MCDERMOTT INTERNATIONAL INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q
(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the period ended September 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from to
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Commission File No. 1-8430

McDERMOTT INTERNATIONAL, INC.
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(Exact name of registrant as specified in its charter)

REPUBLIC OF PANAMA 72-0593134
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

1450 Poydras Street, New Orleans, Louisiana 70112-6050
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(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code (504) 587-5400
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.

Yes [X] No [ ]

The number of shares outstanding of the registrant's Common Stock at October 28,
2002 was 63,764,371.

McDERMOTT INTERNATIONAL, INC.

INDEX - FORM 10-Q

2

PART I
MCDERMOTT INTERNATIONAL, INC.

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

3

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS

See accompanying notes to condensed consolidated financial statements.

4

LIABILITIES AND STOCKHOLDERS' EQUITY

See accompanying notes to condensed consolidated financial statements.

5

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

See accompanying notes to condensed consolidated financial statements.

6

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

See accompanying notes to condensed consolidated financial statements.

7

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

8

CONTINUED

See accompanying notes to condensed consolidated financial statements.

9

McDERMOTT INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(UNAUDITED)

NOTE 1 - BASIS OF PRESENTATION

We have presented our condensed consolidated financial statements in U.S.
Dollars in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information.
Accordingly, they do not include all the information and GAAP footnotes required
for complete financial statements. We have included all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation. These
condensed consolidated financial statements include the accounts of McDermott
International, Inc. and its subsidiaries and controlled joint ventures. We use
the equity method to account for investments in joint ventures and other
entities we do not control, but over which we have significant influence. We
have eliminated all significant intercompany transactions and accounts. We have
reclassified certain amounts previously reported to conform with the
presentation at and for the three- and nine-month periods ended September 30,
2002.

McDermott International, Inc. ("MII") is the parent company of the McDermott
group of companies, which includes:

o J. Ray McDermott, S.A. ("JRM"), a Panamanian subsidiary of MII,
and its consolidated subsidiaries;

o McDermott Incorporated ("MI"), a Delaware subsidiary of MII, and
its consolidated subsidiaries;

o Babcock & Wilcox Investment Company ("BWICO"), a Delaware
subsidiary of MI;

o BWX Technologies, Inc. ("BWXT"), a Delaware subsidiary of BWICO,
and its consolidated subsidiaries; and

o The Babcock & Wilcox Company ("B&W"), an unconsolidated Delaware
subsidiary of BWICO.

Operating results for the three and nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2002. For further information, refer to the consolidated financial
statements and related footnotes included in MII's annual report on Form 10-K
for the year ended December 31, 2001.

On February 22, 2000, B&W and certain of its subsidiaries filed a voluntary
petition in the U.S. Bankruptcy Court for the Eastern District of Louisiana in
New Orleans (the "Bankruptcy Court") to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. B&W and these subsidiaries took this action as a means to
determine and comprehensively resolve all pending and future asbestos liability
claims against them. As of February 22, 2000, B&W's operations are subject to
the jurisdiction of the Bankruptcy Court and, as a result, our access to cash
flows of B&W and its subsidiaries is restricted.

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Due to the bankruptcy filing, beginning on February 22, 2000, we no longer
consolidate the results of operations of B&W and its subsidiaries in our
condensed consolidated financial statements and we have been presenting our
investment in B&W on the cost method. The Chapter 11 filing, along with
subsequent filings and negotiations, has led to increased uncertainty with
respect to the amounts, means and timing of the ultimate settlement of asbestos
claims and the recovery of our investment in B&W. Due to this increased
uncertainty, we wrote off our net investment in B&W in the quarter ended June
30, 2002. The total impairment charge of $224.7 million included our investment
in B&W of $187.0 million and other related assets totaling $37.7 million,
primarily consisting of accounts receivable from B&W, for which we provided an
allowance of $18.2 million. See Note 9 for information regarding developments in
negotiations relating to the B&W Chapter 11 proceedings.

Effective January 1, 2002, based on a review performed by us and our independent
consultants, we changed our estimate of the useful lives of new major marine
vessels from 12 years to 25 years to better reflect the service lives of our
assets and industry norms. Consistent with this change, we also extended the
lives of major upgrades to existing vessels. We continue to depreciate our major
marine vessels using the units-of-production method, based on the utilization of
each vessel. The change in estimated useful lives reduced our operating loss by
approximately $1.5 million and $2.8 million for the three and nine months ended
September 30, 2002, respectively.

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that we no longer amortize goodwill, but instead perform periodic
testing for impairment. We have completed our transitional goodwill impairment
test and will not incur a transitional goodwill impairment charge as of January
1, 2002. However, due to the deterioration in JRM's financial performance during
the three months ended September 30, 2002 and our revised expectations
concerning JRM's future earnings and cash flow, we are testing the goodwill of
the Marine Construction Services segment for impairment. See Note 8 for
disclosure concerning the goodwill impairment charge and our reconciliation of
reported net income to adjusted net income, which excludes goodwill amortization
expense for all periods presented.

Effective January 1, 2002, we also adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets. It
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of Accounting Pronouncements Bulletin No. 30, "Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and

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Transactions," for the disposal of a segment of a business. See Note 2 for
information on our discontinued operations.

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred. When the liability is
initially recorded, the entity capitalizes a cost by increasing the carrying
amount of the related long-lived asset. Over time, the liability is accreted to
its present value each period, and the capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We are
reviewing the effect SFAS No. 143 will have on our consolidated financial
position and results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities." SFAS No. 146 addresses significant issues regarding the
recognition, measurement and reporting of costs associated with exit and
disposal activities, including restructuring activities. It is effective for
exit or disposal activities that are initiated after December 31, 2002.

NOTE 2 -- DISCONTINUED OPERATIONS

On July 10, 2002, we completed the sale of one of our subsidiaries, Hudson
Products Corporation ("HPC"), a component of our Industrial Operations segment.
The sale price of $40 million consisted of $38 million in cash and a $2 million
subordinated promissory note. In the three and nine months ended September 30,
2002, we recorded a gain on the sale of HPC of $9.4 million, net of a provision
for income taxes of $5.7 million. We have reported the gain on sale and results
of operations for HPC in discontinued operations, and HPC is classified at
December 31, 2001 as an asset held for sale in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which we
adopted on January 1, 2002. The sale price was subject to a $0.5 million
post-closing adjustment, which we finalized and paid to the purchaser in October
2002. We have restated our condensed consolidated statements of income (loss)
for the three and nine months ended September 30, 2001 for consistency to
reflect the current year treatment of HPC as a discontinued operation. Condensed
financial information for our operations reported in discontinued operations
follows:

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At December 31, 2001, we have reported HPC's assets totaling $31.4 million in
other current assets and HPC's liabilities totaling $8.9 million in other
current liabilities in our condensed consolidated balance sheet.

