UNITED STATES SECURITIES AND EXCHANGE COMMISSION

F O R M 1 0 - K

(Mark One)

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

o 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 001-08430

McDERMOTT INTERNATIONAL, INC.

Registrant’s Telephone Number, Including Area Code (504) 587-5400

Securities Registered Pursuant to Section 12(b) of the Act:

     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 þ NO o

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. þ

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). YES þ NO o

The aggregate market value of the registrant’s common stock held by nonaffiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 30, 2004), was approximately $666,737,645.

The number of shares of the registrant’s common stock outstanding at January 31, 2005 was 67,456,902.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s 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 registrant’s 2005 Annual Meeting of Stockholders are incorporated by reference into Part III of this report.

McDERMOTT INTERNATIONAL, INC.

INDEX - FORM 10-K

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INDEX - FORM 10-K

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Statements we make in this Annual Report on Form 10-K which express a belief, expectation or intention, as well as those that are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various risks, uncertainties and assumptions, including those to which we refer under the headings “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements” in Items 1 and 2 of Part I of this report.

P A R T   I

I t e m s   1. a n d   2. B U S I N E S S   A N D   P R O P E R T I E S

A. G E N E R A L

     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., a Panamanian subsidiary of MII (“JRM”), and its consolidated subsidiaries;
	•	McDermott Incorporated, a Delaware subsidiary of MII (“MI”), and its consolidated subsidiaries;
	•	Babcock & Wilcox Investment Company, a Delaware subsidiary of MI (“BWICO”);
	•	BWX Technologies, Inc., a Delaware subsidiary of BWICO (“BWXT”), and its consolidated subsidiaries; and
	•	The Babcock & Wilcox Company, an unconsolidated Delaware subsidiary of BWICO (“B&W”), and its consolidated subsidiaries.

     In this Annual Report on Form 10-K, unless the context otherwise indicates, “we,” “us” and “our” mean MII and its consolidated subsidiaries.

     On February 22, 2000, B&W and certain of its subsidiaries (collectively, the “Debtors”) 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. The Debtors took this action as a means to determine and comprehensively resolve their asbestos liability. B&W’s operations have been subject to the jurisdiction of the Bankruptcy Court since February 22, 2000 and, as a result, our access to cash flows of B&W and its subsidiaries is restricted. The B&W Chapter 11 proceedings require a significant amount of management’s attention, and they represent an uncertainty in the financial marketplace. See Section I, Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and Note 20 to our consolidated financial statements included in this report for further information concerning the effects of the Chapter 11 filing.

     Due to the B&W Chapter 11 filing, on February 22, 2000, we stopped consolidating the results of operations of B&W and its subsidiaries in our consolidated financial statements and we began presenting our investment in B&W on the cost method. During the year ended December 31, 2002, due 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, we wrote off our net investment in B&W. 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. On December 19, 2002, drafts of a joint plan of reorganization and settlement agreement, together with a draft of a related disclosure statement, were filed in the Chapter 11 proceedings, and we determined that a liability related to the proposed settlement was probable and that the value was reasonably estimable. Accordingly, as of December 31, 2002, we established an estimate for the cost of the settlement of the B&W Chapter 11 proceedings of $110.0 million, including related tax expense of $23.6 million. We revalue this estimate on a quarterly basis to reflect current conditions. For the years ended December 31, 2004 and 2003, the revaluation of the estimated cost of the settlement resulted in an aggregate increase in the provision of $11.9 million and $18.0 million, respectively. The increase in the provision includes associated tax expense of $0.7 million and $3.4 million for the years ended December 31, 2004 and 2003, respectively. The proposed settlement contemplates, among other things, the issuance of shares of our common stock to an asbestos personal injury settlement trust, and the increase in the provision for the cost of the proposed settlement is primarily due to an increase in our stock price. As of December 31, 2004, our estimate for the cost of the proposed settlement is $140.0 million.

     At a special meeting of our shareholders on December 17, 2003, our shareholders voted on and approved a resolution relating to the proposed agreement. The shareholders’ approval of the resolution is conditioned on the subsequent approval of the proposed settlement by MII’s Board of Directors (the “Board”). We would become

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bound to the settlement only when the plan of reorganization becomes effective, and the plan of reorganization cannot become effective without the approval of the Board within 30 days prior to the effective time of the plan. The Board’s decision will be made after consideration of any developments that might occur prior to the effective date, including any changes in the status of any potential federal legislation concerning asbestos liabilities, including “The Fairness in Asbestos Injury Resolution (FAIR) Act of 2005.” See Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and Note 20 to our consolidated financial statements included in this report for information regarding developments in the B&W Chapter 11 proceedings and a summary of the components of the proposed settlement.

     We operate in three business segments:

	•	Marine Construction Services includes the results of operations of JRM and its subsidiaries, which supply services to offshore oil and gas field developments worldwide. This segment’s principal activities include the front-end and detailed engineering, fabrication and installation of offshore drilling and production facilities and installation of marine pipelines and subsea production systems. This segment operates in most major offshore oil and gas producing regions throughout the world, including the U.S. Gulf of Mexico, Mexico, South America, the Middle East, India, the Caspian Sea and Asia Pacific. See Section I, Risk Factors, and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
	•	Government Operations includes the results of operations of BWXT and its subsidiaries. This segment supplies nuclear components to the U.S. Government and provides various services to the U.S. Government, including uranium processing, environmental site restoration services and management and operating services for various U.S. Government-owned facilities, primarily within the nuclear weapons complex of the U.S. Department of Energy (“DOE”). Government Operations also includes the results of McDermott Technology, Inc. (“MTI”).
	•	Power Generation Systems includes the results of operations of our Power Generation Group, which is conducted primarily through B&W and its subsidiaries. This segment provides a variety of services, equipment and systems to generate steam and electric power at energy facilities worldwide. Due to the B&W Chapter 11 filing, effective February 22, 2000, we no longer consolidate B&W’s and its subsidiaries’ results of operations in our consolidated financial statements. Amounts reported for this segment reflect the results of operations of subsidiaries not owned by B&W. See Note 20 to our consolidated financial statements included in this report for information on the condensed consolidated results of B&W and its subsidiaries.

     The following tables summarize our revenues and operating income by business segment for the years ended December 31, 2004, 2003 and 2002. See Note 17 to our consolidated financial statements included in this report for additional information about our business segments and operations in different geographic areas.

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B. M A R I N E   C O N S T R U C T I O N   S E R V I C ES

General

     The Marine Construction Services segment’s business involves the front-end and detailed engineering, fabrication and installation of offshore drilling and production facilities and installation of marine pipelines and subsea production systems. This segment also provides comprehensive project management and procurement services. This segment operates in most major offshore oil and gas producing regions throughout the world, including the U.S. Gulf of Mexico, Mexico, South America, the Middle East, India, the Caspian Sea and Asia Pacific.

     See Section I, Risk Factors, and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for information on significant losses incurred by JRM in prior years.

Marine Construction Vessels and Properties

     We operate a large fleet of marine vessels used in major offshore construction. The nucleus of a “marine 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. We currently own or, through our ownership interests in joint ventures, operate two derrick vessels, one pipelaying vessel and nine combination derrick-pipelaying vessels. We also operate a pipelay vessel for a subdivision of the state-owned oil company of Azerbaijan. The lifting capacities of our derrick and combination derrick-pipelaying vessels range from 600 to 4,400 tons. These vessels range in length from 350 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 equipment. Six of the vessels are self-propelled, with two also having dynamic positioning systems. We also have a substantial inventory of specialized support equipment for intermediate water and deepwater construction and pipelay. In

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addition, we own or lease a substantial number of other vessels, such as tugboats, utility boats, launch barges and cargo barges, to support the operations of our major marine construction vessels.

     The following table sets forth certain information with respect to the major marine construction vessels utilized to conduct our Marine Construction Services business, including their location at December 31, 2004 (except where otherwise noted, each of the vessels is owned and operated by us):

     Governmental regulations, our insurance policies and some of our financing arrangements require us to maintain our vessels in accordance with standards of seaworthiness and safety set by governmental authorities or classification societies. We maintain our fleet to the standards for seaworthiness, safety and health set by the American Bureau of Shipping, Den Norske Veritas and other world-recognized classification societies.

     Our principal fabrication facilities are located near Morgan City, Louisiana, in Indonesia on Batam Island and in Dubai, U.A.E. In addition, we operate, through a 95% interest in a consolidated subsidiary, a ship repair facility in Veracruz, Mexico, which we have used as a fabrication facility from time to time. We also operate a portion of the Baku Deepwater Jacket Factory fabrication facility in Baku, Azerbaijan. The Baku Deepwater Jacket Factory facility is a wholly owned subsidiary of the State Oil Company of the Azerbaijan Republic. Our 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. We fabricate a full range of offshore structures, from conventional jacket-type fixed platforms to intermediate water and deepwater platform configurations employing Spar, compliant-tower and tension leg technologies, as well as floating, production, storage and offtake (“FPSO”) technology.

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     Expiration dates, including renewal options, of leases covering land for JRM’s fabrication facilities at December 31, 2004 were as follows:

     As a result of renewal options on the various tracts comprising the Morgan City fabrication facility, we have the ability, within our sole discretion, to continue leasing almost all the land we are currently using for that facility until 2048.

Foreign Operations

     JRM’s revenues, net of intersegment revenues, and its segment income (loss) derived from operations located outside of the United States, as well as the approximate percentages to our total consolidated revenues and total consolidated segment income (loss), respectively, for each of the last three years were as follows:

     We participate in joint ventures involving operations in foreign countries that sometimes require majority ownership by local interests. One of our joint ventures, Construcciones Maritimas Mexicanas, S.A. de C.V., is a Mexican joint venture which provides marine installation services for Pemex in the Gulf of Mexico, in which we own a 49% interest.

Raw Materials

     Our Marine Construction Services segment uses raw materials, such as carbon and alloy steels in various forms, welding gases, paint, fuels and lubricants, which are available from many sources. JRM does not depend on any single supplier or source for any of these materials. Although shortages of some of these materials and fuels have existed from time to time, no material shortage currently exists. However, steel prices are volatile and increasing and deliveries are less than orderly, indicating that shortages may occur in the near future.

Competition

     We believe we are among the few marine construction contractors capable of providing the full range of services in major offshore oil and gas producing regions of the world. We believe that the substantial capital costs involved in becoming a full-service marine construction contractor create a significant barrier to entry into the market as a global, fully integrated competitor. We do, however, face substantial competition from regional competitors and less integrated providers of marine construction services, such as engineering firms, fabrication facilities, pipelaying companies and shipbuilders.

     A number of companies compete with us in each of the separate marine pipelay and construction and fabrication phases in various parts of the world. These competitors include Allseas Marine Contractors S.A., Daewoo Engineering & Construction Co., Ltd., Global Industries Ltd., NPCC (Abu Dhabi), Heerema Group, Hyundai Heavy Industrial Co., Ltd., Kiewit Offshore Services, Ltd., Nippon Steel Corporation, Saipem S.p.A., Stolt Offshore S.A. and Technip S.A. Contracts are usually awarded on a competitive bid basis. Although we believe customers consider, among other things, the availability and technical capabilities of equipment and personnel, efficiency, condition of equipment, safety record and reputation, price competition is normally the primary factor in determining which qualified contractor with available equipment is awarded a contract. Major marine construction vessels have few alternative uses and, because of their nature and the environment in which they work, have

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relatively high maintenance costs whether or not they are operating. See discussion in Risk Factors for additional information on the competitive nature of our Marine Construction Services segment.

Customers

     JRM’s customers are primarily oil and gas companies, including several foreign government-owned companies. JRM’s five largest customers during 2004 were Azerbaijan International Operating Company, BP Plc and its subsidiaries, Ras Laffan Liquified Natural Gas Company Limited, Murphy Oil Corporation and PT Brown and Root Indonesia which accounted for 22.1%, 14.3%, 6.6%, 5.8% and 2.9% of our total consolidated revenues, respectively. JRM’s five largest customers during 2003, BP plc, Azerbaijan International Operating Company, Ras Laffan Liquified Natural Gas Company Limited, Murphy Oil Corporation, and Dominion Resources, Inc., accounted for 13.0%, 11.2%, 7.7%, 7.0% and 6.7% of our total consolidated revenues, respectively.

     In 2001, we entered into a contract with a unit of BP Plc for the exclusive use of our Morgan City, Louisiana fabrication facility for a period of approximately three years to perform fabrication of topsides facilities for four new major deepwater hubs for the Gulf of Mexico: Holstein, Thunder Horse, Mad Dog and Atlantis. Historically, this arrangement has been cost-plus, but it was reduced to an hourly rate in 2004. We expect the agreement to expire in 2005.

     The level of engineering and construction services required by any one customer depends upon the amount of that customer’s capital expenditure budget for offshore marine construction services any single year. Consequently, customers that account for a significant portion of revenues in one year may represent an immaterial portion of revenues in subsequent years.

Contracts

     We have historically performed work on a fixed-price, cost-plus or day-rate basis or a combination of these methods. Most of our long-term contracts have provisions for progress payments.

     We recognize our contract revenues and related costs on a percentage-of-completion basis. Accordingly, we review contract price and cost estimates periodically as the work progresses and reflect adjustments in income proportionate to the percentage of completion in the period when we revise those estimates. To the extent that these adjustments result in a reduction or an elimination of previously reported profits with respect to a project, we would recognize a charge against current earnings, which could be material.

     We attempt to cover anticipated increases in costs of labor, material and service costs of our long-term contracts, either through an estimate of such charges, which is reflected in the original price, or through price escalation clauses. However, for certain projects we have been unable to accurately forecast total cost to complete until we have performed all major phases of the project. Our experience on these long-term contracts has shown that revenue, cost and gross profit realized on fixed-price contracts will often vary from the original and subsequently estimated amounts because of changes in job conditions and variations in labor and equipment productivity over the term of the contract. We may experience reduced profitability or losses on projects as a result of these variations and the risks inherent in the marine construction industry, including, but not limited to, operating in foreign countries, adverse weather conditions, mechanical failures and pollution or other environmental mishaps.

     Our arrangements with customers frequently require us to provide letters of credit or bid and performance bonds to secure bids or performance under contracts for marine construction services. While these letters of credit and bonds may involve significant dollar amounts, historically there have been no material payments to our customers under these arrangements. These arrangements are typical in the industry for projects outside the U.S. Gulf of Mexico.

Backlog

     As of December 31, 2004 and 2003, our Marine Construction Services segment’s backlog amounted to approximately $1.2 billion and $1.4 billion, respectively. This represents approximately 42% and 44% of our total

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consolidated backlog at December 31, 2004 and 2003, respectively. Of the December 31, 2004 backlog, we expect to recognize approximately $900 million in revenues in 2005 and $300 million in 2006.

     While fabrication projects are typically awarded substantially in advance of performance as a result of the required lead time for procurement, the marine construction industry is highly seasonal in some geographic regions. Because of the more conducive weather conditions, most installation operations are conducted in the warmer months of the year in those areas, and many of these contracts are awarded with only a short period of time before the desired time of project performance. Projects in our backlog may be cancelled by customers. Significant or numerous cancellations could adversely affect our business, financial condition and results of operations.

Factors Affecting Demand

     Our Marine Construction Services segment’s activity depends mainly on the capital expenditures for offshore marine construction services of oil and gas companies and foreign governments for construction of development projects. Numerous factors influence these expenditures, including:

	•	oil and gas prices, along with expectations about future prices;
	•	the cost of exploring for, producing and delivering oil and gas;
	•	the terms and conditions of offshore leases;
	•	the discovery rates of new oil and gas reserves in offshore areas;
	•	the ability of businesses in the oil and gas industry to raise capital; and
	•	local and international political and economic conditions.

     See Section I for further information on factors affecting demand.

C.   G O V E R N M E N T    O P E R A T I O N S

General

     Our Government Operations segment provides nuclear components and various services to the U.S. Government. Examples of this segment’s activities include environmental restoration services and the management of government-owned facilities, primarily within the nuclear weapons complex of the DOE.

     This segment’s principal plants are located in Lynchburg, Virginia; Barberton, Ohio; and Mount Vernon, Indiana. BWXT conducts all the operations of our Government Operations segment.

Raw Materials

     Our Government Operations segment relies on certain single source suppliers for materials used in its products. We believe these suppliers are viable, and we and the U.S. Government expend significant effort to maintain the supplier base.

