MCDERMOTT INTERNATIONAL INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

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

For the period ended June 30, 2002

OR

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

For the transition period from ______________to______________

Commission File No. 1-8430

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.

Yes [X] No [ ]

The number of shares outstanding of the registrant's Common Stock at July 30,
2002 was 63,315,113.

McDERMOTT INTERNATIONAL , IN .

INDEX - FORM 10 - Q

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PART I

McDERMOTT INTERNATIONAL, INC.

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

3

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

See accompanying notes to condensed consolidated financial statements.

4

LIABILITIES AND STOCKHOLDERS' EQUITY

See accompanying notes to condensed consolidated financial statements.

5

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

See accompanying notes to condensed consolidated financial statements.

6

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

See accompanying notes to condensed consolidated financial statements.

7

McDERMOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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CONTINUED

See accompanying notes to condensed consolidated financial statements.

9

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

NOTE 1 - BASIS OF PRESENTATION

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

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

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

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

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

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

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

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

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

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Due to the bankruptcy filing, beginning on February 22, 2000, we no longer
consolidate B&W's financial results in our condensed consolidated financial
statements, and we have been presenting our investment in B&W on the cost
method. The filing, along with subsequent filings and negotiations, have led to
increased uncertainty with respect to the amounts, means and timing of the
ultimate settlement of asbestos claims and the recovery of our investment in
B&W. Due to this increased uncertainty, we wrote off our net investment in B&W
in the three months ended June 30, 2002. The total impairment charge of $224.7
million included our investment in B&W of $187.0 million and other related
assets totaling $37.7 million, primarily consisting of accounts receivable from
B&W, for which we provided an allowance of $18.2 million. This non-cash charge
was precipitated by a combination of factors including a change in our
expectations regarding our ability to retain our equity in B&W. Subsequent to
June 30, 2002, we have reached an agreement in principle with representatives of
the present and future asbestos claimants in the Chapter 11 proceedings on
several key terms, although a number of significant issues and numerous details
remain to be negotiated and resolved. See Note 9 for information regarding
recent developments in negotiations relating to the B&W Chapter 11 proceedings.

Effective January 1, 2002, based on a review performed by us and our independent
consultants, we changed our estimate of the useful lives of new major marine
vessels from 12 years to 25 years to better reflect the service lives of our
assets and industry norms. Consistent with this change, we also extended the
lives of major upgrades to existing vessels. We continue to depreciate our major
marine vessels using the units-of-production method, based on the utilization of
each vessel. The change in estimated useful lives improved our operating income
by approximately $0.9 million and $1.3 million for the three and six months
ended June 30, 2002, respectively.

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that we no longer amortize goodwill, but instead perform periodic
testing for impairment. We have completed our transitional goodwill impairment
test and will not incur a transitional goodwill impairment charge as of January
1, 2002. See Note 8 for a reconciliation of reported net income to adjusted net
income, which excludes goodwill amortization expense for all periods presented.

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

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Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
See Note 2 for information on our discontinued operations.

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

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities." SFAS No. 146 addresses significant issues regarding the
recognition, measurement and reporting of costs associated with exit and
disposal activities, including restructuring activities. It is effective for
exit or disposal activities that are initiated after December 31, 2002. We are
reviewing the effect SFAS No. 146 will have on our consolidated financial
position and results of operations.

NOTE 2 - DISCONTINUED OPERATIONS
As of June 30, 2002, we have classified our subsidiary Hudson Products
Corporation ("HPC"), a component of our Industrial Operations segment, as an
asset held for sale in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which we adopted on January 1,
2002. Accordingly, we have reported the results of operations for HPC in
discontinued operations. The condensed consolidated statements of income (loss)
for the three and six months ended June 30, 2001 have been restated for
consistency to reflect the current year treatment of HPC as a discontinued
operation. Condensed financial information for our operations reported in
discontinued operations follows:

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We have reported the assets and liabilities of HPC in our condensed consolidated
balance sheets as held for sale, as follows:

On July 10, 2002, we completed the sale of HPC for $40 million, consisting of
$38 million in cash and a $2 million subordinated promissory note. See Note 11
for more information.

