primarily due to the acquisition
of Babcock & Wilcox Volund ApS, an international power generation operation in
the prior year.
Income (loss) from investees increased $24,524,000 from a loss of $23,443,000 to
income of $1,081,000, primarily due to charges to exit and impair certain
foreign joint ventures in the prior year.
Corporate
Corporate expenses increased $15,296,000 from income of $5,106,000 to expense of
$10,190,000, primarily due to lower income from our over-funded pension plans,
legal and professional fees relating to the declaratory action with respect to
the assets transferred out of B&W, higher insurance expenses, severance costs,
and costs associated with the termination of our information technology
arrangement with AT&T Solutions. A favorable insurance recovery and legal fees
related to claims in the prior year partially offset these increases.
33
Other Income Statement Items
Interest income decreased $4,909,000 to $15,687,000, primarily due to a decrease
in investments.
Other-net decreased $6,363,000 from income of $5,534,000 to a loss of $829,000,
primarily due to foreign currency transaction losses in the current period as
compared to gains in the prior period. In addition, a loss of $4,000,000 was
recorded in the current period related to the curtailment of a foreign pension
plan.
The provision for income taxes for the nine months ended September 30, 2001 and
2000 reflected non-deductible amortization of goodwill of $13,506,000. The
goodwill was created by the premium we paid on the acquisition of the minority
interest in JRM in June 1999. The provision for income taxes for the nine months
ended September 30, 2000 also included a provision of $3,800,000 for B&W for the
pre-filing period and a tax benefit of $1,400,000 from the use of certain tax
attributes in a foreign joint venture. Also included are tax benefits primarily
related to favorable tax settlements in foreign jurisdictions totaling
approximately $5,215,000 and $5,500,000 for the nine months ended September 30,
2001 and 2000, respectively, and a provision for proposed IRS tax deficiencies
in the nine months ended September 30, 2001. In addition, income before the
provision for income taxes for the nine months ended September 30, 2000 included
losses and charges of $23,940,000 to exit certain foreign joint ventures which
had no associated tax benefits. We operate in many different tax jurisdictions.
Within these jurisdictions, tax provisions vary because of nominal rates,
allowability of deductions, credits and 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>
9/30/01 12/31/00
----------- -----------
(Unaudited)
(In thousands)
Marine Construction Services $ 1,530,167 $ 541,647
Government Operations 903,959 1,078,803
Industrial Operations 363,519 396,429
Power Generation Systems 56,859 48,631
----------- -----------
TOTAL BACKLOG $ 2,854,504 $ 2,065,510
=========== ===========
</Table>
Backlog for the Marine Construction Services segment increased primarily because
of recent awards relating to new offshore construction projects in the Gulf of
Mexico and the Eastern Hemisphere.
Backlog for our Industrial Operations segment included MECL backlog of
approximately $329,000,000 at September 30, 2001.
34
At September 30, 2001, Government Operations' backlog with the U. S. Government
was $821,654,000 (of which $33,608,000 had not been funded). However, we expect
this segment's backlog to remain relatively constant since it is the sole source
provider of nuclear fuel assemblies and nuclear reactor components for the U. S.
Government.
Liquidity and Capital Resources
During the nine months ended September 30, 2001, our cash and cash equivalents
increased $6,023,000 to $90,643,000 and our total debt decreased $68,010,000 to
$351,493,000, primarily due to a decrease in short-term borrowings of
$66,286,000. During this period, our operating activities generated cash of
$64,589,000 and we received cash of $963,491,000 from sales and maturities of
investments and $3,002,000 from the sale of assets. We used cash of $929,393,000
for the purchase of investments and $27,644,000 for additions to property, plant
and equipment.
At September 30, 2001 and December 31, 2000, we had available various
uncommitted short-term lines of credit from banks totaling $14,873,000 and
$12,819,000, respectively. Borrowings outstanding against these lines at
September 30, 2001 were $216,000. There were no borrowings against these lines
at December 31, 2000.
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. There were no borrowings under this facility at
September 30, 2001 or December 31, 2000. Letters of credit outstanding under
this facility at September 30, 2001 totaled approximately $111,000,000. See Note
8 to the condensed consolidated financial statements for further information on
the DIP Credit Facility.
On 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, consists 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.