NOTE 3 - INVENTORIES

Inventories are as follows:

NOTE 4 - ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss included in stockholders'
equity are as follows:

NOTE 5 - INVESTIGATIONS AND LITIGATION

On March 12, 2001, the plaintiffs' motion for rehearing en banc was denied by
the U.S. Court of Appeals for the Fifth Circuit in the December 1998 lawsuit
filed by Den norske stats oljeselskap a.s. and several related entities against
MII, JRM and others arising from alleged anticompetitive activities. The
plaintiffs filed a petition for writ of certiorari to the U.S. Supreme Court. On
February 20, 2002, the U.S. Supreme Court denied the petition for certiorari.
The plaintiffs filed a motion for rehearing by the U.S. Supreme Court. On April
15, 2002, the U.S. Supreme Court denied the motion for rehearing. During the
nine months ended September 30, 2002, Heerema and MII executed agreements to
settle the heavy lift antitrust claims against Heerema and MII with British Gas,
Phillips, Exxon, BP, Total Fina Elf, El Paso Group Companies and

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Burlington Resources, and the Court has entered an order of dismissal relating
to each of these plaintiffs except for Burlington Resources. We expect the order
of dismissal relating to the settlement with Burlington Resources will be
entered shortly. Because we previously accrued amounts adequate to cover these
claims, no additional provision was recorded in the nine months ended September
30, 2002. The remaining claims are proceeding before the Court.

On December 15, 2000, a number of Norwegian oil companies filed lawsuits against
MII, Heeremac, Heerema and Saipem S.p.A. for violations of the Norwegian Pricing
Act of 1953, in connection with projects in Norway. Plaintiffs include Norwegian
affiliates of various of the plaintiffs in the Shell civil case pending in
Houston. Most of the projects were performed by Saipem S.p.A. or its affiliates,
with some by Heerema/HeereMac and none by JRM. We understand that the conduct
alleged by plaintiffs is the same conduct which plaintiffs allege in the U.S.
civil cases. The cases were heard by the Conciliation Boards in Norway during
the first week of October 2001. The Conciliation Boards referred the cases to
the court of first instance for further proceedings. The plaintiffs have one
year from the date of referral to proceed with the cases. Several of the
plaintiffs who filed cases before the Conciliation Boards have filed writs with
the courts of first instance, in order to commence the court proceedings.

In December 1998, a subsidiary of JRM (the "Operator Subsidiary") was in the
process of installing the south deck module on a compliant tower in the Gulf of
Mexico for Texaco Exploration and Production, Inc. ("Texaco") when the main
hoist load line failed, resulting in the loss of the module. In December 1999,
Texaco filed a lawsuit seeking consequential damages for delays resulting from
the incident, as well as costs incurred to complete the project with another
contractor and uninsured losses. This lawsuit was filed in the U. S. District
Court for the Eastern District of Louisiana against a number of parties, some of
which brought third-party claims against the Operator Subsidiary and another
subsidiary of JRM, the owner of the vessel that attempted the lift of the deck
module (the "Owner Subsidiary"). Both the Owner Subsidiary and the Operator
Subsidiary were subsequently tendered as direct defendants to Texaco. In
addition to Texaco's claims in the federal court action, damages for the loss of
the south deck module have been sought by Texaco's builder risk insurers in
claims against the Owner Subsidiary and the other defendants, excluding the
Operator Subsidiary, which was an additional insured under the policy. Total
damages sought by Texaco and its builder risk insurers in the federal court
proceeding approximate $280 million. Texaco's federal court claims against the
Operator Subsidiary were stayed in favor of a pending binding arbitration
proceeding between them required by contract, which the Operator Subsidiary
initiated to collect $23 million due for work performed under the contract, and
in which Texaco also sought the same consequential damages and uninsured losses
as it seeks in the federal court action, and also seeks approximately $2 million
in other damages not sought in the federal court action. The federal court
trial, on the issue of liability only,

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commenced in October 2001. On March 27, 2002, the Court orally found that the
Owner Subsidiary was liable to Texaco, specifically finding that Texaco had
failed to sustain its burden of proof against all named defendants except the
Owner Subsidiary relative to liability issues, and, alternatively, that the
Operator Subsidiary's highly extraordinary negligence served as a superceding
cause of the loss. The finding was subsequently set forth in a written order
dated April 5, 2002, which found against the Owner Subsidiary on the claims of
Texaco's builder risk insurers in addition to the claims of Texaco. The judge
has not entered a final judgment on this matter. On May 6, 2002, the Owner
Subsidiary filed a notice of appeal of the April 5, 2002 order, which appeal it
subsequently withdrew without prejudice for technical reasons. We believe the
April 5, 2002 order is unsupported under the applicable law and facts and intend
to appeal when timely. The case has recently been transferred to a new district
court judge, and a trial date of February 10, 2003 has been set for damages and
certain insurance issues. The trial in the binding arbitration proceeding is set
to commence on January 13, 2003. Although the Owner Subsidiary is not a party to
the arbitration, we believe that the claims against the Owner Subsidiary, like
those against the Operator Subsidiary, are governed by the contractual
provisions which waive the recovery of consequential damages against the
Operator Subsidiary and its affiliates. We plan to vigorously pursue the
arbitration proceeding and any appeals process in the federal court action, and
we do not believe that a material loss with respect to these matters is likely.
In addition, we believe our insurance will provide coverage for the builder risk
and consequential damage claims in the event of liability. However, the ultimate
outcome of the proceedings and any challenge by our insurers to coverage is
uncertain, and an adverse ruling in either the arbitration or court proceeding
or any potential proceeding with respect to insurance coverage for any losses,
or any bonding requirements applicable to any appeal from an adverse ruling,
could have a material adverse impact on our consolidated financial position,
results of operations and cash flow.

