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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One) F O R M 1 0 - K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ____________________
Commission File Number 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
Incorporation or Organization) Identification No.)
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
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of each class on which registered
------------------- -------------------
Common Stock, $1.00 par value New York Stock Exchange
Rights to Purchase Preferred Stock New York Stock Exchange
(Currently Traded with Common Stock)
Securities registered pursuant to Section 12(g) of the Act: None
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 and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of voting Common Stock held by non-affiliates of the
registrant was $2,628,588,072 as of May 14, 1998.
The number of shares outstanding of the Company's Common Stock at May 14, 1998
was 60,710,803.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934
in connection with the Company's 1998 Annual Meeting of Stockholders are
incorporated by reference into Part III hereof.
McDERMOTT INTERNATIONAL, INC.
INDEX - FORM 10-K
PART 1
PAGE
Items 1. & 2. BUSINESS AND PROPERTIES
A. General 1
B. Marine Construction Services
General 4
Foreign Operations 6
Raw Materials 6
Customers and Competition 6
Backlog 6
Factors Affecting Demand 7
C. Power Generation Systems
General 8
Foreign Operations 8
Raw Materials 9
Customers and Competition 9
Backlog 9
Factors Affecting Demand 10
D. Government Operations
General 11
Raw Materials 11
Customers and Competition 11
Backlog 11
Factors Affecting Demand 12
E. Other Operations
General 12
Foreign Operations 12
Raw Materials 13
Customers and Competition 13
Backlog 13
Factors Affecting Demand 13
F. Patents and Licenses 13
G. Research and Development Activities 14
H. Insurance 14
I. Employees 15
J. Environmental Regulations and Matters 15
I
INDEX - FORM 10-K
PAGE
Item 3. LEGAL PROCEEDINGS 17
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS 19
Item 6. SELECTED FINANCIAL DATA 20
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General 22
Fiscal Year 1998 vs Fiscal Year 1997 23
Fiscal Year 1997 vs Fiscal Year 1996 25
Effects of Inflation and Changing Prices 28
Liquidity and Capital Resources 28
Impact of the Year 2000 31
New Accounting Standard 32
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
Company Report on Consolidated Financial Statements 33
Report of Independent Auditors 34
Consolidated Balance Sheet - March 31, 1998 and 1997 35
Consolidated Statement of Income (Loss) for the Three
Fiscal Years ended March 31, 1998 37
Consolidated Statement of Stockholders' Equity for the
Three Fiscal Years ended March 31, 1998 38
Consolidated Statement of Cash Flows for the Three
Fiscal Years ended March 31, 1998 40
Notes to Consolidated Financial Statements 42
Item 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 82
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 83
Item 11. EXECUTIVE COMPENSATION 83
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 83
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 83
II
INDEX - FORM 10-K
PART IV
PAGE
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K 84
Signatures 86
Exhibit 21 - SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT 90
Exhibit 23 - CONSENT OF INDEPENDENT AUDITORS 91
Exhibit 27 - FINANCIAL DATA SCHEDULE 92
III
P A R T I
Items 1. and 2. BUSINESS AND PROPERTIES
A. GENERAL
McDermott International, Inc. ("McDermott International") was incorporated under
the laws of the Republic of Panama in 1959 and is the parent company of the
McDermott group of companies, which includes J. Ray McDermott, S.A. ("JRM") and
McDermott Incorporated. McDermott International's Common Stock, JRM's Common
Stock and 9.375% Senior Subordinated Notes due July 2006, and McDermott
Incorporated's Series A $2.20 Cumulative Convertible Preferred Stock and Series
B $2.60 Cumulative Preferred Stock are publicly traded.
Unless the context otherwise requires, hereinafter "McDermott International"
means McDermott International, Inc., a Panama corporation; "JRM" means J. Ray
McDermott, S.A., a Panama corporation, which is a majority owned subsidiary of
McDermott International, and its consolidated subsidiaries; the "Delaware
Company" means McDermott Incorporated, a Delaware corporation which is a
subsidiary of McDermott International, and its consolidated subsidiaries; and
"International" means the consolidated enterprise.
International operates in three business segments:
o Marine Construction Services includes the results of the operations of JRM,
which supplies worldwide services for the offshore oil and gas exploration
and production and hydrocarbon processing industries, and to other marine
construction companies. Principal activities include the design,
engineering, fabrication and installation of offshore drilling and production
platforms and other specialized structures, modular facilities, marine
pipelines and subsea production systems and procurement activities.
o Power Generation Systems includes the results of the operations of the
Babcock & Wilcox Power Generation Group, which provides services and
equipment and systems to generate steam and electric power at energy
facilities worldwide.
o Government Operations includes the results of the operations of BWX
Technologies, Inc. and B&W Services, Inc., formerly, the Babcock & Wilcox
Government Group, which supplies nuclear reactor components and nuclear fuel
assemblies to the U. S. Navy, various other equipment and services to the U.
S. Government and manages various U. S. Government owned facilities.
Other Operations includes the results of small operations not included above.
The business of the Power Generation Systems and Government Operations segments
are conducted primarily through a subsidiary of McDermott Incorporated, Babcock
& Wilcox Investment Company, the principal subsidiary of which is The Babcock &
Wilcox Company. Unless the context otherwise requires, hereinafter "B&W" means
Babcock & Wilcox Investment Company and its consolidated subsidiaries, including
The Babcock & Wilcox Company.
International has a continuing program of reviewing joint venture, acquisition
and disposition opportunities.
1
The following tables show revenues and operating income (loss) of International
for the three fiscal years ended March 31, 1998. See Note 17 to the
consolidated financial statements for additional information with respect to
International's business segments and operations in different geographic areas.
REVENUES
(Dollars in Millions)
FOR FISCAL YEARS ENDED MARCH 31,
1998 1997 1996
--------------- --------------- ---------------
Marine Construction Services $1,855.5 50.5% $1,408.5 44.7% $1,259.4 38.8%
Power Generation Systems 1,142.7 31.1% 985.4 31.3% 1,145.1 35.3%
Government Operations 370.5 10.1% 373.1 11.8% 369.7 11.4%
Other Operations 337.8 9.2% 458.1 14.5% 500.8 15.4%
Adjustments and Eliminations (31.9) (0.9%) (74.2) (2.3%) (30.7) (0.9%)
- --------------------------------------------------------------------------------------------
Total Revenues $3,674.6 100.0% $3,150.9 100.0% $3,244.3 100.0%
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2
OPERATING INCOME (LOSS)
(Dollars in Millions)
FOR FISCAL YEARS ENDED MARCH 31,
1998 1997 1996
OPERATING INCOME (LOSS): -------------- -------------- --------------
Segment Operating Income (Loss):
Marine Construction Services $ 107.1 46.6% $ 10.8 -- $ 36.9 --
Power Generation Systems 82.5 35.8% (34.6) -- 20.0 --
Government Operations 35.8 15.6% 32.5 -- 25.9 --
Other Operations 4.7 2.0% (30.6) -- (32.9) --
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Total $ 230.1 100.0% $ (21.9) 100.0% $ 49.9 100.0%
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Gain (Loss) on Asset Disposals
and Impairments - Net:
Marine Construction Services $ (40.1) -- $ 29.0 -- $ 2.5 5.7%
Power Generation Systems (6.1) -- (19.2) -- 3.5 7.9%
Government Operations .5 -- .4 -- 0.3 0.7%
Other Operations 128.2 -- (11.9) -- 37.9 85.7%
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Total $ 82.5 100.0% $ (1.7) 100.0% $ 44.2 100.0%
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Income (Loss) from Investees:
Marine Construction Services $ 70.2 82.2% $ (7.8) -- $ 9.1 18.8%
Power Generation Systems 7.5 8.8% (0.3) -- 35.7 73.8%
Government Operations 4.3 5.0% 3.6 -- 2.3 4.7%
Other Operations 3.4 4.0% 0.7 -- 1.3 2.7%
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Total $ 85.4 100.0% $ (3.8) 100.0% $ 48.4 100.0%
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SEGMENT INCOME (LOSS):
Marine Construction Services $137.2 34.5% $ 32.0 -- $ 48.5 34.0%
Power Generation Systems 83.9 21.1% (54.1) -- 59.2 41.6%
Government Operations 40.6 10.2% 36.5 -- 28.5 20.0%
Other Operations 136.3 34.2% (41.8) -- 6.3 4.4%
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Total Segment Income (Loss): 398.0 100.0% (27.4) 100.0% 142.5 100.0%
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Other Unallocated Items (5.3) (72.4) (17.8)
General Corporate Expenses-Net (37.2) (47.4) (37.1)
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Total Operating Income (Loss) $355.5 $(147.2) $ 87.6
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3
B. MARINE CONSTRUCTION SERVICES
GENERAL
On January 31, 1995, International contributed substantially all of its marine
construction services business to JRM, a new company incorporated under the laws
of the Republic of Panama in 1994. Also, on January 31, 1995, JRM acquired
Offshore Pipelines, Inc. ("OPI") in a merger transaction (the "Merger"). Prior
to the Merger with OPI, JRM was a wholly owned subsidiary of McDermott
International; as a result of the Merger, JRM is a majority owned subsidiary of
McDermott International. The business activities of this segment are conducted
through JRM.
The Marine Construction Services segment consists of the basic and detailed
design, engineering, fabrication and installation of offshore drilling and
production platforms and other specialized structures, modular facilities,
marine pipelines and subsea production systems. This segment also provides
comprehensive project management services, feasibility studies, engineering
services, subsea trenching services, diving services, procurement activities,
and removal, salvage and refurbishment services for offshore fixed platforms.
This segment operates throughout the world in all major offshore oil and gas
producing regions, including the Gulf of Mexico, the North Sea, West Africa,
South America, the Middle East, India and the Far East.
This segment conducts operations both directly and through its participation in
joint ventures, some of which it manages and others of which are managed by
other marine construction contractors. Some of the joint ventures are
consolidated for financial reporting purposes while others are accounted for
using either the equity or the cost method. JRM's joint ventures are largely
financed through their own resources, including, in some cases, stand-alone
borrowing arrangements. JRM's two most significant joint venture investments
were in the HeereMac joint venture, which was accounted for by the cost method,
and the McDermott-ETPM joint venture, which was comprised of several joint
venture operating companies, all of which were consolidated for financial
reporting purposes other than McDermott-ETPM West, Inc., which was accounted for
by the equity method.
On December 19, 1997, JRM and Heerema Offshore Construction Group, Inc.
("Heerema") terminated the HeereMac joint venture. The HeereMac joint venture
was formed in January 1989 and utilized the specialized, heavy-lift marine
construction vessels which were previously owned by the two parties. Each
party had a 50% interest in the joint venture, and Heerema had responsibility
for its day-to-day operations. Pursuant to the termination, Heerema acquired and
assumed JRM's 50% interest in the joint venture in exchange for cash of
$318,500,000 and title to several pieces of equipment. The equipment
transferred to JRM included two launch barges and the derrick barge 101, a 3,500
ton lift capacity, semi-submersible derrick barge.
