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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, 1999
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.
(Exact name of registrant as specified in its charter)
REPUBLIC OF PANAMA 72-0593134
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1450 POYDRAS STREET
NEW ORLEANS, LOUISIANA 70112-6050
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (504) 587-5400
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 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 the Company's Common Stock held by non-affiliates
of the registrant was $1,725,490,308 as of April 29, 1999.
The number of shares outstanding of the Company's Common Stock at April 29, 1999
was 59,248,598.
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 1999 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 3
Foreign Operations 4
Raw Materials 5
Customers and Competition 5
Backlog 5
Factors Affecting Demand 6
C. Power Generation Systems
General 6
Foreign Operations 6
Raw Materials 7
Customers and Competition 7
Backlog 7
Factors Affecting Demand 8
D. Government Operations
General 8
Raw Materials 9
Customers and Competition 9
Backlog 9
Factors Affecting Demand 9
E. Industrial Operations
General 10
Foreign Operations 10
Raw Materials 10
Customers and Competition 10
Backlog 11
Factors Affecting Demand 11
F. Patents and Licenses 11
G. Research and Development Activities 11
H. Insurance 12
I. Employees 13
J. Environmental Regulations and Matters 13
i
INDEX - FORM 10-K
PAGE
Item 3. LEGAL PROCEEDINGS 15
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS 18
Item 6. SELECTED FINANCIAL DATA 19
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General 21
Fiscal Year 1999 vs Fiscal Year 1998 22
Fiscal Year 1998 vs Fiscal Year 1997 24
Effects of Inflation and Changing Prices 26
Liquidity and Capital Resources 27
Impact of the Year 2000 30
New Accounting Standards 32
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK 33
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
Company Report on Consolidated Financial
Statements 35
Report of PricewaterhouseCoopers LLP 36
Report of Ernst & Young LLP 37
Consolidated Balance Sheet - March 31, 1999
and 1998 38
Consolidated Statement of Income (Loss) for the
Three Fiscal Years ended March 31, 1999 40
Consolidated Statement of Comprehensive Income
(Loss) for the Three Fiscal Years ended
March 31, 1999 41
Consolidated Statement of Stockholders'
Equity for the Three Fiscal Years ended
March 31, 1999 42
Consolidated Statement of Cash Flows for the
Three Fiscal Years ended March 31, 1999 44
Notes to Consolidated Financial Statements 46
Item 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 84
ii
INDEX - FORM 10-K
PAGE
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT 85
Item 11. EXECUTIVE COMPENSATION 85
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 85
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 85
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K 86
Signatures 88
Exhibit 4.1 - AMENDED AND RESTATED RIGHTS AGREEMENT
Exhibit 21 - SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT
Exhibit 23.1 - CONSENT OF PRICEWATERHOUSECOOPERS LLP
Exhibit 23.2 - CONSENT OF ERNST & YOUNG LLP
Exhibit 27 - FINANCIAL DATA SCHEDULE
iii
P A R T I
Items 1. and 2. BUSINESS AND PROPERTIES
A. GENERAL
McDermott International, Inc. ("MII") 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. MII's Common Stock and JRM's Common Stock and 9.375% Senior
Subordinated Notes due July 2006 are publicly traded. On May 7, 1999, MII and
JRM jointly announced that they executed a definitive merger agreement pursuant
to which MII will acquire all shares of JRM not already owned by MII for $35.62
per share in cash. Pursuant to the merger agreement, on May 13, 1999, MII
initiated a tender offer for all shares of JRM common stock for $35.62 per share
in cash. The tender offer will expire on June 10, 1999 unless extended. Any
shares not purchased in the tender offer will be acquired for the same price in
cash in a second-step merger . The tender offer is subject to the condition
that the majority of the publicly held shares are validly tendered pursuant to
the tender offer, as well as other customary conditions. JRM currently has
approximately 39,060,000 shares of common stock outstanding, of which 24,668,297
shares, or 63%, are owned by MII, and approximately 14,400,000 are publicly
held.
Hereinafter, unless the context requires otherwise, the following terms shall
mean:
. MII for McDermott International, Inc., a Panama corporation,
. JRM for J. Ray McDermott, S. A., a majority owned Panamanian subsidiary of
MII, and its consolidated subsidiaries,
. MI for McDermott Incorporated, a Delaware subsidiary of MII, and its
consolidated subsidiaries,
. BWICO for Babcock & Wilcox Investment Company, a Delaware subsidiary of MI,
. B&W for the Babcock & Wilcox Company, a Delaware subsidiary of BWICO, and
its consolidated subsidiaries,
. BWXT for BWX Technologies, Inc., a Delaware subsidiary of BWICO, and its
consolidated subsidiaries, and
. McDermott for the consolidated enterprise.
McDermott operates in four business segments:
. 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.
. Power Generation Systems includes the results of the operations of the
Power Generation Group, which is conducted primarily through B&W, and
provides services and equipment and systems to generate steam and electric
power at energy facilities worldwide.
. Government Operations includes the results of the operations of BWXT, which
supplies nuclear reactor components and nuclear fuel assemblies to the U.S.
Navy and various other equipment and services to the U.S. Government and
manages various U.S. Government-owned facilities.
. Industrial Operations includes the results of the operations of McDermott
Engineers & Constructors (Canada) Ltd., Hudson Products Corporation,
McDermott Technologies, Inc. ("MTI") and other smaller businesses.
McDermott has a continuing program of reviewing joint venture, acquisition and
disposition opportunities. The following tables show revenues and operating
income (loss) of McDermott for the three fiscal years ended March 31, 1999. See
Note 17 to the consolidated financial statements for additional information with
respect to McDermott's business segments and operations in different geographic
areas.
1
FOR FISCAL YEARS ENDED MARCH 31,
(Dollars in Millions)
1999 1998 1997
---- ---- ----
REVENUES
Marine Construction Services $1,279.6 40.6% $1,855.5 50.5% $1,408.5 44.7%
Power Generation Systems 1,066.2 33.8% 1,142.7 31.1% 985.4 31.3%
Government Operations 382.7 12.1% 370.5 10.1% 373.1 11.8%
Industrial Operations 427.5 13.5% 337.8 9.2% 458.1 14.5%
Adjustments and Eliminations (6.0) - (31.9) (0.9%) (74.2) (2.3%)
- ---------------------------------------------------------------------------------------------------------
Total Revenues $3,150.0 100.0% $3,674.6 100.0% $3,150.9 100.0%
- ---------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS):
Segment Operating Income (Loss):
Marine Construction Services $ 126.5 46.3% $ 107.1 46.6% $ 10.8 -
Power Generation Systems 90.3 33.1% 82.5 35.8% (34.6) -
Government Operations 39.4 14.4% 35.8 15.6% 32.5 -
Industrial Operations 16.9 6.2% 4.7 2.0% (30.6) -
- ---------------------------------------------------------------------------------------------------------
Total $273.1 100.0% $230.1 100.0% $(21.9) 100.0%
- ---------------------------------------------------------------------------------------------------------
Gain (Loss) on Asset Disposals
and Impairments - Net:
Marine Construction Services $ 18.6 80.8% $(40.1) - $ 29.0 -
Power Generation Systems 4.4 19.4% (6.1) - (19.2) -
Government Operations 0.2 0.8% 0.5 - 0.4 -
Industrial Operations (0.2) (1.0%) 128.2 - (11.9) -
- ---------------------------------------------------------------------------------------------------------
Total $ 23.0 100.0% $ 82.5 100.0% $ (1.7) 100.0%
- ---------------------------------------------------------------------------------------------------------
Income (Loss) from Investees:
Marine Construction Services $ 10.7 - $ 70.2 82.2% $ (7.8) -
Power Generation Systems (4.7) - 7.5 8.8% (0.3) -
Government Operations 4.1 - 4.3 5.0% 3.6 -
Industrial Operations (1.7) - 3.4 4.0% 0.7 -
- ---------------------------------------------------------------------------------------------------------
Total $ 8.4 100.0% $ 85.4 100.0% $ (3.8) 100.0%
- ---------------------------------------------------------------------------------------------------------
SEGMENT INCOME (LOSS):
Marine Construction Services $155.8 51.2% $137.2 34.5% $ 32.0 -
Power Generation Systems 90.0 29.6% 83.9 21.1% (54.1) -
Government Operations 43.7 14.3% 40.6 10.2% 36.5 -
Industrial Operations 15.0 4.9% 136.3 34.2% (41.8) -
- ---------------------------------------------------------------------------------------------------------
Total Segment Income (Loss): 304.5 100.0% 398.0 100.0% (27.4) 100.0%
- ---------------------------------------------------------------------------------------------------------
Other Unallocated Items (51.0) (5.3) (72.4)
General Corporate Expenses-Net (36.1) (37.2) (47.4)
- ---------------------------------------------------------------------------------------------------------
Total Operating Income (Loss) $217.4 $355.5 $(147.2)
- ---------------------------------------------------------------------------------------------------------
2
B. MARINE CONSTRUCTION SERVICES
GENERAL
On January 31, 1995, McDermott 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. Prior to the merger
with OPI, JRM was a wholly owned subsidiary of MII; as a result of the merger,
JRM became a majority owned subsidiary of MII. On May 7, 1999, MII and JRM
entered into a merger agreement pursuant to which MII initiated a tender offer
for those shares of JRM that it did not already own for $35.62 per share in
cash. Any such shares not purchased in the offer will be acquired for the same
price in cash in a second-step merger. JRM conducts the business activities of
this segment.