Customers and Competition

     Our Government Operations segment supplies nuclear components for the U.S. Government. There are a limited number of suppliers of specialty nuclear components, with BWXT being the largest based on revenues. Through the operations of this segment, we are also involved along with other companies in the operation of:

	•	the Idaho National Laboratory near Idaho Falls, Idaho;
	•	the Rocky Flats Environmental Technology Site near Boulder, Colorado;
	•	the Savannah River Site in Aiken, South Carolina;
	•	the Strategic Petroleum Reserve in Louisiana and Texas;
	•	the Pantex Site in Amarillo, Texas;
	•	the Oak Ridge National Lab Site (the “Y-12” facility) in Oak Ridge, Tennessee; and
	•	the Miamisburg Closure Project in Miamisburg, Ohio.

     Our competition in the operation of these facilities include Bechtel National Inc., Washington Group International, CH2M Hill, Inc, Fluor Corporation and Nuclear Fuel Services, Inc.

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     All of these contracts are subject to annual funding determinations by the U.S. Government.

     The U.S. Government accounted for approximately 27%, 21% and 29% of our total consolidated revenues for the years ended December 31, 2004, 2003 and 2002, respectively, including 26%, 20% and 22%, respectively, related to nuclear components.

Backlog

     At December 31, 2004 and 2003, our Government Operations segment’s backlog amounted to $1.7 billion and $1.8 billion, or approximately 58% and 56%, respectively, of our total consolidated backlog. Of the December 31, 2004 backlog in this segment, we expect to recognize revenues of approximately $500 million in 2005, $400 million in 2006 and $800 million thereafter, of which we expect to recognize approximately 58% in 2006 through 2008. At December 31, 2004, this segment’s backlog with the U.S. Government was $1.7 billion (of which $1.1 million had not yet been funded), or approximately 57% of our total consolidated backlog. During the year ended December 31, 2004, the U.S. Government awarded this segment new orders of approximately $417.0 million.

Factors Affecting Demand

     Our Government Operations segment’s operations are generally capital-intensive on the manufacturing side. This segment may be impacted by U.S. Government budget restraints and delays.

     The demand for nuclear components for the U.S. Government comprises a substantial portion of this segment’s backlog. We expect that orders for nuclear components will continue to be a significant part of backlog for the foreseeable future, however such orders are subject to defense department budget constraints.

     See Section I for further information on factors affecting demand.

D.   P A T E N T S   AND   L I C E N S E S

     We currently hold a large number of U.S. and foreign patents and have numerous pending patent applications. We have acquired patents and licenses and granted licenses to others when we have considered it advantageous for us to do so. Although in the aggregate our patents and licenses are important to us, we do not regard any single patent or license or group of related patents or licenses as critical or essential to our business as a whole. In general, we depend on our technological capabilities and the application of know-how rather than patents and licenses in the conduct of our various businesses.

E.   R E S E A R C H   AND   D E V E L O P M E N T   A C T I V I T I E S

     We conduct our principal research and development activities through individual business units at our various manufacturing plants and engineering and design offices. Our research and development activities cost approximately $29.7 million, $39.8 million and $61.6 million in the years ended December 31, 2004, 2003 and 2002, respectively. Contractual arrangements for customer-sponsored research and development can vary on a case-by-case basis and include contracts, cooperative agreements and grants. Of our total research and development expenses, our customers paid for approximately $25.1 million, $34.9 million and $47.8 million in the years ended December 31, 2004, 2003 and 2002, respectively.

F.   I N S U R A N C E

     We maintain liability and property insurance in amounts we consider adequate for those risks we consider necessary. Some risks are not insurable or insurance to cover them is available only at rates that we consider uneconomical. These risks include war and confiscation of property in some areas of the world, pollution liability in excess of relatively low limits and asbestos liability. Depending on competitive conditions and other factors, we endeavor to obtain contractual protection against uninsured risks from our customers. Insurance or contractual indemnity protection, when obtained, may not be sufficient or effective under all circumstances or against all hazards to which we may be subject.

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     Our insurance policies do not insure against liability and property damage losses resulting from nuclear accidents at reactor facilities of our utility customers. To protect against liability for damage to a customer’s property, we endeavor to obtain waivers of subrogation from the customer and its insurer and are usually named as an additional insured under the utility customer’s nuclear property policy. To protect against liability from claims brought by third parties, we are insured under the utility customer’s nuclear liability policies and have the benefit of the indemnity and limitation of any applicable liability provision of the Price-Anderson Act. The Price-Anderson 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 we provide environmental remediation services, we seek the same protection from our customers as we do for our other nuclear activities. The Price-Anderson Act, as amended, includes a sunset provision and requires renewal each time that it expires. Contracts that were entered into during a period of time that Price-Anderson was in full force and effect continue to receive the benefit of the Price-Anderson Act nuclear indemnity. The Price-Anderson Act last expired on December 31, 2004, but was extended for an additional two years through December 31, 2006. BWXT currently has no contracts involving nuclear materials that are not covered by and subject to the nuclear indemnity of the Price-Anderson Act.

     Although we do not own or operate any nuclear reactors, we have coverage under commercially available nuclear liability and property insurance for three of our four locations that are licensed to possess special nuclear materials. The fourth location operated 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 facilities are located at our 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, which we sold during the fiscal year ended March 31, 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, the two facilities in Lynchburg have statutory indemnity and limitation of liability under the Price-Anderson Act. In addition, our contracts to manufacture and supply nuclear components to the U.S. Government contain statutory indemnity clauses under which the U.S. Government has assumed the risks of public liability claims related to nuclear incidents.

     BWXT, through two of its dedicated limited liability companies, has management and operating agreements with the U.S. Government for the Pantex and Y-12 facilities. Most insurable liabilities arising from these sites are not protected in our corporate insurance program but rely on government contractual agreements and certain specialized self-insurance programs funded by the U.S. Government. The U.S. Government has historically fulfilled its contractual agreement to reimburse for insurable claims, and we expect it to continue this process during our administration of these two facilities. However, in most of these situations in which the U. S. Government is contractually obligated to pay, the payment obligation is subject to the availability of authorized government funds.

     JRM’s offshore construction business is subject to the usual risks of operations at sea, including accidents resulting in the loss of life or property, pollution or other environmental mishaps, adverse weather conditions, mechanical failures, collisions, property losses to our vessels, business interruption due to political action in foreign countries, and labor stoppages. 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 that could result in the escape of oil and gas into the sea. Litigation arising from any such event may result in our being named as a defendant in lawsuits asserting large claims. Depending on competitive conditions and other factors, we have endeavored to obtain contractual protection against uninsured risks from our customers. When obtained, such contractual indemnification protection may not in all cases be supported by adequate insurance maintained by the customer. These contractual protections are not available in all cases. In addition, in recent years, we have been named as a defendant in litigation concerning exposure to lead-based paint, silica, asbestos and welding rod fumes. While we are vigorously defending these claims, it is possible that existing insurance will not be sufficient to cover all potential exposure should these proceedings result in an adverse decision for us. See Note 10 to our consolidated financial statements included in this report for additional information on these issues.

     As a result of the asbestos contained in 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 nonemployee liability claims

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asserting asbestos-related injuries. The vast majority of these claims relate to exposure to asbestos occurring prior to 1977, the year in which the U.S. Occupational Safety and Health Administration adopted new regulations that impose liability on employers for, among other things, job-site exposure to asbestos.

     B&W received its first asbestos claims in 1983. Initially, B&W’s primary insurance carrier, a unit of Travelers Group, handled the claims. B&W exhausted the limits of its primary products liability insurance coverage in 1989. Prior to its Chapter 11 filing, B&W had been handling the claims under a claims-handling program funded primarily by reimbursements from its excess-coverage insurance carriers. B&W’s excess coverage available for asbestos-related products liability claims runs from 1949 through March 1986. This coverage has been provided by a total of 136 insurance companies. B&W obtained varying amounts of excess-coverage insurance for each year within that period, and within each year there are typically several increments of coverage. For each of those increments, a syndicate of insurance companies has provided the coverage.

     B&W had agreements with the majority of its excess-coverage insurers concerning the method of allocating products liability asbestos claim payments to the years of coverage under the applicable policies. See Note 20 to our consolidated financial statements included in this report for information regarding B&W’s Chapter 11 filing and liability for nonemployee asbestos claims.

     We have several wholly owned insurance subsidiaries that provide general and automotive liability insurance and, from time-to-time, builder’s risk within certain limits, marine hull and workers’ compensation insurance to our companies. These insurance subsidiaries have not provided significant amounts of insurance to unrelated parties. These captive insurers provide certain coverages for our subsidiary entities and related coverages. Claims as a result of our operations, or arising in the B&W Chapter 11 proceedings, could adversely impact the ability of these captive insurers to respond to all claims presented, although we believe such a result is unlikely.

     As a result of the impact of the September 11, 2001 terrorist attacks, we have experienced higher costs, higher deductibles and more restrictive terms and conditions as we have renewed our insurance coverage. Specifically, several of our insurance programs, including property, onshore builder’s risk and others, now contain exclusions that were not previously applicable, including war and acts of terrorism. This issue has been impacted by the Terrorism Risk Insurance Act, although at this point insurers are quite divergent in the prices and coverage they are offering. We expect to continue to maintain coverage that we consider adequate at rates that we consider economical. However, some previously insured risks may no longer be insurable or insurance to cover them will be available only at rates that we consider uneconomical.

G.   E M P L O Y E E S

     At December 31, 2004, we employed approximately 12,500 persons compared with 16,000 at December 31, 2003. Approximately 1,900 of our employees were members of labor unions at December 31, 2004, compared with approximately 5,000 at December 31, 2003. Many of our operations are subject to union contracts, which we customarily renew periodically. Currently, we consider our relationship with our employees to be satisfactory.

H.   G O V E R N M E N T A L    R E G U L A T I O N S    AND   E N V I R O N M E N T A L   M A T T E R S

General

     Many aspects of our operations and properties are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to:

	•	construction and equipping of offshore production platforms and other marine facilities;
	•	constructing and equipping electric power and other industrial facilities;
	•	possessing and processing special nuclear materials;
	•	marine vessel safety;
	•	workplace health and safety;
	•	currency conversions and repatriation;
	•	taxation of foreign earnings and earnings of expatriate personnel; and
	•	protecting the environment.

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     In addition, we depend on the demand for our marine construction services from the oil and gas industry and, therefore, are affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry generally. The adoption of laws and regulations curtailing offshore exploration and development drilling for oil and gas for economic and other policy reasons would adversely affect our operations by limiting demand for our services.

     We are required by various other governmental and quasi-governmental agencies to obtain certain permits, licenses and certificates with respect to our operations. The kinds of permits, licenses and certificates required in our operations depend upon a number of factors.

     The exploration and development of oil and gas properties on the continental shelf of the United States is regulated primarily under the U.S. Outer Continental Shelf Lands Act and regulations promulgated thereunder. These laws require the construction, operation and removal of offshore production facilities located on the outer continental shelf of the United States to meet stringent engineering and construction specifications. Similar regulations govern the plugging and abandoning of wells located on the outer continental shelf of the United States and the removal of all production facilities. Violations of regulations issued pursuant to the U.S. Outer Continental Shelf Lands Act and related laws can result in substantial civil and criminal penalties as well as injunctions curtailing operations.

     We cannot determine the extent to which new legislation, new regulations or changes in existing laws or regulations may affect our future operations.

Environmental

     Our operations and properties are subject to a wide variety of increasingly complex and stringent foreign, federal, state and local environmental laws and regulations, including those governing discharges into the air and water, the handling and disposal of solid and hazardous wastes, the remediation of soil and groundwater contaminated by hazardous substances and the health and safety of employees. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties and criminal prosecution. Some environmental laws provide for strict, joint and several liability for remediation of spills and other releases of hazardous substances, as well as damage to natural resources. In addition, companies may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances. Such laws and regulations may also expose us to liability for the conduct of or conditions caused by others, or for our acts that were in compliance with all applicable laws at the time such acts were performed.

     These laws and regulations include the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (“CERCLA”), the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act and similar laws that provide for responses to, and liability for, releases of hazardous substances into the environment. These laws and regulations also include similar foreign, state or local counterparts to these federal laws, which regulate air emissions, water discharges, hazardous substances and waste, and require public disclosure related to the use of various hazardous substances. Our operations are also governed by laws and regulations relating to workplace safety and worker health, primarily, in the United States, the Occupational Safety and Health Act and regulations promulgated thereunder.

     We are currently in the process of investigating and remediating some of our former operating sites. Although we have recorded reserves in connection with certain of these matters, due to the uncertainties associated with environmental remediation, we cannot assure you that the actual costs resulting from these remediation matters will not exceed the recorded reserves.

     Our compliance with U.S. federal, state and local environmental control and protection regulations resulted in pretax charges of approximately $11.4 million in the year ended December 31, 2004. In addition, compliance with existing environmental regulations necessitated capital expenditures of $0.6 million in the year ended December 31, 2004. We expect to spend another $2.3 million on such capital expenditures over the next five years. We cannot predict all of the environmental requirements or circumstances that will exist in the future but anticipate that environmental control and protection standards will become increasingly stringent and costly. Based on our experience to date, we do not currently anticipate any material adverse effect on our business or consolidated

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financial position as a result of future compliance with existing environmental laws and regulations. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures by us, which may be material. Accordingly, there can be no assurance that we will not incur significant environmental compliance costs in the future.

     In addition, offshore construction and drilling in some areas have been opposed by environmental groups and, in some areas, have been restricted. To the extent laws are enacted or other governmental actions are taken that prohibit or restrict offshore construction and drilling or impose environmental protection requirements that result in increased costs to the oil and gas industry in general and the offshore construction industry in particular, our business and prospects could be adversely affected.

     We have been identified as a potentially responsible party at various cleanup sites under CERCLA. CERCLA and other environmental laws can impose liability for the entire cost of cleanup on any of the potentially responsible parties, regardless of fault or the lawfulness of the original conduct. Generally, however, where there are multiple responsible parties, a final allocation of costs is made based on the amount and type of wastes disposed of by each party and the number of financially viable parties, although this may not be the case with respect to any particular site. We have not been determined to be a major contributor of wastes to any of these sites. On the basis of our relative contribution of waste to each site, we expect our share of the ultimate liability for the various sites will not have a material adverse effect on our consolidated financial position, results of operations or liquidity in any given year.

     Environmental remediation projects have been and continue to be undertaken at certain of our current and former plant sites. During the fiscal year ended March 31, 1995, we decided to close B&W’s nuclear manufacturing facilities in Parks Township, Armstrong County, Pennsylvania (the “Parks Facilities”), and B&W proceeded to decommission the facilities in accordance with its existing license from the Nuclear Regulatory Commission (the “NRC”). B&W subsequently transferred the facilities to BWXT in the fiscal year ended March 31, 1998. During the fiscal year ended March 31, 1999, BWXT reached an agreement with the NRC on a plan that provides for the completion of facilities dismantlement and soil restoration by 2001 and license termination in 2003. BWXT filed its application to terminate the NRC license for the Parks Township facility and the NRC terminated the license in 2004 and released the facility for unrestricted use. At December 31, 2004, the remaining provision for the decontamination, decommissioning and closing of these facilities was $0.3 million. For a discussion of certain civil litigation we are involved in concerning the Parks Facilities, see Note 10 to our consolidated financial statements included in this report.

     The Department of Environmental Protection of the Commonwealth of Pennsylvania (“PADEP”) advised B&W in March 1994 that it would seek monetary sanctions and remedial and monitoring relief related to the Parks Facilities. The relief sought related to potential groundwater contamination resulting from previous operations at the facilities. BWXT now owns these facilities. PADEP has advised BWXT that it does not intend to assess any monetary sanctions, provided that BWXT continues its remediation program for the Parks Facilities. Whether additional nonradiation contamination remediation will be required at the Parks facility remains unclear. BWXT has performed a risk assessment that indicates that no additional work is necessary for non-radiation contamination of the Parks facility. We expect to meet with representatives of the PADEP in March 2005 to review the risk assessment and to discuss whether additional work will be required.