NOTE 3 - INVENTORIES

Our inventories are summarized below:

NOTE 4 - ACCUMULATED OTHER COMPREHENSIVE LOSS

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

NOTE 5 - Investigations and Litigation

On March 12, 2001, the plaintiffs' motion for rehearing en banc was denied by
the U.S. Court of Appeals for the Fifth Circuit in the December 1998 lawsuit
filed by Den norske stats oljeselskap a.s. and several related entities against
MII, JRM and others arising from alleged anti-competitive activities. The
plaintiffs filed a petition for writ of certiorari to the U.S. Supreme Court. On
February 20, 2002, the U.S. Supreme Court denied the petition for certiorari.
The plaintiffs filed a motion for rehearing by the U.S. Supreme Court. On April
15, 2002, the U.S. Supreme Court denied the motion for rehearing. During the
three months ended

13

June 30, 2002, Heerema and MII executed agreements to settle the heavy lift
anti-trust claims against Heerema and MII with British Gas, Phillips, Exxon, BP
and Total Fina Elf. Because we previously accrued amounts adequate to cover
these claims, no additional provision was recorded in the quarter ended June 30,
2002.

In December 1998, a subsidiary of JRM (the "Operator Subsidiary") was in the
process of installing the south deck module on a compliant tower in the Gulf of
Mexico for Texaco Exploration and Production, Inc. ("Texaco") when the main
hoist load line failed, resulting in the loss of the module. In December 1999,
Texaco filed a lawsuit seeking consequential damages for delays resulting from
the incident, as well as costs incurred to complete the project with another
contractor and uninsured losses. This lawsuit was filed in the U. S. District
Court for the Eastern District of Louisiana against a number of parties, some of
which brought third-party claims against the Operator Subsidiary and another
subsidiary of JRM, the owner of the vessel that attempted the lift of the deck
module (the "Owner Subsidiary"). Both the Owner Subsidiary and the Operator
Subsidiary were subsequently tendered as direct defendants to Texaco. In
addition to Texaco's claims in the federal court action, damages for the loss of
the south deck module have been sought by Texaco's builder risk insurers in
claims against the Owner Subsidiary and the other defendants, excluding the
Operator Subsidiary, which was an additional insured under the policy. Total
damages sought by Texaco and its builder risk insurers in the federal court
proceeding approximate $250 million. Texaco's federal court claims against the
Operator Subsidiary were stayed in favor of a pending binding arbitration
proceeding between them required by contract, which the Operator Subsidiary
initiated to collect $23 million due for work performed under the contract, and
in which Texaco also sought consequential damages and uninsured losses. The
federal court trial, on the issue of liability only, commenced in October 2001.
On March 27, 2002, the Court orally found that the Owner Subsidiary was liable
to Texaco, specifically finding that Texaco had failed to sustain its burden of
proof against all named defendants except the Owner Subsidiary relative to
liability issues, and, alternatively, that the Operator Subsidiary's highly
extraordinary negligence served as a superceding cause of the loss. The finding
was subsequently set forth in a written order dated April 5, 2002, which found
against the Owner Subsidiary on the claims of Texaco's builder risk insurers in
addition to the claims of Texaco. The judge has not entered a final judgment on
this matter. On May 6, 2002, the Owner Subsidiary filed a notice of appeal of
the April 5, 2002 order, which appeal it subsequently withdrew without prejudice
for technical reasons. We believe the April 5, 2002 order is unsupported under
the applicable law and facts and intend to appeal when timely. The case has
recently been transferred to a new district court judge, and a trial date of
February 10, 2003 has been set for damages and certain insurance issues. The
trial in the arbitration proceeding is set to commence on January 13, 2003.
Although the Owner Subsidiary is not a party to the arbitration, we believe that
the claims against the Owner Subsidiary, like those against the Operator
Subsidiary, are governed by the contractual provisions which require arbitration
and waive the

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recovery of consequential damages against the Operator Subsidiary and its
affiliates. We plan to vigorously pursue the arbitration proceeding and any
appeals process in the federal court action, and we do not believe that a
material loss with respect to these matters is likely. In addition, we are
evaluating our insurance coverage in the event of any liability. However, the
ultimate outcome of the proceedings is uncertain, and an adverse ruling in
either proceeding could have a material adverse impact on our consolidated
financial position, results of operations and cash flow.