JRM formed its initial joint venture with ETPM S.A., McDermott-ETPM, in April
1989 to provide general marine construction services to the petroleum industry
in West Africa, South America, the Middle East and India and offshore
pipelaying services in the North Sea. With the addition of two new joint
venture operating companies in March 1995, JRM and ETPM S. A. expanded their
joint venture's operations to include the Far East and began jointly pursuing
subsea contracting work on a worldwide basis. Most of the operating companies
in the McDermott-ETPM joint venture were majority-owned and controlled by JRM.
However, the operations of McDermott-ETPM West, Inc., which conducted operations
in the North Sea, South America and West Africa, were managed and controlled by
ETPM S.A.
On April 3, 1998, JRM and ETPM S.A. terminated the McDermott-ETPM joint venture.
Pursuant to the termination, JRM received net cash of approximately $105,000,000
and the derrick/lay barge 1601 and assumed 100% ownership of McDermott-ETPM
East, Inc. and McDermott-ETPM Far East, Inc. ETPM S.A. received the lay barge
200 and took ownership of McDermott Subsea Constructors Limited ("MSCL") and
McDermott-ETPM West, Inc.
4
JRM participates in other joint ventures involving operations in foreign
countries that require majority-ownership by local interests. Through a
subsidiary, JRM also participates in an equally owned joint venture with the
Brown & Root Energy Services unit of Halliburton Company ("Brown & Root"), which
was formed in February 1995 to combine the operations of JRM's Inverness and
Brown & Root's Nigg fabrication facilities in Scotland.
In May 1998, JRM sold its interest in McDermott Engineering (Europe) Limited and
announced its intention to exit other European engineering operations. See Note
17 to the consolidated financial statements regarding these events. These
actions leave only Mentor Subsea Technology Services, Ltd. to maintain JRM's
presence in the European subsea markets.
At March 31, 1998, the Marine Construction Services segment owned or operated 6
fabrication facilities throughout the world. This segment's principal domestic
fabrication yard and offshore base is located on 1,114 acres of land, under
lease, near Morgan City, Louisiana. This segment also owns or operates
fabrication facilities near Corpus Christi, Texas, near Inverness, Scotland, in
Indonesia on Batam Island, in Jebel Ali, U.A.E. and in Warri, Nigeria. This
segment also owns and operates a ship repair and fabrication yard in VeraCruz,
Mexico.
The fabrication facilities are equipped with a wide variety of heavy-duty
construction and fabrication equipment, including cranes, welding equipment,
machine tools and robotic and other automated equipment, most of which is
movable. JRM has the capability to fabricate a full range of offshore
structures, from conventional jacket-type fixed platforms to deepwater platform
configurations employing compliant-tower, tension leg, floating production
platform and spar technology. JRM also fabricates platform deck structures and
modular components, including complete production processing systems,
hydrocarbon separation and treatment systems, pressure and flow control systems
and personnel quarters.
At March 31, 1998, expiration dates, including renewal options, of leases
covering land for the fabrication yards, were as follows:
Morgan City, Louisiana Years 2000-2033
Jebel Ali, U.A.E. Year 2005
Batam Island, Indonesia Year 2008
Warri, Nigeria Year 2065
Pursuant to the termination of the McDermott-ETPM joint venture in April 1998,
ETPM S.A. acquired the fabrication facility located at Warri, Nigeria.
JRM owns or, through its ownership interests in joint ventures, has interest in
one of the largest fleets of marine equipment used in major offshore
construction. The nucleus of a "construction spread" is a large derrick barge,
pipelaying barge or combination derrick-pipelaying barge capable of offshore
operations for an extended period of time in remote locations. At March 31,
1998, JRM owned or, through ownership interests in joint ventures, had interests
in 5 derrick vessels, 4 pipelaying vessels, 9 combination derrick-pipelaying
vessels and 3 pipe burying vessels. The lifting capacities of the derrick and
combination derrick-pipelaying vessels range from 250 to 5,000 tons. These
vessels range in length from 400 to 698 feet and are fully equipped with stiff
leg or revolving cranes, auxiliary cranes, welding equipment, pile-driving
hammers, anchor winches and a variety of additional gear. The largest vessels
are the semi-submersible derrick barge 101 and the lay barge 200, a semi-
submersible pipelaying vessel. Pursuant to the termination of the McDermott
ETPM joint venture, ETPM S.A. received the lay barge 200 and two other vessels
owned by MSCL and JRM received the derrick/lay barge 1601. In addition,
subsequent to fiscal year end, JRM's Malaysian joint venture sold two
combination derrick-pipelaying vessels and JRM sold two pipe burying vessels.
5
To support the operations of these major marine construction vessels, JRM and
its joint ventures also own or lease a substantial number of other vessels, such
as tugboats, utility boats, launch barges and cargo barges. In connection with
its construction and pipelaying activities, this segment conducts diving
operations which, because of the water depths involved, require sophisticated
equipment, including diving bells and an underwater habitat.
FOREIGN OPERATIONS
The amount of Marine Construction Services' revenues, net of intersegment
revenues, and segment income derived from operations located outside of the
United States, and the approximate percentages to International's total revenues
and total segment income, respectively, follow:
REVENUES SEGMENT INCOME
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in thousands)
1998 $ 1,112,685 30% $ 317,482 80%
1997 839,583 27% 14,525 -
1996 848,050 26% 16,883 12%
RAW MATERIALS
The raw materials used by this segment, such as carbon and alloy steel in
various forms, welding gases, concrete, fuel oil and gasoline, are available
from many sources and this segment is not dependent upon any single supplier or
source. Although shortages of certain of these raw materials and fuels have
existed from time to time, no serious shortage exists at the present time.
CUSTOMERS AND COMPETITION
This segment's principal customers are oil and gas companies, including foreign
government owned companies. Customers generally contract with this segment for
the design, engineering, fabrication and installation of offshore drilling and
production platforms and other specialized structures, modular facilities,
marine pipelines and subsea production systems. Contracts are usually awarded
on a competitive bid basis. There are a number of companies which compete
effectively with International and its joint ventures in each of the separate
marine construction phases in various parts of the world.
BACKLOG
As of March 31, 1998 and 1997, the Marine Construction Services' backlog
amounted to $1,266,310,000 and $1,771,170,000, or approximately 37% and 42%,
respectively, of International's total backlog. Backlog decreased primarily as
a result of a decline in engineering, procurement and construction activities in
the Middle East, procurement activities in the Far East, engineering activities
in the North Sea and management's focus on higher margin projects. Of the March
31, 1998 backlog, it is expected that approximately $941,239,000 will be
recognized in revenues in fiscal year 1999, $225,602,000 in fiscal year 2000 and
$99,469,000 thereafter.
During fiscal year 1998, Marine Construction Services received contract awards
valued at $50,000,000 from British-Borneo Exploration, Inc. for work on the
Morpeth Field Development in the Gulf of Mexico. Under the contract, JRM will
transport and install a SeaStar mini-tension leg platform and associated
pipelines at Ewing Banks Block 921 in 1,670 feet of water. JRM also has the
responsibility for subsea system design, procurement, and commissioning through
its subsidiary Mentor Subsea Technology Services Ltd. JRM will
6
also install 21 miles of 8-inch and 12-inch diameter pipeline utilizing
conventional S-lay technology. The installation will be complete in the summer
of 1998. Marine Construction Services has also been awarded a contract from
Shell Offshore Inc., valued at approximately $25,000,000, for construction of a
fixed-base platform for an offshore development in the Gulf of Mexico. The
platform is being designed by JRM under a separate contract with Shell. The
installation will take place in July 1998 and the lift will be the heaviest to
date in the Gulf of Mexico. When complete, this platform will be the world's
deepest tripod, standing 750 feet above the floor of the Gulf of Mexico.
Backlog also includes a $112,300,000 contract attributable to an agreement
with a customer for exclusive use of a company vessel over a two-year period. As
of March 31, 1998, the customer could release the vessel to the company for a
stand-by payment of $16,200,000. In management's opinion, the vessel will be
utilized at levels to achieve the backlog amount.
Not included in backlog at March 31, 1998, is a $70,000,000 contract awarded in
May 1998 from British-Borneo Exploration, Inc., for work on the Allegheny field
development in the Gulf of Mexico. Under the contract, JRM will transport and
install the hull, deck, pilings and tendons for a SeaStar mini-tension leg
platform in 3,300 feet of water. JRM will also design steel catenary risers
("SCRs") and design, procure and commission five subsea completions and two
riser-end manifolds. In addition, the contract includes the installation of two
12-inch diameter export pipeline SCRs and six miles of interfield flowlines and
associated SCRs. The work is scheduled for completion in the summer of 1999.
Not included in Marine Construction Services' backlog at March 31, 1998 and 1997
was backlog relating to contracts to be performed by unconsolidated joint
ventures of approximately $587,000,000 (excluding McDermott-ETPM West, Inc.) and
$1,426,000,000, respectively. Included in the 1997 backlog was $645,000,000 and
$300,000,000 related to the HeereMac and McDermott-ETPM West, Inc. joint
ventures, respectively.
Work has historically been performed on a fixed-price, cost-plus or day-rate
basis or a combination thereof. More recently, certain partnering-type contracts
have introduced a risk and reward element wherein a portion of total
compensation is tied to the overall performance of the alliance partners. This
segment attempts to cover increased costs of anticipated changes in labor,
material and service costs of long-term contracts either through an estimate of
such changes, which is reflected in the original price, or through price
escalation clauses. Most long-term contracts have provisions for progress
payments.
FACTORS AFFECTING DEMAND
The activity of the Marine Construction Services' segment depends mainly on the
capital expenditures of oil and gas companies and foreign governments for
developmental construction. These expenditures are influenced by the selling
price of oil and gas along with the cost of production and delivery, the terms
and conditions of offshore leases, the discovery rates of new reserves offshore,
the ability of the oil and gas industry to raise capital, and local and
international political and economic conditions. In some Far East countries,
internal consumption of oil and gas products has decreased due to the current
economic crises.
Oil and gas company capital exploration and production budgets for calendar year
1998 were projected to increase for the fourth consecutive year to the highest
level in the past ten years, but may now be curtailed by falling oil and gas
prices. Increased production and lower worldwide demand for petroleum products
has led to a significant drop in oil prices and downward pressure on natural gas
prices. Economic and political instability in Indonesia and political turmoil on
the Indian subcontinent are expected to have an adverse effect on exploration
and production spending. Worldwide demand for offshore drilling rigs,
particularly for deepwater exploration, has remained strong and this,
historically, has been a leading indicator for an increase in the need for
marine construction services. JRM's markets are expected to continue to emerge
from the competitive environment that has put pressure on margins in prior
periods.