     We perform significant amounts of work for the U.S. Government under both prime contracts and subcontracts and operate certain facilities that are licensed to possess and process special nuclear materials. As a result of these activities, we are subject to continuing reviews by governmental agencies, including the Environmental Protection Agency and the NRC.

     The NRC’s decommissioning regulations require BWXT and MTI to provide financial assurance that they will be able to pay the expected cost of decommissioning their facilities at the end of their service lives. BWXT and MTI will continue to provide financial assurance aggregating $25.5 million during the year ending December 31, 2005 with existing letters of credit for the ultimate decommissioning of all their 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 DOE.

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     An agreement between the NRC and the State of Ohio to transfer regulatory authority for MTI’s NRC licenses for by-product and source nuclear material was finalized in December 1999. In conjunction with the transfer of this regulatory authority and upon notification by the NRC, MTI issued decommissioning financial assurance instruments naming the State of Ohio as the beneficiary.

     At December 31, 2004 and 2003, we had total environmental reserves (including provisions for the facilities discussed above) of $15.3 million and $17.0 million, respectively. Of our total environmental reserves at December 31, 2004 and 2003, $6.8 million and $9.0 million, respectively, were included in current liabilities. Our estimated recoveries of these costs totaling $0.2 million are included in accounts receivable – other in our consolidated balance sheet at December 31, 2004 and 2003. Inherent in the estimates of those reserves and recoveries are our expectations regarding the 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 material adjustments to our operating results, and the ultimate loss may differ materially from the amounts we have provided for in our consolidated financial statements.

I.   R I S K    F A C T O R S

If we are unable to finalize a settlement in the B&W Chapter 11 proceedings, including obtaining the requisite approvals and court confirmation, with substantially the same terms as contained in the agreement in principle, our financial condition and results of operations may be materially and adversely affected.

     During the year ended December 31, 2002, we reached an agreement in principle with the Asbestos Claimants Committee (the “ACC”) and the Future Claimants Representative (the “FCR”) in the B&W Chapter 11 proceedings, which includes the following key terms, among others:

	•	MII would effectively assign all its equity in B&W to a trust to be created for the benefit of the asbestos personal injury claimants.
	•	MII and all its subsidiaries would assign, transfer or otherwise make available their rights to all applicable insurance proceeds to the trust.
	•	MII would issue 4.75 million shares of restricted common stock and cause those shares to be transferred to the trust, and 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.
	•	MI would issue promissory notes to the trust in an aggregate principal amount of $92.0 million, with principal payments of $8.4 million per year payable over 11 years, with interest payable on the outstanding balance at the rate of 7.5% per year. The payment obligations under those notes would be guaranteed by MII.
	•	In exchange for those contributions, MII and its subsidiaries (other than B&W and its subsidiaries) would be released and indemnified from and against claims arising from B&W’s use of asbestos and would receive other protections from claims arising from B&W activities.

     The terms of the agreement in principle are reflected in a third amended joint plan of reorganization and accompanying form of settlement agreement that was recommended for confirmation by the Bankruptcy Court on October 8, 2004. As of December 31, 2004, we have recorded an estimate for the cost of the proposed settlement. However, there are continuing risks and uncertainties that will remain with us until all requisite approvals are obtained and the final settlement is reflected in a nonappealable order of confirmation. An agreed or litigated settlement, or the final decision by the Court, could result in the ultimate liability exceeding amounts recorded as of December 31, 2004.

     The asbestos claims and the B&W Chapter 11 proceedings require a significant amount of management’s attention, and they represent an uncertainty in the financial marketplace. Until the uncertainty is resolved, we may be unable to deliver to our shareholders the maximum value potentially available to them through our operations and businesses, taken as a whole. There is no assurance that the proposed joint plan of reorganization, or any amendment thereto, will be approved by the Court.

     There are a number of issues and matters to be resolved before the ultimate outcome of the B&W Chapter 11 proceedings can be determined, including, among others, the following:

	•	the ultimate asbestos liability of B&W and its subsidiaries;
	•	the outcome of negotiations with our insurers as to additional amounts of coverage available to B&W and its subsidiaries and their participation in the funding of the settlement trust;

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	•	the Bankruptcy Court’s and U.S. District Court’s decisions relating to numerous substantive and procedural aspects of the Chapter 11 proceedings;
	•	the outcome of objections and potential appeals involving approval of the disclosure statement and confirmation of the plan of reorganization;
	•	conversion of B&W’s debtor-in-possession financing to exit financing;
	•	the continued ability of our insurers to reimburse B&W and its subsidiaries for payments made to asbestos claimants and the resolution of claims filed by insurers for recovery of insurance amounts previously paid for asbestos personal injury claims; and
	•	other insurance-related issues.

We have significant guarantee obligations, other contingent claim exposures and collateral agreements with creditors and customers of our subsidiaries, including B&W, that could adversely impact our future liquidity and access to capital resources.

     MII has entered into credit arrangements to support its operating subsidiaries and, in some cases, guaranteed or otherwise become contingently liable for the credit arrangements and customer contractual obligations of its subsidiaries. These exposures include the following:

	•	B&W letter of credit exposure. At the time of the B&W bankruptcy filing, MII was a maker or a guarantor of outstanding letters of credit aggregating approximately $146.5 million that were issued in connection with the business operations of B&W and its subsidiaries. At that time, MI and BWICO were similarly obligated with respect to additional letters of credit aggregating approximately $24.9 million that were issued in connection with the business operations of B&W and its subsidiaries. Although a permitted use of B&W’s debtor-in-possession revolving credit facility (the “DIP Credit Facility”) is the issuance of new letters of credit to backstop or replace these preexisting letters of credit, each of MII, MI and BWICO has agreed to indemnify and reimburse B&W and its filing subsidiaries for any customer draw on any letter of credit issued under the DIP Credit Facility to backstop or replace any such preexisting letter of credit for which it has exposure and for the associated letter of credit fees paid under the facility. As of December 31, 2004, approximately $17.3 million in letters of credit has been issued under the DIP Credit Facility to replace or backstop these preexisting letters of credit.
	•	Indemnification obligations under surety arrangements. MII has agreed to indemnify our two surety companies for obligations of various subsidiaries of MII, including B&W and several of its subsidiaries, under surety bonds issued to meet bid bond and performance bond requirements imposed by their customers. As of December 31, 2004, the aggregate outstanding amount of surety bonds that were guaranteed by MII and issued in connection with the business operations of its subsidiaries was approximately $48.0 million, of which $43.8 million related to the business operations of B&W and its subsidiaries.

     As to the guarantee and indemnity obligations related to B&W, the proposed B&W Chapter 11 settlement contemplates indemnification and other protections for MII, MI and BWICO.

     The existence of these arrangements may adversely impact our flexibility in accessing new capital resources to address liquidity issues or other needs for capital that may arise in the future.

Our Marine Construction Services segment derives substantially all its revenues from companies in the oil and gas exploration and production industry, a historically cyclical industry with levels of activity that are significantly affected by the levels and volatility of oil and gas prices.

     The demand for marine construction services has traditionally been cyclical, depending primarily on the capital expenditures of oil and gas companies for construction of development projects. These capital expenditures are influenced by such factors as:

	•	prevailing oil and gas prices;
	•	expectations about future prices;
	•	the cost of exploring for, producing and delivering oil and gas;
	•	the sale and expiration dates of available offshore leases;
	•	the discovery rate of new oil and gas reserves in offshore areas;
	•	domestic and international political, military, regulatory and economic conditions;
	•	technological advances; and

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•

the ability of oil and gas companies to generate funds for capital expenditures.

     Prices for oil and gas historically have been extremely volatile and have reacted to changes in the supply of and demand for oil and natural gas (including changes resulting from the ability of the Organization of Petroleum Exporting Countries to establish and maintain production quotas), domestic and worldwide economic conditions and political instability in oil producing countries. We anticipate prices for oil and natural gas will continue to be volatile and affect the demand for and pricing of our marine construction services. A material decline in oil or natural gas prices or activities over a sustained period of time could materially adversely affect the demand for our marine construction services and, therefore, our results of operations and financial condition.

War, other armed conflicts or terrorist attacks could have a material adverse effect on our business.

     The war in Iraq as well as the terrorist attacks of September 11, 2001 and subsequent terrorist attacks and unrest, have caused instability in the world’s financial and commercial markets, have significantly increased political and economic instability in some of the geographic areas in which we operate and have contributed to high levels of volatility in prices for oil and gas. The continuing instability and unrest in Iraq, as well as threats of war or other armed conflict elsewhere, may cause further disruption to financial and commercial markets and contribute to even higher levels of volatility in prices for oil and gas. In addition, the continued unrest in Iraq could lead to acts of terrorism in the United States or elsewhere, and acts of terrorism could be directed against companies such as ours. In addition, acts of terrorism and threats of armed conflicts in or around various areas in which we operate, such as the Middle East and Indonesia, could limit or disrupt our markets and operations, including disruptions from evacuation of personnel, cancellation of contracts or the loss of personnel or assets. Armed conflicts, terrorism and their effects on us or our markets may significantly affect our business and results of operations in the future.

We are subject to risks associated with contractual pricing in the offshore marine construction industry, including the risk that, if our actual costs exceed the costs we estimate on our fixed-price contracts, our profitability will decline and we may suffer losses.

     Because of the highly competitive nature of the offshore marine construction industry, our Marine Construction Services segment performs a substantial number of its projects on a fixed-price basis. We attempt to cover increased costs of anticipated changes in labor, material and service costs of long-term contracts, either through estimates of cost increases, which are reflected in the original contract price, or through price escalation clauses. Despite these attempts, however, the revenue, cost and gross profit we realize on a fixed-price contract will often vary from the estimated amounts because of changes in job conditions and variations in labor and equipment productivity over the term of the contract. These variations and the risks generally inherent in the marine construction industry may result in actual revenues or costs being different from those we originally estimated and may result in reduced profitability or losses on projects. In particular, if steel prices rise beyond what we have estimated, we may suffer reduced profitability or losses on our fixed-price projects, including those contracts in our backlog. During 2002 and 2003, our Marine Construction Services segment experienced material losses on three of our Spar projects, Medusa, Devils Tower and Front Runner; the Carina Aries project; and the Belanak FPSO project. These contracts contained first-of-a-kind aspects for JRM, and were long-term in nature. We experienced schedule delays and cost overruns on these contracts that adversely impacted our financial results and liquidity. As disclosed in our 2003 Annual Report on Form 10-K, we had identified certain matters involving internal controls and operations of our Marine Construction Services segment which, among other things, impacted our ability to accurately forecast total cost to complete fixed-price contracts, primarily first-of-a-kind projects, until all major phases of the work were performed. We also received a letter from our auditors advising that our inability to accurately estimate the cost to complete these types of contracts was considered a “material weakness.” Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates,” for a discussion of the actions we have taken to address this issue.

     In addition, we recognize revenues under our long-term contracts in the Marine Construction Services segment on a percentage-of-completion basis. Accordingly, we review contract price and cost estimates periodically as the work progresses and reflect adjustments proportionate to the percentage of completion in income in the period when we revise those estimates. To the extent these adjustments result in a reduction or an elimination of previously reported profits with respect to a project, we would recognize a charge against current earnings, which could be material. Our current estimates of our contract costs and the profitability of our long-term projects could change, and adjustments to overall contract costs may continue to be significant in future periods.

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We face risks associated with investing in foreign subsidiaries and joint ventures, including the risk that we may be restricted in our ability to access the cash flows or assets of these entities.

     We conduct some operations through foreign subsidiaries and joint ventures. We do not manage all of these entities. Even in those joint ventures that we manage, we are often required to consider the interests of our joint venture partners in connection with decisions concerning the operations of the joint ventures. Arrangements involving these subsidiaries and joint ventures may restrict us from gaining access to the cash flows or assets of these entities. In addition, these foreign subsidiaries and joint ventures sometimes face governmentally imposed restrictions on their abilities to transfer funds to us. At December 31, 2004, JRM had approximately $37 million in accounts and notes receivable due from one of its joint ventures in Mexico and expects to generate revenues and cash flows in 2005 from the charter of two of its vessels to this venture. The note receivable is attributable to the sale of JRM’s DB17 vessel during the quarter ended September 30, 2004. In addition, JRM also had approximately $16 million in currency translation losses associated with this joint venture in accumulated other comprehensive loss at December 31, 2004. This joint venture is experiencing liquidity problems attributable to tax assessment issues and potential consequential damages due to cancellation of a contract with its major customer. While this joint venture is current on its obligations to JRM, it is possible that JRM could experience delays in collection of and ultimate realization of its receivables from this joint venture. Recognition of a gain of approximately $6 million on the sale of the DB17 is currently being deferred.

Our international operations are subject to political, economic and other uncertainties not encountered in our domestic operations.

     We derive a significant portion of our revenues from international operations, including customers in the Middle East. Our international operations are subject to political, economic and other uncertainties not generally encountered in our U.S. operations. These include:

	•	risks of war, terrorism and civil unrest;
	•	expropriation, confiscation or nationalization of our assets;
	•	renegotiation or nullification of our existing contracts;
	•	changing political conditions and changing laws and policies affecting trade and investment;
	•	the overlap of different tax structures; and
	•	the risks associated with the assertion of foreign sovereignty over areas in which our operations are conducted.

     Our Marine Construction Services segment may be particularly susceptible to regional conditions that may adversely affect its operations. Its major marine construction vessels typically require relatively long periods of time to mobilize over long distances, which could affect our ability to withdraw them from areas of conflict. Additionally, various foreign jurisdictions have laws limiting the right and ability of foreign subsidiaries and joint ventures to pay dividends and remit earnings to affiliated companies. Our international operations sometimes face the additional risks of fluctuating currency values, hard currency shortages and controls of foreign currency exchange.

Our operations are subject to operating risks and limits on insurance coverage, which could expose us to potentially significant liability costs.

     We are subject to a number of risks inherent in our operations, including:

	•	accidents resulting in injury to or the loss of life or property;
	•	environmental or toxic tort claims, including delayed manifestation claims for personal injury or loss of life;
	•	pollution or other environmental mishaps;
	•	adverse weather conditions;
	•	mechanical failures;
	•	collisions;
	•	property losses;
	•	business interruption due to political action in foreign countries; and
	•	labor stoppages.

     We have been, and in the future we may be, named as defendants in lawsuits asserting large claims as a result of litigation arising from events such as these. Insurance against some of the risks inherent in our operations is either

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unavailable or available only at rates that we consider uneconomical. This has particularly been the case following the September 11, 2001 terrorist attacks in New York City and Washington, D.C., which led to significant changes in various insurance markets, including decreased coverage limits, more limited coverage, additional exclusions in coverage, increased premium costs, and increased deductibles and self-insured retentions. These changes were in addition to similar changes we had seen in certain markets prior to September 11, 2001. Risks that are difficult to insure include, among others, the risk of war and confiscation of property in some areas of the world, losses or liability resulting from acts of terrorism, certain risks relating to construction, and pollution liability. Depending on competitive conditions and other factors, we endeavor to obtain contractual protection against uninsured risks from our customers. When obtained, such contractual indemnification protection may not in all cases be supported by adequate insurance maintained by the customer. Such insurance or contractual indemnity protection may not be sufficient or effective under all circumstances or against all hazards to which we may be subject. A successful claim for which we are not fully insured could have a material adverse effect on us.

     BWXT, through two of its dedicated limited liability companies, has management and operating agreements with the U.S. Government for the Y-12 and the Pantex facilities. Most insurable liabilities arising from these sites are not protected in our corporate insurance program but rely on government contractual agreements and certain specialized self-insurance programs funded by the U.S. Government. The U.S. Government has historically fulfilled its contractual agreement to reimburse for insurable claims and we expect it to continue this process during our administration of these two facilities. However, it should be noted that, in most situations, the U. S. Government is contractually obligated to pay, subject to the availability of authorized government funds.

     We have captive insurers which provide certain coverages for our subsidiary entities and related coverages. Claims as a result of our operations, or arising in the B&W Chapter 11 proceedings, could adversely impact the ability of these captive insurers to respond to all claims presented, although we believe such a result is unlikely.

     In addition, if the proposed settlement in the bankruptcy proceedings involving B&W is finalized, MII and its subsidiaries will assign to a trust formed in connection with the settlement their rights to insurance coverages that have substantial available limits of coverage for, among other things, asbestos-related personal injury claims. As a result, these insurance rights would no longer be available to MII and its subsidiaries to address any future claims against them, including any future asbestos-related personal injury claims against them.