In early April 2001, a group of insurers (the "Plaintiff Insurers") who have
previously provided insurance to B&W under our excess liability policies filed
(1) a complaint for declaratory judgment and damages against MII in the B&W
Chapter 11 proceedings in the U.S. District Court for the Eastern District of
Louisiana and (2) a declaratory judgment complaint against B&W in the Bankruptcy
Court, which actions have been consolidated before the U.S. District Court for
the Eastern District of Louisiana, which has jurisdiction over portions of the
B&W Chapter 11 proceeding. The insurance policies at issue in this litigation
provide a significant portion of B&W's excess liability coverage available for
the resolution of the asbestos-related claims that are the subject of the B&W
Chapter 11 proceeding. The consolidated complaints contain substantially
identical factual allegations. These include allegations that, in the course of
settlement discussions with the representatives of the asbestos claimants in the
B&W bankruptcy proceeding, MII and B&W breached the confidentiality provisions
of an agreement they entered into with these Plaintiff Insurers relating to
insurance payments by the Plaintiff Insurers as a result of asbestos claims.
They also allege that MII and B&W have wrongfully attempted to expand the
underwriters' obligations under that settlement agreement and the applicable
policies through the filing of a plan of reorganization in the B&W bankruptcy
proceeding that contemplates the transfer of rights under that agreement and
those policies to a trust that will manage the pending and future
asbestos-related claims against B&W and certain of its affiliates. The
complaints seek declarations that, among other things, the defendants are in
material breach of the settlement agreement with the Plaintiff Insurers and that
the Plaintiff Insurers owe no further obligations to MII and B&W under that
agreement. With respect to the insurance policies, if the Plaintiff Insurers
should succeed in terminating the settlement agreement, they seek to litigate
issues under the policies in order to reduce their coverage obligations. The
complaint against MII also seeks a recovery of unspecified compensatory damages.
B&W filed a counterclaim against the Plaintiff Insurers, which asserts a claim
for breach of contract for amounts owed and unpaid under the settlement
agreement, as well as a claim for anticipatory breach for amounts that will be
owed in the future under the settlement agreement. B&W seeks a declaratory
judgment as to B&W's rights and the obligations of the Plaintiff Insurers and
other insurers under the settlement agreement and under their respective
insurance policies with respect to asbestos claims. On October 2, 2001, MII and
B&W filed dispositive motions with the District Court seeking dismissal of the
Plaintiff Insurers' claim that MII and B&W had materially breached the
settlement agreement at issue. In a ruling issued

15

January 4, 2002, the District Court granted MII's and B&W's motion for summary
judgment and dismissed the declaratory judgment action filed by the Plaintiff
Insurers. The ruling concluded that the Plaintiff Insurers' claims lacked a
factual or legal basis. Our agreement with the underwriters went into effect in
April 1990 and has served as the allocation and payment mechanism to resolve
many of the asbestos claims against B&W. We believe this ruling reflects the
extent of the underwriter's contractual obligations and underscores that this
coverage is available to settle B&W's asbestos claims. As a result of the
January 4, 2002 ruling, the only claims that remained in the litigation were
B&W's counterclaims against the Plaintiff Insurers and against other insurers.
The parties agreed to dismiss without prejudice those of B&W's counterclaims
seeking a declaratory judgment regarding the parties' respective rights and
obligations under the settlement agreement. B&W's counterclaim seeking a money
judgment for approximately $6.5 million due and owing by insurers under the
settlement agreement remains pending. A trial of this counterclaim is scheduled
for September 23, 2002. The parties have reached a preliminary agreement in
principle to settle B&W's counterclaim for in excess of the claimed amounts, and
approximately $4 million has been received to date from the insurers, subject to
reimbursement in the event a final settlement agreement is not reached.
Following the resolution of this remaining counterclaim, the Plaintiff Insurers
will have an opportunity to appeal the January 4, 2002 ruling. At this point,
the Plaintiff Insurers have not indicated whether they intend to pursue an
appeal.