In early April 2001, a group of insurers (the "Plaintiff Insurers") who have
previously provided insurance to B&W under our excess liability policies filed
(1) a complaint for declaratory judgment and damages against MII in the B&W
Chapter 11 proceedings in the U.S. District Court for the Eastern District of
Louisiana and (2) a declaratory judgment complaint against B&W in the Bankruptcy
Court, which actions have been consolidated before the U.S. District Court for
the Eastern District of Louisiana, which has jurisdiction over portions of the
B&W Chapter 11 proceeding. The insurance policies at issue in this litigation
provide a significant portion of B&W's excess liability coverage available for
the resolution of the asbestos-related claims that are the subject of the B&W
Chapter 11 proceeding. The consolidated complaints contain substantially
identical factual allegations. These include allegations that, in the course of
settlement discussions with the representatives of the asbestos claimants in the
B&W bankruptcy proceeding, MII and B&W breached the confidentiality provisions
of an agreement they entered into with these Plaintiff Insurers relating to
insurance payments by the Plaintiff Insurers as a result of asbestos claims.
They also allege that

15

MII and B&W have wrongfully attempted to expand the underwriters' obligations
under that settlement agreement and the applicable policies through the filing
of a plan of reorganization in the B&W bankruptcy proceeding that contemplates
the transfer of rights under that agreement and those policies to a trust that
will manage the pending and future asbestos-related claims against B&W and
certain of its affiliates. The complaints seek declarations that, among other
things, the defendants are in material breach of the settlement agreement with
the Plaintiff Insurers and that the Plaintiff Insurers owe no further
obligations to MII and B&W under that agreement. With respect to the insurance
policies, if the Plaintiff Insurers should succeed in terminating the settlement
agreement, they seek to litigate issues under the policies in order to reduce
their coverage obligations. The complaint against MII also seeks a recovery of
unspecified compensatory damages. B&W filed a counterclaim against the Plaintiff
Insurers, which asserts a claim for breach of contract for amounts owed and
unpaid under the settlement agreement, as well as a claim for anticipatory
breach for amounts that will be owed in the future under the settlement
agreement. B&W seeks a declaratory judgment as to B&W's rights and the
obligations of the Plaintiff Insurers and other insurers under the settlement
agreement and under their respective insurance policies with respect to asbestos
claims. On October 2, 2001, MII and B&W filed dispositive motions with the
District Court seeking dismissal of the Plaintiff Insurers' claim that MII and
B&W had materially breached the settlement agreement at issue. In a ruling
issued January 4, 2002, the District Court granted MII's and B&W's motion for
summary judgment and dismissed the declaratory judgment action filed by the
Plaintiff Insurers. The ruling concluded that the Plaintiff Insurers' claims
lacked a factual or legal basis. Our agreement with the underwriters went into
effect in April 1990 and has served as the allocation and payment mechanism to
resolve many of the asbestos claims against B&W. We believe this ruling reflects
the extent of the underwriter's contractual obligations and underscores that
this coverage is available to settle B&W's asbestos claims. As a result of the
January 4, 2002 ruling, the only claims that remained in the litigation were
B&W's counterclaims against the Plaintiff Insurers and against other insurers.
The parties agreed to dismiss without prejudice those of B&W's counterclaims
seeking a declaratory judgment regarding the parties' respective rights and
obligations under the settlement agreement. B&W's counterclaim seeking a money
judgment for approximately $6.5 million due and owing by insurers under the
settlement agreement remains pending. A trial of this counterclaim is scheduled
for November 25, 2002. The parties have reached a preliminary agreement in
principle to settle B&W's counterclaim for in excess of the claimed amounts, and
approximately $4 million has been received to date from the insurers, subject to
reimbursement in the event a final settlement agreement is not reached.
Following the resolution of this remaining counterclaim, the Plaintiff Insurers
will have an opportunity to appeal the January 4, 2002 ruling. At this point,
the Plaintiff Insurers have not indicated whether they intend to pursue an
appeal.

On or about November 5, 2001, The Travelers Indemnity Company and Travelers
Casualty and Surety Company (collectively, "Travelers") filed an adversary
proceeding against B&W and related entities in the

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U.S. Bankruptcy Court for the Eastern District of Louisiana seeking a
declaratory judgment that Travelers is not obligated to provide any coverage to
B&W with respect to so-called "non-products" asbestos bodily injury liabilities
on account of previous agreements entered into by the parties. On or about the
same date, Travelers filed a similar declaratory judgment against MI and MII in
the U.S. District Court for the Eastern District of Louisiana. The cases filed
against MI and MII have been consolidated before the District Court, and the
Asbestos Claimants Committee ("ACC") and the Future Claimants Representative
("FCR") have intervened in the action. On February 4, 2002, B&W and MII filed
answers to Travelers' complaints, denying that previous agreements operate to
release Travelers from coverage responsibility for asbestos "non-products"
liabilities and asserting counterclaims requesting a declaratory judgment
specifying Travelers' duties and obligations with respect to coverage for B&W's
asbestos liabilities. The Court has bifurcated the case into two phases, with
Phase I addressing the issue of whether previous agreements between the parties
serve to release Travelers from any coverage responsibility for asbestos
"non-products" claims. On August 14, 2002, the Court granted B&W's and MII's
motion for leave to file an amended answer and counterclaims, adding additional
counterclaims against Travelers. Discovery was completed in September 2002 and
the parties have filed cross-motions for summary judgment, which are set to be
heard on December 19, 2002. No trial date has been scheduled. This insurance, if
available, would be in addition to the amounts already included in B&W's
financial statements as of September 30, 2002.

On April 30, 2001, B&W filed a declaratory judgment action in its Chapter 11
proceeding in the U.S. Bankruptcy Court for the Eastern District of Louisiana
against MI, BWICO, BWXT, Hudson Products Corporation and McDermott Technology,
Inc. seeking a judgment, among other things, that (1) B&W was not insolvent at
the time of, or rendered insolvent as a result of, a corporate reorganization
that we completed in the fiscal year ended March 31, 1999, which included, among
other things, B&W's cancellation of a $313 million note receivable and B&W's
transfer of all the capital stock of Hudson Products Corporation, Tracy Power,
BWXT and McDermott Technology, Inc. to BWICO, and (2) the transfers are not
voidable. As an alternative, and only in the event that the Bankruptcy Court
finds B&W was insolvent at a pertinent time and the transactions are voidable
under applicable law, the action preserved B&W's claims against the defendants.
The Bankruptcy Court permitted the ACC and the FCR in the Chapter 11 proceedings
to intervene and proceed as plaintiff-intervenors and realigned B&W as a
defendant in this action. The ACC and the FCR are asserting in this action,
among other things, that B&W was insolvent at the time of the transfers and that
the transfers should be voided. The Bankruptcy Court ruled that Louisiana law
applied to the solvency issue in this action. Trial commenced on October 22,
2001 to determine B&W's solvency at the time of the corporate reorganization and
concluded on November 2, 2001. In a ruling filed on February 8, 2002, the
Bankruptcy Court found B&W solvent at the time of the corporate reorganization.
On February 19, 2002, the ACC and FCR filed a motion with the District Court
seeking leave to appeal the February 8, 2002 ruling.