7
C. POWER GENERATION SYSTEMS
GENERAL
The Power Generation Systems segment supplies engineered-to-order services,
products and systems for energy conversion worldwide, which includes the
manufacturing of heavy pressure equipment, including boilers fueled by coal,
oil, bitumen, natural gas, solid municipal waste, biomass, and other fuels; and
related industrial equipment, such as burners, pulverizer mills, soot blowers
and ash handlers. The Power Generation Systems segment also fabricates steam
generators for nuclear power plants and designs and supplies environmental
control systems, including both wet and dry scrubbers for flue gas
desulfurization; modules for selective catalytic reduction of the oxides of
nitrogen; and electrostatic precipitators and similar devices.
The Power Generation Systems segment supports operating plants with a wide
variety of services, including the installation of new systems and replacement
parts, engineered upgrades, construction, maintenance, and field technical
services such as condition assessment. It also provides inventory services to
help customers respond quickly to plant interruptions and to construction crews
to maintain and repair operating equipment. The segment also provides power
through cogeneration, refuse-fueled power plants, and other independent power
producing facilities. It participates in this market as a contractor for
engineer-procure-construct services, as an equipment supplier, as an operations
and maintenance contractor, and through ownership interests.
The principal manufacturing plants of this segment, which are owned by B&W, are
located at West Point, Mississippi; Paris, Texas; Lancaster, Ohio; and
Cambridge, Ontario, Canada. After extensive study, B&W has elected to close its
Paris, Texas plant. The closure is expected to be completed by late summer 1998.
This segment's unconsolidated affiliates' (equity investees) foreign plants are
located in Beijing, China; Batam Island, Indonesia; Pune, India; and Cairo,
Egypt. This segment also operates independent power facilities located in
Ebensburg, Pennsylvania and Sunnyside, Utah. All of these plants are well
maintained, have suitable equipment and are of adequate size.
FOREIGN OPERATIONS
The amounts of Power Generation Systems' revenues, net of intersegment
revenues, and segment income (loss) derived from operations located outside of
the United States, and the approximate percentages to International's total
revenues and total segment income (loss), respectively, follow:
REVENUES SEGMENT INCOME (LOSS)
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in Thousands)
1998 $196,831 5% $ 25,694 6%
1997 296,544 9% (33,701) 123%
1996 553,938 17% 38,456 27%
Products for international installation are engineered and built in B&W's United
States and Canadian facilities, as well as in the facilities of the segment's
equity investees in China, Indonesia, India and Egypt.
8
RAW MATERIALS
The principal raw materials used by this segment to construct power generation
systems and equipment consist of carbon and alloy steels in various forms, such
as plates, forgings, structurals, bars, sheets, strips, heavy wall pipes and
tubes. Significant amounts of components and accessories are also purchased for
assembly into the supplied systems and equipment. These raw materials and
components generally are purchased as needed for individual contracts. Although
shortages of certain of these raw materials have existed from time to time, no
serious shortage exists at the present time. This segment is not sole source
dependent for any significant raw materials.
CUSTOMERS AND COMPETITION
The principal customers of this segment are the electric power generation
industry (including government-owned utilities and independent power producers);
the pulp and paper industry; process industries such as petrochemical plants,
oil refineries and steel mills; and other steam-using industries and
institutions. The electric power generation industry accounted for
approximately 24%, 22% and 22% of International's total revenues for fiscal
years 1998, 1997 and 1996, respectively.
Customers normally purchase services, equipment or systems from the Power
Generation Systems segment after an extensive evaluation process based on
competitive bids. Proposals are submitted based on the estimated cost of each
job.
Within the United States, a number of domestic and foreign-based companies
specializing in steam generating systems, equipment and services compete with
the Power Generation Systems segment. Examples include ABB Asea Brown Boveri
Ltd., Ahlstrom Corporation, DB Riley, Inc., Foster Wheeler Corporation, Kvaerner
ASA, and other companies. In international markets, this segment competes
against these companies, plus additional foreign-based companies. A number of
additional companies compete in environmental control equipment, related
specialized industrial equipment and the independent power producing business.
Other suppliers of steam systems, as well as many other businesses, compete for
replacement parts, repair and alteration, and other services required to backfit
and maintain existing systems.
BACKLOG
Backlog as of March 31, 1998 and 1997 for the Power Generation Systems segment
was $1,070,351,000 and $1,495,885,000, or approximately 31% and 35%,
respectively, of International's backlog. Backlog decreased primarily as a
result of delays and cancellations of power projects in Southeast Asia due to
the current Asian economic crisis and management's focus on higher margin
projects. Of the March 31, 1998 backlog, it is expected that approximately
$703,955,000 will be recognized in revenues in fiscal year 1999, $170,447,000 in
fiscal year 2000 and $195,949,000 thereafter, of which approximately 70% will be
recognized in fiscal years 2001 through 2003.
During fiscal year 1998, the Power Generation Systems segment received contract
awards valued at $710,330,000. This included two contracts with a combined
value of $53,000,000 for cyclones (a type of boiler that burns crushed fuel) at
Commonwealth Edison's State Line and Kincaid Stations. B&W is the only company
to successfully fabricate and put into service these products for utility
boilers in the United States. This segment also received a $35,000,000 contract
for the design and manufacture of components for eight steam generators to be
installed at the Qinshan nuclear project in China; a contract valued at
$33,000,000 to upgrade two plants for American Electric Power; and a contract
valued at $23,300,000 to convert an idle ABB-CE recovery boiler at Bowater,
Inc.'s Calhoun, Tennessee newsprint facility to a bubbling fluid bed boiler.
Not included in backlog at March 31, 1998 is a $20,000,000 contract awarded to
B&W Mexicana S.A. de C.V., a B&W joint venture. The company will modernize five
20 year old boilers manufactured by a competitor of The Babcock & Wilcox Company
and located in Monterrey, State of Nuevo Leon,
9
Mexico. B&W Mexicana will design, manufacture and supply all pressure parts,
drum internals, burners, steam coil air heaters and sootblowers. Part of the
scope also includes new electronic controls and the construction work. The
project will span more than two years. This order, from the country's state-
owned oil company, is Mexico's largest single award for a boiler service
project. In addition, Babcock & Wilcox Beijing Company, a B&W joint venture,
has begun engineering and manufacturing of a $29,000,000 order from Pucheng
Electricity Generating Company, Ltd., in Pucheng, China, for two 330 megawatt
pulverized coal-fired boilers for its station in the Shaanxi Province.
If in management's judgment it becomes doubtful whether contracts will proceed,
the backlog is adjusted accordingly. If contracts are deferred or cancelled,
the Power Generation Systems segment is usually entitled to a financial
settlement related to the individual circumstances of the contract. Operations
and maintenance contracts, which are performed over an extended period, are
included in backlog based upon an estimate of the revenues from these contracts.
The Power Generation Systems segment attempts to cover increased costs of
anticipated changes in labor, material and service costs of long-term contracts
either through an estimation of such changes, which is reflected in the original
price, or through price escalation clauses. Most long-term contracts have
provisions for progress payments.
FACTORS AFFECTING DEMAND
Electric utilities in parts of Asia and the Middle East are current purchasers
of new baseload generating units and environmental control systems, due to the
growth of their economies and to the small existing stock of electrical
generating capacity in most developing countries. The currency crisis, which
began in Southeast Asia in the summer of 1997, has slowed the number of
inquiries and orders from the level of the previous year. This segment is also
expected to be adversely affected by the economic and political instability in
Indonesia and political turmoil on the Indian subcontinent.
Electrical consumption has grown moderately in the United States in recent years
and competition within the electric power industry in the United States has
intensified. The Energy Policy Act of 1992 deregulated the electric power
generation industry by allowing independent power producers access to the
electric utilities' transmission and distribution systems. Several states have
changed their laws to encourage competition among generators of electricity.
The modest growth in demand and the changes associated with this transition from
a regulated to a competitive industry have caused electric power companies to
defer ordering new baseload power plants in the United States. When electric
utilities are in need of peaking capacity, many are purchasing combustion
turbines with short lead-times or they are purchasing electricity from other
utilities and non-regulated sources, such as cogenerators and independent power
producers.
Substantially all the customers of the Power Generation Systems segment are
affected by environmental regulations of the countries in which their facilities
are located. In the United States, the Clean Air Act requires many customer
industries to implement systems to limit or remove emissions. These mandated
expenditures have caused some customers to defer refurbishments of existing
plants. The same requirements have caused other customers to purchase
environmental control equipment from this segment. Future changes in
environmental regulations will continue to affect demand for this segment's
products and services.
The systems, products and services of the Power Generation Systems segment are
capital intensive. As such, demand for the company's products is heavily
affected by the variations in the business cycles of our customers and by the
overall economies of their countries. Availability of funds for project
financing, investment and maintenance at this segment's customers varies with
the conditions of their domestic businesses.
10
D. GOVERNMENT OPERATIONS
GENERAL
The Government Operations segment provides nuclear fuel assemblies and nuclear
reactor components to the U. S. Navy for the Naval Reactors Program. This
activity has made contributions to operating income of International in all
three fiscal years and is expected to do so in the foreseeable future. This
segment, in addition to its Naval Reactors Program business, supplies other
equipment and services to the U. S. Government and is proceeding with new
Government projects and exploring new programs which require the technological
capabilities it developed as a Government contractor. Examples of these
markets include environmental restoration services and the management of
government-owned facilities, primarily within the Department of Energy's ("DOE")
nuclear weapons complex.
The principal plants of this segment are located in Lynchburg, Virginia and
Barberton, Ohio.
RAW MATERIALS
This segment is not sole source dependent for any significant raw materials
except for uranium, which is furnished and owned by the U.S. Government and used
in the nuclear fuel assemblies supplied to the U.S. Navy for the Naval Reactors
Program.
CUSTOMERS AND COMPETITION
This segment is the sole supplier to the U.S. Navy of all major nuclear steam
system equipment and all nuclear fuel assemblies and reactor components for the
Naval Reactors Program. There are a small number of suppliers of small nuclear
components with B&W being the largest based on revenues. This segment is
involved along with other companies in the operation of the Idaho National
Engineering and Environmental Laboratory located near Idaho Falls, Idaho; the
Rocky Flats Environmental Technology Site located near Boulder, Colorado; the
Savannah River Site located in Aiken, South Carolina, and the Hanford Site
located in Richland, Washington. During fiscal year 1998, the Government
Operations segment received a contract from the U. S. DOE as the prime
contractor to manage the environmental remediation and site transition project
at the DOE's Mound site in Miamisburg, Ohio. A B&W subsidiary, Babcock & Wilcox
of Ohio, Inc., began performance under the several hundred million dollar multi-
year contract in October 1997, which contract is subject to annual funding. For
the fiscal years 1998, 1997 and 1996, the U.S. Government accounted for
approximately 10%, 11% and 12%, respectively, of International's total revenues,
including 7%, 10% and 10%, respectively, related to nuclear fuel assemblies and
reactor components for the U.S. Navy.