On or about November 5, 2001, The Travelers Indemnity Company and Travelers
Casualty and Surety Company (collectively, "Travelers") filed an adversary
proceeding against B&W and related entities in the U.S. Bankruptcy Court for the
Eastern District of Louisiana seeking a declaratory judgment that Travelers is
not obligated to provide any coverage to B&W with respect to so-called
"non-products" asbestos bodily injury liabilities on account of previous
agreements entered into by the parties. On or about the same date, Travelers
filed a similar declaratory judgment against MI and MII in the U.S. District
Court for the Eastern District of Louisiana. The cases filed against MI and MII
have been consolidated before the District Court, and the Asbestos Claimants
Committee ("ACC") and the Future Claimants Representative ("FCR") have
intervened in the action. On February 4, 2002, B&W and MII filed answers to
Travelers' complaints, denying that previous agreements operate to release
Travelers from coverage responsibility for asbestos "non-products" liabilities
and asserting counterclaims requesting a declaratory judgment specifying
Travelers' duties and obligations with respect to coverage for B&W's asbestos
liabilities. The Court has bifurcated the case into two phases, with Phase I
addressing the issue of whether previous agreements between the parties serve to
release Travelers from any coverage responsibility for asbestos "non-products"
claims. On or about July 12, 2002, B&W and MII filed motions for leave to file
amended answers and counterclaims. The Court has not ruled on these motions.
Discovery has commenced on Phase I issues, and the Court set July 22, 2002 as
the close of Phase I discovery, with the briefing of dispositive motions to
follow. No trial date has been

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scheduled. This insurance, if available, would be in addition to the amounts
already included in B&W's financial statements as of June 30, 2002.

On April 30, 2001, B&W filed a declaratory judgment action in its Chapter 11
proceeding in the U.S. Bankruptcy Court for the Eastern District of Louisiana
against MI, BWICO, BWXT, Hudson Products Corporation and McDermott Technology,
Inc. seeking a judgment, among other things, that (1) B&W was not insolvent at
the time of, or rendered insolvent as a result of, a corporate reorganization
that we completed in the fiscal year ended March 31, 1999, which included, among
other things, B&W's cancellation of a $313 million note receivable and B&W's
transfer of all the capital stock of Hudson Products Corporation, Tracy Power,
BWXT and McDermott Technology, Inc. to BWICO, and (2) the transfers are not
voidable. As an alternative, and only in the event that the Bankruptcy Court
finds B&W was insolvent at a pertinent time and the transactions are voidable
under applicable law, the action preserved B&W's claims against the defendants.
The Bankruptcy Court permitted the ACC and the FCR in the Chapter 11 proceedings
to intervene and proceed as plaintiff-intervenors and realigned B&W as a
defendant in this action. The ACC and the FCR are asserting in this action,
among other things, that B&W was insolvent at the time of the transfers and that
the transfers should be voided. The Bankruptcy Court ruled that Louisiana law
applied to the solvency issue in this action. Trial commenced on October 22,
2001 to determine B&W's solvency at the time of the corporate reorganization and
concluded on November 2, 2001. In a ruling filed on February 8, 2002, the
Bankruptcy Court found B&W solvent at the time of the corporate reorganization.
On February 19, 2002, the ACC and FCR filed a motion with the District Court
seeking leave to appeal the February 8, 2002 ruling. On February 20, 2002, MI,
BWICO, BWXT, Hudson Products Corporation and McDermott Technology, Inc. filed a
motion for summary judgment asking that judgment be entered on a variety of
additional pending counts presented by the ACC and FCR that we believe are
resolved by the February 8, 2002 ruling. On March 20, 2002, at a hearing in the
Bankruptcy Court, the judge granted this motion and dismissed all claims
asserted in complaints filed by the ACC and the FCR regarding the 1998 transfer
of certain assets from B&W to its parent, which ruling was memorialized in an
Order and Judgment dated April 17, 2002 that dismissed the proceeding with
prejudice. On April 26, 2002, the ACC and FCR filed a notice of appeal of the
April 17, 2002 Order and Judgment and on June 20, 2002 filed their appeal brief.
On July 22, 2002, MI, BWICO, BWXT, Hudson Products Corporation and McDermott
Technology, Inc. filed their brief in opposition. In addition, an injunction
preventing asbestos suits from being brought against non-filing affiliates of
B&W, including MI, JRM and MII, and B&W subsidiaries not involved in the Chapter
11 extends through October 14, 2002.