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. As a strategic operating
decision, JRM has transitioned away from installation, particularly heavy-lift
technology, into deep water subsea technology. This segment also provides
comprehensive project management services, feasibility studies, 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 also participates in joint ventures. The joint ventures 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 and the McDermott-ETPM joint
venture. JRM has terminated its interests in both of these joint ventures.
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. On December 19, 1997,
JRM and Heerema Offshore Construction Group, Inc. ("Heerema") terminated the
HeereMac joint venture. 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 includes two launch barges and
the derrick barge 101, a 3,500-ton lift capacity, semi-submersible derrick
barge. The HeereMac joint venture was accounted for using the equity method
until March 31, 1997 and the cost method thereafter.
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 to provide offshore
pipelaying services in the North Sea. 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 and were consolidated for financial reporting purposes. However, the
operations of McDermott-ETPM West, Inc., which conducts operations in the North
Sea, South America and West Africa, were managed and controlled by ETPM S.A.
McDermott-ETPM West, Inc. was accounted for using the equity method. 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.
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
3
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 Aberdeen based engineering business of McDermott
Engineering (Europe) Limited and announced its intention to withdraw from
traditional European engineering markets. See Note 17 to the consolidated
financial statements regarding these events. JRM retains a presence in the
European markets via Mentor Subsea Technology Services, Ltd. to focus on subsea
opportunities. During fiscal year 1999, McDermott announced its intention to
withdraw from substantially all third-party engineering activities.
At March 31, 1999, JRM owned or operated 5 fabrication facilities throughout the
world. JRM's principal domestic fabrication yard and offshore base is located
on 1,114 acres of land, under lease, near Morgan City, Louisiana. JRM also owns
or operates fabrication facilities in the following locations: near Corpus
Christi, Texas; near Inverness, Scotland; in Indonesia on Batam Island; and in
Jebel Ali, U.A.E. JRM also owns and operates a ship repair yard in Veracruz,
Mexico.
JRM's 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 can 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, 1999, expiration dates, including renewal options, of leases
covering land for JRM's fabrication yards were as follows:
Morgan City, Louisiana Years 2000-2033
Jebel Ali, U.A.E. Year 2005
Batam Island, Indonesia Year 2008
JRM owns or, through its ownership interests in joint ventures, has interests 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,
1999, JRM owned or, through ownership interests in joint ventures, had interests
in 5 derrick vessels, 2 pipelaying vessels and 8 combination derrick-pipelaying
vessels. The lifting capacities of the derrick and combination derrick-
pipelaying vessels range from 800 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 vessel is the semi-submersible derrick
barge 101.
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.
FOREIGN OPERATIONS
JRM's revenues, net of intersegment revenues, and segment income derived from
operations located outside of the United States, and the approximate percentages
to McDermott's total revenues and total segment income, respectively, follow:
4
REVENUES SEGMENT INCOME
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in thousands)
1999 $ 731,022 23% $129,440 43%
1998 1,112,685 30% 317,482 80%
1997 839,583 27% 14,525 -
RAW MATERIALS
This segment uses raw materials such as carbon and alloy steel in various forms,
welding gases, concrete, fuel oil and gasoline that are available from many
sources. JRM 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 JRM 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. A number of companies compete effectively with JRM
and its joint ventures in each of the separate marine construction phases in
various parts of the world. Examples are Aker Gulf Marine, Gulf Island
Fabrication, Inc., Hyundai Heavy Industries, Global Industries Ltd., Saipem
S.p.A., Heerema Offshore Construction Group, Inc. and other companies.
BACKLOG
At March 31, 1999 and 1998, Marine Construction Services' backlog amounted to
$406,183,000 and $1,266,310,000, respectively. This represents approximately
16% and 37%, respectively, of McDermott's total backlog. JRM's backlog declined
in all operating areas because of lower oil prices. In addition, backlog
declined because of JRM's withdrawal from traditional engineering markets.
Finally, backlog decreased because of sluggish economic conditions in the Middle
and Far East and the political instability in the Far East. Of the March 31,
1999 backlog, management expects that approximately $386,454,000 will be
recognized in revenues in fiscal year 2000 and $19,729,000 in fiscal year 2001.
JRM has been awarded a contract valued at $20,500,000 from Larsen & Toubro
Limited for the ONGC Pipelines and Platform Modification Project. Under this
contract, JRM is responsible for transportation of coated pipelines and offshore
installation of 12 pipelines, 17 risers, 3 subsea tie-ins, and 19 crossings.
JRM is also responsible for freespan rectification and de-watering and
commissioning of one pipeline with platform gas.
Subsequent to March 31, 1999, JRM was awarded a contract for $335,000,000 from
Conoco Indonesia Inc. and other West Natuna Sea operators to construct a subsea
natural gas pipeline from Indonesia's West Natuna Sea gas fields to Singapore.
This award was not included in backlog at March 31, 1999.
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.
5
FACTORS AFFECTING DEMAND
The activity of this segment depends mainly on the capital expenditures of oil
and gas companies and foreign governments for developmental construction.
Several factors influence these expenditures:
. oil and gas prices, 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
1999 have been significantly reduced because of falling oil and gas prices.
These budgets are now set and, therefore, unaffected by the partial recovery in
prices resulting from the recent OPEC production agreements. Economic and
political conditions in Asia have had an adverse effect on exploration and
production spending.
C. POWER GENERATION SYSTEMS
GENERAL
The Power Generation Systems segment:
. supplies engineered-to-order services, products and systems for energy
conversion worldwide and related industrial equipment, such as burners,
pulverizer mills, soot blowers and ash handlers,
. manufactures heavy pressure equipment for energy conversion such as boilers
fueled by coal, oil, bitumen, natural gas, solid municipal waste, biomass,
and other fuels,
. fabricates steam generators for nuclear power plants,
. designs and supplies environmental control systems, including both wet and
dry scrubbers for flue gas desulfurization, modules for selective catalytic
reduction of nitrogen oxides, and electrostatic precipitators and similar
devices,
. supports operating plants with a wide variety of services, including the
installation of new systems and replacement parts, engineering upgrades,
construction, maintenance, and field technical services such as condition
assessment,
. provides inventory services to help customers respond quickly to plant
interruptions and to construction crews to maintain and repair operating
equipment, and
. provides power through cogeneration, refuse-fueled power plants, and other
independent power producing facilities, and 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 B&W owns, are located
in West Point, Mississippi; Lancaster, Ohio; and Cambridge, Ontario, Canada. B&W
closed its Paris, Texas plant in fiscal year 1999. 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
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 McDermott's total revenues and total segment
income (loss), respectively, follow:
6
REVENUES SEGMENT INCOME (LOSS)
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in Thousands)
1999 $189,148 6% $ 8,283 3%
1998 196,831 5% 25,694 6%
1997 296,544 9% (33,701) 123%
Products for McDermott 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.