BACKLOG
Backlog as of March 31, 1998 and 1997 for the Government Operations segment was
$810,230,000 and $791,981,000, or approximately 24% and 19%, respectively, of
International's backlog. Of the March 31, 1998 backlog, management expects that
approximately $309,251,000 will be recognized in revenues in fiscal year 1999,
$215,841,000 in fiscal year 2000 and $285,138,000 thereafter, of which
approximately 91% will be recognized in fiscal years 2001 through 2003. At
March 31, 1998, this segment's backlog with the U. S. Government was
$799,967,000 (of which $40,376,000 had not yet been funded), or approximately
23% of International's total backlog. The March 31, 1998 U. S. Government
backlog includes only the current year funding for the DOE Mound site in
Miamisburg, Ohio. During fiscal year 1998, this segment was awarded
approximately $250,000,000 in new orders for aircraft carrier components and
prototypical steam generation equipment for the newest submarine design.
11
FACTORS AFFECTING DEMAND
The systems, products and services of the Government Operations segment are
generally capital intensive. This segment may be impacted by U. S. Government
budget restraints.
Even with the maturing of the U. S. Navy's shipbuilding program and U. S.
Government defense budget reductions, the demand for nuclear fuel assemblies
and reactor components for the U. S. Navy has continued to comprise a
substantial portion of this segment's backlog. Orders for U. S. Navy nuclear
fuel assemblies and nuclear reactor components are expected to continue to be a
significant part of backlog since this segment is the sole source provider of
these nuclear fuel assemblies and nuclear reactor components.
E. OTHER OPERATIONS
GENERAL
Other Operations includes the results of Engineering and Construction
operations, Hudson Products Corporation and McDermott Technology, Inc.,
(formerly B&W's Research & Development Division and Contract Research Division),
and other businesses. The business activities of Other Operations are conducted
through McDermott Engineers & Constructors (Canada), Ltd. ("MECL"), Hudson
Products Corporation and McDermott Technology, Inc.
MECL provides services, including project management, conceptual and process
design, front-end engineering and design, detailed engineering, procurement,
construction management and contract maintenance. Hudson Products Corporation
products include air-cooled heat exchangers, combination water and air-cooled
systems, air-cooled vacuum steam condensers, fiber-glass reinforced axial flow
fans for air-cooled heat exchangers and wet cooling towers and fan control
systems. McDermott Technology, Inc.'s Research & Development Division performs
research activities for internal operating segments of International, while its
Contract Research Division markets, negotiates and administers contracts that
leverage company research and development technology needs with external funds.
The principal plant of Hudson Products is located in Beasley, Texas. One of
Other Operations' unconsolidated affiliates has a plant in Monterrey, Mexico,
which manufactures axial flow fans and structural components for air-cooled heat
exchangers. Both of these plants are well maintained, have suitable equipment
and are of adequate size. McDermott Technology, Inc's research and development
facilities are located in Alliance, Ohio and Lynchburg, Virginia. MECL is
located in Calgary, Alberta, Canada.
FOREIGN OPERATIONS
The amount of Other Operations' revenues, net of intersegment revenues, and
segment income (loss) derived from operations located outside of the United
States, and the approximate percentages to International's total revenues and
total segment income (loss), respectively, follow:
REVENUES SEGMENT INCOME (LOSS)
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in Thousands)
1998 $195,886 5% $ 90,516 23%
1997 242,973 8% (29,614) 108%
1996 342,234 11% 13,788 10%
12
RAW MATERIALS
The principal raw materials used by Other Operations consist of carbon and alloy
steels in various forms, such as plates, bars, sheets, and pipes, and aluminum
pipes, aluminum strips, fiberglass cloth and epoxy resins. The majority of raw
materials and components are purchased as needed for individual contracts.
Additional quantities of raw material are carried as base stock for jobs
requiring quick turnaround. Although extended lead time of certain raw
materials have existed from time to time, no serious shortage exists at the
present, nor is any shortage expected in the foreseeable future. Other
Operations is not sole source dependent for any significant raw materials.
CUSTOMERS AND COMPETITION
The principal customers of Other Operations include oil and natural gas
producers, the electric power generation industry, petrochemical and chemical
processing industries, state and federal government agencies and non-profit
utility groups.
Equipment orders for items such as air-cooled heat exchangers are customarily
awarded after competitive bids have been submitted as proposals to customers
based on the estimated cost of each job. In both the U. S. and international
markets, a number of domestic and foreign-based companies specializing in air-
cooled heat exchanger equipment compete with this segment. The majority of the
engineering and construction operations contracts are awarded in a competitive
market in which both price and quality are considerations.
BACKLOG
As of March 31, 1998 and 1997, Other Operations backlog amounted to $262,339,000
and $168,416,000, or approximately 8% and 4%, respectively, of International's
total backlog. Of the March 31, 1998 backlog, management expects that
approximately $231,958,000 will be recognized in revenues in fiscal year 1999,
$23,234,000 in fiscal year 2000 and $7,147,000 thereafter.
During fiscal year 1998, Other Operations received a contract award valued at
$49,000,000 to engineer and construct a natural gas treatment plant in
northwestern British Columbia, Canada for Novagas Canada Limited. Other
Operations also received a contract award valued at $12,717,000 to supply 113
air-cooled heat exchanger units to TransCanada Pipelines.
FACTORS AFFECTING DEMAND
The equipment and services provided by Other Operations are somewhat capital
intensive and the demand for its equipment and services are affected by
variations in the business cycles (which are affected by the price of oil) in
the customers' industries and in the overall economies in their regions. Other
Operations is also affected by legislative issues such as environmental
regulations and fluctuations in U. S. Government funding patterns. Availability
of funds for investment and maintenance at various customers' facilities varies
partly due to seasonal plant outages, business cycles and economic conditions.
F. PATENTS AND LICENSES
Many U. S. and foreign patents have been issued to International and it has many
pending patent applications. Patents and licenses have been acquired and
licenses have been granted to others when advantageous to International. While
International regards its patents and licenses to be of value, no single patent
or license or group of related patents or licenses is believed to be material in
relation to its business as a whole.
13
G. RESEARCH AND DEVELOPMENT ACTIVITIES
International conducts its principal research and development activities at its
research centers in Alliance, Ohio and Lynchburg, Virginia; and also conducts
development activities at its various manufacturing plants and engineering and
design offices. During the fiscal years ended March 31, 1998, 1997 and 1996,
approximately $37,928,000, $50,749,000 and $68,106,000, respectively, was spent
by International on research and development activities, of which approximately
$22,803,000, $34,170,000 and $45,106,000, respectively, was paid for by
customers of International. Research and development activities were related to
development and improvement of new and existing products and equipment and
conceptual and engineering evaluation for translation into practical
applications. International's multi-million dollar clean environment development
facility in Alliance, Ohio was constructed in response to present and future
emission pollution standards in the U.S. and worldwide. Approximately 160
employees were engaged full time in research and development activities at
March 31, 1998.
H. INSURANCE
International maintains liability and property insurance against such risk and
in such amounts as it considers adequate. However, certain risks are either not
insurable or insurance is available only at rates which International considers
uneconomical. Among such risks are war and confiscation of property in certain
areas of the world, pollution liability in excess of relatively low limits and,
in recent years, asbestos liability. Depending on competitive conditions and
other factors, International endeavors to obtain contractual protection against
uninsured risks from its customers. However, there is no assurance that
insurance or contractual indemnity protection, when obtained, will be sufficient
or effective under all circumstances or against all hazards to which
International may be subject.
International's insurance policies do not insure against liability and property
damage losses resulting from nuclear accidents at reactor facilities of its
utility customers. To protect against liability for damage to a customer's
property, International obtains waivers of subrogation from the customer and its
insurer and is generally named as an additional insured under the utility
customer's nuclear property policy. To protect against liability from claims
brought by third parties, International is insured under the utility customer's
nuclear liability policies and has the benefit of the indemnity and limitation
of any applicable liability provision of the Price-Anderson Act, as amended (the
"Act"). The Act limits the public liability of manufacturers and operators of
licensed nuclear facilities and other parties who may be liable in respect of,
and indemnifies them against, all claims in excess of an amount which is
determined by the sum of commercially available liability insurance plus certain
retrospective premium assessments payable by operators of commercial nuclear
reactors. For those sites where International provides environmental
remediation services, it seeks the same protection from its customers as it does
for its other nuclear activities.
Although International does not own or operate any nuclear reactors, it has
coverage under commercially available nuclear liability and property insurance
for three of its four facilities which are licensed to possess special nuclear
materials. The fourth facility operates primarily as a conventional research
center. This facility is licensed to possess special nuclear material and has a
small and limited amount of special nuclear material on the premises. Two of
the four owned facilities are located at International's Lynchburg, Virginia
site. These facilities are insured under a nuclear liability policy which also
insures the facility of B&W Fuel Company ("BWFC") that was sold during fiscal
year 1993. All three facilities share the same nuclear liability insurance
limit as the commercial insurer would not allow BWFC to obtain a separate
nuclear liability insurance policy. Due to the type or quantity of nuclear
material present, two of the four facilities have the benefit of the indemnity
and limitation of liability provisions of the Act, pursuant to Indemnity
Agreements entered into with the U. S. Government. In addition, contracts to
manufacture and supply nuclear fuel or nuclear components to the U. S.
Government generally contain contractual indemnity clauses, which become
effective at the time of shipment, whereby the U. S. Government has assumed the
risks of public liability claims.
14
JRM's offshore construction business is subject to the usual risks of operations
at sea, with additional exposure due to the utilization of expensive
construction equipment, sometimes under extreme weather conditions, often in
remote areas of the world. In addition, JRM operates in many cases on or in
proximity to existing offshore facilities which are subject to damage by JRM and
such damage could result in the escape of oil and gas into the sea.
The insurance coverage of International for products liability and employers'
liability claims is subject to varying insurance limits which are dependent upon
the year involved. The Babcock & Wilcox Company has agreements with the
majority of its principal insurers concerning the method of allocation of
products liability asbestos claim payments to the years of coverage. Pursuant
to those agreements, The Babcock & Wilcox Company negotiates and settles these
claims and bills these amounts to the appropriate insurers. For financial
reporting purposes, a provision has been recognized to the extent that recovery
of these amounts from International's insurers has not been determined to be
probable. Estimated liabilities for pending and future non-employee products
liability asbestos claims are derived from International's claims history and
constitute management's best estimate of such future costs. Estimated insurance
recoveries are based upon analysis of insurers providing coverage of the
estimated liabilities. Inherent in the estimate of such liabilities and
recoveries are expected trends in claim severity and frequency and other
factors, including recoverability from insurers (see Note 11 to the consolidated
financial statements), which may vary significantly as claims are filed and
settled. Accordingly, the ultimate loss may differ materially from the amount
provided in the consolidated financial statements.
International has two wholly owned insurance subsidiaries. To date, these
subsidiaries have written policies concerning general and automobile liability,
builders' risk within certain limits, marine hull, and workers' compensation for
International and its subsidiaries. No significant amounts of insurance have
been written for unrelated parties.
I. EMPLOYEES
At March 31, 1998, International employed, under its direct supervision,
approximately 24,700 persons compared with 24,600 at March 31, 1997.