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On February 20, 2002, MI, BWICO, BWXT, Hudson Products Corporation and McDermott
Technology, Inc. filed a motion for summary judgment asking that judgment be
entered on a variety of additional pending counts presented by the ACC and FCR
that we believe are resolved by the February 8, 2002 ruling. On March 20, 2002,
at a hearing in the Bankruptcy Court, the judge granted this motion and
dismissed all claims asserted in complaints filed by the ACC and the FCR
regarding the 1998 transfer of certain assets from B&W to its parent, which
ruling was memorialized in an Order and Judgment dated April 17, 2002 that
dismissed the proceeding with prejudice. On April 26, 2002, the ACC and FCR
filed a notice of appeal of the April 17, 2002 Order and Judgment and on June
20, 2002 filed their appeal brief. On July 22, 2002, MI, BWICO, BWXT, Hudson
Products Corporation and McDermott Technology, Inc. filed their brief in
opposition. The ACC and FCR have not yet filed their reply brief pending
discussions regarding settlement and the potential filing of a consensual joint
plan of reorganization. In addition, an injunction preventing asbestos suits
from being brought against non-filing affiliates of B&W, including MI, JRM and
MII, and B&W subsidiaries not involved in the Chapter 11 extends through January
14, 2003. See Note 9 for information regarding B&W's potential liability for
non-employee asbestos claims and additional information concerning the B&W
Chapter 11 proceedings.

On July 12, 2002, AE Energietechnic GmbH ("Austrian Energy") applied for the
appointment of a receiver in the Bankruptcy Court of Graz, Austria. Austrian
Energy is a subsidiary of Babcock-Borsig AG which filed for bankruptcy on July
4, 2002 in Germany. One of our subsidiaries, Babcock and Wilcox Volund ApS
("Volund"), is jointly and severally liable with Austrian Energy pursuant to
both their consortium agreement as well as their contract with the ultimate
customer, SK Energi, for construction of a biomass boiler facility in Denmark.
As a result of performance delays attributable to Austrian Energy and other
factors, SK Energi has asserted claims for damages associated with the failure
to complete the construction and commissioning of the facility on schedule. On
August 30, 2002, Volund filed a claim against Austrian Energy in the Austrian
Bankruptcy Court to establish Austrian Energy's liability for SK Energi's
claims. On October 8, 2002, Austrian Energy notified Volund that it had
terminated its consortium agreement with Volund in accordance with the Austrian
bankruptcy laws. Volund is pursuing its claim in the Austrian Bankruptcy Court
as well as other potential remedies available under Danish contract law.
Assuming no recovery from Austrian Energy, the cost to Volund is currently
estimated at $2.5 million, which we accrued during the three months ended
September 30, 2002. See Note 12 for information concerning the sale of Volund to
B&W.

In February 2002, one of our subsidiaries, J. Ray McDermott West Africa, Inc.
("JRMWA"), and Global Energy Company Limited ("GEC") entered into a joint
venture agreement related to a construction project. The parties entered into an
associated escrow agreement, with Citibank as the escrow agent, pursuant to
which JRMWA deposited $10.2 million into an escrow account at Citibank. The
joint venture agreement provided that, under certain

18

circumstances of termination, GEC would be entitled to certain amounts from the
escrow account and such transfer would constitute a full and final release of
JRMWA from all obligations, and JRMWA would retain the remainder of the escrowed
funds. On July 15, 2002, GEC filed two instruments with the High Court of Lagos
State, Nigeria against JRMWA, and Citibank: (1) an application for injunction to
restrain Citibank from remitting the sum of $10.2 million to JRMWA; and (2) a
lawsuit seeking a declaration that GEC is entitled to specific performance and
that the $10.2 million held by Citibank can only be exchanged for shares
representing a 12.75 % interest in Nigerdock Nigeria PLC. Also on July 15, 2002,
JRMWA filed an application for injunction to restrain Citibank from remitting
$1.3 million to GEC, which application for injunctive relief JRMWA subsequently
dismissed as duplicative. On August 19, 2002, JRMWA filed a motion to stay
proceedings in Nigeria in lieu of arbitration in London, as provided for in the
joint venture agreement. GEC has attempted through a series of motions to
dismiss JRMWA's motion to stay proceedings in lieu of arbitration. The hearing
on JRMWA's motion to stay was set for October 30, 2002 and on that date the
parties agreed to a settlement. Pursuant to the settlement, GEC will receive
$1.8 million and JRMWA will receive $8.4 million of the escrowed funds, JRMWA
has waived invoiced amounts of approximately $1.0 million and each party was
granted a full and final release and discharge of all claims. This settlement
was entered as an order of the Nigerian High Court on October 31, 2002. We
previously provided for our estimated loss in this matter.

In September 2002, we were advised that the Securities and Exchange Commission
and the New York Stock Exchange were conducting inquiries into the trading of
MII securities occurring prior to our public announcement of August 7, 2002 with
respect to our second quarter 2002 results, our revised 2002 guidance and
developments in negotiations relating to the B&W Chapter 11 proceedings. We are
cooperating fully with both inquiries.

Additionally, due to the nature of our business, we are, from time to time,
involved in routine litigation or subject to disputes or claims related to our
business activities, including performance- or warranty-related matters under
our customer and supplier contracts and other business arrangements. In our
management's opinion, none of this litigation or disputes and claims will have a
material adverse effect on our consolidated financial position, results of
operations or cash flows.

Other than as noted above, the following legal proceedings have had no change in
status from that disclosed in the consolidated financial statements included in
MII's annual report on Form 10-K for the year ended December 31, 2001:

o The Department of Justice investigation into allegations of
wrongdoing by a limited number of former employees of MII and JRM
concerning the heavy-lift business of JRM's Heeremac joint
venture with Heerema Offshore Construction Group, Inc. and the
heavy-lift business of JRM.

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o The Department of Justice investigation into possible
anticompetitive activity in the marine construction business of
McDermott-ETPM East, Inc., one of the operating companies within
JRM's former McDermott-ETPM joint venture with ETPM, S.A., a
French company.

o The June 1998 lawsuit filed by Shell Offshore, Inc. and several
related entities against MII and others, referred to as the
"Shell Litigation" in our annual report.

o The lawsuit filed by Donald F. Hall, Mary Ann Hall and others
against B&W and Atlantic Richfield Company, referred to as the
"Hall Litigation" in our annual report, as well as the
controversy between B&W and its insurers as to the amount of
coverage available under the liability policies covering the
facilities involved in that litigation.