We depend on significant customers, including the U.S. Government.

     Our Marine Construction Services and Government Operations segments derive a significant amount of their revenues and profits from a small number of customers. The inability of these segments to continue to perform services for a number of their large existing customers, if not offset by contracts with new or other existing customers, could have a material adverse effect on our business and operations.

     Our significant customers include state and federal government agencies and utilities. In particular, our Government Operations segment derives substantially all its revenue from the U.S. Government. Some of our large multiyear contracts with the U.S. Government are subject to annual funding determinations. State and U.S. Government budget restraints and other factors affecting these governments may adversely affect our business.

We may not be able to compete successfully against current and future competitors.

     Most industry segments in which we operate are highly competitive. Some of our competitors or potential competitors have greater financial or other resources than we have. Our operations may be adversely affected if our current competitors or new market entrants introduce new products or services with better features, performance, prices or other characteristics than those of our products and services. This is significant to our Marine Construction Services business, where capital investment is becoming critical to our ability to compete.

The loss of the services of one or more of our key personnel, or our failure to attract, assimilate and retain trained personnel in the future, could disrupt our operations and result in loss of revenues.

     Our success depends on the continued active participation of our executive officers and key operating personnel. The loss of the services of any one of these persons could adversely affect our operations.

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     Our operations require the services of employees having the technical training and experience necessary to obtain the proper operational results. As a result, our operations depend, to a considerable extent, on the continuing availability of such personnel. If we should suffer any material loss of personnel to competitors or be unable to employ additional or replacement personnel with the requisite level of training and experience to adequately operate our equipment, our operations could be adversely affected. While we believe our wage rates are competitive and our relationships with our employees are satisfactory, a significant increase in the wages paid by other employers could result in a reduction in our workforce, increases in wage rates, or both. If either of these events occurred for a significant period of time, our financial condition and results of operations could be adversely impacted.

     A substantial number of our employees are members of labor unions. Although we expect to renew our union contracts without incident, if we are unable to negotiate acceptable new contracts with our unions in the future, we could experience strikes or other work stoppages by the affected employees, and new contracts could result in increased operating costs attributable to both union and non-union employees. If any such strikes or other work stoppages were to occur, or if our other employees were to become represented by unions, we could experience a significant disruption of our operations and higher ongoing labor costs.

We are subject to government regulations that may adversely affect our future operations.

     Many aspects of our operations and properties are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to:

	•	construction and equipping of production platforms and other marine facilities;
	•	marine vessel safety;
	•	currency conversions and repatriation;
	•	oil exploration and development;
	•	taxation of foreign earnings and earnings of expatriate personnel; and
	•	use of local employees and suppliers by foreign contractors.

     In addition, our Marine Construction Services segment depends on the demand for its services from the oil and gas industry and, therefore, is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry generally. The adoption of laws and regulations curtailing offshore exploration and development drilling for oil and gas for economic and other policy reasons would adversely affect the operations of our Marine Construction Services segment by limiting the demand for its services. We cannot determine the extent to which our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations.

Environmental laws and regulations and civil liability for contamination of the environment or related personal injuries may result in increases in our operating costs and capital expenditures and decreases in our earnings and cash flow.

     Governmental requirements relating to the protection of the environment, including solid waste management, air quality, water quality, the decontamination and decommissioning of former nuclear manufacturing and processing facilities and cleanup of contaminated sites, have had a substantial impact on our operations. These requirements are complex and subject to frequent change. In some cases, they can impose liability for the entire cost of cleanup on any responsible party without regard to negligence or fault and impose liability on us for the conduct of others or conditions others have caused, or for our acts that complied with all applicable requirements when we performed them. Our compliance with amended, new or more stringent requirements, stricter interpretations of existing requirements or the future discovery of contamination may require us to make material expenditures or subject us to liabilities that we currently do not anticipate. Such expenditures and liabilities may adversely affect our business, results of operations or financial condition. See Section H above for further information. In addition, some of our operations and the operations of predecessor owners of some of our properties have exposed us to civil claims by third parties for liability resulting from contamination of the environment or personal injuries caused by releases of hazardous substances into the environment. For a discussion of civil proceedings of this nature in which we are currently involved, see Note 10 to our consolidated financial statements included in this report.

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Our internal controls may not be sufficient to achieve all stated goals and objectives.

     Our internal controls and procedures were developed through a process in which our management applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding the control objectives. You should note that the design of any system of internal controls and procedures is based in part upon various assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

We are subject to other risks including legal proceedings that we discuss in other sections of this annual report.

     For discussions of various factors that affect the demand for our products and services in our segments, see the discussions under the heading “Factors Affecting Demand” in each of Sections B and C above. For a discussion of our insurance coverages and uninsured exposures, see Section F above. For discussions of various legal proceedings in which we are involved, in addition to those we refer to above, see Note 10 to our consolidated financial statements included in this report. In addition to the risks we describe or refer to above, we are subject to other risks, contingencies and uncertainties, including those we have referred to under the heading “Cautionary Statement Concerning Forward-Looking Statements” in Section J below.

J.   C A U T I O N A R Y    S T A T E M E N T   C O N C E R N I N G   F O R W A R D - L O O K I N G   S T A T E M E N T S

     We are including the following discussion to inform our existing and potential security holders generally of some of the risks and uncertainties that can affect our company and to take advantage of the “safe harbor” protection for forward-looking statements that applicable federal securities law affords.

     From time to time, our management or persons acting on our behalf make forward-looking statements to inform existing and potential security holders about our company. These statements may include projections and estimates concerning the timing and success of specific projects and our future backlog, revenues, income and capital spending. Forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “plan,” “goal” or other words that convey the uncertainty of future events or outcomes. In addition, sometimes we will specifically describe a statement as being a forward-looking statement and refer to this cautionary statement.

     In addition, various statements in this Annual Report on Form 10-K, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements. Those forward-looking statements appear in Items 1 and 2 – “Business and Properties” in Part I of this report and in Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to our consolidated financial statements in Item 8 of Part II of this report and elsewhere in this report. These forward-looking statements speak only as of the date of this report; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control. These risks, contingencies and uncertainties relate to, among other matters, the following:

	•	general economic and business conditions and industry trends;
	•	general developments in the industries in which we are involved;
	•	decisions about offshore developments to be made by oil and gas companies;
	•	the highly competitive nature of our businesses;
	•	our future financial performance, including compliance with covenants in our credit agreements and other debt instruments, and availability, terms and deployment of capital;
	•	the continued availability of qualified personnel;
	•	the operating risks normally incident to offshore marine construction operations;

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	•	changes in, or our failure or inability to comply with, government regulations and adverse outcomes from legal and regulatory proceedings;
	•	estimates for pending and future nonemployee asbestos claims against B&W and potential adverse developments that may occur in the Chapter 11 reorganization proceedings and the related proposed settlement involving B&W and certain of its subsidiaries and MII;
	•	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;
	•	the potential impact on available insurance due to bankruptcy filings by asbestos-troubled companies;
	•	the potential impact on our captive insurance subsidiaries of B&W asbestos-related claims under policies issued by those subsidiaries;
	•	changes in, and liabilities relating to, existing or future environmental regulatory matters;
	•	rapid technological changes;
	•	realization of deferred tax assets;
	•	consequences of significant changes in interest rates and currency exchange rates;
	•	difficulties we may encounter in obtaining regulatory or other necessary approvals of any strategic transactions;
	•	social, political and economic situations in foreign countries where we do business, including, among others, countries in the Middle East and Asia Pacific, and the former Soviet Union;
	•	the possibilities of war, other armed conflicts or terrorist attacks;
	•	effects of asserted and unasserted claims;
	•	our ability to obtain surety bonds and letters of credit;
	•	the continued ability of our insurers to reimburse us for payments made to asbestos claimants; and
	•	our ability to maintain builder’s risk, liability and property insurance in amounts we consider adequate at rates that we consider economical.

     We believe the items we have outlined above are important factors that could cause estimates in our financial statements to differ materially from actual results and those expressed in a forward-looking statement made in this report or elsewhere by us or on our behalf. We have discussed many of these factors in more detail elsewhere in this report. These factors are not necessarily all the important factors that could affect us. Unpredictable or unknown factors we have not discussed in this report could also have material adverse effects on actual results of matters that are the subject of our forward-looking statements. We do not intend to update our description of important factors each time a potential important factor arises, except as required by applicable securities laws and regulations. We advise our security holders that they should (1) be aware that important factors not referred to above could affect the accuracy of our forward-looking statements and (2) use caution and common sense when considering our forward-looking statements.

K.   A V A I L A B L E    I N F O R M A T I O N

     Our website address is www.mcdermott.com. We make available through this website under “SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file those materials with, or furnish those materials to, the Securities and Exchange Commission (the “SEC”). We have also posted on our website our: Corporate Governance Guidelines; Code of Ethics for our Chief Executive Officer, and other Senior Financial Officers; Board of Directors Conflicts of Interest Policies and Procedures; Officers, Board Members and Contact Information; By-Laws; and charters for the Audit, Governance and Compensation Committees of our Board.

Item 3.   L E G A L    P R O C E E D I N G S

     The information set forth under the heading Investigations and Litigation in Note 10, Contingencies and Commitments, to our consolidated financial statements included in this report is incorporated by reference into this Item 3.

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I t e m   4 . S U B M I S S I O N    O F    M A T T E R S    T O    A   V O T E   O F   S E C U R I T Y    H O L D E R S

     We did not submit any matter to a vote of security holders, through the solicitation of proxies or otherwise during the quarter ended December 31, 2004.

P A R T  I I

I t e m    5 .   M A R K E T    F O R    T H E    R E G I S T R A N T ’ S   C O M M O N   E Q U I T Y   A N D    R E L A T E D
S T O C K H O L D E R   M A T T E R S

     Our common stock is traded on the New York Stock Exchange. In accordance with Section 303A.12(a) of the New York Stock Exchange Listed Company’s Manual, we submitted the Annual CEO Certification to the New York Stock Exchange in 2004. Additionally, we filed certifications of the Chief Executive Officer and Chief Financial Officers pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 32.1 and 32.2, respectively, to our Annual Report on Form 10-K for the year ended December 31, 2004. High and low stock prices by quarter in the years ended December 31, 2003 and 2004 were as follows:

Y E A R   E N D E D   D E C E M B E R   3 1 ,   2 0 0 3

Y E A R   E N D E D   D E C E M B E R   3 1 ,   2 0 0 4

     In the third quarter of 2000, MII’s Board of Directors determined to suspend the payment of regular dividends on MII’s common stock. We do not intend to declare or pay dividends in 2005, however, our Board of Directors will evaluate our dividend policy from time to time.

     As of December 31, 2004, there were approximately 3,615 record holders of our common stock.

     The following table provides information on our equity compensation plans as of December 31, 2004:

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I t e m   6.     S E L E C T E D   F I N A N C I A L   D A T A

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     See Note 18 to our consolidated financial statements included in this report for significant items included in the years ended December 31, 2004 and 2003.

     Results for the year ended December 31, 2002 include: impairment charges of $224.7 million to write-off our net investment in B&W of $187.0 million and other related assets totaling $37.7 million and of $313.0 million related to JRM’s goodwill; a provision for the estimated costs of the settlement of B&W Chapter 11 proceedings of $110.0 million, including associated tax expense of $23.6 million; and a gain on the sale of a subsidiary of $9.4 million, net of taxes of $5.7 million, which is reported in discontinued operations.

     Results for the year ended December 31, 2001 include a pretax gain on our sale of an engineering subsidiary totaling $28 million and tax of approximately $85.4 million associated with the intended exercise of an intercompany stock purchase and sale agreement.

     Pretax results for the year ended December 31, 2000 include losses totaling $23.4 million to exit certain foreign joint ventures.

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Statements we make in the following discussion which express a belief, expectation or intention, as well as those that are not historical fact, are forward-looking statements that are subject to risks, uncertainties and assumptions. Our actual results, performance or achievements, or industry results, could differ materially from those we express in the following discussion as a result of a variety of factors, including the risks and uncertainties we have referred to under the headings “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements” in Items 1 and 2 of Part I of this report.

G E N E RA L

     In general, our business segments are composed of capital-intensive businesses that rely on large contracts for a substantial amount of their revenues. Each of our business segments has been capitalized and is financed on a stand-alone basis. Our debt covenants generally preclude using the financial resources or the movement of excess cash from one segment for the benefit of the other. Our Marine Construction Services segment incurred operating losses in 2003 and 2002 which substantially strained its liquidity. Liquidity available to our other segment, Government Operations, is not available to satisfy the needs of our Marine Construction Services segment. For further discussion, see “Liquidity and Capital Resources,” below.

     Beginning in 2005, qualified pension plan expense on MI’s pension plan will be allocated to our Government Operations segment from Unallocated Corporate. We expect this allocation will be approximately $22 million. In 2004, approximately $21.8 million of pension expense related to BWXT (substantially all of our Government Operations Segment) was recorded in Unallocated Corporate. In addition, effective January 31, 2005 the B&W portion of MI’s qualified pension plan has been spun-off into a new plan sponsored by B&W. In 2004, pension expense associated with the spun-off plan was recorded in Unallocated Corporate and totaled approximately $38.6 million. Because of these two changes, we expect pension expense in Unallocated Corporate to be approximately $4.0 million in 2005.

Marine Construction Services Segment — Recent Operating Results and Outlook

     In 2004, JRM successfully implemented certain plans to address its liquidity issues and, as a result, we believe there is no longer substantial doubt about JRM’s ability to continue as a going concern through our 2005 forecast period. In addition, in 2004, JRM addressed these issues by improving controls and procedures throughout the bidding, contracting and project management process and made several changes in operating management personnel. As a result of these actions, our management has concluded that JRM no longer has a “material weakness” (as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003) in its ability to forecast accurately estimated total costs to complete fixed-priced contracts until all major phases of the work are completed.

     Our operating results for the years ended December 31, 2003 and 2002 were adversely affected by material losses on several large marine construction contracts, including the contracts related to: three Spar projects, Medusa, Devils

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Tower and Front Runner; the Carina Aries project off the coast of Argentina; and the Belanak FPSO project on Batam Island. Each of these projects had significant first-of-a-kind aspects. JRM entered into the contracts for each of these projects on a fixed-price basis.

     We recorded losses of $149.3 million during 2002 and $27.9 million during 2003 on the three Spar projects. During 2003, we also recorded estimated losses of $66.5 million on the Carina Aries project and $25.2 million on the Belanak FPSO project. We recorded approximately $46.6 million in recoveries and productivity improvements on these contracts in our income statement during the year ended December 31, 2004. However, we may continue to incur cash outflows on certain of these projects primarily due to the cost overruns recorded in 2003.

     The three Spar projects have been delivered to the respective customers. The Front Runner Spar has ongoing exposure to potential warranty claims from the customer until expiration of the warranty period in August 2005. We have accrued warranty reserves which we believe are adequate to cover all known and likely warranty claims at this time. However, our experience with respect to Spar warranties is limited, and it is possible that actual warranty claims will exceed the amounts we have provided for at December 31, 2004.

     The primary issue remaining related to Medusa is resolution of a dispute with a subcontractor, Bay Ltd. The one-year warranty period on Medusa expired on August 22, 2004. In the year ended December 31, 2004, we recorded charges totaling approximately $2.8 million related to the Medusa project.

     A substantial portion of the costs and delay impacts on Devils Tower was attributable to remedial activities undertaken with regard to the paint supplied. On March 21, 2003, we filed an action against the paint supplier and certain of its related parties for recovery of the remediation costs, delays and other damages. We received a certificate of final completion from our customer on this project in April 2004. In the year ended December 31, 2004, we recorded favorable contract adjustments on Devils Tower totaling approximately $6.1 million, primarily attributable to change orders approved during the period and an insurance recovery of costs incurred on pile-related issues. Remaining issues include a dispute with the subcontractor, Bay Ltd. The claims between JRM and Bay, Ltd. arising from the construction of Devils Tower have been set for arbitration on May 2, 2005. The one-year warranty period on Devils Tower expired on February 24, 2005.