Approximately 6,400 employees were members of labor unions at March 31, 1998 as
compared with approximately 5,700 at March 31, 1997. The majority of B&W's
manufacturing facilities operate under union contracts which customarily are
renewed every two to three years. During the next twelve months, six union
contracts covering approximately 1,800 B&W hourly workers will expire. Five of
these contracts have been successfully renegotiated. B&W's management expects
to renew the remaining contract without incident. International considers its
relationship with its employees to be satisfactory.
J. ENVIRONMENTAL REGULATIONS AND MATTERS
International is subject to the existing and evolving legal and regulatory
standards relating to the environment. These laws include the Comprehensive
Environmental Response, Compensation, and Liability Act of 1980 ("CERCLA") and
similar laws which provide for responses to and liability for releases of
hazardous substances into the environment; and the Clean Air Act, the Clean
Water Act, the Resource Conservation and Recovery Act and other federal laws,
each as amended, and similar foreign, state or local counterparts to these
federal laws, which regulate air emissions, water discharges, hazardous
substances and wastes, and require public disclosure related to the use of
various hazardous substances. International's operations are also governed by
laws and regulations relating to workplace safety and worker health, primarily
the Occupational Safety and Health Act and regulations promulgated thereunder.
International believes that its facilities are in substantial compliance with
current regulatory standards.
International's compliance with U.S. federal, state and local environmental
control and protection regulations necessitated capital expenditures of
$379,000 in fiscal year 1998, and management expects to spend another $2,580,000
on such capital expenditures over the next five years. Management cannot
predict all of the environmental requirements or circumstances which will exist
in
15
the future, but anticipates that environmental control and protection standards
will become increasingly stringent and costly. Complying with existing
environmental regulations resulted in pretax charges of approximately $8,973,000
in fiscal year 1998.
International has been identified as a potentially responsible party at various
cleanup sites under CERCLA. International has not been determined to be a
major contributor of wastes to these sites. However, each potentially
responsible party or contributor may face assertions of joint and several
liability. Generally, however, a final allocation of costs is made based on
relative contribution of wastes to each site. Based on its relative
contribution of waste to each site, International's share of the ultimate
liability for the various sites is not expected to have a material adverse
effect on International's consolidated financial position, results of operations
or liquidity in any given year.
Remediation projects have been or may be undertaken at certain of
International's current and former plant sites, and, during fiscal year 1995,
B&W completed subject to Nuclear Regulatory Commission ("NRC") certification,
the decommissioning and decontamination of its former nuclear fuel processing
plant at Apollo, Pennsylvania. All fabrication and support buildings have been
removed, and all contaminated soil has been shipped to authorized disposal
facilities. In fiscal year 1997, B&W was notified by the NRC that the Apollo
plant site had been released for unrestricted use. The Apollo plant site is the
first major nuclear facility in the U. S. to achieve "green-field" status after
remediation, and will now be removed from the NRC's Site Decommissioning
Management Plan. The nuclear license for the plant was terminated.
During fiscal year 1995, management decided to close B&W's nuclear
manufacturing facilities in Parks Township, Armstrong County, Pennsylvania (the
"Parks Facilities"), and a provision of $41,724,000 for the decontamination,
decommissioning and the closing of these facilities was recognized. Previously,
decontamination and decommissioning costs were being accrued over the
facilities' remaining expected life. Decontamination is proceeding as permitted
by the existing NRC license. A decommissioning plan was submitted to the NRC
for review and approval during January 1996. The facilities were recently
transferred to BWX Technologies, Inc. ("BWXT"), a subsidiary of The Babcock &
Wilcox Company. BWXT's management expects to reach an agreement with the NRC in
fiscal year 1999 on a plan that provides for the completion of facilities
dismantlement and soil restoration by 2001 and license termination in 2002.
BWXT's management expects to request approval from the NRC to release the site
for unrestricted use at that time.
At March 31, 1998 and 1997, International had total environmental reserves
(including provision for the facilities discussed above), of $46,164,000 and
$32,438,000, of which $9,934,000 and $11,841,000, respectively, were included in
current liabilities. Estimated recoveries of these costs are included in
environmental and products liabilities recoverable at March 31, 1998. Inherent
in the estimates of such reserves and recoveries are expected levels of
contamination, decommissioning costs and recoverability from other parties,
which may vary significantly as decommissioning activities progress.
Accordingly, changes in estimates could result in a material adjustment to
operating results and the ultimate loss may differ materially from amounts
provided in the consolidated financial statements.
The Department of Environmental Protection of the Commonwealth of Pennsylvania
("PADEP"), by letter dated March 19, 1994, advised The Babcock & Wilcox Company
that it would seek monetary sanctions, and remedial and monitoring relief,
related to the Parks Facilities. The relief sought related to potential
groundwater contamination of the previous operations of the facilities. These
facilities are now a part of BWXT. PADEP has advised BWXT that it does not
intend to assess any monetary sanctions provided that BWXT continues its
remediation program of the Parks Facilities.
International performs significant amounts of work for the U. S. Government
under both prime contracts and subcontracts and operates certain facilities that
are licensed to possess and process special nuclear materials and thus is
subject to continuing reviews by governmental agencies, including the
Environmental Protection Agency and the NRC.
16
Decommissioning regulations promulgated by the NRC require BWXT to provide
financial assurance that it will be able to pay the expected cost of
decommissioning its facilities at the end of their service lives. BWXT will
continue to provide financial assurance of $20,439,000 during fiscal year 1999
by issuing letters of credit for the ultimate decommissioning of all its
licensed facilities, except one. This facility, which represents the largest
portion of BWXT's eventual decommissioning costs, has provisions in its
government contracts pursuant to which all of its decommissioning costs and
financial assurance obligations are covered by the U. S. Government (DOE).
Compliance with existing government regulations controlling the discharge of
materials into the environment, or otherwise relating to the protection of the
environment (including decommissioning), does not have, nor does management
expect it to have, a material adverse effect on International's consolidated
financial position or results of operations.
ITEM 3. LEGAL PROCEEDINGS
In March 1997, McDermott International and JRM, with the help of outside
counsel, began an investigation into allegations of wrongdoing by a limited
number of former employees of McDermott International and JRM and others. The
allegations concerned the heavy-lift business of the HeereMac joint venture.
Upon becoming aware of these allegations, McDermott International and JRM
notified authorities, including the Antitrust Division of the U. S. Department
of Justice and the European Commission. As a result of McDermott
International's and JRM's prompt disclosure of the allegations, both companies
and the individuals who were officers, directors and employees of International
or JRM at the time of the disclosure were granted immunity from criminal
prosecution by the Department of Justice for any anti-competitive acts involving
worldwide heavy-lift activities.
After receiving the allegations, JRM initiated action to terminate its interest
in HeereMac, and on December 19, 1997, JRM's partner in the joint venture,
Heerema Offshore Construction Group, Inc. ("Heerema"), acquired JRM's interest
in exchange for $318,500,000 in cash and title to several pieces of equipment,
including launch barges and the derrick barge 101, a 3,500 ton lift capacity
semi-submersible derrick barge. On December 21, 1997, HeereMac and a HeereMac
employee pled guilty to criminal charges by the Department of Justice that they
and others had participated in a conspiracy to rig bids in connection with the
heavy-lift business of HeereMac in the Gulf of Mexico, North Sea and Far East.
HeereMac was fined $49,000,000 and the employee $100,000. As part of the plea,
both HeereMac and certain employees of HeereMac agreed to cooperate fully with
the Department of Justice's investigation. Neither McDermott International, JRM
nor any of their officers, directors or employees was a party to those
proceedings.
McDermott International and JRM have cooperated and are continuing to cooperate
with the Department of Justice in its investigation. Near the end of calendar
1997, the Department of Justice requested additional information from the
companies relating to 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. Pursuant to the termination of the McDermott-ETPM joint venture
on April 3, 1998, JRM assumed 100% ownership of McDermott-ETPM East, Inc., which
has been renamed J. Ray McDermott Middle East, Inc.
McDermott International and JRM are also cooperating with the Securities and
Exchange Commission ("SEC"), which also requested information and documents from
the companies with respect to certain of the foregoing matters. McDermott
International and JRM are subject to a judicial order entered in 1976, with the
consent of the Delaware Company (which at that time was the parent of the
McDermott group of companies), pursuant to an SEC complaint ("Consent Decree").
The Consent Decree prohibits the companies from making false entries in their
books, maintaining secret or unrecorded funds or using corporate funds for
unlawful purposes. Violations of the Consent Decree could result in substantial
civil and/or criminal penalties to the companies.
17
In June 1998, Phillips Petroleum Company (individually and on behalf of certain
co-venturers) and certain related entities filed a complaint in the United
States District Court for the Southern District of Texas against McDermott
International, JRM, the Delaware Company, McDermott-ETPM, Inc., certain JRM
subsidiaries, HeereMac, Heerema, certain Heerema affiliates, and others. The
complaint alleges that the defendants engaged in anti-competitive acts in
violation of Sections 1 and 2 of the Sherman Act and Sections 15.05 (a) and (b)
of the Texas Business and Commerce Code, engaged in fraudulent activity and
tortiously interfered with the plaintiffs' businesses in connection with certain
offshore transportation and installation projects in the Gulf of Mexico, North
Sea and Far East. In addition to seeking actual damages and attorneys' fees,
the plaintiffs have requested punitive as well as treble damages.
It is not possible to predict the ultimate outcome of the Department of Justice
investigation, the SEC inquiry, the companies' internal investigation, the above
referenced lawsuit, or the actions that may be taken by others as a result of
HeereMac's guilty plea or otherwise. However, these matters could result in
civil and/or criminal liability and have a material adverse effect on
International's consolidated financial position and results of operations.
In addition to the foregoing, due to the nature of its business, International
is, from time to time, involved in routine litigation related to its business
activity. It is management's opinion that none of this litigation will have a
material adverse effect on International's consolidated financial position or
results of operations.
See Item 1H and Note 11 to the consolidated financial statements regarding
International's potential liability for non-employee products liability asbestos
claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by
this report to a vote of security holders, through the solicitation of proxies
or otherwise.
18
P A R T I I
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
McDermott International's Common Stock is traded on the New York Stock Exchange.
High and low stock prices and dividends declared for the fiscal years ended
March 31, 1997 and 1998 were as follows:
FISCAL YEAR 1997
----------------
SALES PRICE CASH
---------------- DIVIDENDS
QUARTER ENDED HIGH LOW DECLARED
- --------------------- ---------------- --------- ---------
June 30, 1996 $ 23 - 1/4 $19 - 1/4 $0.25
September 30, 1996 22 - 1/4 17 - 7/8 0.25
December 31, 1996 22 - 1/2 16 0.05
March 31, 1997 22 - 7/8 16 0.05
FISCAL YEAR 1998
----------------
SALES PRICE CASH
---------------- DIVIDENDS
QUARTER ENDED HIGH LOW DECLARED
- --------------------- ---------------- --------- ---------
June 30, 1997 $ 29 - 5/8 $ 18 $0.05
September 30, 1997 36 - 1/2 28 - 1/2 0.05
December 31, 1997 40 - 1/8 28 - 7/8 0.05
March 31, 1998 41 - 15/16 29 - 1/4 0.05
As of March 31, 1998, the approximate number of record holders of Common Stock
was 4,974.