For a detailed description of these proceedings, please refer to Note 11 to the
consolidated financial statements included in Part II of MII's annual report on
Form 10-K for the year ended December 31, 2001.

NOTE 6 - SEGMENT REPORTING

For the three and nine months ended September 30, 2002, we have reported the
results of operations for HPC in discontinued operations. In addition, we have
included the results of McDermott Technology, Inc. ("MTI") in Government
Operations. HPC and MTI were previously included in our Industrial Operations
segment. Segment information for the three and nine months ended September 30,
2001 has been restated to reflect these changes in our reportable segments. We
have not changed our basis of measurement of segment profit or loss from our
last annual report. An analysis of our operations by segment is as follows:

20

Segment Information for the Three and Nine Months Ended September 30, 2002 and
2001.

22

NOTE 7 - EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings
(loss) per share:

Due to rounding, the net income (loss) per share does not equal the sum of the
per share amounts for the individual components of the net income (loss) in all
periods.

23

For the three and nine months ended September 30, 2002, we excluded from the
diluted share calculation incremental shares of 1,634,101 and 2,045,335,
respectively, related to stock options and restricted stock as their effect
would have been antidilutive.

NOTE 8 - GOODWILL

On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, we no longer amortize goodwill to earnings, but
instead we periodically test for impairment. Due to the deterioration in JRM's
financial performance during the three months ended September 30, 2002 and our
revised expectations concerning JRM's future earnings and cash flow, we are
testing the goodwill of the Marine Construction Services segment for impairment
as of September 30, 2002. With the assistance of an independent consultant, we
have recently completed the first step of the goodwill impairment test and have
determined that the carrying amount including goodwill of the reporting unit,
JRM, exceeds its fair value. The fair value of JRM was estimated using a
discounted cash flow approach. The second step of the goodwill impairment test,
the measurement of the potential loss, is not yet complete. However, we have
concluded that it is probable that a goodwill impairment loss has occurred and
recorded an estimated impairment charge of $313 million, which is the total
amount of JRM's goodwill. We expect to complete the measurement of the
impairment loss prior to December 31, 2002 and will record any adjustment to the
estimated loss at that time.

Following is our reconciliation of reported net income to adjusted net income,
which excludes goodwill amortization expense (including related tax effects),
for the periods presented:

Changes in the carrying amount of goodwill for the nine months ended
September 30, 2002 are as follows:

NOTE 9 - THE BABCOCK & WILCOX COMPANY

General

As a result of asbestos-containing commercial boilers and other products B&W and
certain of its subsidiaries sold, installed or serviced in prior decades, B&W is
subject to a substantial volume of non-employee liability claims asserting
asbestos-related injuries. All of the personal injury claims are similar in
nature, the primary

25

difference being the type of alleged injury or illness suffered by the plaintiff
as a result of the exposure to asbestos fibers (e.g., mesothelioma, lung cancer,
other types of cancer, asbestosis or pleural changes).

On February 22, 2000, B&W and certain of its subsidiaries filed a voluntary
petition in the U.S. Bankruptcy Court for the Eastern District of Louisiana in
New Orleans (the "Bankruptcy Court") to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. Included in the filing are B&W and its subsidiaries Americon,
Inc., Babcock & Wilcox Construction Co., Inc. and Diamond Power International,
Inc. (collectively, the "Debtors"). The Debtors took this action as a means to
determine and comprehensively resolve all pending and future asbestos liability
claims against them. Following the filing, the Bankruptcy Court issued a
preliminary injunction prohibiting asbestos liability lawsuits and other actions
for which there is shared insurance from being brought against non-filing
affiliates of the Debtors, including MI, JRM and MII. The preliminary injunction
is subject to periodic hearings before the Bankruptcy Court for extension.
Currently, the preliminary injunction runs through January 14, 2003.

As discussed in Note 1, we wrote off our net investment in B&W in the quarter
ended June 30, 2002. The total impairment charge of $224.7 million included our
investment in B&W of $187.0 million and other related assets totaling $37.7
million, primarily consisting of accounts receivable from B&W, for which we
provided an allowance of $18.2 million.

The following sections outline significant information and events related to the
B&W Chapter 11 proceedings as well as the impact of developments in negotiations
with the ACC and FCR.

Insurance Coverage and Pending Claims

Prior to their bankruptcy filing, the Debtors had engaged in a strategy of
negotiating and settling asbestos personal injury claims brought against them
and billing the settled amounts to insurers for reimbursement. At September 30,
2002, receivables of $23.1 million were due from insurers for reimbursement of
settled claims paid by the Debtors prior to the Chapter 11 filing. Currently,
certain insurers are refusing to reimburse the Debtors for these receivables
until the Debtors' assumption, in bankruptcy, of their pre-bankruptcy filing
contractual reimbursement arrangements with such insurers. To date, this has not
had a material adverse impact on the Debtors' liquidity or the conduct of their
business and we do not expect it to in the future.

Pursuant to the Bankruptcy Court's order, a March 29, 2001 bar date was set for
the submission of allegedly unpaid pre-Chapter 11 settled asbestos claims and a
July 30, 2001 bar date for all other asbestos personal injury claims, asbestos
property damage claims, derivative asbestos claims and claims relating to
alleged nuclear liabilities arising from the operation of the Apollo/Parks
Township facilities against the Debtors. As of the March 29, 2001 bar date, over
49,000 allegedly settled claims had been filed. The Debtors have

26

accepted approximately 8,600 as pre-Chapter 11 binding settled claims at this
time with an approximate value of $66 million. The Bankruptcy Court has
disallowed approximately 28,000 claims as settled claims, and the Debtors are in
the process of challenging virtually all of the remaining claims. If the
Bankruptcy Court determines these claims were not settled prior to the filing of
the Chapter 11 petition, these claims may be refiled as unsettled personal
injury claims. As of July 30, 2001, approximately 220,000 additional asbestos
personal injury claims, 60,000 related party claims, 168 property damage claims,
212 derivative asbestos claims and 524 claims relating to the Apollo/Parks
Township facilities had been filed. Since the July 30, 2001 bar date,
approximately 12,363 additional personal injury claims were filed, including
approximately 1,700 claims originally filed as allegedly settled claims that
were disallowed by the Bankruptcy Court as settled claims and subsequently
refiled as unsettled personal injury claims. The estimated total alleged value,
as asserted by the claimants in the Chapter 11 proceeding and in filed proofs of
claim, of the asbestos-related claims, including the alleged settled claims,
exceeds the combined value of the Debtors and certain assets transferred by B&W
to its parent in a corporate reorganization completed in fiscal year 1999 and
the known available products liability and property damage insurance coverages.
As set forth in the proposed Litigation Protocol that the Debtors filed with the
U. S. District Court on October 18, 2001, the Debtors intend to challenge all
unsupported claims and believe that a significant number may be disallowed by
the Bankruptcy Court. The ACC and FCR filed briefs opposing the Litigation
Protocol and requesting an estimation of pending and future claims.