     We completed and handed over Front Runner, receiving acceptance from the customer on August 2, 2004. In the year ended December 31, 2004, we recorded favorable contract adjustments on Front Runner totaling approximately $5.2 million, primarily attributable to a change order for offshore work, reductions in cost estimates for work completed during the period and reduced exposure to schedule-related liquidated damages. The one-year warranty period on Front Runner will expire on August 2, 2005.

     With regard to the Carina Aries project, we provided for our best estimate of the total cost to achieve project completion and recorded losses totaling $66.5 million during the year ended December 31, 2003. We completed the pipeline work in March 2004 and topsides installation in May 2004. All remaining work necessary to obtain the customer’s acceptance is now complete. In the year ended December 31, 2004, we recorded favorable contract adjustments on Carina Aries totaling approximately $23.6 million, primarily attributable to reduced cost estimates for the offshore work completed during the period, insurance recoveries, and reduced fees for letters of credit associated with the project. Remaining issues include ongoing exposure to potential warranty claims from the customer during the warranty period, which will begin when we obtain provisional acceptance from the customer.

     The Belanak FPSO project involved a subcontract to JRM for the fabrication of topsides for an FPSO in Indonesia. During the year ended December 31, 2003, we provided for our best estimate of the total cost to achieve project completion and recorded losses totaling $25.2 million. Increases in cost were attributable to overruns of the material and subcontractor cost estimates, as well as labor costs to complete. In the year ended December 31, 2004, we recorded favorable contract adjustments on Belanak totaling approximately $14.5 million, primarily attributable to reduced cost estimates as a result of productivity improvements, revenue increases, as well as reduced exposure to liquidated damages. Schedule extensions to dates related to liquidated damages have been agreed with the customer and the JRM portion of the project is complete. The Belanak FPSO sailed on October 11, 2004.

     As of December 31, 2004, in accordance with the percentage-of-completion method of accounting, we have provided for our estimated costs to complete all our ongoing contracts. However, it is possible that current estimates

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could change due to unforeseen events, which could result in adjustments to overall contract costs. The risk on fixed-priced contracts is that revenue from the customer does not rise to cover increases in our costs. It is possible that current estimates could materially change for various reasons including, but not limited to fluctuations in forecasted labor productivity, pipeline lay rates, or steel and other raw material prices. Increases in costs on our fixed-price contracts could have a material adverse impact on our results of operations, financial condition and cash flow. Alternatively, reductions in overall contract costs at completion could materially improve our results of operations, financial condition and cash flow.

     At December 31, 2004, JRM had approximately $37 million in accounts and notes receivable due from one of its joint ventures in Mexico and expects to generate revenues and cash flows in 2005 from the charter of two of its vessels to this venture. The note receivable is attributable to the sale of JRM’s DB17 vessel during the quarter ended September 30, 2004. In addition, JRM also had approximately $16 million in currency translation losses associated with this joint venture in accumulated other comprehensive loss at December 31, 2004. This joint venture is experiencing liquidity problems attributable to tax assessment issues and potential consequential damages due to cancellation of a contract with its major customer. While this joint venture is current on its obligations to JRM, it is possible that JRM could experience delays in collection of and ultimate realization of its receivables from this joint venture. Recognition of a gain of approximately $6 million on the sale of the DB17 is currently being deferred.

     The amount of revenues our Marine Construction Services segment generates largely depends on the level of oil and gas development activity in the world’s major hydrocarbon-producing regions. Numerous factors influence this activity, including:

	•	oil and gas prices, along with expectations about future prices;
	•	the cost of exploring for, producing and delivering oil and gas;
	•	the terms and conditions of offshore leases;
	•	the discovery rates of new oil and gas reserves in offshore areas;
	•	reserve depletion and replacement rates;
	•	technological barriers or advances;
	•	socio-political drivers in developing countries;
	•	the ability of businesses in the oil and gas industry to raise capital; and
	•	local and international political and economic conditions.

     The decision-making process for oil and gas companies in making capital expenditures on marine construction services for a development project differs depending on whether the project involves new or existing development. In the case of new development projects, the demand for marine construction services generally follows the exploratory drilling and, in some cases, initial development drilling activities. Based on the results of these activities and evaluations of field economics, customers determine whether to install new platforms and new infrastructure, such as subsea gathering lines and pipelines. For existing development projects, demand for marine construction services is generated by decisions to, among other things, expand development in existing fields and expand existing infrastructure.

     Due to the deterioration in JRM’s financial performance during the year ended December 31, 2002, we revised our expectations concerning JRM’s future earnings and cash flow and tested the goodwill of our Marine Construction Services segment for impairment. During the year ended December 31, 2002, we recorded an impairment charge of $313.0 million, which was the total amount of JRM’s goodwill.

Government Operations Segment - Recent Operating Results and Outlook

     The revenues of our Government Operations segment are largely a function of capital spending by the U.S. Government. As a supplier of major nuclear components for certain U.S. Government programs, BWXT is a significant participant in the defense industry. The strong bookings in our Government Operations segment continued during 2004 allowing us to maintain a healthy backlog. Additionally, with BWXT’s unique capability of full life-cycle management of special nuclear materials, facilities and technologies, BWXT is well positioned to continue to participate in the continuing cleanup and management of the Department of Energy’s nuclear sites and weapons complexes.

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     BWXT is expected to continue producing strong financial results. Its backlog of approximately $1.7 billion is expected to produce revenues for 2005 of approximately $500 million, not including any new contracts that may be awarded during the year. BWXT’s commitment to cost containment, in addition to the potential for new service contract awards, leads management to believe operating results should remain consistent with 2004 levels, on a comparable basis.

     Beginning in 2005, we will allocate the pension expense which in previous years was recorded in Unallocated Corporate to our Government Operations Segment. We anticipate the allocated expense for 2005 will be approximately $22 million.

Other

     The results of Menck GmbH (“Menck”), previously a component of our Marine Construction Services segment, and the results of Hudson Products Corporation (“HPC”), are reported in discontinued operations. We sold Menck in August 2003 and HPC in July 2002. See Note 2 to our consolidated financial statements included in this report for further information on discontinued operations.

     The results of operations of our Power Generation Systems segment include primarily the results of Volund, which we sold to B&W on October 11, 2002. See Note 2 to our consolidated financial statements included in this report for information concerning that sale.

     As a result of the Chapter 11 reorganization proceedings involving B&W and several of its subsidiaries, we stopped consolidating the results of operations of B&W and its subsidiaries in our consolidated financial statements and began presenting our investment in B&W on the cost method. During the year ended December 31, 2002, due to increased uncertainty with respect to the amounts, means and timing of the ultimate settlement of B&W asbestos claims and the recovery of our investment in B&W, we wrote off our net investment in B&W. 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. On December 19, 2002, drafts of a joint plan of reorganization and settlement agreement, together with a draft of a related disclosure statement, were filed in the Chapter 11 proceedings, and we determined that a liability related to the proposed settlement was probable and that the value was reasonably estimable. Accordingly, as of December 31, 2002, we established an estimate for the cost of the settlement of the B&W bankruptcy proceedings of $110.0 million, including related tax expense of $23.6 million. As of December 31, 2004, we have updated our estimated cost of the proposed settlement to reflect current conditions, and for the year ended December 31, 2004 we recorded an aggregate increase in the provision of $11.9 million, including associated tax expense of $0.7 million. The proposed settlement contemplates, among other things, the issuance of shares of our common stock to an asbestos personal injury settlement trust, and the increase in the provision for the cost of the proposed settlement is primarily due to an increase in our stock price. As of December 31, 2004, our estimate for the cost of the proposed settlement is $140.0 million.

     At a special meeting of our shareholders on December 17, 2003, our shareholders voted on and approved a resolution relating to a proposed settlement that would resolve the B&W Chapter 11 proceedings. The shareholders’ approval of the resolution is conditioned on the subsequent approval of the proposed settlement by MII’s Board of Directors (the “Board”). We would become bound to the settlement only when the plan of reorganization becomes effective, and the plan of reorganization cannot become effective without the approval of the Board within 30 days prior to the effective time of the plan. The Board’s decision on whether to approve the proposed settlement will be made after consideration of any developments that might occur prior to the effective date, including any changes in the status of any potential federal legislation concerning asbestos liabilities, including “The Fairness in Asbestos Injury Resolution (FAIR) Act of 2005.” The asbestos personal injury claimants have voted in favor of the proposed B&W plan of reorganization. See Note 20 to our consolidated financial statements included in this report for details regarding the estimated cost of the proposed settlement and for further information regarding developments in negotiations relating to the B&W Chapter 11 proceedings.

     At December 31, 2004, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions,” we decreased our minimum pension liability by approximately $22.2 million primarily due to the improvement in financial markets in 2004. Effective January 31, 2005, the assets and liabilities associated with B&W’s portion of the MI pension plan were spun-off into a B&W sponsored plan.

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Approximately 46% of the employees in the MI pension plan at January 30, 2005 were transferred to the new B&W sponsored plan.

     Effective December 31, 2004, benefit accruals under the McDermott International, Inc. Supplemental Executive Retirement Plan, Amended and Restated effective December 1, 1999 (the “Old SERP Plan”) ceased and we adopted the McDermott International, Inc. Supplemental Executive Retirement Plan effective January 1, 2005 (the “New SERP Plan”). The Old SERP Plan is a defined benefit plan, while the New SERP Plan is a defined contribution plan. The cessation of benefits of the Old SERP Plan did not affect the rights of retired or disabled participants (or their spouses) who were receiving benefits under the plan as of December 31, 2004. However, some of the retired participants elected to receive a discounted lump-sum distribution in lieu of any future entitlements under the Old SERP Plan. All active participants in the Old SERP Plan on December 31, 2004 became participants in the New SERP Plan on January 1, 2005. We recorded a settlement and curtailment gain of approximately $4.6 million in connection with the cessation of benefits. We also recorded expenses related to the New SERP Plan of approximately $1.4 million in the year ended December 31, 2004.

     As a result of our reorganization in 1982, which we completed through a transaction commonly referred to as an “inversion,” our company is a corporation organized under the laws of the Republic of Panama. In prior years, the U.S. House and Senate have considered legislation that would change the tax law applicable to corporations that have completed inversion transactions. We entered into an agreement with two shareholders pursuant to which management will sponsor and recommend a proposal for re-domestication in the proxy statement for the annual meeting in the event the tax, costs and other considerations impacted by re-domestication are determined by our Board of Directors to be in the best interests of our shareholders. In the event that re-domestication is determined by our Board of Directors not to be in the best interests of our shareholders, pursuant to our agreement described in this paragraph, management will present the re-domestication proposal on the proxy but may recommend against it. The timing of any such management proposal is contingent upon the completion of the B&W reorganization proceedings.

     Effective January 1, 2002, based on a review performed by us and independent consultants we engaged, 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 estimated useful 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 and net loss by approximately $3.2 million for the year ended December 31, 2002.

     We derive a significant portion of our revenues from foreign operations. As a result, international factors, including variations in local economies and changes in foreign currency exchange rates, affect our revenues and operating results. We attempt to limit our exposure to changes in foreign currency exchange rates by attempting to match anticipated foreign currency contract receipts with like foreign currency disbursements. To the extent that we are unable to match the foreign currency receipts and disbursements related to our contracts, we enter into foreign currency derivative instruments to reduce the impact of foreign exchange rate movements on our operating results. Because we generally do not hedge beyond our exposure, we believe this practice minimizes the impact of foreign exchange rate movements on our operating results.

C R I T I C A L   A C C O U N T I N G   P O L I C I E S   A N D   E S T I M A T E S

     We believe the following are our most critical accounting policies that we apply in the preparation of our financial statements. These policies require our most difficult, subjective and complex judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

     Restricted Cash. We record cash as restricted when we are unable to use such cash and cash equivalents freely for general operating purposes. Our long-term restricted cash and cash equivalents are those funds we expect to use to finance capital expenditures at JRM, funds required to be offered to holders of the JRM Secured Notes before restrictions are released and those funds securing JRM letter of credit obligations having expiration dates beyond one year from our Balance Sheet date.

      Contracts and Revenue Recognition. We determine the appropriate accounting method for each of our long-term contracts when work on the project begins. We generally recognize contract revenues and related costs on a percentage-of-completion method for individual contracts or combinations of contracts under the guidelines of the Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (“SOP 81-1”). This is based on our experience and history of being able to prepare reasonably dependable estimates of the cost to complete our projects. Under this method, we recognize estimated contract revenue and resulting income based on costs incurred to date as a percentage of total estimated costs. Total estimated costs, and resulting contract income, are affected by changes in the expected cost of materials and labor, productivity, scheduling and other factors. Additionally, external factors such as weather, customer requirements and other factors outside of our control, may affect the progress and estimated cost of a project’s completion and, therefore, the timing of revenue and income recognition. We routinely review estimates related to our contracts, and revisions to profitability are reflected in the quarterly and annual earnings we report. As discussed in more detail below, SOP 81-1 provides that the use of percentage-of-completion accounting requires the ability to make reasonably dependable estimates.

      We had significant adjustments to earnings as a result of revisions to contract estimates on the Medusa, Devils Tower and Front Runner Spars, the Carina Aries, and the Belanak FPSO projects. Each of those projects involved a long-term, fixed price contract. The Medusa Spar, Devils Tower Spar and Carina Aries projects started in 2001. The other two projects, the Front Runner Spar and Belanak FPSO commenced in the first quarter of 2002. As a result of significant operational issues and other factors that negatively impacted our performance on these contracts, we were unable to forecast accurately the total cost to complete these projects until we performed almost all of their major phases. This led to the 2003 material weakness determination from our auditors citing our inability to accurately estimate the cost to complete these types of contracts. In their letter to us, our auditors recommended implementation of a common, comprehensive project management framework, the lack of which impacted our ability to accurately estimate the cost to complete these contracts and constituted a “material weakness” as defined in AU325, Communication of Internal Control Related Matters Noted in an Audit. As we discuss below, we have implemented various policies and procedures designed to eliminate this material weakness and, as of December 31, 2004, based on an evaluation of our internal controls under Section 404 of the Sarbanes Oxley Act, our management concluded that there was no material weakness in our ability to estimate cost to complete. Our management has also determined that, while giving appropriate consideration to the requirement of reasonably dependable estimates as a condition to the application of the percentage-of-completion method, and notwithstanding the prior existence of the material weakness noted above, the percentage-of-completion method was the appropriate method for us to use to account for our results under these five contracts.

      At the inception of work on each of the projects under the five contracts referred to above, our decision to use the percentage-of-completion method rather than the completed-contract method was based on our belief that we had reasonably dependable cost estimates at the time work on the projects started. At project inception, we had previous experience in performing and/or pricing their work scopes. Prior to submitting the Medusa bid, we had participated in the topsides fabrication and offshore installation parts of four Spar projects (the Neptune, Genesis, Nansen, and Boomvang Spars) We had also completed the Typhoon tension leg platform, which included fabrication of a tubular hull in our Morgan City yard. While the hull was smaller in size than the Medusa, Devils Tower, and Front Runner tubular hulls, it did provide us with direct experience on the cost to build tubular hulls. We also had information concerning the costs our unrelated joint venture partner experienced to fabricate the tubular hulls for the Genesis, Nansen, and Boomvang Spars. We were informed that our price on Medusa was within 5% of the high (losing) bid on Medusa, giving us another benchmark for the reasonableness of our cost estimate as of the time work on the project started. Our price for Devils Tower was increased based on our experience relating to the cost over-runs on Medusa. In addition, we increased our price on Front Runner based upon our experience with our Devils Tower costs. The Carina Aries project was for the fabrication of two jackets and decks along with pipeline work. We have many years of experience fabricating jackets and decks of similar size, as well as substantial experience as a pipelay contractor. We used the information we developed from this experience, as well as price quotes from four independent fabrication yards, to estimate the fabrication cost. We used our substantial experience in laying pipe under harsh conditions in the North China Sea, as well as the U.K. and Norwegian sectors of the North Sea to estimate our cost to complete the pipeline scope. The cost estimate for the Belanak FPSO reflected our

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experiences with the Foinaven FPSO fabricated in Europe, as well as the Jamestown FPSO fabricated in the United States. We used these factors to support the reasonableness of our cost estimates when these projects started and account for them under the percentage-of-completion method.