Additionally, due to the nature of our business, we are, from time to time,
involved in routine litigation or subject to disputes or claims related to our
business activities, including performance or warranty related

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matters under our customer and supplier contracts and other business
arrangements. In our management's opinion, none of this litigation or disputes
and claims will have a material adverse effect on our consolidated financial
position, results of operations or cash flows.

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

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

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

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

o The December 2000 lawsuits filed by a number of Norwegian oil
companies against MII and others alleging violations of the Norwegian
Pricing Act of 1953 in connection with projects in Norway.

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

For a detailed description of these proceedings, please refer to Note 11 to the
consolidated financial statements included in Part II of MII's annual report on
Form 10-K for the year ended December 31, 2001. Also, see Note 9 to the
condensed consolidated financial statements regarding B&W's potential liability
for non-employee asbestos claims and additional information concerning the B&W
Chapter 11 proceedings.

NOTE 6 - SEGMENT REPORTING

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

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Segment Information for the Three and Six Months Ended June 30, 2002 and 2001.

20

NOTE 7 - EARNINGS (LOSS) PER SHARE

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

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

21

For the three and six months ended June 30, 2002, incremental shares of
2,302,893 and 2,250,954, respectively, related to stock options and restricted
stock were excluded from the diluted share calculation as their effect would
have been anti-dilutive.

NOTE 8 - GOODWILL

On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, we no longer amortize goodwill to earnings, but
instead we periodically test for impairment. Following is our reconciliation of
reported net income to adjusted net income, which excludes goodwill amortization
expense (including related tax effects), for the periods presented:

22

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

NOTE 9 - THE BABCOCK & WILCOX COMPANY

General

As a result of asbestos-containing commercial boilers and other products B&W and
certain of its subsidiaries sold, installed or serviced in prior decades, B&W is
subject to a substantial volume of non-employee liability claims asserting
asbestos-related injuries. All of the personal injury claims are similar in
nature, the primary difference being the type of alleged injury or illness
suffered by the plaintiff as a result of the exposure to asbestos fibers (e.g.,
mesothelioma, lung cancer, other types of cancer, asbestosis or pleural
changes).

On February 22, 2000, B&W and certain of its subsidiaries filed a voluntary
petition in the U.S. Bankruptcy Court for the Eastern District of Louisiana in
New Orleans (the "Bankruptcy Court") to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. Included in the filing are B&W and its subsidiaries Americon,
Inc., Babcock & Wilcox Construction Co., Inc. and Diamond Power International,
Inc. (the "Debtors"). The Debtors took this action as a means to determine and
comprehensively resolve all pending and future asbestos liability claims against
them. Following the filing, the Bankruptcy Court issued a preliminary injunction
prohibiting asbestos liability lawsuits and other actions for which there is
shared insurance from being brought against non-filing affiliates of the
Debtors, including MI, JRM and MII. The preliminary injunction is subject to
periodic hearings before the Bankruptcy Court for extension. Currently, the
preliminary injunction runs through October 14, 2002.

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

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

23

Insurance Coverage and Pending Claims

Prior to their bankruptcy filing, the Debtors had engaged in a strategy of
negotiating and settling asbestos personal injury claims brought against them
and billing the settled amounts to insurers for reimbursement. At June 30, 2002,
receivables of $23.5 million were due from insurers for reimbursement of settled
claims paid by the Debtors prior to the Chapter 11 filing. Currently, certain
insurers are refusing to reimburse the Debtors for these receivables until the
Debtors' assumption, in bankruptcy, of their pre-bankruptcy filing contractual
reimbursement arrangements with such insurers. To date, this has not had a
material adverse impact on the Debtors' liquidity or the conduct of their
business and we do not expect it to in the future. We anticipate that the
Debtors will eventually recover these insurance reimbursements.