RAW MATERIALS
The Power Generations Systems segment uses raw materials such as carbon and
alloy steels in various forms, such as plates, forgings, structurals, bars,
sheets, strips, heavy wall pipes and tubes to construct power generation systems
and equipment. 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
This segment's principal customers 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 26%, 24% and
22% of McDermott's total revenues for fiscal years 1999, 1998 and 1997,
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, the Power Generation Systems segment competes with a
number of domestic and foreign-based companies specializing in steam generating
systems, equipment and services. 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
At March 31, 1999 and 1998, this segment's backlog amounted to $905,283,000 and
$1,070,351,000, or approximately 35% and 31%, respectively, of McDermott's
backlog. Backlog decreased primarily as a result of delays and cancellations of
power projects in Southeast Asia due to that region's current economic crisis
and management's focus on higher margin projects. Backlog includes $65,000,000
of delayed contracts as a result of the Asian economic crisis. Of the March 31,
1999 backlog, it is expected that approximately $552,534,000 will be recognized
in revenues in fiscal year 2000, $173,501,000 in fiscal year 2001 and
$179,248,000 thereafter, of which approximately 77% will be recognized in fiscal
years 2002 through 2004.
During fiscal year 1999, this segment was awarded a contract valued at
approximately $100,000,000 to supply four nuclear steam generators to Baltimore
Gas and Electric's Calvert Cliffs nuclear power plant on Chesapeake Bay in
Calvert County, Maryland. This segment also received a $46,000,000 contract for
a Sidi Krir, Egypt
7
build, own, operate and transfer ("BOOT") project for two utility boilers from
Bechtel International Inc. for Intergen; and a contract valued at $40,000,000
for boiler maintenance and precipitator installation at Dominion Energy's
Kincaid Station in Kincaid, Illinois.
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 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
Electric utilities in parts of Asia and the Middle East are current purchasers
of new baseload generating units and environmental control systems. This was
due to the growth of their economies and to the small existing stock of
electrical generating capacity in most developing countries. However, a
currency crisis, which began in Southeast Asia in the summer of 1997, has slowed
the number of inquiries and orders. With the international markets in an
unsettled condition, several projects in emerging markets have been delayed,
suspended or cancelled. Management expects this segment to be adversely
affected if the adverse economic and political conditions in Southeast Asia
continue.
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 coal-fired 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 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.
This segment's systems, products and services are capital intensive. As such,
customer demand is heavily affected by the variations in their business cycles
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.
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 McDermott 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. It is
8
also proceeding with new Government projects and exploring new programs which
require the technological capabilities it developed as a Government contractor.
Environmental restoration services and the management of government-owned
facilities, primarily within the Department of Energy's ("DOE") nuclear weapons
complex, are examples of these markets.
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 BWXT 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 near Idaho Falls, Idaho; the Rocky
Flats Environmental Technology Site near Boulder, Colorado; the Savannah River
Site in Aiken, South Carolina; and the Hanford Site 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 BWXT subsidiary, Babcock & Wilcox of Ohio, Inc., began performance
under the several hundred million dollar multi-year contract in October 1997.
The contract is subject to annual funding. For the fiscal years 1999, 1998 and
1997, the U.S. Government accounted for approximately 12%, 10% and 11%,
respectively, of McDermott's total revenues, including 8%, 7% and 10%,
respectively, related to nuclear fuel assemblies and reactor components for the
U.S. Navy.
BACKLOG
At March 31, 1999 and 1998, Government Operations segment backlog amounted to
$860,981,000 and $810,230,000, or approximately 33% and 24%, respectively, of
McDermott's backlog. Of the March 31, 1999 backlog, management expects that
approximately $330,532,000 will be recognized in revenues in fiscal year 2000,
$194,694,000 in fiscal year 2001 and $335,755,000 thereafter, of which
approximately 89% will be recognized in fiscal years 2002 through 2004. At
March 31, 1999, this segment's backlog with the U.S. Government was $760,202,000
(of which $12,023,000 had not yet been funded), or approximately 30% of
McDermott's total backlog. The March 31, 1999 U.S. Government backlog includes
only the current year funding for the DOE Mound Site in Miamisburg, Ohio.
During fiscal year 1999, this segment was awarded approximately $270,000,000 in
new orders for aircraft carrier components, prototypical steam generation
equipment for the newest submarine design and the downloading of enriched
uranium for the commercial markets.
FACTORS AFFECTING DEMAND
This segment's systems 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.
9
E. INDUSTRIAL OPERATIONS
GENERAL
Industrial Operations includes the results of Engineering and Construction
operations, Hudson Products Corporation ("HPC") and MTI, and other businesses.
Engineering and Construction operations are conducted primarily through
McDermott Engineers & Constructors (Canada), Ltd. ("MECL").
MECL provides services, including project management, conceptual and process
design, front-end engineering and design, detailed engineering, procurement,
construction management and contract maintenance. HPC products include air-
cooled heat exchangers, combination water and air-cooled systems, air-cooled
vacuum steam condensers, fiberglass reinforced axial flow fans for air-cooled
heat exchangers and wet cooling towers and fan control systems. MTI performs
research activities for internal operating segments of McDermott and markets,
negotiates and administers contracts that leverage company research and
development technology needs with external funds.
The principal plant of HPC is located in Beasley, Texas. One of Industrial
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. MTI's research and development facilities are located
in Alliance, Ohio and Lynchburg, Virginia. MECL is located in Calgary, Alberta,
Canada.
FOREIGN OPERATIONS
Industrial Operations' revenues, net of intersegment revenues, and segment
income (loss) derived from operations located outside of the United States, and
the approximate percentages to McDermott's total revenues and total segment
income (loss), respectively, follow:
REVENUES SEGMENT INCOME (LOSS)
FISCAL YEAR AMOUNT PERCENT AMOUNT PERCENT
(Dollars in Thousands)
1999 $319,937 10% $ 4,592 2%
1998 195,886 5% 90,516 23%
1997 242,973 8% (29,614) 108%
RAW MATERIALS
Industrial Operations uses raw materials such as 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 materials 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 time, nor is any shortage expected in the foreseeable future.
Industrial Operations is not sole source dependent for any significant raw
materials.
CUSTOMERS AND COMPETITION
Industrial Operations' principal customers 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, this segment competes with a number of domestic and foreign-based
companies
10
specializing in air-cooled heat exchanger equipment. The majority of
the engineering and construction operations contracts are awarded in a
competitive market in which both price and quality are considerations.
BACKLOG
At March 31, 1999 and 1998, Industrial Operations' backlog amounted to
$400,649,000 and $262,339,000, or approximately 16% and 8%, respectively, of
McDermott's total backlog. Of the March 31, 1999 backlog, management expects
that approximately $352,900,000 will be recognized in revenues in fiscal year
2000, $43,509,000 in fiscal year 2001 and $4,240,000 thereafter.
This segment received a contract award valued at $80,000,000 for the
engineering, procurement and construction management contract for the Impress
Phase 5 Natural Gas Liquids Extraction Plant for Canada Petroleum Company and
its partner TransCanada Pipelines Ltd.
Also, they were awarded a contract for the engineering, procurement and
construction management contract for $60,000,000 cogeneration plant in Fort
Saskatchewan, Alberta by TransAlta Energy Corporation and Air Liquide Canada
Inc.
In addition, they were awarded a $200,000,000 contract to supply engineering and
procurement services for world scale gas liquids extraction facilities and
fractionation facilities to be built near Joliet, Illinois by Aux Sable Liquid
Products LP.
The remaining value of all contracts with the above three customers reflected in
the March 31, 1999 backlog is $262,545,000.