      There were, however, significant first-of-a-kind aspects to each of these projects. The Medusa hull was the first Spar hull we have ever fabricated, and its topsides the first we fabricated in our Veracruz/Harbor Island facilities. The Devils Tower hull was the first fabricated in our Batam Island facility. The Front Runner topsides were the first Spar topsides we subcontracted to a third party. The Carina Aries pipeline was the first we laid in Southern Argentina. The Belanak FPSO was much larger in size than topsides previously fabricated in our Batam Island facility. Based on a consideration weighing of all these factors, we believe that we had reasonably dependable cost estimates at the start of each of these projects.

      As we noted above, we had significant adjustments to earnings as a result of revisions to our contract estimates relating to these projects in 2001, 2002, 2003 and 2004. These adjustments were, in large measure, attributable to operational issues we encountered in the course of performance under the contracts. Although some of these issues arose from the first-of-a-kind aspects referred to above, other issues were attributable to poor project performance and oversight, including poor performance by subcontractors and by our personnel in facilities that were being overloaded with work and staffed by laborers and other personnel who, in many cases, were inexperienced. In addition, vendor supplied lead paint and a storm off the Southern coast of Argentina in June of 2003, contributed to substantial cost overruns on two of these projects. The material weakness in estimating cost to complete identified by our independent auditors reflected concern over the lack of a common, comprehensive project management framework to permit us to recognize and assess these operational issues relating to these large, fixed-priced contracts, and to factor those assessments into our overall estimates of contract profitability. However, due to the additional procedures and analyses which we implemented as the performance issues arose under the contracts and which effectively compensated for the lack of a comprehensive project management framework, we believe that our estimates with respect to these five contracts for each reporting period during the years 2001 through 2004 were reasonable at the times they were made. As indicated above, continuing operational issues and many factors beyond our control caused actual results under these contracts to deteriorate from the estimated results. We have carefully considered the reasons for that deterioration and the accounting guidance provided by SOP 81-1 and confirmed that the percentage-of-completion method was the appropriate method for us to use to account for our operations under these five contracts.

      In response to the difficulties encountered on these five large contracts, we implemented a number of policies and procedures in 2003, including a procedure requiring review and approval of our chief executive officer, chief financial officer, and general counsel for all JRM contracts over $50 million. Additionally, all contracts, irrespective of their value, that have significant first-of-a-kind aspects, such as new products, new geographic locations or work, and scope of work which we have never attempted, must be approved by the same officers. Since inception of the procedure, no contracts with significant first-of-a-kind aspects have been approved.

      JRM has now installed common project control software to provide more prompt and accurate reporting of the status of each element of the work on a time-effective basis and has established a global project management division.

      JRM’s new Project Risk/Opportunity Management (“PROM”) system was developed and is applied to every contract over $15 million. The
      PROM system assists our management in:

	•	identifying and ranks risks and opportunities in each project;
	•	analyzing JRM’s capability to manage the risks;
	•	estimating the contingency amount to be added to JRM’s bid price to cover the risk;
	•	developing a risk management/mitigation action plan for each high priority risk; and
	•	developing a management plan to maximize realization of opportunities.

      In addition, JRM now requires comprehensive monthly “Health of the Project” reports and reviews for all contracts that have projected revenues over $15 million. Part of these reviews focus on the realization or mitigation of the risks identified by the PROM system. JRM has also instituted quarterly project certifications

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to be executed by project managers and local management attesting to the accuracy of the reported progress and forecast cost to complete all high-risk projects over $15 million. JRM has instituted a Global Lessons Learned Website to share knowledge throughout its worldwide operations. It also has instituted a change management tracking system to capture timely change-order information and obtain timely agreements from customers. Global procurement, subcontracting, construction, project management, and risk management controls have been instituted and are administered by the JRM Vice President of Project Management and his staff, a group created in 2003 in response to JRM’s experience with the five projects discussed above.

      As a result of these changes, we have determined that as of December 31, 2004, JRM no longer has a material weakness relating to estimates of costs to complete contracts.

      For contracts as to which we are unable to estimate the final profitability except to assure that no loss will ultimately be incurred, we recognize equal amounts of revenue and cost until the final results can be estimated more precisely. For these deferred profit recognition contracts, we recognize revenue and cost equally and only recognize gross margin when probable and reasonably estimable, which we generally determine to be when the contract is approximately 70% complete. We treat long-term construction contracts that contain such a level of risk and uncertainty that estimation of the final outcome is impractical except to assure that no loss will be incurred, as deferred profit recognition contracts. We currently have one contract being accounted for under our deferred profit recognition basis, JRM’s contract to build offshore platform complexes for the Dolphin Upstream Facilities. This project, which is on schedule, is approximately 18% complete as of December 31, 2004; and we have deferred approximately $4.5 million in gross profit on this project. The major risk on this project (which arose after we had bid the contract but before we started work), was escalation in the prices of steel and steel-based products we are required to purchase. We are reasonably confident, based on our detailed project reviews to date which show that we have firm price commitments for over 75% of the value of our required purchases, our improved risk management procedures on long-term contracts, and our recently updated forecast concerning cost estimates, that no loss will be incurred on this contract. However, as discussed above, it is possible that unforeseen events or circumstances beyond our control could materially affect the total estimated cost of this project.

      Fixed-price contracts are required to be accounted for under the completed-contract method if we are unable to reasonably forecast cost to complete at start-up. For example, if we have no experience in performing the type of work on a particular project and were unable to develop reasonably dependable estimates of total costs to complete, we would follow the completed-contract method of accounting for such projects. Our management’s policy is not to enter into fixed-price contracts without an accurate estimate of cost to complete. However, it is possible that in the time between contract execution and the start of work on a project, we could lose confidence in our ability to forecast cost to complete based on intervening events, including but not limited to experience on similar projects, civil unrest, strikes and volatility in our expected costs. In such a situation, we would use the completed-contract method of accounting for that project. No such contracts were executed by JRM in 2004 and our estimating weakness was corrected as of December 31, 2004.

      For all contracts, if a current estimate of total contract cost indicates a loss on a contract, the projected loss is recognized in full when determined.

      Although we continually strive to improve our ability to estimate our contract costs and profitability, adjustments to overall contract costs due to unforeseen events may continue to be significant in future periods. We recognize claims for extra work or for changes in scope of work in contract revenues, to the extent of costs incurred, when we believe collection is probable and can be reasonably estimated. We recognize income from contract change orders or claims when formally agreed with the customer. We reflect any amounts not collected as an adjustment to earnings. We regularly assess the collectibility of contract revenues and receivables from customers.

     Property, Plant and Equipment. We carry our property, plant and equipment at depreciated cost, reduced by provisions to recognize economic impairment when we determine impairment has occurred. Factors that impact our determination of impairment include forecasted utilization of equipment and estimates of cash flow from projects to be performed in future periods. Our estimates of cash flow may differ from actual cash flow due to, among other things, technological changes, economic conditions or changes in operating performance. Any changes in such factors may negatively affect our business segments and result in future asset impairments.

     Except for major marine vessels, we depreciate our property, plant and equipment using the straight-line method, over estimated economic useful lives of eight to 40 years for buildings and two to 28 years for machinery and equipment. We depreciate major marine vessels using the units-of-production method based on the utilization of each vessel. Effective January 1, 2002, based on a review performed by us and independent consultants we engaged, we changed our estimate of the useful lives of new major marine vessels from 12 years to 25 years. Our depreciation expense calculated under the units-of-production method may be less than, equal to or greater than depreciation expense calculated under the straight-line method in any period. The annual depreciation based on utilization of each vessel will not be less than the greater of 25% of annual straight-line depreciation and 50% of cumulative straight-line depreciation.

     We expense the costs of maintenance, repairs and renewals, which do not materially prolong the useful life of an asset, as we incur them, except for drydocking costs. We accrue estimated drydocking costs for our marine fleet over the period of time between drydockings, generally three to five years. We accrue drydocking costs in advance of the anticipated future drydocking, commonly known as the “accrue in advance” method. We charge actual drydocking costs against the liability when incurred, and we recognize any differences between actual costs and accrued costs over the remaining months of the drydocking cycle. Our actual drydocking costs often differ from our estimates due to the long period between drydockings and the inherent difficulties in estimating cost of vessel repairs and renewals until the drydocking occurs.

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     Self-Insurance. We have several wholly owned insurance subsidiaries that provide general and automotive liability and workers compensation insurance and from time-to-time, builder’s risk within certain limits, and marine hull to our companies. Reserves related to these insurance programs are based on the facts and circumstances specific to the insurance claims and our past experience with similar claims. The actual outcome of insured claims could differ significantly from estimated amounts. We maintain actuarially-determined accruals in our consolidated balance sheets to cover self-insurance retentions for the coverage’s discussed above. These accruals are based on certain assumptions developed utilizing historical data to project future losses. Loss estimates in the calculation of these accruals are adjusted as required based upon actual claim settlements and reported claims. These loss estimates and accruals recorded in our financial statements for claims have historically been reasonable in light of the actual amount of claims paid.

     Pension Plans and Postretirement Benefits. We estimate income or expense related to our pension and postretirement benefit plans based on actuarial assumptions, including assumptions regarding discount rates and expected returns on plan assets. We determine our discount rate based on a review of published financial data and discussions with our actuary regarding rates of return on high-quality fixed-income investments currently available and expected to be available during the period to maturity of our pension obligations. Based on historical data and discussions with our actuary, we determine our expected return on plan assets based on the expected long-term rate of return on our plan assets and the market-related value of our plan assets. Changes in these assumptions can result in significant changes in our estimated pension income or expense. We revise our assumptions on an annual basis based upon changes in current interest rates, return on plan assets and the underlying demographics of our workforce. These assumptions are reasonably likely to change in future periods and may have a material impact on future earnings. Effective March 31, 2003, participation and benefits for the JRM pension plan were frozen. As a result, we recorded a curtailment gain totaling approximately $2.5 million in other-net for the year ended December 31, 2003.

     Loss Contingencies. We estimate liabilities for loss contingencies when it is probable that a liability has been incurred and the amount of loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision or if such loss is not reasonably estimable. We are currently involved in some investigations and litigation as discussed in Note 10 to our consolidated financial statements included in this report. We have accrued our estimates of the probable losses associated with these matters. However, our losses are typically resolved over long periods of time and are often difficult to estimate due to the possibility of multiple actions by third parties. Therefore, it is possible future earnings could be affected by changes in our estimates related to these matters. Our most significant loss contingencies include our estimate of the cost of the potential settlement of the B&W Chapter 11 proceedings, which is now dependent on the finalization of the proposed settlement discussed in this report (see Notes 10 and 20 to our consolidated financial statements included in this report).

     Goodwill. SFAS No. 142, “Goodwill and Other Intangible Assets,” requires that we no longer amortize goodwill, but instead perform periodic testing for impairment. It requires a two-step impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss. The first step of the test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. Both steps of goodwill impairment testing involve significant estimates. We wrote off $313 million, which represented all of JRM’s goodwill, in 2002. As a result, our total goodwill has been substantially reduced.

     Asset Retirement Obligations and Environmental Clean-up Costs. We accrue for future decommissioning of our nuclear facilities that will permit the release of these facilities to unrestricted use at the end of each facility’s life, which is a requirement of our licenses from the Nuclear Regulatory Commission. Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” requiring us to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When we initially record such a liability, we capitalize 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 a liability, we will settle the obligation for its recorded amount or incur a gain or loss. SFAS No. 143 applies to environmental liabilities associated with assets that we currently operate and are obligated to remove from service. For environmental liabilities associated with assets that we no longer operate, we have accrued amounts based on the estimated costs of clean-up activities, net of any cost-sharing arrangements. We adjust the estimated costs as further

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information develops or circumstances change. An exception to this accounting treatment relates to the work we perform for one facility, for which the U.S. Government is obligated to pay all the decommissioning costs.

     Deferred Taxes. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We believe that the deferred tax asset recorded as of December 31, 2004 is realizable through carrybacks, future reversals of existing taxable temporary differences and future taxable income. If we were to subsequently determine that we would be able to realize deferred tax assets in the future in excess of our net recorded amount, an adjustment to deferred tax assets would increase earnings for the period in which such determination was made. We will continue to assess the adequacy of the valuation allowance on a quarterly basis. Any changes to our estimated valuation allowance could be material to our consolidated financial condition and results of operations.

     Warranty. In our Marine Construction Services segment, we include warranty costs as a component of our total contract cost estimate to satisfy contractual requirements. In addition, we make specific provisions where we expect the actual warranty costs to significantly exceed the accrued estimates. In our Marine Construction Services segment, warranty periods are generally limited, and we have had minimal warranty cost in prior years. Factors that impact our estimate of warranty costs include prior history of warranty claims and our estimates of future costs of materials and labor. In our Government Operations segment, we accrue estimated expenses to satisfy contractual warranty requirements when we recognize the associated revenue on the related contracts. Our future warranty provisions may vary from what we have experienced in the past.

     For a discussion of recently adopted accounting standards, see Note 1 to our consolidated financial statements included in this report.

Y E A R    E N D E D   D E C E M B E R   3 1 ,   2 0 0 4   C O M P A R E D   T O   Y E A R   E N D E D   D E C E M B E R   3 1 ,   2003

M a r i n e   C o n s t r u c t i o n   S e r v i c e s

     Revenues decreased 24% to $1.4 billion, primarily due to reduced activity in Southeast Asia, which resulted in lower revenues of approximately $300 million, and lower activity on Spar projects and the Carina Aries project off the coast of southern Argentina, which resulted in lower revenues of approximately $240 million. The lower activity on Spar projects was due to completion of the Medusa Spar in August 2003 and the Devils Tower Spar in February 2004, and lower activity on the Carina Aries project was due to that project having been substantially complete at the end of March 2004. That reduced activity was partially offset by increased activity on topsides fabrication and pipeline installation projects in the Azerbaijan sector of the Caspian Sea, which resulted in increased revenues of approximately $174 million.

     Segment operating income, which is before equity in income of investees, increased $102.7 million to $51.6 million. This increase resulted primarily from improvements on the Spar projects and the Carina Aries project and reversal of drydock reserves of $8.0 million due to the sale of a vessel, partially offset by lower fabrication activity in all our facilities and lower marine installation activity worldwide, as well as increased general and administrative expenses. During the year ended December 31, 2004 we recorded favorable adjustments to loss estimates as a result of favorable productivity and change order settlements on the Spar projects, the Carina Aries project and the Belanak FPSO project totaling $46.6 million, compared to charges totaling $119.6 million in the year ended December 31, 2003. We also realized increased operating profits of $37.8 million in the Caspian Sea region during the year ended December 31, 2004 due to higher revenues and improved margins. The lower fabrication activity and the lower marine activity in the year ended December 31, 2004 resulted in declines of $34.8 million and $12.4 million, respectively, compared to the year ended December 31, 2003. General and administrative expenses increased $31.6 million to $100.4 million, primarily due to increased sales and proposals expense and increased regulatory compliance expense attributable to JRM’s compliance with the Sarbanes-Oxley Act of 2002. We record our costs to comply with the Sarbanes-Oxley Act in our respective segments. Higher premiums for officers and directors insurance, increased costs associated with treasury and financial systems and increased oversight efforts related to project controls and project management and increased sales and marketing expenses also contributed to increased general and administrative expense.

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     Gain (loss) on asset disposals and impairments-net improved $24.6 million to $30.3 million, due to gains on sales of nonstrategic assets, including an idle fabrication facility in Scotland, the DB 60 and the Oceanic 93.

     Equity in income (loss) of investees improved $2.4 million, from a loss of $0.5 million to income of $1.9 million, primarily due to increased royalty income of approximately $1.4 million recognized in our Spars International Inc. joint venture. In addition, the year ended December 31, 2003 included a loss of approximately $1.0 million recorded for final settlement of tax liabilities of a previously dissolved international joint venture.

     Backlog was $1.2 billion and $1.4 billion, respectively, at December 31, 2004 and 2003. The December 31, 2004 backlog includes $165.7 million for a project with Dolphin Energy Ltd. that is accounted for under our deferred profit recognition policy. Under this policy, the profit on the project, which was approximately $4.5 million at December 31, 2004, will be deferred until the project is approximately 70% complete and we are confident of our cost estimate to complete, which is expected to be by the end of 2005. Revenues on this project totaled approximately $48 million in 2004.