Settlement Negotiations

We are continuing our discussions with the ACC and FCR concerning a potential
settlement. As a result of those discussions, we reached an agreement in
principle in August 2002 with representatives of the ACC and FCR on several key
terms; however, a number of significant issues and numerous details remain to be
negotiated and resolved. The parties are currently working to address the
remaining unresolved issues and details in a joint plan of reorganization and
related settlement agreement. Should the remaining issues and details not be
negotiated and resolved to the mutual satisfaction of the parties, the parties
may be unable to resolve the B&W Chapter 11 proceedings through settlement.
Additionally, the potential settlement will be subject to various conditions,
including the requisite approval of the asbestos claimants, the Bankruptcy Court
confirmation of a plan of reorganization reflecting the settlement and approval
by MII's stockholders. The agreement in principle, as modified by subsequent
settlement discussions through the date of this report, includes the following
key terms:

o MII would assign all its equity in B&W to (1) one or more trusts
to be created for the benefit of the asbestos claimants and (2)
certain other claimants.

o MII and all its subsidiaries would assign, transfer or otherwise
make available their rights to all applicable insurance proceeds
to the trusts.

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o MII would issue 4.75 million shares of restricted common stock to
the trusts. The resale of the shares would be subject to certain
limitations, in order to provide for an orderly means of selling
the shares to the public. Certain sales by the trusts would also
be subject to an MII right of first refusal. If any of the shares
issued to the trusts are still held by the trusts after three
years, and to the extent those shares could not have been sold in
the market at a price greater than or equal to $19.00 per share
(based on quoted market prices), taking into account the
restrictions on sale and any waivers of those restrictions that
may be granted by MII from time to time, MII would effectively
guarantee that those shares would have a value of $19.00 per
share on the third anniversary of the date of their issuance. MII
would be able to satisfy this guaranty obligation by making a
cash payment or through the issuance of additional shares of its
common stock. If MII elects to issue shares to satisfy this
guaranty obligation, it would not be required to issue more than
12.5 million shares.

o MII or one of its domestic subsidiaries would issue promissory
notes to the trusts. In exchange for the forgiveness of certain
intercompany indebtedness owed to B&W and its subsidiaries, the
settlement discussions have resulted in an increase in the
aggregate principal amount of the notes from $85 million to $92
million and an extension of their final maturity from 10 to 11
years. The notes would be unsecured obligations and would provide
for payments of principal of $8.36 million per year to be payable
over 11 years, with interest payable on the outstanding balance
at the rate of 7.5% per year.

o MII and all its past and present directors, officers and
affiliates, including its captive insurers, would receive the
full benefit of Section 524(g) of the Bankruptcy Code with
respect to personal injury asbestos-related claims and would be
released and protected from all pending and future
asbestos-related claims stemming from B&W's operations, as well
as other claims (whether contract claims, tort claims or other
claims) of any kind relating to B&W, including but not limited to
claims relating to the 1998 corporate reorganization that has
been the subject of litigation in the Chapter 11 proceedings.

o The settlement would be conditioned on the approval by MII's
stockholders of the terms of the settlement outlined above.

As the settlement discussions proceed, we expect that some of the court
proceedings in or relating to the B&W Chapter 11 case will continue and that the
parties will continue to maintain their previously asserted positions. The
Bankruptcy Court has directed the parties to file a disclosure statement which
reflects the status of the negotiations by December 19, 2002. Following that
filing, the Bankruptcy Court may schedule further proceedings concerning this
matter. The process of finalizing and implementing the settlement could take up
to a year, depending on, among other things, the nature and extent of any
objections or appeals in the bankruptcy case.

28

Due to the preliminary nature of the agreement in principle and the various
requirements on which a settlement would be conditioned, including Bankruptcy
Court approval and the approval of MII's stockholders, the agreement in
principle will have no immediate impact on our earnings. When a final settlement
becomes probable, we estimate that we would record an after-tax charge against
earnings of between $100 million to $130 million, reflecting the present value
of our contributions and contemplated payments to the trusts as outlined above.
That charge would be in addition to the $220.9 million after-tax charge we
recorded in the quarter ended June 30, 2002 to write off our investment in B&W
and other related assets.

Despite our recent progress in our settlement discussions, there are continuing
risks and uncertainties that will remain with us until the requisite approvals
are obtained and the final settlement is reflected in a plan of reorganization
that is confirmed by the Bankruptcy Court pursuant to a final nonappealable
order of confirmation.

Remaining Issues to be Resolved

While the Chapter 11 reorganization proceedings continue to progress, there are
a number of issues and matters related to the Debtors' asbestos liability to be
resolved prior to their emergence from the proceedings. Remaining issues and
matters to be resolved include, but are not limited to:

o the ultimate asbestos liability of the Debtors;

o the outcome of negotiations with the ACC, the FCR and other
participants in the Chapter 11 proceedings, concerning, among
other things, the size and structure of one or more trusts to
satisfy the asbestos liability and the means for funding these
trusts;

o the outcome of negotiations with our insurers as to additional
amounts of coverage of the Debtors and their participation in a
plan to fund the settlement trusts;

o the Bankruptcy Court's decisions relating to numerous substantive
and procedural aspects of the Chapter 11 proceedings, including
the Bankruptcy Court's periodic determinations as to whether to
extend the existing preliminary injunction that prohibits
asbestos liability lawsuits and other actions for which there is
shared insurance from being brought against non-filing affiliates
of B&W, including MI, JRM and MII;

o the anticipated need for an extension of the three-year term of
the $300 million debtor-in-possession revolving credit and letter
of credit facility (the "DIP Credit Facility"), which is
currently scheduled to expire on February 21, 2003, to
accommodate the issuance of letters of credit expiring after that
date in connection with new construction and other contracts on
which the Debtors intend to bid;

29

o the continued ability of our insurers to reimburse B&W for
payments made to asbestos claimants; and

o the ultimate resolution of the appeals from the ruling issued by
the Bankruptcy Court on February 8, 2002, which found B&W solvent
at the time of a corporate reorganization completed in the fiscal
year ended March 31, 1999, and the related ruling issued on April
17, 2002 (collectively, the "Transfer Case"). See Note 5 for
further information.