19
ITEM 6. SELECTED FINANCIAL DATA
FOR THE FISCAL YEARS ENDED MARCH 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except for per share amounts)
Revenues $3,674,635 $3,150,850 $3,244,318 $3,043,680 $3,059,912
Income (Loss) before
Cumulative Effect of
Accounting Changes $ 215,690 $ (206,105) $ 20,625 $ 10,876 $ 89,956
Net Income (Loss) $ 215,690 $ (206,105) $ 20,625 $ 9,111 $ (10,794)
Basic Earnings (Loss) per
Common Share:
Income (Loss) before
Cumulative Effect of
Accounting Changes $ 3.74 $ (3.95) $ 0.23 $ 0.05 $ 1.59
Net Income (Loss) $ 3.74 $ (3.95) $ 0.23 $ 0.02 $ (0.32)
Diluted Earnings (Loss) per
Common Share:
Income (Loss) before
Cumulative Effect of
Accounting Changes $ 3.48 $ (3.95) $ 0.23 $ 0.05 $ 1.59
Net Income (Loss) $ 3.48 $ (3.95) $ 0.23 $ 0.02 $ (0.32)
Total Assets $4,501,130 $4,599,482 $4,387,251 $4,751,670 $4,223,569
Long-Term Debt $ 598,182 $ 667,174 $ 576,256 $ 579,101 $ 667,066
Subsidiary's
Redeemable
Preferred Stocks 155,358 170,983 173,301 179,251 196,672
---------- ---------- ---------- ---------- ----------
Total $ 753,540 $ 838,157 $ 749,557 $ 758,352 $ 863,738
Cash Dividends Per
Common Share $ 0.20 $ 0.60 $ 1.00 $ 1.00 $ 1.00
See Note 18 to the consolidated financial statements for significant items
included in fiscal year 1998 and 1997 results. Earnings per share for the
previous periods presented have been restated due to International's adoption of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," during
fiscal year 1998. Fiscal year 1996 results include an equity income gain of
$30,612,000 resulting from the sale of two power purchase contracts, favorable
workers' compensation cost and other insurance adjustments of $24,640,000, a
gain of $34,788,000 resulting from the sale of International's interest in
Caspian Sea oil fields and the write-off of an insurance claim of $12,600,000
due to an unfavorable arbitration ruling related to the recovery of cost
incurred for corrective action in certain utility and industrial installations.
Fiscal year 1995 results include a $46,489,000 charge for the decontamination,
decommissioning and closing of certain nuclear manufacturing facilities and the
closing
20
of a manufacturing facility, a $14,478,000 charge for the reduction of estimated
products liability asbestos claims recoveries from insurers, and a $26,300,000
benefit for a reduction in accrued interest expense due to the settlement of
outstanding tax issues.
See Note 3 to the consolidated financial statements regarding the change to the
cost method of accounting for International's investment in the HeereMac joint
venture in fiscal year 1997. Equity in income of HeereMac was $1,083,000,
$6,244,000, and $79,386,000 in fiscal years 1996, 1995, and 1994, respectively.
See Note 3 regarding the April 3, 1998 termination of the McDermott-ETPM joint
venture. Fiscal year 1995 includes the cumulative effect of the adoption of SFAS
No. 112. Fiscal year 1994 includes the cumulative effect of the adoption of
Emerging Issues Task Force Issue No. 93-5. See Note 11 regarding the
uncertainty as to the ultimate loss relating to products liability asbestos
claims and the results of the ongoing investigation by McDermott International,
JRM and the U. S. Department of Justice into possible anti-competitive practices
by McDermott International and JRM, and a related lawsuit filed in federal court
in June 1998.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Revenues of the Marine Construction Services segment are largely a function of
the level of oil and gas development activity in the world's major hydrocarbon
producing regions. Consequently, revenues reflect the variability associated
with the timing of significant development projects. During fiscal year 1998,
U. S. and North Sea markets remained steady while Far East and Middle East
markets started to weaken. Economic and political instability in Indonesia and
political turmoil on the Indian subcontinent are also expected to have an
adverse effect on exploration and production spending.
Revenues of the Power Generation Systems segment are largely a function of
capital spending by the electric power generation industry. This segment has
recently experienced weak and difficult markets in nearly all of its product
lines. Domestic utility original equipment markets remain sluggish as growth in
demand remains modest and the electric power industry transitions from a
regulated to a competitive environment. However, demand for services and
replacement nuclear steam generators to the domestic utility industry continue
at significant levels. In addition, most foreign markets for industrial and
utility boilers remain strong. However, the currency crisis, which began in
Southeast Asia in the summer of 1997, has slowed the number of inquiries and
orders from the level of the previous year. This segment is also expected to be
adversely affected by the economic and political instability in Indonesia and
political turmoil on the Indian subcontinent.
Revenues of the Government Operations segment are largely a function of capital
spending by the U. S. Government. Management does not expect this segment to
experience any significant growth because of reductions in the defense budget
over the past several years; however, management expects it to remain relatively
constant since it is the sole source provider of nuclear fuel assemblies and
nuclear reactor components to the U. S. Government.
In general, all of International's business segments are capital intensive
businesses that rely on large contracts for a substantial amount of their
revenues.
Revenues of Other Operations are somewhat capital intensive and the demand for
its equipment and services are affected by variations in the business cycles in
the customers' industries and the overall economy. Other Operations is also
affected by legislative issues such as environmental regulations and
fluctuations in U. S. Government funding patterns.
A significant portion of International's revenues and operating results are
derived from its foreign operations. As a result, International's operations
and financial results are affected by international factors, such as changes in
foreign currency exchange rates. International attempts to minimize its exposure
to changes in foreign currency exchange rates by attempting to match foreign
currency contract receipts with like foreign currency disbursements. To the
extent that it is unable to match the foreign currency receipts and
disbursements related to its contracts, its practice of entering into forward
exchange contracts to hedge foreign currency transactions reduces the impact of
foreign exchange rate movements on operating results.
Statements made herein which express a belief, expectation or intention, as well
as those which are not historical fact, are forward looking. They involve a
number of risks and uncertainties which may cause actual results to differ
materially from such forward looking statements. These risks and uncertainties
include, but are not limited to: decisions about offshore developments to be
made by oil and gas companies; the deregulation of the U. S. energy market;
governmental regulation and the continued funding of International's contracts
with U. S. governmental agencies; estimates for pending and future non-employee
asbestos claims; the highly competitive nature of International's businesses;
operating risks associated with the marine construction services business;
economic
22
and political instability in Indonesia; political turmoil on the Indian
subcontinent; and the results of the ongoing investigation by McDermott
International and JRM and the U. S. Department of Justice into possible anti-
competitive practices by McDermott International and JRM, and a related lawsuit
filed in federal court in June 1998.
FISCAL YEAR 1998 VS FISCAL YEAR 1997
Marine Construction Services
Revenues increased $447,017,000 to $1,855,486,000, primarily due to higher
volume in virtually all activities in all operating areas, except in offshore
activities in the Far East, engineering activities in the Middle East and
engineering and procurement activities in Europe and West Africa.
Segment operating income increased $96,303,000 to $107,122,000. Virtually all
activities in all operating areas, except the Far East and Engineering,
reflected this increase.
Gain (loss) on asset disposals and impairments - net decreased $69,140,000 from
a gain of $29,021,000 to a loss of $40,119,000, primarily due to the impairment
loss of $262,901,000 relating to goodwill associated with the acquisition of
OPI. Prior year gains from the sale of the derrick barges 15 and 21,
participation in a gain from the sale of the derrick barge 100 by the HeereMac
joint venture and the realization of a portion of the deferred gain resulting
from the sale of the derrick barges 101 and 102 also contributed to the
decrease. These decreases were partially offset by the $224,472,000 gain
recognized from the termination of the HeereMac joint venture.
Income (loss) from investees increased $78,069,000 from a loss of $7,833,000 to
income of $70,236,000, primarily due to a $61,637,000 distribution of earnings
related to the termination of the HeereMac joint venture. Equity in loss from
the McDermott ETPM-West, Inc. joint venture decreased $9,248,000 to a loss of
$7,584,000 in fiscal year 1998.
See Note 3 to the consolidated financial statements regarding the April 3, 1998
termination of the McDermott-ETPM joint venture. See Note 17 to the consolidated
financial statements regarding the sale and intention to exit certain European
operations.
Backlog for the Marine Construction Services segment at March 31, 1998 and 1997
was $1,266,310,000 and $1,771,170,000, respectively. Backlog decreased primarily
as a result of a decline in engineering, procurement and construction activities
in the Middle East, procurement activities in the Far East, engineering
activities in the North Sea and management's focus on higher margin projects.
Not included in backlog at March 31, 1998 and 1997 was backlog relating to
contracts to be performed by unconsolidated joint ventures of approximately
$587,000,000 (excluding McDermott-ETPM, West, Inc.) and $1,426,000,000,
respectively. Included in the 1997 backlog was $645,000,000 and $300,000,000
related to the HeereMac and McDermott-ETPM West, Inc. joint ventures,
respectively.
Power Generation Systems
Revenues increased $157,291,000 to $1,142,721,000, primarily due to higher
revenues from fabrication and erection of fossil fuel steam and environmental
control systems, plant enhancement projects, boiler cleaning equipment, and
engineering, procurement and construction of cogeneration plants. These
increases were partially offset by lower revenues from replacement nuclear steam
generators.
Segment operating income increased $117,015,000 from a loss of $34,584,000 to
income of $82,431,000, primarily due to higher volume and margins from
fabrication and erection of fossil fuel steam and environmental control systems,
plant enhancement projects, boiler cleaning equipment and engineering,
procurement and construction of cogeneration plants. In addition, there
23
were higher margins from replacement nuclear steam generators and replacement
parts and lower selling and general and administrative expenses.
Loss on asset disposals and impairments - net decreased $13,119,000 to
$6,086,000, primarily due to the write-down of an equity investment in a
domestic cogeneration joint venture and an asset impairment loss on a domestic
manufacturing facility in the prior year.
Income from investees increased $7,888,000 from a loss of $347,000 to income of
$7,541,000. This represents the results of approximately twelve joint ventures.
The increase is primarily due to the favorable operating results from three
foreign joint ventures and a provision for a loss on a Canadian joint venture in
the prior year. This increase was partially offset by a favorable termination
agreement of a domestic joint venture in the prior year.
Backlog for the Power Generation Systems segment at March 31, 1998 and 1997 was
$1,070,351,000 and $1,495,855,000, respectively. Backlog decreased primarily
as a result of delays and cancellations of power projects in Southeast Asia due
to the current Asian economic crisis and management's focus on higher margin
projects.
Government Operations
Revenues decreased $2,532,000 to $370,519,000, primarily due to lower revenues
from nuclear fuel assemblies and reactor components for the U. S. Government,
commercial nuclear environmental services and other government related
operations. These decreases were partially offset by higher revenues from
management and operation contracts for U. S. Government owned facilities.