FACTORS AFFECTING DEMAND
The equipment and services provided by Industrial Operations are somewhat
capital intensive, and the demand for its equipment and services is affected by
variations in the business cycles of their customers' industries and in the
overall economies in their regions. Variations in business cycles are affected
by the price of oil. Industrial Operations is also affected by legislative
issues such as environmental regulations and fluctuations in U.S. Government
funding patterns. Seasonal plant outages, business cycles and economic
conditions cause variations in availability of funds for investment and
maintenance at customers' facilities.
F. PATENTS AND LICENSES
McDermott has been issued many U.S. and foreign patents and it has many pending
patent applications. Patents and licenses have been acquired and licenses have
been granted to others when advantageous to McDermott. While McDermott 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.
G. RESEARCH AND DEVELOPMENT ACTIVITIES
McDermott conducts its principal research and development activities at MTI's
research centers in Alliance, Ohio and Lynchburg, Virginia. McDermott also
conducts development activities at its various manufacturing plants and
engineering and design offices. McDermott spent approximately $28,064,000,
$37,928,000 and $50,749,000, on research and development activities during the
fiscal years ended March 31, 1999, 1998 and 1997, respectively. Contractual
arrangements for customer-sponsored research and development can vary on a case
by case basis, and includes contracts, cooperative agreements and grants.
Customers of McDermott paid for approximately $15,752,000, $22,803,000 and
$34,170,000, of the total spent on research and development expenses during
fiscal years 1999, 1998 and 1997, respectively. 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. MTI's multi-million dollar clean environment
development facility in Alliance, Ohio was constructed in response to present
and future emission pollution standards in the
11
U.S. and worldwide. Approximately 125 employees were engaged full time in
research and development activities at March 31, 1999.
H. INSURANCE
McDermott 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 McDermott considers
uneconomical. These risks include 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, McDermott 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 McDermott
may be subject.
McDermott'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, McDermott 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, McDermott 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 a certain amount. This
amount 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 McDermott provides
environmental remediation services, it seeks the same protection from its
customers as it does for its other nuclear activities.
Although McDermott 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 that 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 MTI's Lynchburg, Virginia site. These
facilities are insured under a nuclear liability policy that also insures the
facility of Framatome Cogema Fuel Company ("FCFC"), formerly B&W Fuel Company,
that was sold during fiscal year 1993. All three licensed facilities share the
same nuclear liability insurance limit, as the commercial insurer would not
allow FCFC to obtain a separate nuclear liability insurance policy. Due to the
type or quantity of nuclear material present under contract with the U.S.
Government, two facilities in Lynchburg have statutory indemnity and limitation
of liability as provided under the Act. In addition, contracts to manufacture
and supply nuclear fuel or nuclear components to the U.S. Government contain
statutory indemnity clauses, whereby the U.S. Government has assumed the risks
of public liability claims related to nuclear incidents.
JRM's offshore construction business is subject to the usual risks of operations
at sea. JRM has additional exposure because it uses expensive construction
equipment, sometimes under extreme weather conditions, often in remote areas of
the world. In many cases, JRM also operates on or in proximity to existing
offshore facilities. These facilities are subject to damage which could result
in the escape of oil and gas into the sea.
McDermott's insurance coverage for products liability and employers' liability
claims is subject to varying insurance limits that are dependent upon the year
involved. B&W 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, B&W negotiates
and settles these claims and bills these amounts to the appropriate insurers.
McDermott has recognized a provision to the extent that recovery of these
amounts from the insurers is not probable. McDermott's estimates of future
asbestos products liability and probable insurance recoveries are based on prior
history and management's best estimate of cost based on all available
information. However, future costs to settle claims, as well as the number of
claims, could be adversely
12
affected by changes in judicial rulings and influences beyond McDermott's
control. Accordingly, changes in the estimates of future asbestos products
liability and insurance recoverables and differences between the proportion of
any additional asbestos products liabilities covered by insurance, and that
experienced in the past could result in material adjustments to the results of
operations for any fiscal quarter or year, and the ultimate loss may differ
materially from amounts provided in the consolidated financial statements.
MII has two wholly-owned insurance subsidiaries that provide general and
automotive liability, builders' risk within certain limits, marine hull, and
workers' compensation insurance to the McDermott group of companies. These
insurance subsidiaries have not provided significant amounts of insurance to
unrelated parties.
I. EMPLOYEES
At March 31, 1999, McDermott employed, under its direct supervision,
approximately 20,350 persons compared with 24,700 at March 31, 1998.
Approximately 7,000 employees were members of labor unions at March 31, 1999 as
compared with approximately 6,400 at March 31, 1998. After nine months of
negotiations between BWXT and one of its unions, BWXT temporarily discontinued
operations for their union workforce on April 23, 1999 due to the union's
refusal to vote on a new labor contract. Negotiations continued and the union
ratified BWXT's final offer on May 9, 1999 and the union workers returned to
work. The majority of B&W's and BWXT's manufacturing facilities operate under
union contracts which customarily are renewed every two to three years. One
union contract covering 200 hourly workers at one of B&W's Ohio facilities
expired on April 24, 1999. The negotiating groups are operating under a day-to-
day agreement and management expects to renew the contract without incident.
During the next twelve months, three union contracts covering approximately 100
B&W hourly workers will expire. Management expects to renew the contracts
without incident. McDermott considers its relationship with its employees to be
satisfactory.
J. ENVIRONMENTAL REGULATIONS AND MATTERS
McDermott is subject to the existing and evolving legal and regulatory standards
relating to the environment. These standards include the Clean Air Act, the
Clean Water Act, the Resource Conservation and Recovery Act, and the
Comprehensive Environmental Response, Compensation, and Liability Act of 1980
("CERCLA"). They also include any similar laws that provide for responses to
and liability for releases of hazardous substances into the environment, and
other federal laws, each as amended. These standards also include 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.
McDermott'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. McDermott believes that its
facilities are in substantial compliance with current regulatory standards.
McDermott's compliance with U.S. federal, state and local environmental control
and protection regulations necessitated capital expenditures of $413,000 in
fiscal year 1999. Management expects to spend another $3,046,000 on such
capital expenditures over the next five years. Management cannot predict all of
the environmental requirements or circumstances that will exist in 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 $13,299,000 in fiscal
year 1999.
McDermott has been identified as a potentially responsible party at various
cleanup sites under CERCLA. McDermott 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, McDermott's share of the ultimate liability for the various
sites is not expected to have a material adverse effect on McDermott's
consolidated financial position, results of operations or liquidity in any given
year.
13
Remediation projects have been or may be undertaken at certain of McDermott's
current and former plant sites. 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"). 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 transferred to BWXT in fiscal
year 1998. BWXT's management reached 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, 1999, the remaining provision for the
decontamination, decommissioning and the closing of these facilities was
$15,811,000.
The Department of Environmental Protection of the Commonwealth of Pennsylvania
("PADEP"), by letter dated March 19, 1994, advised B&W 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.
At March 31, 1999 and 1998, McDermott had total environmental reserves
(including provisions for the facilities discussed above), of $31,568,000 and
$46,164,000,respectively. Of the total environmental reserves at March 31, 1999
and 1998, $19,835,000 and $9,934,000, respectively, were included in current
liabilities. Estimated recoveries of these costs are included in environmental
and products liability recoverable at March 31, 1999. 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.
McDermott 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. McDermott is thus
subject to continuing reviews by governmental agencies, including the
Environmental Protection Agency and the NRC.
Decommissioning regulations promulgated by the NRC require BWXT and MTI 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 and MTI
will continue to provide financial assurance of $25,103,000 during fiscal year
2000 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).
An agreement between the NRC and the State of Ohio to transfer regulatory
authority for MTI/NRC licenses for byproduct and source nuclear material is
anticipated to occur in July 1999. In conjunction with the transfer of this
regulatory authority and upon notification by NRC of the effective date of
agreement, MTI will reissue decommissioning financial assurance instruments
naming the State of Ohio as the beneficiary. No other provisions of the
instruments will be modified at this time.