The MII Credit Facility consists of two tranches, each of which has a three-year
term. One is a revolving credit facility that provides for up to $100,000,000 to
the 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 and may be used to reimburse issuers for
drawings under certain outstanding
35
letters of credit totaling $25,412,000 issued for the benefit of B&W and its
subsidiaries. The aggregate amount of loans and amounts available for drawing
under letters of credit outstanding under the MII Credit Facility may not exceed
$200,000,000. This facility is secured by a collateral account funded with
various U.S. government securities with a marked-to-market value equal to 105%
of the aggregate amount available for drawing under letters of credit and
revolving credit borrowings then outstanding. Borrowings against this facility
at September 30, 2001 and December 31, 2000 were $29,600,000 and $10,000,000,
respectively. Letters of credit against this facility outstanding at September
30, 2001 totaled approximately $61,000,000. Borrowings against this facility
were $8,600,000 at November 1, 2001.
The JRM Credit Facility also 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. Borrowings against this facility at December 31, 2000
were $50,000,000. There were no borrowings against this facility at September
30, 2001. Letters of credit outstanding against this facility at September 30,
2001 totaled approximately $62,000,000. There were no borrowings under this
facility at November 1, 2001.
At September 30, 2001, we had total cash, cash equivalents and investments of
$421,443,000. Our investment portfolio consists primarily of government
obligations and other investments in debt securities. The fair value of our
investments at September 30, 2001 was $330,800,000. As of September 30, 2001, we
had pledged approximately $45,912,000 fair value of these investments to secure
a letter of credit in connection with certain reinsurance agreements. In
addition, approximately $210,413,000 fair value of these investments were
pledged to secure the MII Credit Facility.
In connection with B&W's bankruptcy filing, MII entered into a support agreement
pursuant to which it agreed to provide MI with standby financial support on its
interest payments on its (i) $225,000,000 in aggregate principal amount of
9.375% Notes due 2002, (ii) $9,500,000 in aggregate principal amount of Series A
Medium Term Notes due 2003, (iii) $64,000,000 in aggregate principal amount of
Series B Medium Term Notes due 2005, 2008 and 2023, and (iv) $17,000,000 in
principal amount under a Pollution Control Note due 2009. MI is required to pay
MII $5,000 per month under the support agreement which expires on March 15,
2002.
MI's 9.375% notes with an aggregate principal amount of $225,000,000 are
scheduled to mature on March 15, 2002. MI currently has insufficient cash and
other liquid resources on hand to fund the repayment of its
36
9.375% notes. However, we have generated a significant amount of cash flow in
the June and September 2001 quarters which gives us some confidence that our
fourth quarter cash flow from operations will also be positive. We completed the
sale of McDermott Engineers & Constructors (Canada) Ltd. on October 29, 2001
which generated additional cash that we may use to pay down debt (see Note 9 to
the condensed consolidated financial statements). We are also exploring other
alternatives, including further asset sales, early bond redemptions and
potential refinancing or extension of these notes. MI's ability to satisfy,
extend or refinance these notes will be significantly influenced by the results
of the litigation involving our corporate reorganization completed in the fiscal
year ended March 31, 1999. If the action in this litigation is decided against
us by the Bankruptcy Court, it could have a material adverse effect on MI's
ability to satisfy, extend or refinance these notes.
MI owns substantial subsidiaries outside the B&W Chapter 11 filing, including
BWXT, which comprises our Government Operations segment, and Hudson Products
Corporation, which operates our heat exchanger business. BWXT and Hudson
Products Corporation are defendants in the action brought in the Chapter 11
proceeding concerning our corporate reorganization completed in the fiscal year
ended March 31, 1999, and our alternatives regarding these subsidiaries may be
limited until, and depending upon, a resolution in our favor of the action
seeking to void the transfers of B&W of the capital stock of BWXT and Hudson
Products Corporation to BWICO (the parent of B&W) in connection with the
reorganization. In addition, MI has a financial asset pursuant to a stock
purchase and sale agreement with MII (the "Intercompany Agreement"). For the
2001 year, MI would be entitled to $249,637,000 on the exercise of all of its
rights under that agreement, which would generate a tax liability of
$87,338,000. MI does not currently intend to exercise its right to sell under
the Intercompany Agreement (although it may in the future elect to do so). Since
MI is not expected to generate sufficient operating cash flow to repay the
9.375% notes at maturity, and if its extension or refinancing alternatives do
not materialize, MI will have to consider exercising its rights under the
Intercompany Agreement, selling all or a part of one or more of its operating
subsidiaries, requesting a capital contribution or loan from MII or some
combination of these and other alternatives. As a result, MI's inability to
successfully refinance or repay these notes could have a material adverse impact
on MII's liquidity, financial position and results of operations. MI's level of
indebtedness and its lack of liquidity pose substantial risks to the holders of
its debt securities and to its ability to continue as a going concern.