Government Operations

     Revenues increased $23.6 million to $555.1 million, primarily due to higher volumes from the manufacture of nuclear components for certain U.S. Government programs, our commercial nuclear environmental services, one of our management and operating contracts, and our other government operations due to additional uranium recovery and fuel fabrication work. These increases were partially offset by lower revenues from our commercial work. In addition, the year ended December 31, 2003 included revenues resulting from the favorable resolution of two contract disputes.

     Segment operating income, which is before equity income from investees, increased $18.5 million to $76.7 million, primarily due to higher volume and margin from the manufacture of nuclear components for certain U.S. Government programs. In addition, we experienced improved volume and margins from our other government operations due to additional uranium recovery and fuel fabrication work. These increases were partially offset by higher general and administrative costs due to higher corporate allocations, costs related to implementation of a new enterprise resource planning system and increased bidding activity. In addition, the year ended December 31, 2003 included income resulting from favorable resolution of two contract disputes.

     Segment operating income for the year ended December 31, 2004 also includes approximately $7.2 million of additional cost reimbursements related to the BWXT qualified pension plan, whose sponsor is MI. As a result, approximately $21.8 million of qualified pension expense attributable to the Government Operations segment is included in unallocated corporate expense and is not included in the Government Operations segment results. In 2005, MI will allocate to BWXT its share of qualified pension plan expense, which we expect to be approximately $22 million.

     Equity in income from investees increased $4.5 million to $32.6 million, primarily due to increased operating results from joint ventures in Tennessee, Idaho, and Texas.

Corporate

     Unallocated corporate expenses decreased $43.9 million to $49.6 million, primarily due to the gain we recognized in the fourth quarter on the settlement of our pension plan in the United Kingdom totaling $27.7 million, a $14.9 million reduction in qualified pension plan expense from $75.7 million in 2003 to $60.8 million in 2004 and increased allocation of corporate costs to the operating segments. The gain on the settlement of our pension plan was attributable to a change in estimate due to a ruling obtained from the taxing authorities in the quarter ending December 2004 of excise taxes owed on the settlement and favorable exchange rates. We also had a gain on the settlement of our Old SERP Plan. These decreases were partially offset by higher expenses associated with our compliance requirements under the Sarbanes-Oxley Act of 2002.

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     We record MI’s qualified pension plan expense in Corporate. For the year ended December 31, 2004, if such pension expense were allocated, the allocated amounts would have been approximately as follows:

Other Income Statement Items

     Interest income increased $2.4 million to $5.6 million, primarily due to an increase in average cash equivalents and investments and prevailing interest rates.

     Interest expense increased $17.1 million to $36.1 million, primarily due to higher interest costs associated with JRM’s 11% senior secured notes. These increases were partially offset by lower amortization of deferred debt issue costs in 2004 on our credit facilities.

     Other-net decreased $3.9 million to expense of $1.8 million, primarily due to a decrease in minority interest income.

Provision for Income Taxes

     For the year ended December 31, 2004, income (loss) before income (loss) from continuing operations before provision for income taxes increased by $183.4 million from a loss of $80.9 million to income of $102.5 million, while the provision for income taxes increased $19.5 million to $40.8 million. Our effective tax rate for the year ended December 31, 2004 was approximately 40%.

     MII is a Panamanian corporation that has earned all of its income outside of Panama. Under Panamanian tax law, MII is not subject to income tax in Panama on income earned outside of Panama.

     We have provided for income taxes based on the tax laws and rates in the countries in which we conduct our operations. MII and its subsidiaries operate in the United States taxing jurisdiction and various other taxing jurisdictions around the world. Each of these jurisdictions has a regime of taxation that varies from the others. The taxation regimes vary not only with respect to nominal rates, but also with respect to the allowability of deductions, credits and other benefits and tax bases (for example, revenue versus income). These variances, along with variances in our mix of income from these jurisdictions, are responsible for shifts in our effective tax rate.

     Income (loss) from continuing operations, provision for income taxes and effective tax rates for MII major subsidiaries are as follows:

     MI is subject to United States federal income tax at the rate of 35%. The effective tax rate for MI is primarily affected by the B&W Chapter 11 settlement adjustment which generates little or no associated United States income tax effect and applicable state income taxes on its profitable BWXT subsidiary. In addition, J. Ray McDermott Holdings, Inc. (“JRHMI”) is subject to United States income tax at a rate of 35%. No current United States income tax is payable by JRHMI due to the past tax losses which it has generated. JRHMI’s valuation allowance for the realization of deferred tax assets had been adjusted in accordance with SFAS No. 109, “Accounting for Income

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Taxes.” JRMHI’s provision for income taxes is primarily associated with its operations performed outside the United States, which has no relationship to its income (loss) before income tax.

     See Note 4 to our consolidated financial statements included in this report for further information on taxes.

Y E A R   E N D E D    D E C E M B E R   3 1 ,   2 0 0 3    C O M P A R E D    T O   Y E A R   E N D E D  
D E C E M B E R    3 1 ,   2 0 0 2

M a r i n e    C o n s t r u c t i o n   S e r v i c e s

     Revenues increased 59% to $1.8 billion for the year ended December 31, 2003. The improvement in revenues resulted from increased fabrication and marine installation on the major projects listed below:

	•	a topside fabrication project for BP in our Morgan City facility;
	•	AIOC projects for fabrication of topsides and marine installation of topsides and pipelines in the Azerbaijan sector of the Caspian Sea;
	•	wellhead deck and jacket fabrication and marine installation project offshore Qatar for an ExxonMobil affiliate;
	•	fabrication of platforms and installation of subsea cables for a Middle Eastern operator;
	•	fabrication and installation of decks for an operator offshore Vietnam;
	•	the Devils Tower and Front Runner Spar projects;
	•	the Carina Aries project; and
	•	the Belanak FPSO project.

Partially offsetting these increases was a decline in Gulf of Mexico and Asia Pacific projects other than those listed above.

     Segment operating loss, which is before equity in income from investees, for the year ended December 31, 2003 was a loss of $51.1 million, compared to a loss of $165.3 million for the year ended December 31, 2002. Each of the projects listed above contributed operating income to partially offset the segment operating loss for the year ended December 31, 2003, with the following exceptions:

	•	the Carina Aries project, where we recorded losses of $66.5 million in 2003 as compared to a $9.6 million loss in 2002;
	•	the Front Runner Spar project, where we recorded additional losses of $39.7 million in 2003, as compared to a $9.3 million loss in 2002; and
	•	the Belanak FPSO project, where we recorded a loss of $29.2 million in the December 2003 quarter, which offset $3.9 million and $8.0 million of profit previously recorded in 2003 and 2002, respectively, under the percentage-of-completion method. This put the Belanak FPSO project in a loss position of $17.3 million at December 31, 2003.

The year ended December 31, 2003 included losses of $27.9 million (with improvements on Medusa and Devils Tower offsetting the additional $39.7 million loss on Front Runner) on the three Spar projects as compared to losses of $149.3 million for the year ended December 31, 2002.

     Gain (loss) on asset disposals and impairments-net for the year ended December 31, 2003 included a $2.9 million gain on the sale of assets associated with operations in Europe that are no longer active and a $1.4 million gain on the sale of an investment in an oil and gas property. During the year ended December 31, 2002, we wrote-off goodwill of $313.0 million.

     Equity in income (loss) of investees declined to a loss of $0.5 million during the year ended December 31, 2003 compared to income of $5.3 million during the year ended December 31, 2002. The year ended December 31, 2002 included income from a European joint venture that is no longer active and income from our Spars International joint venture, offset by losses associated with our Mexican joint venture, which is now being accounted for on the cost method.

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Government Operations

     Revenues decreased $22.3 million to $531.5 million, primarily due to lower volumes from our management and operating contract at the U. S. Government-owned facility in Miamisburg, Ohio. We are no longer the prime contractor but are now a subcontractor for this site, and, as a result, we now record only our fee in revenues rather than the full revenues from the contract. In addition, our research and development division reported lower revenues due to reassigning contracts out to their responsible divisions (including B&W and its subsidiaries) as part of the decentralization of our research and development activities. We also experienced lower revenues from our commercial work and other government operations, primarily due to an early lease buyout and the completion of a very profitable contract in 2002. The decreases in revenues were partially offset by revenues attributable to higher volumes from the manufacture of nuclear components for certain U.S. Government programs and our commercial nuclear environmental services. In addition, we resolved two contract disputes favorably.

     Segment operating income, which is before equity income from investees, increased $23.6 million to $58.2 million, primarily due to higher volume and margins from the manufacture of nuclear components for certain U.S. Government programs. In addition, we decreased spending on fuel cell research and development and, as mentioned above, we resolved two contract disputes favorably. These increases in operating income were partially offset by lower volume and margins from our commercial work and from our other government operations. In addition, we experienced higher general and administrative expenses due to increased facility management oversight costs and increased regulatory compliance costs. We also experienced lower costs in the prior year due to the receipt of an insurance settlement relating to environmental restoration costs.

     Equity in income from investees increased $3.4 million to $28.0 million, primarily due to increased operating results from several of our joint ventures operating in Idaho, Louisiana, Tennessee and Texas.

Corporate

     Unallocated corporate expenses increased $70.0 million to $93.6 million, primarily due to higher qualified pension plan expenses as a result of changes in our discount rate and plan asset performance. Also, the results of our captive insurers were lower in the year ended December 31, 2003 compared with the year ended December 31, 2002.

     During the year ended December 31, 2003, we recognized expense from certain of our qualified pension plans of approximately $75.7 million. During the year ended December 31, 2002, we recognized expense from these plans of approximately $11.1 million.

Other Income Statement Items

     Interest income decreased $5.3 million to $3.2 million, primarily due to a decrease in average cash equivalents and investments and prevailing interest rates.

     Interest expense increased $3.9 million to $19.0 million, primarily due to higher interest costs associated with our omnibus revolving credit facility and JRM’s 11% senior secured notes. These increases were partially offset by lower interest expense resulting from the repayment of MI’s remaining 9.375% Notes due March 15, 2002.

     Other-net improved $6.3 million to income of $2.1 million, primarily due to income resulting from the curtailment of JRM’s qualified pension plan and minority interest income associated with a JRM subsidiary. These improvements were partially offset by an increase in foreign currency transaction losses.

Provision for Income Taxes

     The net pre-tax provision for the estimated cost of the B&W Chapter 11 settlement recorded in the year ended December 31, 2003 includes approximately $24.4 million of expenses with no associated tax benefits. The remaining items, consisting primarily of estimated benefits we expect to receive as a result of the proposed B&W Chapter 11 settlement, constitute income in jurisdictions where we are subject to income taxation. In addition, for the year ended December 31, 2003, we decreased our valuation allowance for the realization of deferred tax assets by $15.5 million to $199.3 million.

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     We recorded the following charges in the year ended December 31, 2002, with little or no associated tax benefit:

	•	the impairment of the remaining $313.0 million of goodwill attributable to the premium we paid on the acquisition of the minority interest in JRM in June 1999;
	•	the write-off of the investment in B&W and other related assets totaling $224.7 million; and
	•	the net pre-tax provision of $86.4 million for the estimated cost of settlement of the B&W Chapter 11 proceedings.

     We operate in many different tax jurisdictions. Within these jurisdictions, tax provisions vary because of nominal rates, allowability of deductions, credits and other benefits and tax bases (for example, revenue versus income). These variances, along with variances in our mix of income from these jurisdictions, are responsible for shifts in our effective tax rate.

Cumulative Effect of Accounting Change

     Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires us 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, we capitalize 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, we will either settle the obligation for its recorded amount or incur a gain or loss upon settlement. As a result of the adoption of SFAS No. 143, we recorded income of approximately $3.7 million as the cumulative effect of an accounting change.

E F F E C T S   O F   I N F L A T I O N    A N D   C H A N G I N G   P R I C E S

     Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, using historical U.S. dollar accounting (“historical cost”). Statements based on historical cost, however, do not adequately reflect the cumulative effect of increasing costs and changes in the purchasing power of the dollar, especially during times of significant and continued inflation.

     In order to minimize the negative impact of inflation on our operations, we attempt to cover the increased cost of anticipated changes in labor, material and service costs, either through an estimate of those changes, which we reflect in the original price, or through price escalation clauses in our contracts.

L I Q U I D I T Y    A N D   C A P I T A L   R E S O U R C E S

     As we disclosed in our annual report on Form 10-K for the year ended December 31, 2003, as of December 31, 2003, there was substantial doubt about JRM’s ability to continue as a going concern. Since December 31, 2003, we have implemented certain portions of our plan to address JRM’s liquidity issues. Since December 31, 2003, the following items have improved JRM’s liquidity:

	•	JRM completed the sales of its DB60 and Oceanic 93 vessels resulting in cash proceeds of approximately $44 million and $18.7 million, respectively. The $18.7 million amount is now unrestricted while the $44 million amount continues to be restricted for capital expenditures through July 2005. In addition, JRM sold its inactive Ardersier, Scotland fabrication facility for approximately $14.5 million. (See the discussion of asset sales below for additional details);
	•	JRM completed the Spar projects and, as a result, a $22 million temporary interest reserve has been released to unrestricted cash;
	•	the Belanak FPSO and Carina Aries projects are both substantially complete and, as a result, the risk of these projects negatively impacting JRM’s liquidity has been significantly reduced;
	•	JRM completed a new $25 million letter of credit facility that allowed for the release of approximately $25.3 million of cash previously restricted as collateral for letters of credit;
	•	JRM has entered into an uncommitted credit facility with MII under which JRM can request up to $25 million in loans from MII, subject to certain negotiated terms and conditions; through the date of this report, this facility has not been utilized; and
	•	JRM has implemented cost reductions and downsizing at certain of its facilities.

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As a result of the successful completion of these items, we believe that JRM will fulfill its liquidity requirements throughout our 2005 forecast period and there is no longer substantial doubt concerning JRM’s ability to continue as a going concern through our 2005 forecast period. Although JRM has improved its liquidity, various factors could have a negative impact on JRM’s cash flows in the future, including the risk that JRM may be unable to increase backlog and reduce future costs and credit risks at one of JRM’s Mexican joint ventures, as described under “General — Marine Construction Services Segment – Recent Operating Results and Outlook.”

     On December 9, 2003, we completed new financing arrangements for JRM and BWXT on a stand- alone basis. These financing arrangements included the issuance of $200 million aggregate principal amount of 11% senior secured notes due 2013 by JRM (the “JRM Secured Notes”) and the entering into of a three year, $125 million revolving credit facility by BWXT (the “BWXT Credit Facility”). The BWXT Credit Facility was increased to $135 million in January 2004. Concurrent with the new financing arrangements, we cancelled our $166.5 million omnibus revolving credit facility, which was scheduled to expire in April 2004. Neither the JRM Secured Notes nor the BWXT Credit Facility is guaranteed by MII.

     The JRM Secured Notes were issued in an original aggregate principal amount of $200 million, mature on December 15, 2013 and bear interest at 11% per annum, payable semiannually on each June 15 and December 15, commencing June 15, 2004. These notes were issued at a discount, yielding proceeds to JRM of $194.1 million before payment of approximately $8.0 million in debt issuance costs. The JRM Secured Notes are senior secured obligations of JRM and are guaranteed by certain subsidiaries of JRM.

     On or after December 15, 2008, JRM may redeem some or all of the JRM Secured Notes at a redemption price equal to the percentage of principal amount set forth below plus accrued and unpaid interest to the redemption date.

     Before December 15, 2006, JRM may redeem the JRM Secured Notes with the cash proceeds from public equity offerings by JRM at a redemption price equal to 111% of the principal amount plus accrued and unpaid interest to the redemption date, in an aggregate principal amount for all such redemptions not to exceed 35% of the original aggregate principal amount of the notes, subject to specified conditions.

     JRM’s obligations under the indenture relating to the JRM Secured Notes are unconditionally guaranteed, jointly and severally, by (1) all subsidiaries that own a marine vessel that is or is required to become a mortgaged vessel under the terms of the indenture and related collateral agreements and (2) all significant subsidiaries of JRM as defined in the indenture. The JRM Secured Notes are secured by first-priority liens, subject to certain exceptions and permitted liens, on (1) capital stock of some of the subsidiary guarantors and (2) specified major marine construction vessels owned by JRM and certain subsidiary guarantors. The indenture relating to the JRM Secured Notes requires JRM to comply with various covenants that, among other things, restrict JRM’s ability to:

	•	incur additional debt or issue subsidiary preferred stock or stock with a mandatory redemption feature before the maturity of the notes;
	•	pay dividends on its capital stock;
	•	redeem or repurchase its capital stock;
	•	make some types of investments and sell assets;
	•	use proceeds from asset sales to fund working capital needs;
	•	create liens or engage in sale and leaseback transactions;
	•	engage in transactions with affiliates, except on an arm’s-length basis; and
	•	consolidate or merge with, or sell its assets substantially as an entirety to, another person.