14
ITEM 3. LEGAL PROCEEDINGS
In March 1997, MII and JRM, with the help of outside counsel, began an
investigation into allegations of wrongdoing by a limited number of former
employees of MII and JRM and others. The allegations concerned the heavy-lift
business of JRM's HeereMac joint venture ("HeereMac") with Heerema Offshore
Construction Group, Inc. ("Heerema"). Upon becoming aware of these allegations,
MII and JRM notified authorities, including the Antitrust Division of the U.S.
Department of Justice and the European Commission. As a result of MII's and
JRM's prompt disclosure of the allegations, both companies and their officers,
directors and employees 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 co-venturer in the joint venture,
Heerema, acquired JRM's interest in exchange for cash and title to several
pieces of equipment. On December 21, 1997, HeereMac and one of its employees
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 and the HeereMac employee were fined $49,000,000 and $100,000,
respectively. As part of the plea, both HeereMac and certain employees of
HeereMac agreed to cooperate fully with the Department of Justice investigation.
Neither MII, JRM nor any of their officers, directors or employees was a party
to those proceedings.
MII and JRM have cooperated and are continuing to cooperate with the Department
of Justice in its investigation. The Department of Justice also has 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. In connection with 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.
In June 1998, Phillips Petroleum Company (individually and on behalf of certain
co-venturers) and certain related entities (the "Phillips Plaintiffs") filed a
lawsuit in the United States District Court for the Southern District of Texas
against MII, JRM, MI, McDermott-ETPM, Inc., certain JRM subsidiaries, HeereMac,
Heerema, certain Heerema affiliates, and others alleging 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 (the "Phillips
Litigation"). In December 1998, Den norske stats oljeselskap a.s., individually
and on behalf of certain of its ventures and its participants, filed a similar
lawsuit in the same court. In addition to seeking injunctive relief, actual
damages and attorneys' fees, the plaintiffs in the Phillips Litigation have
requested punitive as well as treble damages. In January 1999, the court
dismissed without prejudice, due to the court's lack of subject matter
jurisdiction, the claims of the Phillips Plaintiffs relating to alleged injuries
sustained on any foreign projects.
In June 1998, Shell Offshore, Inc. and certain related entities also filed a
lawsuit in the United States District Court for the Southern District of Texas
against MII, JRM, MI, McDermott-ETPM, Inc., certain JRM subsidiaries, HeereMac,
Heerema and others alleging that the defendants engaged in anti-competitive acts
in violation of Sections 1 and 2 of the Sherman Act (the "Shell Litigation").
Subsequent thereto, Amoco Production Company and B.P. Exploration & Oil, Inc.;
Amerada Hess Corporation; Conoco Inc. and certain of its affiliates; Texaco
Exploration and Production Inc. and certain of its affiliates; Elf Exploration
UK PLC and Elf Norge a.s.; Burlington Resources Offshore, Inc. and The Louisiana
Land & Exploration Company; Marathon Oil Company and certain of its affiliates;
VK-Main Pass Gathering Company, L.L.C., Green Canyon Pipeline Company, L.L.C.
and Delos Gathering Company, L.L.C.; Chevron U.S.A. Inc. and Chevron Overseas
Petroleum Inc.; Shell U.K. Limited and certain of its affiliates; Woodside
Energy, Ltd; and Saga Petroleum, S.A. intervened (acting for themselves and, if
applicable, on behalf of their respective co-venturers and for whom
15
they operate) as plaintiffs in the Shell Litigation. Also, in December 1998,
Total Oil Marine p.l.c. and Norsk Hydro Produksjon a.s., individually and on
behalf of their respective co-venturers, filed similar lawsuits in the same
court, which lawsuits were consolidated with the Shell Litigation. In addition
to seeking injunctive relief, actual damages and attorneys' fees, the plaintiffs
in the Shell Lawsuit request treble damages.
MII and JRM are also cooperating with a Securities and Exchange Commission
("SEC") investigation into whether the companies may have violated U.S.
securities laws in connection with, but not limited to, the matters described
above. MII and JRM are subject to a judicial order entered in 1976, with the
consent of MI (which at that time was the parent of the McDermott group of
companies), pursuant to an SEC complaint (the "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.
As a result of the initial allegations of wrongdoing in March 1997, both MII and
JRM formed and continue to maintain special committees of their Board of
Directors to monitor and oversee the companies' investigation into all of these
matters.
It is not possible to predict the ultimate outcome of the Department of Justice
investigation, the SEC investigation, the companies' internal investigation, the
above-referenced lawsuits, or any 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 criminal liability and have a material adverse effect on
McDermott's consolidated financial position and results of operations.
B&W and Atlantic Richfield Company ("ARCO")are defendants in lawsuits filed by
Donald F. Hall, Mary Ann Hall and others in the United States District Court for
the Western District of Pennsylvania involving over 120 separate cases relating
to the operation of two former nuclear fuel processing facilities located in
Pennsylvania (the "Hall Litigation"), alleging, among other things, that they
suffered personal injury and other damages as a result of radioactive emissions
from these facilities. In September 1998, a jury found B&W and ARCO liable to
the plaintiffs in the first eight cases brought to trial, awarding $36,700,000
in compensatory damages. B&W believes that adequate insurance is available to
meet any possible liability in this matter. However, the jury verdict is not
final, and a number of post trial lawsuits are pending contesting this
contingency. There is a controversy between B&W and its insurer as to the
amount of insurance coverage under the insurance policies covering these
facilities available for this award, and all other claims. B&W has filed an
action seeking a judicial determination of this matter, which is currently
pending in a Pennsylvania court. Management believes that the award and all
other claims will be resolved within the limits and coverage of such insurance
policies; however, no assurance on insurance coverage or financial impact if
limits of coverage are exceeded can be given. In connection with the foregoing,
B&W settled all pending and future punitive damage claims represented by the
plaintiffs' lawyers in the Hall Litigation for $8,000,000 and seeks
reimbursement of this amount from other parties.
Two purported class actions have been filed in the Civil District Court for the
Parish of Orleans, State of Louisiana, by alleged public shareholders of JRM,
challenging MII's initial proposal to acquire the publicly traded shares of JRM
Common Stock in a stock for stock merger. On May 7, 1999, MII and JRM announced
that they had entered into a merger agreement pursuant to which MII
will acquire all of such publicly traded shares of JRM Common Stock for $35.62
per share pursuant to a cash tender offer followed by a second step merger. On
the same day, the Court entered an order consolidating the two actions under the
caption In re J. Ray McDermott Shareholder Litigation. There have been no
further proceedings in either of the actions to date. JRM and MII believe that
the actions are without merit and intend to contest these suits vigorously.
Additionally, due to the nature of its business, McDermott is, from time to
time, involved in routine litigation related to its business activities. It is
management's opinion that none of this routine litigation will have a material
adverse effect on McDermott's consolidated financial position or results of
operations.
See Item 1H and Note 11 to the consolidated financial statements regarding
McDermott's potential liability for non-employee products liability asbestos
claims.
16
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.
17
P A R T I
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
MII'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, 1998 and 1999
were as follows:
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
FISCAL YEAR 1999
SALES PRICE CASH
----------------------- DIVIDENDS
QUARTER ENDED HIGH LOW DECLARED
- ------------------ ----------- --------- ---------
June 30, 1998 $43 - 15/16 $ 34 - 3/8 $0.05
September 30, 1998 35 19 - 1/4 0.05
December 31, 1998 32 - 5/16 21 - 31/32 0.05
March 31, 1999 27 19 - 1/4 0.05
As of March 31, 1999, the approximate number of record holders of Common Stock
was 4,609.