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 September 30, 2001, substantially all the net assets of MI were
subject to those restrictions. At September 30, 2001, JRM and its subsidiaries
could make unsecured loans to or investments in MII and its other subsidiaries
of approximately $71,000,000.
37
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. 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 a result of the impact of the September 11, 2001, terrorist attacks on the
insurance industry, 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 will be available only at rates that we consider uneconomical. We
do not expect this situation to impact our liquidity negatively for the
foreseeable future.
We expect to meet capital expenditure, working capital and debt maturity
requirements for the remainder of 2001 from cash and cash equivalents and
short-term borrowings.
MI and its subsidiaries are unable to incur additional long-term debt
obligations under one of MI's public debt indentures, other than in connection
with certain extension, renewal or refunding transactions (including an
extension or refinancing of MI's 9.375% notes).
As a result of its bankruptcy filing, B&W and its filing subsidiaries are
precluded from paying dividends to stockholders 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
Inter-company Payables") and other creditors during the pendency of the
bankruptcy case, without the Bankruptcy Court's approval.
In September 2001, Moody's Investor Service lowered MI's credit rating form BA3
to B2. JRM's credit rating remained unchanged at BA3. Our rating by Standard &
Poors remain unchanged at B. This downgrade by Moody's Investor Service has
impacted our cost of capital and could impact our access to capital.
The Babcock & Wilcox Company
B&W and its subsidiaries conduct substantially all the operations of our Power
Generation Systems segment. The amount of revenues we generate from our Power
Generation Systems segment primarily depends on
38
capital spending by customers in the electric power generation industry. In that
industry, persistent economic growth in the United States has brought the supply
of electricity into approximate balance with energy demand, except during
periods of peak demand. In recent years, electric power producers have generally
been meeting these peaks with new combustion turbines rather than new base-load
capacity. In January 2001, the state of California began experiencing shortages
of electricity during periods of peak demand. This has caused many power
companies to re-examine their needs for new power plants and for improvements at
existing power plants. Depending on the outcome of these studies, power
companies may order new plants and may improve their existing plants. New U.S.
emissions requirements have also prompted 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. We currently expect the 2001
operating activity of this segment to be about the same as in 2000. In addition,
the September 11, 2001 terrorist attacks have increased the risk associated with
certain contracts in the Middle East.
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 (1) whose
financial statements were previously consolidated with those of its parent (as
B&W's were with ours) and (2) 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 September 30, 2001 is subject to periodic reviews for recoverability. When
B&W emerges from the jurisdiction of the Bankruptcy Court, the subsequent
accounting will be determined based upon the applicable facts and circumstances
at that time, including the terms of any plan of reorganization. See Note 8 to
the condensed consolidated financial statements for B&W's financial information
at September 30, 2001.
In the three months ended September 30, 2001:
B&W's revenues increased $54,190,000 to $304,575,000, primarily due to
higher volumes from the fabrication, repair and retrofit of existing
facilities, nuclear services, fabrication and erection of fossil fuel
steam and environmental control systems, replacement nuclear steam
generators and replacement parts;
B&W's operating income increased $1,218,000 to $2,559,000, primarily due
to higher volumes and margins from the fabrication and erection of fossil
fuel steam and environmental control systems and boiler cleaning
equipment and higher volumes from nuclear services. Lower margins from
the fabrication, repair and retrofit of existing facilities, replacement
parts, and higher general and
39
administrative expenses and reorganization expenses associated with the
Chapter 11 filing partially offset these increases;
In the nine months ended September 30, 2001:
B&W's revenues increased $205,152,000 to $1,026,350,000, primarily due to
higher volumes from the fabrication and erection of fossil fuel steam and
environmental control systems, fabrication, repair and retrofit of
existing facilities, nuclear services, replacement nuclear steam
generators, boiler cleaning equipment and replacement parts;
B&W's operating income increased $32,517,000 to $42,848,000, primarily
due to higher volumes and margins from the fabrication and erection of
fossil fuel steam and environmental control systems which, in the prior
year, included additional charges to substantially completed original
equipment contracts still under warranty or in dispute resolution. In
addition, B&W experienced higher volumes and margins from the
fabrication, repair and retrofit of existing facilities and nuclear
services. Higher general and administrative expenses and reorganization
expenses associated with the Chapter 11 filing and lower operating
results from a joint venture in Pennsylvania partially offset these
increases;
Interest expense increased $2,649,000 to $5,146,000, primarily due to an
increase in expenses related to the DIP facility and the settlement of an
ongoing state income tax dispute;
Other-net expense increased $5,796,000 from income of $327,000 to expense
of $5,469,000, primarily due to a loss on the sale of investment
securities. In addition, B&W experienced higher income in the prior
period from estimated future non-employee products liability asbestos
claim recoveries.