Segment operating income increased $3,358,000 to $35,816,000, primarily due to
higher volume from management and operation contracts for U. S. Government owned
facilities and higher margins from nuclear fuel assemblies and reactor
components for the U. S. Government and other government related operations.
These increases were partially offset by lower volume and margins from
commercial nuclear environmental services and higher operating expenses.
Backlog for the Government Operations segment at March 31, 1998 and 1997 was
$810,230,000 and $791,981,000, respectively. At March 31, 1998, this segment's
backlog with the U. S. Government was $799,967,000 of which $40,376,000 had not
been funded.
Other Operations
Revenues decreased $120,329,000 to $337,787,000, primarily due to lower revenues
from engineering and construction activities in Canadian operations and the
disposition of non-core businesses (domestic shipyard and ordnance operations).
These decreases were partially offset by higher revenues from air cooled heat
exchangers and plant maintenance activities in Canadian operations.
Operating income (loss) increased $35,320,000 from a loss of $30,641,000 to
income of $4,679,000, primarily due to cost overruns on an engineering and
construction contract in the prior period, higher volume on air-cooled heat
exchangers, lower selling and general and administrative expenses and prior year
losses in non-core businesses (domestic shipyard and ordnance operations).
Gain (loss) on asset disposals and impairments-net increased $140,097,000 from a
loss of $11,858,000 to a gain of $128,239,000, primarily due to the sale of
International's interest in Sakhalin Energy Investment Company Ltd. and
Universal Fabricators Incorporated in the current year and an asset impairment
in the prior year.
24
Other Operations' income from investees increased $2,639,000 to $3,376,000,
primarily due to higher operating results from two foreign joint ventures.
Backlog for Other Operations at March 31, 1998 and 1997 was $262,339,000 and
$168,416,000, respectively. At March 31, 1998, Other Operations' backlog with
the U. S. Government was $8,029,000 (all of which had been funded).
Other Unallocated Items
Other Unallocated Items decreased $67,096,000 to expense of $5,286,000,
primarily due to provisions for estimated future non-employee products asbestos
claims and contract claims in the prior year.
General Corporate Expenses - Net
General Corporate Expenses - Net decreased $10,205,000 to $37,251,000, primarily
due to staff reductions, other economy measures, and certain one-time costs
incurred in the prior period, which was partially offset by gains on the sale of
certain corporate aircraft in the prior period.
Other Income Statement Items
Interest income increased $15,793,000 to $62,535,000, primarily due to increases
in investments in government obligations and other debt securities.
Interest expense decreased $13,646,000 to $81,454,000, primarily due to changes
in debt obligations and interest rates prevailing thereon.
Minority interest expense increased $42,422,000 to $47,984,000, primarily due to
minority shareholder participation in the improved operating results of JRM and
MSCL.
Other-net increased $22,785,000 from expense of $19,532,000 to income of
$3,253,000. This increase was primarily due to bank fees and discounts on the
sale of certain accounts receivable and a loss of $19,446,000 for insolvent
insurers providing coverage for estimated future non-employee asbestos claims,
both in the prior year. These increases were partially offset by income in the
prior year for certain reimbursed financing costs.
The provision for income taxes increased $90,709,000 from a benefit of
$14,592,000 to a provision of $76,117,000, while income before provision for
income taxes increased $512,504,000 from a loss of $220,697,000 to income of
$291,807,000. The increase in income taxes is primarily due to an increase in
income. In addition, International operates in many different tax
jurisdictions. Within these jurisdictions, tax provisions vary because of
nominal rates, allowability of deductions, credits and other benefits, and tax
basis (for example, revenues versus income). These variances, along with
variances in the mix of income within jurisdictions, are responsible for shifts
in the effective rate. As a result of these factors, the provision for income
taxes was 26% of pretax income for the fiscal year ended 1998 as compared to a
benefit for income taxes of 7% of pretax loss in fiscal year 1997.
FISCAL YEAR 1997 VS FISCAL YEAR 1996
Marine Construction Services
Revenues increased $149,018,000 to $1,408,469,000, primarily due to higher
volume in virtually all activities in all operating areas, except in fabrication
activities in the Far East and all activities in Europe and West Africa.
25
Segment operating income decreased $26,095,000 to $10,819,000. The decrease was
primarily due to lower volume in Europe and West Africa and lower margins in the
Far East. These decreases were partially offset by higher volume in North
American operations and in the Middle East. In addition, there was higher net
operating expenses.
Gain on asset disposals - net increased $26,491,000 to $29,021,000, primarily
due to gains from the sale of the derrick barges 15 and 21, participation in a
gain from the sale of the derrick barge 100 by the HeereMac joint venture and
the realization of a portion of the deferred gain resulting from the sale of the
derrick barges 101 and 102. These increases were partially offset by certain
asset write-downs.
Income (loss) from investees decreased $16,957,000 from income of $9,124,000 to
a loss of $7,833,000. This decrease was primarily due to the lower results from
the McDermott-ETPM West, Inc. joint venture. Revenues of the McDermott-ETPM
West, Inc. joint venture increased $97,207,000 to $347,849,000 in fiscal year
1997, primarily due to increased volume in the North Sea and West Africa. Equity
income from this joint venture decreased $19,366,000 to a loss of $16,833,000 in
fiscal year 1997, primarily due to lower margins in West Africa. These
decreases were partially offset by favorable results from a Mexican joint
venture.
Power Generation Systems
Revenues decreased $159,641,000 to $985,430,000, primarily due to lower revenues
from the fabrication and erection of fossil fuel steam and environmental control
systems, replacement nuclear steam generators, nuclear services, boiler cleaning
equipment and replacement parts. These decreases were partially offset by higher
revenues from plant enhancement projects.
Segment operating income (loss) decreased $54,568,000 from income of $19,984,000
to a loss of $34,584,000, primarily due to lower volume and margins from
fabrication and erection of fossil fuel steam and environmental control systems
and replacement parts. There were also lower volumes on replacement nuclear
steam generators and boiler cleaning equipment, lower margins on plant
enhancement projects and higher net operating expenses.
Gain (loss) on asset disposals and impairments - net decreased $22,719,000 from
a gain of $3,514,000 to a loss of $19,205,000, primarily due to the write-down
of an equity investment in a domestic cogeneration joint venture and an asset
impairment loss on a domestic manufacturing facility.
Income (loss) from investees decreased $36,068,000 from income of $35,721,000 to
a loss of $347,000. This represents the results of approximately 15 active
joint ventures. The income in fiscal year 1996 was primarily due to the gain on
the sale of power purchase contracts back to a local utility. There were also
lower operating results in three of the joint ventures in the current year.
Government Operations
Revenues increased $3,346,000 to $373,051,000, primarily due to higher revenues
from commercial nuclear environmental services and management and operation
contracts for U. S. Government owned facilities. These increases were partially
offset by lower revenues from nuclear fuel assemblies and reactor components for
the U. S. Government and other government related operations.
Segment operating income increased $6,589,000 to $32,458,000, primarily due to
higher volume and margins from commercial nuclear environmental services and
higher volume from management and operation contracts for U. S. Government owned
facilities. These increases were partially
26
offset by lower volume and margins from nuclear fuel assemblies and reactor
components for the U. S. Government.
Income from investees increased $1,371,000 to $3,630,000, primarily due to the
favorable operating results from a domestic joint venture.
Other Operations
Revenues decreased $42,685,000 to $458,116,000, primarily due to lower revenues
from engineering and construction activities in Canadian and other domestic
operations. These decreases were partially offset by higher revenues from
domestic shipbuilding operations.
Operating loss decreased $2,242,000 to $30,641,000, primarily due to higher
volume and margins from plant maintenance activities in Canadian operations. In
addition, there were lower net operating expenses and lower general and
administrative expenses. These decreases were partially offset by cost overruns
on a contract for a Canadian operations cogeneration plant and cost overruns on
domestic barge operations.
Gain (loss) on asset disposal and impairments-net decreased $49,710,000 from
income of $37,852,000 to a loss of $11,858,000, primarily due to the gain on the
sale of an interest in three Caspian Sea oil fields in the prior period and the
write-down of certain assets during the current period.
Other Unallocated Items
Other Unallocated Items increased $54,639,000 to expense of $72,382,000,
primarily due to provisions for estimated future non-employee products asbestos
claims.
General Corporate Expenses - Net
General Corporate Expenses - Net increased $10,356,000 to $47,456,000, primarily
due to certain one-time costs incurred in the current period, which was
partially offset by gains on the sale of certain corporate aircraft.
Other Income Statement Items
Interest income increased $9,504,000 to $46,742,000, primarily due to interest
on the promissory note received as part of the consideration from the sale of
the derrick barges 101 and 102.
Interest expense increased $10,788,000 to $95,100,000, primarily due to changes
in debt obligations and interest rates prevailing thereon.
Minority interest expense decreased $4,468,000 to $5,562,000, primarily due to
minority shareholder participation in the operating results of JRM.
Other-net expense increased $10,701,000 to $19,532,000, primarily due to a loss
of $19,446,000 in the current year for insolvent insurers providing coverage for
estimated future non-employee asbestos claims, partially offset by foreign
currency transaction gains in the current year compared to foreign currency
transaction losses in the prior year.
The provision for income taxes decreased $15,671,000 from a provision of
$1,079,000 to a benefit of $14,592,000, while income before income taxes
decreased $242,401,000 from income of $21,704,000 to a loss of $220,697,000.
The decrease in income taxes is primarily due to a decrease in income offset, in
part, due to a limitation on the recognition of income tax benefits in the U. S.
In addition, International operates in many different tax jurisdictions. Within
these
27
jurisdictions, tax provisions vary because of nominal rates, allowability of
deductions, credits and other benefits, and even tax basis (for example,
revenues versus income). These variances, along with variances in the mix of
income within jurisdictions, are responsible for shifts in the effective tax
rate. As a result of these factors, the benefit from income taxes was 7% of
pretax loss in fiscal year 1997 compared to a provision from income taxes of 5%
of pretax income in fiscal year 1996.
EFFECT OF INFLATION AND CHANGING PRICES
International's financial statements are prepared in accordance with generally
accepted accounting principles, using historical dollar accounting (historical
cost). Statements based on historical cost, however, do not adequately reflect
the cumulative effect of increasing costs and changes in the purchasing power of
the dollar, especially during times of significant and continued inflation.
In order to minimize the negative impact of inflation on its operations,
International attempts to cover the increased cost of anticipated changes in
labor, material and service costs, either through an estimation of such changes,
which is reflected in an original price, or through price escalation clauses in
its contracts.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal year 1998, International's cash and cash equivalents increased
$20,093,000 to $277,876,000 and total debt decreased $364,549,000 to
$754,482,000, primarily due to a reduction in short-term borrowings of
$208,759,000 and repayment of $152,116,000 in long-term debt. During this
period, International provided cash of $577,737,000 from operating activities,
and received cash proceeds of $457,337,000 from asset disposals (including (i)
$256,863,000 from the termination of the HeereMac joint venture; (ii)
$118,114,000 from the sale of its interest in Sakhalin Energy Investment
Company, Ltd; and (iii) $35,009,000 from the sale of Universal Fabricators
Incorporated), and $31,431,000 from the issuance of stock upon exercise of stock
options. International used cash of $580,704,000 for net purchases of
investments, $45,090,000 for additions to property, plant and equipment,
$32,605,000 for the acquisition of preferred and common stock, $6,627,000 for
acquisitions, and $19,367,000 for dividends on McDermott International's common
and preferred stock.