18
ITEM 6. SELECTED FINANCIAL DATA
FOR THE FISCAL YEARS ENDED MARCH 31,
1999 1998 1997 1996 1995
---------- ---------- ----------- ---------- ----------
(In thousands, except for per share amounts)
Revenues $3,149,985 $3,674,635 $3,150,850 $3,244,318 $3,043,680
Income (Loss) before Extraordinary
Item and Cumulative Effect of
Accounting Change $ 192,081 $ 215,690 $ (206,105) $ 20,625 $ 10,876
Net Income (Loss) $ 153,362 $ 215,690 $ (206,105) $ 20,625 $ 9,111
Basic Earnings (Loss) per Common Share:
Income (Loss) before Extraordinary
Item and Cumulative Effect of
Accounting Change $ 3.25 $ 3.74 $ (3.95) $ 0.23 $ 0.05
Net Income (Loss) $ 2.60 $ 3.74 $ (3.95) $ 0.23 $ 0.02
Diluted Earnings (Loss) per Common Share:
Income (Loss) before Extraordinary
Item and Cumulative Effect of
Accounting Change $ 3.16 $ 3.48 $ (3.95) $ 0.23 $ 0.05
Net Income (Loss) $ 2.53 $ 3.48 $ (3.95) $ 0.23 $ 0.02
Total Assets $4,305,520 $4,501,130 $4,599,482 $4,387,251 $4,751,670
Long-Term Debt $ 323,774 $ 598,182 $ 667,174 $ 576,256 $ 579,101
Subsidiary's Redeemable
Preferred Stocks - 155,358 170,983 173,301 179,251
---------------------------------------------------------------
Total $ 323,774 $ 753,540 $ 838,157 $ 749,557 $ 758,352
Cash Dividends per Common Share $ 0.20 $ 0.20 $ 0.60 $ 1.00 $ 1.00
See Note 18 to the consolidated financial statements for significant items
included in fiscal year 1999 and 1998 results.
Fiscal year 1997 results include:
. asset impairment losses of $54,642,000,
. gains on asset disposals of $72,121,000, including the realization of
$12,271,000 of the deferred gain on the sale of major marine vessels to
HeereMac,
. favorable workers' compensation cost and other insurance adjustments of
$21,441,000,
. a provision of $72,400,000 for estimated future non-employee products
asbestos claims,
. write-downs of equity investments totaling $25,875,000,
. the write-down of certain claims of $12,506,000 for which recovery was not
probable, and
. a $10,285,000 provision related to employee severance costs.
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 McDermott'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.
19
Fiscal year 1995 results include:
. a $46,489,000 charge for the decontamination, decommissioning and closing of
certain nuclear manufacturing facilities and the closing 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 McDermott's investment in the HeereMac joint
venture in fiscal year 1997. Equity in income of HeereMac was $1,083,000 and
$6,244,000 in fiscal years 1996 and 1995, 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 Statement of Financial
Accounting Standards ("SFAS") No. 112. See Note 11 regarding the uncertainty
as to the ultimate loss relating to products liability asbestos claims and the
results of the ongoing investigations into possible anti-competitive practices
by MII and JRM, and related civil lawsuits.
20
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. As a result of continuing
lower oil prices, Marine Construction Services' customers have significantly
reduced capital expenditures for exploration and production spending, and
backlog has declined over $850,000,000 since the beginning of the fiscal year.
At the current backlog level, management expects revenues in fiscal year 2000 to
be as much as forty percent lower than in the current fiscal year, and
profitability to be lower because of the volume decline. Economic and political
instability in Asia have also had an adverse effect on the timing of exploration
and production spending.
Revenues of the Power Generation Systems segment are largely a function of
capital spending by the electric power generation industry. In the electric
power generation industry, persistent economic growth in the United States has
brought the supply of electricity into approximate balance with energy demand,
except at periods of peak demand. However, electric power producers have
generally chosen to meet these peaks with new combustion turbines rather than
with base-load capacity. New emissions requirements have also prompted some
customers to place orders for environmental equipment. Demand for electrical
power generation industry services and replacement nuclear steam generators
continues at strong levels. International markets remain unsettled, and
economic and political instability in Asia have caused projects in these
emerging markets to be delayed, suspended or cancelled. In the process
industry, demand for services remains strong, and the pulp and paper industry
has begun to issue inquiries relating to the refurbishment or replacement of
existing recovery boilers. Management expects the fiscal year 2000 operating
activity of this segment to be about the same as in the current fiscal year.
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 the segment to remain
relatively constant since it is the sole-source provider of nuclear fuel
assemblies and nuclear reactor components to the U.S. Government. Management
expects the fiscal year 2000 operating activity of this segment to be about the
same as in the current fiscal year.
Revenues of Industrial Operations are affected by variations in the business
cycles in the customers' industries and the overall economy. Legislative issues
such as environmental regulations and fluctuations in U.S. Government funding
patterns also affect Industrial Operations. Backlog for Industrial Operations
has improved significantly from a year ago, primarily because of significant new
contracts in engineering and construction. Management expects the fiscal year
2000 operating activity of this segment to be about the same as in the current
fiscal year.
In general, all of McDermott's business segments are capital intensive
businesses that rely on large contracts for a substantial amount of their
revenues.
A significant portion of McDermott's revenues and operating results are derived
from its foreign operations. As a result, McDermott's operations and financial
results are affected by international factors, such as changes in foreign
currency exchange rates. McDermott attempts to minimize its exposure to changes
in foreign currency exchange rates by matching 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, McDermott enters into forward exchange contracts to reduce the impact
of foreign exchange rate movements on operating results.
21
Statements made herein which express a belief, expectation or intention, as well
as those that are not historical fact, are forward looking. They involve a
number of risks and uncertainties that may cause actual results to differ
materially from such forward-looking statements. These risks and uncertainties
include:
. 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 McDermott's contracts
with U.S. government agencies,
. estimates for pending and future non-employee asbestos claims,
. the highly competitive nature of McDermott's businesses,
. operating risks associated with the marine construction services business,
. economic and political conditions in Asia,
. the results of the ongoing investigation by MII and JRM and the U.S.
Department of Justice into possible anti-competitive practices by MII and
JRM, and related civil lawsuits, and
. the results of the ongoing SEC investigation into whether McDermott may have
violated U.S. securities laws in connection with such anti-competitive
practices and other matters.
FISCAL YEAR 1999 VS FISCAL YEAR 1998
Marine Construction Services
- ----------------------------
Revenues decreased $575,916,000 to $1,279,570,000, primarily due to lower volume
in Europe as a result of the withdrawal from the traditional European
engineering markets and from lower volume in essentially all activities in North
America, the Middle East and in worldwide engineering. These decreases were
partially offset by higher volume in the Far East.
Segment operating income increased $19,360,000 to $126,482,000, primarily due to
higher volume and margins in all activities in the Far East and a favorable
settlement of contract claims in that area. There were also higher margins in
Middle East fabrication operations and lower general and administrative
expenses. In addition, prior period results include amortization of OPI
goodwill of $16,318,000. These increases were partially offset by lower volume
in essentially all activities in North America and the Middle East and in
worldwide engineering. There were also higher net operating expenses and a
charge to restructure foreign joint ventures.
Gain (loss) on asset disposals and impairments--net was a gain of $18,620,000
compared to a loss of $40,119,000 in the prior period. This was primarily due
to gains recognized from the termination of the McDermott-ETPM joint venture and
the sale of three Gulf of Mexico vessels, partially offset by impairment losses
on fabrication facilities and goodwill associated with worldwide engineering and
a Mexican shipyard. The loss in the prior period was primarily due to the
write-off of $262,901,000 of goodwill associated with the acquisition of OPI,
partially offset by the $224,472,000 gain recognized from the termination of the
HeereMac joint venture.
Income from investees decreased $59,566,000 to $10,670,000, primarily due to a
$61,637,000 distribution of earnings related to the termination of the HeereMac
joint venture in the prior period. There were also lower operating results from
Brown & Root McDermott Fabricators Limited and a joint venture in Mexico. These
decreases were partially offset by a gain on the sale of assets in a Malaysian
joint venture. In addition, losses were recorded by McDermott-ETPM West, Inc.
in the prior period.