B&W has provided $1.3 billion for asbestos products liability claims at
September 30, 2002. It is not possible to estimate the range of loss under the
strategy proposed in the Debtor's Amended Plan or the ACC/FCR Plan. However,
amounts claimed by the asbestos claimants are in a wide range and exceed the
value of B&W and certain assets transferred by B&W to its parent in the
corporate reorganization that is the subject of the Transfer Case and our known
available products liability and property damage insurance coverages.

Any changes in (1) the estimates of the Debtors' nonemployee asbestos liability
and insurance, (2) the differences between the proportion of those liabilities
covered by insurance and that experienced in the past and (3) the ultimate
resolution of the Transfer Case could result in material adjustments to B&W's
financial statements and negatively impact our ability to realize our net
investment in B&W, which we wrote off in the quarter ended June 30, 2002, and in
certain assets transferred by B&W to BWICO in the corporate reorganization. In
addition, any settlement involving MII could have a material adverse impact on
our consolidated financial position, results of operations and cash flow.

Debtor-In-Possession Financing

In connection with the bankruptcy filing, the Debtors entered into the DIP
Credit Facility with a group of lenders providing for a three-year term. The
Bankruptcy Court approved the full amount of this facility, giving all amounts
owed under the facility a super-priority administrative expense status in
bankruptcy. The Debtors' obligations under the facility are (1) guaranteed by
substantially all of B&W's other domestic subsidiaries and B&W Canada Ltd. and
(2) secured by a security interest on B&W Canada Ltd.'s assets. Additionally,
B&W and substantially all of its domestic subsidiaries granted a security
interest in their assets to the lenders under the DIP Credit Facility, effective
upon the defeasance or repayment of MI's public debt. The DIP Credit Facility
generally provides for borrowings by the Debtors for working capital and other
general corporate purposes and the issuance of letters of credit, except that
the total of all borrowings and non-performance letters of credit issued under
the facility cannot exceed $100 million in the aggregate. The DIP Credit
Facility also imposes certain financial and non-financial covenants on B&W and
its subsidiaries. There were no borrowings under this facility at September 30,
2002 or December 31, 2001. A permitted use of the DIP Credit Facility is the
issuance of new letters of credit to backstop or replace pre-existing letters of
credit issued in connection with B&W's and its subsidiaries' business
operations, but for which MII, MI or

30

BWICO was a maker or guarantor. As of February 22, 2000, the aggregate amount of
all such pre-existing letters of credit totaled approximately $172 million (the
"Pre-existing LCs"), $9.4 million of which remains outstanding at September 30,
2002. MII, MI and BWICO have agreed to indemnify and reimburse the Debtors for
any customer draw on any letter of credit issued under the DIP Credit Facility
to backstop or replace any Pre-existing LC for which they already have exposure
and for the associated letter of credit fees paid under the facility. As of
September 30, 2002, approximately $108.4 million in letters of credit has been
issued under the DIP Credit Facility of which approximately $54.1 million was to
replace or backstop Pre-existing LCs. We are finalizing documentation with the
agent bank under the DIP Credit Facility to implement a one-year extension of
the expiration date.

Financial Results and Reorganization Items

Summarized financial data for B&W is as follows:

INCOME STATEMENT INFORMATION

BALANCE SHEET INFORMATION

(1)Includes liabilities subject to compromise of approximately
$1.432 billion, which primarily result from asbestos-related
issues.

31

B&W's balance sheet information includes approximately $76 million of goodwill.
A significant increase in the estimated liability for asbestos claims and the
related resolution of those claims could result in the impairment of this
goodwill.

In the course of the conduct of B&W's and its subsidiaries' business, MII and MI
have agreed to indemnify two surety companies for B&W's and its subsidiaries'
obligations under surety bonds issued in connection with their customer
contracts. At September 30, 2002, the total value of B&W's and its subsidiaries'
customer contracts yet to be completed covered by such indemnity arrangements
was approximately $116.5 million, of which approximately $41.0 million relates
to bonds issued after February 21, 2000.

B&W's ability to continue as a going concern depends on its ability to settle
its ultimate asbestos liability from its net assets, future profits and cash
flow and available insurance proceeds, whether through the confirmation of a
plan of reorganization or otherwise. The B&W summarized financial information
set forth above has been prepared on a going concern basis, which contemplates
continuity of operations, realization of assets and liquidation of liabilities
in the ordinary course of business. As a result of the bankruptcy filing and
related events, there is no assurance that the carrying amounts of B&W's assets
will be realized or that B&W's liabilities will be liquidated or settled for the
amounts recorded. In addition, a rejection of the Debtors' Amended Plan or any
settlement agreement which may result in the transfer of a majority ownership
interest in B&W could result in material changes to the amounts reported in the
B&W financial statements. The independent accountant's report on the separate
consolidated financial statements of B&W for the years ended December 31, 2001
and 2000 includes an explanatory paragraph indicating that these issues raise
substantial doubt about B&W's ability to continue as a going concern.

NOTE 10 - LIQUIDITY

MI and JRM and their respective subsidiaries are limited, as a result of
covenants in our credit facilities and our MI public debt instruments, in their
ability to transfer funds to MII and its other subsidiaries through cash
dividends or through unsecured loans or investments. In addition, our ability to
obtain a successful and timely resolution to the B&W Chapter 11 filing has
impacted our ability to obtain additional financing. Other recent issues
impacting our liquidity include the following:

JRM Credit Facility

This facility is subject to certain financial and non-financial covenants. Based
on our most recent forecast, we expect JRM to experience negative cash flows
during the remainder of 2002 and the first three quarters of 2003, primarily due
to losses on the EPIC Spar contracts. As a result, we anticipate that JRM will
need to access borrowed funds beginning in the fourth quarter of 2002 in order
to meet its working capital requirements. If it makes these anticipated
borrowings in the fourth quarter of 2002, JRM will not comply with one of the
financial covenants set forth in the credit facility as of the end of the fourth
quarter of 2002.