On December 19, 1997, JRM and Heerema terminated the HeereMac joint venture.
Pursuant to the termination, Heerema acquired and assumed JRM's 50% interest in
the joint venture in exchange for cash of $318,500,000 and title to several
pieces of equipment, including two launch barges and the derrick barge 101, a
3,500-ton lift capacity, semi-submersible derrick barge. The consideration
received included a $61,637,000 distribution of earnings of the HeereMac joint
venture and payment of principal and interest under a promissory note previously
due to JRM (approximately $100,000,000). As a result of the termination, a gain
on asset disposal of $224,472,000 and a distribution of earnings of $61,637,000
were recorded. JRM invested the cash proceeds it received in debt securities.
Pursuant to agreements with the majority of its principal insurers,
International negotiates and settles products liability asbestos claims from
non-employees and bills these amounts to the appropriate insurers. As a result
of collection delays inherent in the process, and the effect of agreed payment
schedules with specific insurers, reimbursement is usually delayed for three
months or more. The average amount of these claims (historical average of
approximately $6,400 per claim over the last three years) has continued to rise.
Claims paid in fiscal year 1998 were $196,091,000, of which $179,251,000 has
been recovered or is due from insurers. At March 31, 1998, receivables of
$101,680,000 were due from insurers for reimbursement of settled claims,
including $20,988,000 classified as long-term receivables. Estimated
liabilities for pending and future non-employee products liability asbestos
claims are derived from International's claims history and constitute
management's best estimate of such future costs. Settlement of the liability
is expected to occur over approximately the next 15 years. Estimated insurance
recoveries
28
are based upon an analysis of insurers providing coverage of the estimated
liabilities. Inherent in the estimate of such liabilities and recoveries are
expected trends in claim severity and frequency and other factors, including
recoverability from insurers, which may vary significantly as claims are filed
and settled. Accordingly, the ultimate loss may differ materially from amounts
provided in the consolidated financial statements. The collection delays and
the amount of claims paid for which insurance recovery is not probable have not
had a material adverse effect on International's liquidity, and management
believes, based on information currently available, that they will not have a
material adverse effect on liquidity in the future.
Expenditures for property, plant and equipment decreased $46,281,000 to
$45,090,000 in fiscal year 1998. The majority of fiscal year 1998 expenditures
were to maintain, replace and upgrade existing facilities and equipment.
International has committed to make capital expenditures of approximately
$38,284,000 during fiscal 1999.
At March 31, 1998 and 1997, The Babcock & Wilcox Company had sold, with limited
recourse, an undivided interest in a designated pool of qualified accounts
receivable of approximately $82,783,000 and $93,769,000, respectively, under an
agreement with a U.S. bank. During fiscal year 1998, the maximum sales limit
available under the agreement was reduced from $125,000,000 to $100,000,000.
Depending on the amount of qualified accounts receivable available for the pool,
the amount sold to the bank can vary (but not greater than the maximum sales
limit available) from time to time. The existing agreement will expire on July
31, 1998; however, B&W's management is currently negotiating a new receivables
sales agreement. International currently accounts for these sales as secured
borrowings.
At March 31, 1998 and 1997, McDermott International and its subsidiaries had
available various uncommitted short-term lines of credit from banks totaling
$127,061,000 and $179,137,000, respectively. Borrowings against these lines of
credit at March 31, 1998 and 1997 were $5,100,000 and $53,165,000, respectively.
In addition, The Babcock & Wilcox Company had available to it a $150,000,000
unsecured committed revolving credit facility (the "B&W Revolver"). There were
no borrowings against this facility at March 31, 1998, while at March 31, 1997,
$150,000,000 was outstanding. As a condition to borrowing under the B&W
Revolver, The Babcock & Wilcox Company must meet or exceed certain financial
covenant requirements. Negotiations are in progress to replace the current B&W
Revolver with a $200,000,000 three year unsecured committed revolving credit and
letter of credit facility (the "BWICO Revolver") to be issued jointly to The
Babcock & Wilcox Investment Company, The Babcock & Wilcox Company and BWXT.
Borrowings by the three companies against the facility cannot exceed an
aggregate amount of $50,000,000. The remaining $150,000,000 will be reserved
for the issuance of letters of credit. During fiscal year 1999, borrowings
against the BWICO Revolver are expected to be minimal as management expects The
Babcock & Wilcox Company to be able to fund itself from operating cash flow.
JRM was party to an unsecured and committed revolving credit facility (the "JRM
Revolver"). There were no borrowings outstanding at March 31, 1998 and 1997
under the JRM Revolver. The JRM Revolver expired on June 8, 1998. JRM is
currently negotiating a $200,000,000 three year unsecured committed revolving
credit and letter of credit facility. Borrowings against the facility cannot
exceed $50,000,000. The remaining $150,000,000 will be reserved for the
issuance of letters of credit. Management does not anticipate JRM will need to
borrow funds under the new facility during fiscal year 1999.
The Delaware Company and JRM are restricted, as a result of covenants in debt
instruments, in their ability to transfer funds to McDermott International and
certain of its subsidiaries through cash dividends or through unsecured loans or
investments. At March 31, 1998, substantially all of the net assets of the
Delaware Company were subject to such restrictions. JRM is restricted, as a
result of covenants in its indenture relating to its $250,000,000 9.375% Senior
Subordinated Notes due July 2006, from paying cash dividends on, or repurchasing
or redeeming, its capital stock
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(including the shares of Common Stock and Series A Preferred Stock held by
International), or in transferring funds through unsecured loans to or
investments in International. At March 31, 1998, JRM could pay cash dividends
on, or repurchase shares of, its capital stock (including shares held by
International) in the amount of $37,633,000, could pay up to an additional
$9,600,000 of cash dividends on its Series A Preferred Stock held by
International, and could make unsecured loans to or investments in International
of approximately $30,000,000. Additionally, under such indenture, JRM is
required to offer to purchase its outstanding 9.375% Senior Subordinated Notes
at 100% of their principal amount, plus accrued and unpaid interest, to the
extent that it has proceeds from certain asset sales and dispositions equal to
or exceeding $25,000,000 that it has not used to permanently reduce certain
senior or other indebtedness or reinvested in its business within a specified
time period, generally 18 months, following each such asset sale or disposition.
Currently, JRM has approximately $240,000,000 in proceeds from such asset sales
and dispositions, which, if not used for repayment of debt or reinvested as
described above, would be subject to this obligation commencing June 1999.
At March 31, 1998, the Delaware Company was also restricted under its public
debt indentures in its ability to repurchase or redeem its capital stock,
subject to certain exceptions, including to satisfy the annual mandatory sinking
fund obligations on its Series A Cumulative Convertible Preferred Stock and
Series B Cumulative Preferred Stock. Subsequent to March 31, 1998, the Delaware
Company amended its public debt indentures to permit the call for redemption of
its preferred stock provided that any cash outlay is funded by a capital
infusion from McDermott International. It is management's intention to call for
redemption all of the Delware Company's outstanding Series B Cumulative
Preferred Stock in June 1998. Management is also considering calling for
redemption all of the Delaware Company's outstanding Series A Cumulative
Convertible Preferred Stock.
International maintains an investment portfolio of government obligations and
other investments. The fair value of short and long-term investments in debt
securities at March 31, 1998 was $1,073,491,000. At March 31, 1998,
approximately $77,091,000 fair value of these obligations were pledged to secure
a letter of credit in connection with a long-term loan and certain reinsurance
agreements.
Over the past several years, International entered into certain investments in
oil and gas projects in the former Soviet Union. During fiscal year 1998,
International sold its last Soviet Union oil and gas interest, which was in the
Sakhalin Energy Investment Company Ltd., to other members of the consortium.
International received proceeds of $118,114,000.
Working capital decreased $90,141,000 from $225,571,000 at March 31, 1997 to
$135,430,000 at March 31, 1998. During fiscal year 1998, International's
management expects to obtain funds to meet capital expenditure, working capital
and debt maturity requirements from operating activities, cash and cash
equivalents, and short-term borrowings. Leasing agreements for equipment, which
are short-term in nature, are not expected to impact International's liquidity
or capital resources.
JRM's joint ventures are largely financed through their own resources,
including, in some cases, stand-alone borrowing arrangements.
McDermott International's quarterly dividends are $0.05 per share on its Common
Stock and were $0.71875 per share on its Series C Cumulative Convertible
Preferred Stock. The Delaware Company's quarterly dividends are $0.55 per share
on the Series A $2.20 Cumulative Convertible Preferred Stock and $0.65 per share
on the Series B $2.60 Cumulative Preferred Stock. McDermott International's
quarterly dividends were $0.05 per share during fiscal year 1998, $0.05 per
share in the last two quarters in fiscal year 1997 and $0.25 per share in the
first two quarters of fiscal year 1997. The Delaware Company's quarterly
dividends were at the same rates in 1998 and 1997.
At March 31, 1998, the ratio of long-term debt to total stockholders' equity was
0.88 as compared with 1.53 at March 31, 1997.
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During fiscal year 1998, McDermott International's Board of Directors approved a
limited stock buy-back program. Under the program, McDermott International can
purchase up to two million shares of its Common Stock from time to time on the
open market or through negotiated transactions, depending on the availability of
cash and market conditions. As of March 31, 1998, McDermott International had
purchased 100,000 shares of its Common Stock at an average share price of $35.50
under the program.
On April 6, 1998, McDermott International called all of the outstanding shares
of its Series C Cumulative Convertible Preferred Stock for redemption on April
21, 1998. At the close of business on the redemption date, all 2,875,000
preferred shares then outstanding were converted into 4,077,890 common shares.
International has provided a valuation allowance ($69,057,000 at March 31, 1998)
for deferred tax assets which cannot be realized through carrybacks and future
reversals of existing taxable temporary differences. Management believes that
remaining deferred tax assets at March 31, 1998 are realizable through
carrybacks and future reversals of existing taxable temporary differences,
future taxable income and, if necessary, the implementation of tax planning
strategies involving the sales of appreciated assets. Uncertainties that affect
the ultimate realization of deferred tax assets are the risk of incurring losses
in the future and the possibility of declines in value of appreciated assets
involved in identified tax planning strategies. These factors have been
considered in determining the valuation allowance. Management will continue to
assess the adequacy of the valuation allowance on a quarterly basis.
IMPACT OF THE YEAR 2000
The Year 2000 issue is the result of computer systems being written using two
digits rather than four to define the applicable year. This could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, an inability to proce