Backlog for the Marine Construction Services segment at March 31, 1999 and 1998
was $406,183,000 and $1,266,310,000, respectively. Backlog decreased primarily
as a result of lower oil prices. In addition, backlog declined as a result of
JRM's withdrawal from traditional engineering markets. Finally, backlog
decreased as a result of sluggish economic conditions in the Middle and Far East
and the political instability in Asia.
Power Generation Systems
- ------------------------
Revenues decreased $76,504,000 to $1,266,310,000, primarily due to lower
revenues from fabrication and erection of fossil fuel steam and environmental
control systems, replacement nuclear steam generators and
22
industrial boilers. These decreases were partially offset by higher revenues
from repair and alteration of existing fossil fuel steam systems and plant
enhancement projects.
Segment operating income increased $7,887,000 to $90,318,000, primarily due to
higher volume and margins from repair and alteration of existing fossil fuel
steam systems and operation and maintenance contracts. There were also higher
margins from industrial boilers, higher volume from plant enhancement projects
and lower net operating expenses. These increases were partially offset by
lower volume and margins from fabrication and erection of fossil fuel steam and
environmental control systems, lower volume from replacement nuclear steam
generators and higher general and administrative expenses.
Gain (loss) on asset disposals and impairments--net increased $10,551,000 to a
gain of $4,465,000 compared to a loss of $6,086,000 in the prior period. The
gain was primarily due to gains recognized from the sale of a domestic
manufacturing facility. The loss in the prior period was primarily due to asset
impairments in this facility.
Income (loss) from investees decreased $12,274,000 from income of $7,541,000 to
a loss of $4,733,000, primarily due to lower operating results from a foreign
joint venture located in Egypt and the write-off of notes and accounts
receivable from a foreign joint venture located in Turkey.
Backlog for the Power Generation Systems segment at March 31, 1999 and 1998 was
$905,283,000 and $1,070,351,000, respectively. Backlog has been adversely
impacted by suspensions of power generation projects in Southeast Asia and
Pakistan. Also, the U.S. market for industrial and utility boilers remains
weak. However, the U.S. market for services and replacement nuclear steam
generators is expected to remain strong and to make significant contributions to
operating income into the future.
Government Operations
- ---------------------
Revenues increased $12,187,000 to $382,706,000, primarily due to higher revenues
from management and operation contracts for U.S. Government-owned facilities and
from nuclear fuel assemblies and reactor components for the U.S. Government.
These increases were partially offset by lower revenues from other government
operations, commercial operations and commercial nuclear environmental services.
Segment operating income increased $3,537,000 to $39,353,000, primarily due to a
settlement relating to environmental restoration costs. In addition, there was
higher volume from management and operation contracts for U.S. Government-owned
facilities and lower general and administrative expenses. These increases were
partially offset by lower margins from commercial nuclear environmental
services and lower volume from commercial operations and other government
operations. In addition, there was an $8,000,000 settlement of punitive damage
claims relating to a civil suit associated with a Pennsylvania facility formerly
operated by B&W.
Backlog for the Government Operations segment at March 31, 1999 and 1998 was
$860,981,000 and $810,230,000, respectively. At March 31, 1999, this segment's
backlog with the U.S. Government was $760,202,000, of which $12,023,000 had not
been funded.
Industrial Operations
- ---------------------
Revenues increased $89,733,000 to $427,520,000, primarily due to higher revenues
from engineering activities in Canadian operations. This increase was partially
offset by lower revenues from domestic engineering and construction activities
and from the disposition of a non-core business.
Segment operating income increased $12,227,000 to $16,906,000, primarily due to
higher volume from engineering activities in Canadian operations and higher
margins from air-cooled heat exchangers. There were also losses in a non-core
business disposed of in the prior period. These increases were partially offset
by higher general and administrative expenses.
23
Gain (loss) on asset disposals and impairments-net decreased $128,473,000 from
income of $128,239,000 to a loss of $234,000. The prior period gains were
primarily due to the sale of McDermott's interest in Sakhalin Energy Investment
Company Ltd. and Universal Fabricators Incorporated.
Income (loss) from investees decreased by $5,022,000 from income of $3,376,000
to a loss of $1,646,000, primarily due to lower operating results from a
domestic joint venture in Colorado and the shutdown of two foreign joint
ventures in the former Soviet Union.
Backlog for Industrial Operations at March 31, 1999 and 1998 was $400,649,000
and $262,339,000, respectively. Backlog increased because of significant new
bookings in Engineering and Construction.
Other Unallocated Items
- -----------------------
Other unallocated items increased $45,719,000 to $51,005,000, primarily due to
provisions for estimated future non-employee products liability asbestos claims,
higher legal expenses and higher general and administrative expenses. These
decreases were partially offset by lower employee benefit expenses.
Other Income Statement Items
- ----------------------------
Interest income increased $35,430,000 to $97,965,000, primarily due to increases
in investments in government obligations and other debt securities and interest
income on domestic tax refunds. These increases were partially offset by a
decrease in interest income due to the collection of the promissory note
received from the sale of the derrick barges 101 and 102.
Interest expense decreased $18,192,000 to $63,262,000, primarily due to changes
in debt obligations and interest rates prevailing thereon.
Other-net decreased $22,052,000 from income of $3,253,000 to expense of
$18,799,000, primarily due to a loss of $45,535,000 for insolvent insurers
providing coverage for estimated future non-employee products liability asbestos
claims, partially offset by a net gain on the settlement and curtailment of
postretirement benefit plans. (See Note 6 to the consolidated financial
statements.)
The provision for (benefit from) income taxes decreased $80,920,000 from a
provision of $76,117,000 to a benefit of $4,803,000, while income before
provision for (benefit from) income taxes and extraordinary item decreased
$104,529,000 to $187,278,000. The decrease in the provision for income taxes
was primarily the result of a benefit of $25,456,000 recorded as a result of
the decrease in the valuation allowance for deferred taxes, favorable tax
settlements totaling $30,429,000 of prior years' disputed items in various
jurisdictions and a decrease in income. McDermott 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
bases (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.
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
24
acquisition of OPI. Also contributing to the decrease were: 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. 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. In addition, the loss
from the McDermott ETPM-West, Inc. joint venture decreased $9,248,000 to
$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.
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 (loss) 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 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 (loss) 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.
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.
Industrial 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
25
and ordnance operations). These decreases were partially offset by higher
revenues from air-cooled heat exchangers and plant maintenance activities in
Canadian operations.
Segment operating income (loss) increased $35,320,000 from a loss of $30,641,000
to income of $4,679,000. This was 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
McDermott's interest in Sakhalin Energy Investment Company Ltd. and Universal
Fabricators Incorporated in the current year and an asset impairment in the
prior year.
Income from investees increased $2,639,000 to $3,376,000, primarily due to
higher operating results from two foreign joint ventures.
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 liability
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 (benefit from) 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, McDermott 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.
EFFECT OF INFLATION AND CHANGING PRICES
McDermott'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
26
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,
McDermott attempts to cover the increased cost of anticipated changes in labor,
material and service costs, either through an estimate of such changes, which is
reflected in the original price, or through price escalation clauses in its
contracts.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal year 1999, McDermott's cash and cash equivalents decreased
$96,373,000 to $181,503,000 and total debt decreased $399,582,000 to
$354,900,000, primarily due to a reduction in short-term borrowings of
$30,954,000 and repayment of $326,921,000 in long-term debt. During this
period, McDermott provided cash of $300,285,000 from operating activities, and
received cash proceeds of $176,290,000 from the net sales and maturities of
investments, and $145,161,000 from asset disposals, including $95,546,000 from
the termination of the McDermott-ETPM joint venture. McDermott used cash of
$272,061,000 for the acquisition of preferred and common stock , $78,787,000 for
additions to property, plant and equipment and $13,810,000 for dividends on
MII's common and preferred stock.