B&W's backlog at September 30, 2001 and December 31, 2000 was $1,413,162,000 and
$1,030,628,000, respectively.
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. See Note 8 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 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. As a result of the
bankruptcy
40
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 plan of reorganization
could change the liability 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 8 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 4 to
the condensed consolidated financial statements in Part I of this report, which
we incorporate by reference into this Item. In addition, see Note 8 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 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
(b) Adoption of Shareholder Rights Plan. On October 17, 2001, our
board of directors adopted a stockholder rights plan and declared
a dividend of one right to purchase preferred stock for each
outstanding share of our common stock, par value $1.00 per share,
to stockholders of record at the close of business on November 1,
2001. The rights will have antitakeover effects. They will cause
substantial dilution to any person or group that attempts to
acquire us without the approval of our board of directors. As a
result, the overall effect of the rights may be to render more
difficult or discourage any attempt to acquire us, even if that
acquisition may be favorable to the interests of our stockholders.
Because our board of directors can redeem the rights or approve a
permitted offer under the plan, the rights should not interfere
with a merger or other business combination the board of directors
approves. We have issued the rights to protect our stockholders
from coercive or abusive takeover tactics and to afford our board
of directors more negotiating leverage in dealing with prospective
acquirers. The rights are described in (1) Note 9 to the condensed
consolidated financial statements included in this report and (2)
the Form 8-K that we filed with the SEC on October 17, 2001.
41
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 of
McDermott International, Inc.'s Form 10-K for the fiscal year ended
March 31, 1996).
Exhibit 3.2* - Amended and Restated By-Laws of McDermott International,
Inc. (incorporated by reference to Exhibit 4.2 of McDermott
International, Inc.'s Registration Statement on Form S-3 Reg. No.
333-69474).
Exhibit 3.3 - Amended and Restated Certificate of Designation of Series
D Participating Preferred Stock.
Exhibit 4.1* - Rights Agreement dated as of October 17, 2001 between
McDermott International, Inc. and EquiServe Trust Company, N.A., as
Rights Agent (incorporated by reference to Exhibit 1 to McDermott
International, Inc.'s Current Report on Form 8-K dated October 17,
2001).
(b) Reports on Form 8-K
We did not file any reports on Form 8-K during the three months ended
September 30, 2001.
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* Incorporated by reference to the filing indicated.
42
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/ Bruce F. Longaker
--------------------------------------------
By: Bruce F. Longaker
Executive Vice President and Chief Financial
Officer (Principal Financial and Accounting
Officer and Duly Authorized Representative)
November 2, 2001
43
EXHIBIT INDEX
Exhibit Description
3.1 McDermott International, Inc.'s Articles of Incorporation, as
amended (incorporated by reference to Exhibit 3.1 of McDermott
International, Inc.'s Form 10-K for the fiscal year ended
March 31, 1996).
3.2 Amended and Restated By-Laws of McDermott International, Inc.
(incorporated by reference to Exhibit 3.2 of McDermott
International, Inc.'s Form 10-Q for the quarter ended March
31, 2001).
3.3 Amended and Restated Certificate of Designation of Series D
Participating Preferred Stock.
4.1 Rights Agreement dated as of October 17, 2001 between
McDermott International, Inc. and EquiServe Trust Company,
N.A., as Rights Agent (incorporated by reference to Exhibit 1
to McDermott International, Inc.'s Current Report on Form 8-K
dated October 17, 2001).