The indenture also imposes various reporting obligations on JRM.

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     JRM is required to use commercially reasonable efforts to complete an offer to exchange the JRM Secured Notes for notes registered under the Securities Act. JRM has not yet satisfied its exchange offer obligations and, therefore, effective June 2004, is required to pay additional interest at a rate of 0.50% per annum until it satisfies those obligations. We expect JRM will satisfy its exchange offer obligations in 2005.

     The BWXT Credit Facility is a revolving credit agreement providing for borrowings and issuances of letters of credit in an aggregate amount of up to $135 million for a three-year term. Borrowings under the agreement may not exceed $100 million. The BWXT Credit Facility requires BWXT to comply with various financial and nonfinancial covenants and reporting requirements. The financial covenants require BWXT to maintain a minimum leverage ratio; a minimum fixed charge coverage ratio; and a maximum debt to capitalization ratio. BWXT was in compliance with these covenants at December 31, 2004. The interest rate at December 31, 2004 was 5.75%. Commitment fees are charged at a per annum rate of 0.50%, payable quarterly. Proceeds from the BWXT Credit Facility have been used to repay an intercompany loan from MII, to repay amounts owed by BWXT under the omnibus revolving credit facility and for general corporate purposes of BWXT, its subsidiaries and joint ventures. At December 31, 2004, BWXT had no borrowings outstanding and letters of credit outstanding under the facility totaled $52.3 million. In March 2005, this facility was extended to March 18, 2010. In addition, certain covenants were modified which increases permitted acquisition to $75 million over a twelve-month period and increasing allowable unsecured debt to $20 million.

     As a result of improved operations and asset sales, JRM experienced positive cash flows in 2004. In July 2004, JRM completed the sale of its DB60 combination derrick and pipelay barge and its Oceanic 93 barge, together with a shearleg crane installed on that vessel. The cash sales price received for the DB60 was approximately $44 million. JRM currently plans to use the proceeds from the sale of the DB 60 to fund forecasted capital expenditures through July 2005, a permitted use under the indenture related to the JRM secured notes. In accordance with this indenture, after July 2005, (a twelve month period) JRM must make an offer to purchase an aggregate principal amount of the JRM secured notes with any remaining proceeds from the DB 60 sale. To the extent that such an offer expires, any remaining cash proceeds from the offer to purchase will become unrestricted. The cash sales price received for the Oceanic 93 was approximately $18.7 million and, in accordance with the indenture relating to the JRM Secured Notes, JRM made an offer to purchase $18.7 million aggregate principal amount of the JRM Secured Notes. JRM did not receive any tenders of the JRM secured Notes during the offer period and the $18.7 million of previously restricted funds became unrestricted and available for JRM’s general corporate purposes, subject to the restrictive covenants contained in the indenture. In addition, in December 2004, JRM completed the sale of its inactive Ardersier fabrication facility for approximately $14.5 million. The restrictions on these proceeds are the same as those described on the DB 60 above.

     At December 31, 2004, JRM had $69.0 million in outstanding letters of credit secured by collateral accounts funded with cash equal to 105% of the amount outstanding. In addition, JRM had $24.1 million in letters of credit outstanding under a $25 million letter of credit facility entered on August 25, 2004. This facility provided for an immediate credit advance of $25 million, to secure letters of credit issued under the facility. The obligation to repay the $25 million advance under the facility is secured with liens placed on certain JRM assets, including its domestic accounts receivable and the DB26 vessel. The term of the facility is 36 months with an optional redemption by JRM after 18 months, with no financial covenants. The non-financial covenants and certain other terms and conditions of the $25 million letter of credit facility are similar to those set forth in the indenture relating to the JRM Secured Notes. This facility has a 14.5% participation fee and letters of credit are charged at a 0.125% fee.

     As of December 31, 2004, MII had outstanding performance guarantees for four JRM projects. MII has not previously been required to satisfy a material performance guaranty for JRM or any of its other subsidiaries. All of these guarantees (with a total cap of $132 million) relate to projects which have been completed and are in the warranty periods, the latest of which would expire in January 2006. JRM has incurred minimal warranty costs in prior years, and any substantial warranty costs in the future could possibly be covered in whole or in part by insurance. However, if JRM incurs substantial warranty liabilities and is unable to respond, and such liabilities are not covered by insurance, MII would ultimately have to satisfy those claims.

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     In March 2004, Standard and Poor’s raised its corporate credit ratings on MII and MI to B- from CCC+. At the same time, Standard and Poor’s lowered its credit rating on JRM to CCC+ from B-. In March 2004, Moody’s Investor Service also lowered its ratings of JRM to Caa1 from B3.

     MI expects to meet its cash needs in 2004 through intercompany borrowings from BWXT, which BWXT may fund through operating cash flows or borrowings under its credit facility. MI is restricted, as a result of covenants in its debt instruments, in its ability to transfer funds to MII and MII’s other subsidiaries, including JRM, through cash dividends or through unsecured loans or investments.

     At December 31, 2004, we had total restricted cash and cash equivalents of $178.0 million, of which $66.5 million was classified as non-current. The restricted cash and cash equivalents include the following: $77.9 million serves as collateral for letters of credit; $4.8 serves as collateral for foreign exchange trading and other financial obligations; $40.5 million is required to meet reserve requirements of our captive insurance companies; $51.3 million of proceeds from asset sales by JRM is held in a separate account (classified as noncurrent) in order to ensure that JRM’s use of those proceeds will comply with the applicable requirements of the indenture relating to the JRM Secured Notes; and $3.5 million is held in restricted foreign accounts. The $51.3 million of proceeds from JRM’s asset sale is classified as noncurrent since the funds are expected to be used to finance capital expenditures. In addition, $15.2 million of the cash serving as collateral for letters of credit is classified as noncurrent because the associated letters of credit have expiration dates beyond one year from December 31, 2004.

     At December 31, 2004 and 2003, our balance in cash and cash equivalents on our consolidated balance sheets includes approximately $10.6 million and $19.9 million, respectively, in adjustments for bank overdrafts, with a corresponding increase in accounts payable for these overdrafts.

     Our working capital, excluding restricted cash and cash equivalents, improved by approximately $151.6 million from a negative $204.8 million at December 31, 2003 to a negative $53.2 million at December 31, 2004. Since December 31, 2003, $28.7 million of restricted cash held by BWXT has been released. In addition, as of August 2, 2004, in accordance with the indenture relating to the JRM Secured Notes, the temporary interest reserve of $22.0 million is no longer required due to completion of the Front Runner project. Also in August 2004, JRM’s new $25 million letter of credit facility allowed for the release of approximately $25.3 million of cash previously restricted to collateralize letters of credit.

     Our net cash provided by operations was approximately $65.3 million for the year ended December 31, 2004 compared to net cash used by operations of $97.5 million for the year ended December 31, 2003. This improvement was attributable to an increase in net income and cash flow improvements at JRM.

     Our net cash provided by investing activities increased approximately $74.3 million to $57.5 million for the year ended December 31, 2004 from cash used in investing activities of $16.8 million for the year ended December 31, 2003. Net cash provided by investing activities increased in the year ended December 31, 2003 primarily as a result of the reclassification of restricted cash and cash equivalents to unrestricted cash and cash equivalents and increased proceeds from asset sales.

     At December 31, 2004, we had investments with a fair value of $41.9 million. Our investment portfolio consists primarily of investments in government obligations and other highly liquid money market instruments. As of December 31, 2004, we had pledged approximately $41.4 million fair value of these investments to secure a letter of credit in connection with certain reinsurance agreements.

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At March 9, 2005, our liquidity position was as follows (in millions):

Our cash requirements as of December 31, 2004 under current contractual obligations are as follows:

We have interest payments on our long-term debt obligations above as follows: less than one year $27.8 million; one to three years $54.9 million; three to five years $53.3 million and after five years $169.1 million for a total of $305.1 million. These obligations are based on the debt outstanding at December 31, 2004 and the stated interest rates. For these purposes, we have assumed associated long-term debt will remain outstanding until maturity and will not be refinanced. In addition, we expect to contribute approximately $17.2 million to our domestic pension plans and $4.6 million to our domestic other postretirement benefit plans in 2005.

     Our contingent commitments, excluding amounts guaranteed related to B&W, under letters of credit currently outstanding expire as follows:

     As of December 31, 2004, MII had outstanding performance guarantees for four Volund contracts. Volund is currently owned by B&W. These guarantees, the last of which will expire on December 31, 2007, were all executed in 2001 and have a cap of $75 million. These projects have all been completed and MII has never had to satisfy a performance guaranty for Volund. Under the terms of an agreement between MII and B&W, B&W must reimburse MII for any costs MII may incur under any of these performance guarantees. As of December 31, 2004, B&W has sufficient liquidity to cover its obligations under this agreement. However, if Volund incurs and is unable to satisfy substantial warranty liabilities on these projects prior to expiration of the guaranty periods and B&W is not able to satisfy its contractual obligation to MII and such liabilities are not covered by insurance, MII would be liable.

     On February 21, 2000, B&W and certain of its subsidiaries entered into the DIP Credit Facility to satisfy their working capital and letter of credit needs during the pendency of their bankruptcy case. B&W had no borrowings outstanding under this facility at December 31, 2004 or December 31, 2003. Letters of credit outstanding under the DIP Credit Facility at December 31, 2004 totaled approximately $196.5 million. On December 21, 2004 this facility was amended with a two year extension and increased from $227 million to $250 million. As a condition to borrowing or obtaining letters of credit under the DIP Credit Facility, B&W must comply with certain financial covenants. See Note 20 to our consolidated financial statements included in this report for further information on the DIP Credit Facility.

     As of December 31, 2004, MII, MI and BWICO have agreed to indemnify B&W for customer draws on $17.3 million in letters of credit that have been issued under the DIP Facility to replace or backstop letters of credit on which

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MII, MI and BWICO were makers or guarantors as of the time of B&W’s Chapter 11 filing. We are not aware that B&W has ever had a letter of credit drawn on by a customer. However, should customer draws occur on a significant amount of these letters of credit requiring MII, MI and BWICO, either individually or combined, to satisfy their primary, guaranty or indemnity obligations, the liquidity of MII, MI and BWICO would not be strained. In addition, as of December 31, 2004, MII guaranteed surety bonds of approximately $48.0 million, of which $43.8 million related to the business operations of B&W and its subsidiaries. We are not aware that either MII or any of its subsidiaries, including B&W, have ever had a surety bond called. As to the guarantee and indemnity obligations involving B&W, the proposed B&W Chapter 11 settlement contemplates indemnification and other protections for MII, MI and BWICO.

     As a result of its bankruptcy filing, B&W and its filing subsidiaries are precluded from paying dividends to us.

     See Note 20 to our consolidated financial statements included in this report for additional information regarding B&W.

I t e m 7 A .   Q U A N T I T A T I V E   A N D   Q U A L I T A T I V E   D I S C L O S U R E S   A B O U T   M A R K E T   R I S K

     Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents and our investment portfolio, which is primarily comprised of investments in U.S. Government obligations and highly liquid money market instruments denominated in U.S. dollars. We are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk. All our investments in debt securities are classified as available-for-sale.

     We have no material future earnings or cash flow exposures from changes in interest rates on our long-term debt obligations, as substantially all of these obligations have fixed interest rates. We have exposure to changes in interest rates on the BWXT Credit Facility (see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources). At December 31, 2004 we had no outstanding borrowings under this facility.

     We have operations in many foreign locations, and, as a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in those foreign markets. In order to manage the risks associated with foreign currency exchange fluctuations, we attempt to hedge those risks with foreign currency derivative instruments. Historically, we have hedged those risks with foreign currency forward contracts. However, due to limitations in our credit facilities, we have recently hedged those risks with foreign currency option contracts. We do not enter into speculative derivative instruments.

Interest Rate Sensitivity

     The following tables provide information about our financial instruments that are sensitive to changes in interest rates. The tables present principal cash flows and related weighted-average interest rates by expected maturity dates.

Principal Amount by Expected Maturity
(In thousands)

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Exchange Rate Sensitivity

     The following table provides information about our foreign currency forward contracts outstanding at December 31, 2004 and presents such information in U.S. dollar equivalents. The table presents notional amounts and related weighted-average exchange rates by expected (contractual) maturity dates and constitutes a forward-looking statement. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract.

     At December 31, 2004, we had a foreign currency option contract outstanding to purchase 840,000 Euros at a strike price of 1.3 with an expiration date of February 28, 2005. This contract had a total fair value of approximately $56,000 at December 31, 2004.

     At December 31, 2003, we had foreign currency option contracts outstanding to purchase 9.1 million Euros at a weighted-average strike price of 1.245 with varying expiration dates through November 30, 2004. These contracts had a total fair value of approximately $0.4 million at December 31, 2003. We had no foreign currency forward contracts outstanding at December 31, 2003.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of
McDermott International, Inc.:

We have completed an integrated audit of McDermott International, Inc.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of McDermott International, Inc. and its subsidiaries (the “Company”) at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003.

As discussed in Notes 1, 20 and 21 to the consolidated financial statements, on February 22, 2000, The Babcock & Wilcox Company, a wholly owned subsidiary of the Company, filed a voluntary petition with the U.S. Bankruptcy Court to reorganize under Chapter 11 of the U.S. Bankruptcy Code. In 2002, the Company entered into a preliminary settlement agreement with certain claimants to resolve the Chapter 11 filing, and other matters, and in 2003 filed an amended proposed consensual plan of reorganization with the U.S. Bankruptcy Court. In 2004, the U.S. Bankruptcy Court entered its amended findings and proposed findings of fact and conclusions of law regarding core and non-core matters, respectively, and recommended that the Plan be confirmed. The final resolution and timing of these matters remains uncertain.

Internal control over financial reporting

Also, we have audited management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that McDermott International, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, because the Company did not maintain efffective controls over account reconciliations and access to application programs and data, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and

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operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment. As of December 31, 2004, the Company did not maintain effective controls over account reconciliations and access to application programs and data. Specifically, account reconciliations in the Marine Construction Services segment in the Eastern Hemisphere related to cash and cash equivalents, accounts payable and other accounts, were not being properly completed. This control deficiency did not result in a significant adjustment to the 2004 interim or annual consolidated financial statements. However, this control deficiency could result in a misstatement in a number of the Company’s financial statement accounts resulting in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency represents a material weakness. Further, as of December 31, 2004, the Company identified control deficiencies at its business units with respect to access to financial application programs and data. Such deficiencies include a lack of compliance with the Company’s internal access security policies and segregation of duties requirements and a lack of independent monitoring of the activities of technical information technology staff and some users with financial accounting and reporting responsibilities that also have unrestricted access to financial application programs and data. These control deficiencies did not result in an adjustment to the 2004 interim or annual consolidated financial statements. However, these control deficiencies could result in a misstatement in a number of the Company’s financial statement accounts resulting in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that these access control deficiencies represent a material weakness. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.

In our opinion, management’s assessment that McDermott International, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the COSO. Also, in our opinion, because of the effects of the material weaknesses described above on the achievement of the objectives of the control criteria, McDermott International, Inc. has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the COSO.

PricewaterhouseCoopers LLP
New Orleans, Louisiana
March 25, 2005

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M c D E R M O T T   I N T E R N A T I O N A L ,   I N C .

C O N S O L I D A T E D   B A L A N C E   S H E E T S

A S S E T S

See accompanying notes to consolidated financial statements.

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L I A B I L I T I E S   A N D   S T O C K H O L D E R S ’   D E F I C I T

46

M c D E R M O T T   I N T E R N A T I O N A L ,   I N C.

See accompanying notes to consolidated financial statements.

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M c D E R M O T T   I N T E R N A T I O N A L ,   I N C.
C O N S O L I D A T E D   S T A T E M E N T S  O F   C O M P R E H E N S I V E  I N C O M E   (L O S S)