Pursuant to agreements with the majority of its principal insurers, McDermott
negotiates and settles products liability asbestos claims from non-employees and
bills these amounts to the appropriate insurers. Reimbursement of such claims
is subject to varying insurance limits based upon the year involved. Moreover,
as a result of collection delays inherent in this 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 $7,200 per claim over the last three years)
has continued to rise. Claims paid during the fiscal year ended March 31, 1999
were $227,176,000, of which $175,457,000 has been recovered or is due from
insurers. At March 31, 1999, receivables of $85,409,000 were due from insurers
for reimbursement of settled claims. Of the $85,409,000 due from insurers,
$37,287,000 had been included in the pool of qualified receivables sold pursuant
to a receivables purchase and sale agreement (see below). The collection
delays, and the amount of claims paid for which insurance recovery is not
probable, have not had a material adverse effect upon McDermott's liquidity.
At March 31, 1999, the estimated liability for pending and future non-employee
products liability asbestos claims was $1,562,363,000 and estimated insurance
recoveries were $1,366,863,000. Management's expectation is that new claims will
conclude within the next thirteen years, that there will be a significant
decline in new claims received after four years, and that the average cost per
claim will continue to increase only moderately. McDermott's estimates of future
asbestos products liability and probable insurance recoveries are based on prior
history and management's best estimate of cost based on all available
information. However, future costs to settle claims, as well as the number of
claims, could be adversely affected by changes in judicial rulings and
influences beyond McDermott's control. Accordingly, changes in the estimates of
future asbestos products liability and insurance recoverables and differences
between the proportion of any additional asbestos products liabilities covered
by insurance, and that experienced in the past could result in material
adjustments to the results of operations for any fiscal quarter or year, and the
ultimate loss may differ materially from amounts provided in the consolidated
financial statements.
Expenditures for property, plant and equipment increased $33,697,000 to
$78,787,000 in fiscal year 1999. The majority of fiscal year 1999 expenditures
were to maintain, replace and upgrade existing facilities and equipment.
McDermott has budgeted capital expenditures of approximately $38,236,000 during
fiscal 2000.
At March 31, 1998, McDermott had $82,783,000 in secured borrowings pursuant to a
receivables purchase and sale agreement between B&W and certain of its
affiliates and subsidiaries and a U.S. Bank. Through July 31, 1998, $25,854,000
was repaid under the agreement. Effective July 31, 1998, the receivables
purchase and sale agreement was amended and restated to provide for, among other
things, the inclusion of certain insurance recoverables in the pool of qualified
accounts receivable. It also provided for sales treatment as opposed to secured
financing treatment for this arrangement under Financial Accounting Standards
Board ("FASB")
27
Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." As a result, $56,929,000 was removed from notes payable and
current maturities of long-term debt on the balance sheet. This amended and
restated agreement was terminated on April 30, 1999.
On May 7, 1999, MII and JRM entered into a merger agreement pursuant to which
MII initiated a tender offer for those shares of JRM that it did not already own
for $35.62 per share in cash. Under the merger agreement, any shares not
purchased in the tender offer will be acquired for the same price in cash in a
second-step merger. MII estimates that it will require approximately
$560,000,000 to consummate the tender offer and second-step merger and to pay
related fees and expenses. MII expects to obtain the funds from cash on hand
and from a new $525,000,000 senior secured term loan facility with Citibank,
N.A. The facility will terminate and all borrowings thereunder will mature upon
the earlier of five business days after the consummation of the second merger or
September 30, 1999. When the facility terminates, JRM will declare and pay a
dividend and/or loan to MII such amounts that, together with MII's available
cash, will be used to repay all outstanding loans under the facility. Citibank,
N.A. may act either as sole lender under the facility or syndicate all or a
portion of the facility to a group of financial institutions. The facility
contains customary representations, warranties, covenants and events of default.
The facility also includes financial covenants that:
. require MII to maintain a minimum consolidated tangible net worth of not
less than $250,000,000,
. limit MII's ability to pay dividends, and,
. require MII, JRM and certain other subsidiaries to maintain cash, cash
equivalents and investments in debt securities of at least $575,000,000 at
all times.
The facility is secured by a first priority pledge of all JRM capital stock and
securities convertible into JRM capital stock held by or acquired by MII or any
of its subsidiaries.
At March 31, 1999, McDermott had total cash, cash equivalents and investments of
$1,088,402,000. McDermott's investment portfolio consists primarily of
government obligations and other investments in debt securities. The fair value
of short and long-term investments at March 31, 1999 was $921,070,000. At March
31, 1999, approximately $48,760,000 fair value of these obligations were pledged
to secure a letter of credit in connection with certain reinsurance agreements.
Management anticipates that approximately $560,000,000 of this investment
portfolio will be used to fund the tender offer, second-step merger and related
fees and expenses referred to above.
At March 31, 1999 and 1998, McDermott had available various uncommitted short-
term lines of credit from banks totaling $87,578,000 and $127,061,000,
respectively. Borrowings against these lines of credit at March 31, 1998 were
$5,100,000. There were no borrowings against these lines at March 31, 1999. At
March 31, 1998, B&W was a party to a revolving credit facility under which there
were no borrowings. In July 1998, B&W terminated its existing credit facility
and, jointly and severally with BWICO and BWXT, entered into a new $200,000,000
three-year, unsecured credit agreement (the "BWICO Credit Agreement") with a
group of banks. Borrowings by the three companies against the BWICO Credit
Agreement cannot exceed an aggregate amount of $50,000,000. The remaining
$150,000,000 is reserved for the issuance of letters of credit. In connection
with satisfying a condition to borrowing or issuing letters of credit under the
BWICO Credit Agreement, MI made a $15,000,000 capital contribution to BWICO in
August 1998. At March 31, 1999, there were no borrowings under the BWICO Credit
Agreement.
At March 31, 1998, JRM and certain of its subsidiaries were parties to a
revolving credit facility under which there were no borrowings. In June 1998,
JRM and such subsidiaries entered into a new $200,000,000 three-year, unsecured
credit agreement (the "JRM Credit Agreement") with a group of banks. Borrowings
against the JRM Credit Agreement cannot exceed $50,000,000. The remaining
$150,000,000 is reserved for the issuance of letters of credit. At March 31,
1999, there were no borrowings under the JRM Credit Agreement. Management does
not anticipate JRM will need to borrow funds under the JRM Credit Agreement
during fiscal year 2000. Subsequent to year-end, JRM elected to reduce the
commitments on the JRM Credit Agreement from $200,000,000 to $100,000,000.
28
MI and JRM are restricted, as a result of covenants in debt instruments, in
their ability to transfer funds to MII and certain of its subsidiaries through
cash dividends or through unsecured loans or investments. At March 31, 1999,
substantially all of the net assets of MI were subject to such restrictions. At
March 31, 1999, JRM could make unsecured loans to or investments in MII of
approximately $75,000,000 and pay dividends to MII of approximately
$146,300,000. In connection with the tender offer and merger described above,
an amendment to the JRM Credit Agreement was entered into that permits JRM to
loan to MII such amounts as may be required for MII to repay the amounts
outstanding under the $525,000,000 senior secured term loan facility with
Citibank N.A.
On March 5, 1999, JRM consummated an offer to purchase all of its outstanding
9.375% Senior Subordinated Notes at a purchase price of 113.046% of their
principal amount ($1,130.46 per $1,000 principal amount), plus accrued and
unpaid interest. On that date, JRM purchased $248,575,000 in principal amount
of the notes for a total purchase price of $284,564,000, including interest of
$3,560,000. As a result, JRM recorded an extraordinary loss of $38,719,000. In
connection with the purchase of the notes, JRM received consents to certain
amendments that amended or eliminated certain restrictive covenants and other
provisions contained in the indenture relating to the notes. Specifically, the
covenants contained in the indenture that restricted JRM's ability to pay
dividends, repurchase or redeem its capital stock, or to transfer funds through
unsecured loans to or investments in MII were eliminated.
Working capital decreased $26,475,000 from $135,430,000 at March 31, 1998 to
$108,955,000 at March 31, 1999. During the next fiscal year, McDermott's
management expects to obtain funds to meet capital expenditure, working capital
and debt maturity requirements from operating activities, cash and cash
equiv