In connection with borrowings or issuances of letters of credit under its
current credit facility, JRM is required to represent and warrant to its lenders
that there has been no material adverse change in the business, assets,
operations, prospects or condition, financial or otherwise, of JRM and its
subsidiaries, taken as a whole, since March 31, 1999. JRM has informed its
lenders of the losses on the Spars contracts and the other developments that led
us to record a $313.0 million impairment charge relating to JRM's goodwill (as
discussed in Note 8), as well as JRM's anticipated noncompliance with one of the
financial covenants set forth in the credit facility as discussed above. It is
possible that JRM's lenders could conclude that those and other adverse
developments have resulted in, or could reasonably be expected to result in, a
material adverse change or a material adverse effect. If they reach either of
those conclusions, JRM's lenders could limit or restrict JRM's access to future
borrowings or issuances of letters of credit under the facility, and JRM may be
required to secure or provide other support for its outstanding letters of
credit, which are currently in an aggregate face amount of approximately $85
million. If JRM's lenders determine that JRM has suffered a material adverse
change or material adverse effect, JRM and its lenders would have to resolve the
matter, through an amendment or waiver under the credit facility or otherwise,
or JRM would have to seek a replacement credit facility.

We are currently in discussions with the lenders under the JRM credit facility
regarding any necessary waivers and an extension of the facility prior to
February 21, 2003, the currently scheduled expiration date for the facility.
Although we can provide no assurance that the credit facility will be extended,
we believe we will be successful in obtaining an extension and that the
extension will resolve the current uncertainty concerning JRM's liquidity. In
the interim, as JRM continues its discussions with its lenders, JRM does not
believe that it has access to borrowings under its credit facility and JRM may
not have access to letters of credit. JRM intends to meet working capital and
other financing requirements with its available cash balances and intercompany
borrowings from MII, some of which may be funded through borrowings under the
separate credit facility maintained by MII and BWXT.

Our current credit rating has impacted our access to, and sources of capital,
and could result in additional collateral requirements for our debt obligations
if we are unsuccessful in extending or refinancing JRM's credit facility under
terms and conditions that are substantially similar to those that are currently
in place. In addition, our available financing alternatives may be limited. Any
substantial increase in projected cash outflows could have a material adverse
impact on JRM's ability to extend or refinance its credit facility. See Note 11
for a discussion of significant risks and uncertainties. If we are unable to
extend or refinance this credit facility, JRM's ability to pursue additional
projects, which often require letters of credit, and its liquidity will be
adversely impacted, and JRM may be required to secure or provide other support
for its outstanding letters of credit, which are currently in an aggregate face
amount of approximately $85 million. This would put significant additional
strain on our liquidity and could have a material adverse impact on our
financial position, results of operations and cash flows and could cause
substantial doubt about JRM's ability to continue as a going concern. Under
those circumstances, we would have to consider various alternatives.

The financial statements included in this report have been prepared on a going
concern basis, which contemplates continuity of operations, realization of
assets and liquidation of liabilities in the ordinary course of business. As a
result of the factors described in the two preceding paragraphs, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded.

32

MII Credit Facility

We expect MI to continue to experience negative cash flows during the remainder
of 2002, primarily due to tax payments on the exercise of MI's rights under an
Intercompany Agreement referred to below. MI expects to meet its cash needs
through short-term borrowings by BWXT under the credit facility, maintained by
MII and BWXT (or through liquidation of the investments that collateralize that
facility), the cash flow of BWXT, obtaining a loan from MII, a capital
contribution from MII or some combination of those sources. While we expect MI's
cash flow to improve in 2003, MI's lack of liquidity poses substantial risk in
the short term. Although our current projections indicate that MII should be
capable of mitigating MI's lack of liquidity, we can provide no assurance that
MII will be able to provide a loan to MI.

33

During the nine months ended September 30, 2002, MI repurchased or repaid the
remaining $208.8 million in aggregate principal amount of its 9.375% Notes due
March 15, 2002 for aggregate payments of $208.3 million, resulting in an
extraordinary net after-tax gain of $0.3 million. In order to repay the
remaining notes, MI exercised its right pursuant to a stock purchase and sale
agreement with MII (the "Intercompany Agreement"). Under this agreement, MI had
the right to sell to MII and MII had the right to buy from MI, 100,000 units,
each of which consisted of one share of MII common stock and one share of MII
Series A Participating Preferred Stock. MI held this financial asset since prior
to the 1982 reorganization transaction under which MII became the parent of MI.
The price was based on (1) MII's stockholders' equity at the close of the fiscal
year preceding the date on which the right to sell or buy, as the case may be,
was exercised and (2) the price-to-book value of the Dow Jones Industrial
Average. At January 1, 2002, the aggregate unit value of MI's right to sell all
of its 100,000 units to MII was approximately $243 million. MI received this
amount from the exercise of the Intercompany Agreement. MII funded that payment
by (1) receiving dividends of $80 million from JRM and $20 million from one of
our captive insurance companies and (2) reducing its short-term investments and
cash and cash equivalents. The proceeds paid to MI were subject to U.S. federal,
state and other applicable taxes, and we recorded a tax provision totaling
approximately $85.4 million at December 31, 2001. Through September 30, 2002, we
have paid approximately 75% of this amount in estimated tax payments. Payment of
the remaining amount will continue to put a strain on our liquidity.

NOTE 11 - RISKS AND UNCERTAINTIES

During 2002, our Marine Construction Services segment has experienced material
losses on its three EPIC Spar projects: Medusa, Devils Tower and Frontrunner.
These contracts are first-of-a-kind as well as long-term in nature. We have
experienced schedule delays and cost overruns on these contracts that have
adversely impacted our financial results. These projects continue to face
significant issues. The remaining challenge to completing Medusa within its
revised schedule and budget is the marine installation piece of the project. Our
revised schedule requires installation activities during the first quarter of
2003, typically a challenging time due to weather conditions. The major
challenge in completing Devils Tower within its revised budget is to remain on
track with the revised schedule due to significant liquidated damages that are
associated with the contract. At September 30, 2002, we have provided for our
estimated losses on these contracts. Although we continually strive to improve
our ability to estimate our contract costs and profitability associated with
these projects, it is reasonably possible that current estimates could change
and adjustments to overall contract costs may continue to be significant in
future periods.

NOTE 12 - SUBSEQUENT EVENT

On October 11, 2002, we sold Volund to B&W. The consideration received by MII
from B&W included a $3 million note and funding for the repayment of
approximately $14.5 million of principal and interest on a loan owed by Volund
to MII. The purchase price is subject to a possible downward adjustment,
depending