Pursuant to the Bankruptcy Court's order, a March 29, 2001 bar date was set for
the submission of allegedly unpaid pre-Chapter 11 settled asbestos claims and a
July 30, 2001 bar date for all other asbestos personal injury claims, asbestos
property damage claims, derivative asbestos claims and claims relating to
alleged nuclear liabilities arising from the operation of the Apollo/Parks
Township facilities against the Debtors. As of the March 29, 2001 bar date, over
49,000 allegedly settled claims had been filed. The Debtors have accepted
approximately 8,600 as pre-Chapter 11 binding settled claims at this time with
an approximate value of $65 million. The Bankruptcy Court has disallowed
approximately 27,000 claims as settled claims, and the Debtors are in the
process of challenging virtually all of the remaining claims. If the Bankruptcy
Court determines these claims were not settled prior to the filing of the
Chapter 11 petition, these claims may be refiled as unsettled personal injury
claims. As of July 30, 2001, approximately 220,000 additional asbestos personal
injury claims, 60,000 related party claims, 168 property damage claims, 212
derivative asbestos claims and 524 claims relating to the Apollo/Parks Township
facilities had been filed. Since the July 30, 2001 bar date, approximately 4,224
additional personal injury claims were filed. The estimated total alleged value,
as asserted by the claimants in the Chapter 11 proceeding and in filed proofs of
claim, of the asbestos-related claims, including the alleged settled claims,
exceeds the combined value of the Debtors and certain assets transferred by B&W
to its parent in a corporate reorganization completed in fiscal year 1999 and
the known available products liability and property damage coverages. As set
forth in the proposed Litigation Protocol filed with the U. S. District Court on
October 18, 2001, the Debtors intend to challenge all unsupported claims and
believe that a significant number may be disallowed by the Bankruptcy Court. The
ACC and FCR filed briefs opposing the Litigation Protocol and requesting an
estimation of pending and future claims.

24

Debtors' Amended Plan of Reorganization

On February 22, 2001, the Debtors filed a plan of reorganization and a
disclosure statement. On May 7, 2002, the Debtors filed an amended plan of
reorganization and an amended disclosure statement (collectively, the "Debtors'
Amended Plan"), which supercede the plan and disclosure statement filed in
February 2001.

The Debtors' Amended Plan contemplates a resolution of the cases based on the
principle that all creditors with valid claims, including, but not limited to,
valid asbestos-related claims, will be paid in full. If the Debtors' Amended
Plan is approved, all of the shares of B&W will be transferred to a new
corporation (the "Funding Facility"), which will be owned by BWICO, B&W's
present shareholder. Payments under the Debtors' Amended Plan will generally be
funded from three sources: (1) available cash on the effective date of the
Debtors' Amended Plan generated from the Debtors' operations and available
financing; (2) available cash generated from the reorganized Debtors, after
reserves for letter of credit and working capital needs; and (3) insurance
proceeds. The Funding Facility would (a) pay directly claims for which it is
responsible under the Debtors' Amended Plan, including administrative claims not
arising in the ordinary course of the Debtors' businesses, general unsecured
claims, asbestos personal injury claims based on pre-Chapter 11 binding
settlement agreements ("Settled Asbestos Claims"), and any valid asbestos
property damage claims; (b) provide an initial $2.8 million (which we believe to
be covered by insurance) and an assignment of certain insurance rights to a
trust ("Apollo/Parks Township Litigation Facility Trust") established to pay
certain claims arising from alleged nuclear radiation exposure at two of the
Debtors' former facilities in western Pennsylvania (the "Apollo/Parks Township
Claims"); and (c) provide a trust (the "Debtors' Asbestos PI Trust") established
to resolve asbestos personal injury claims, with annual payments of up to $150
million from the three sources described above to satisfy such claims in full.
All asbestos personal injury claims against the Debtors would be channeled to
the Debtors' Asbestos PI Trust.

With respect to the insurance proceeds described above, on the effective date of
the Debtors' Amended Plan, the Debtors would assign to the Funding Facility
their rights against their insurance coverage that relate to asbestos personal
injury and property damage claims against the Debtors. The Debtors' affiliates
would also waive their rights against that insurance to the extent that those
rights would deplete the available $1.15 billion face value products liability
coverage, except that MI, JRM and HPC would retain the right to pursue claims
for coverage on account of asbestos liabilities, if any, relating to their own
operations. The Debtors' Amended Plan contemplates that the Debtors will receive
a full release and discharge from all present and future liability for asbestos
personal injury claims, asbestos property damage claims, the Apollo/Parks
Township Claims, and any other claims against them in their Chapter 11
proceedings (with the exception of certain ordinary course obligations and other
obligations of the Debtors not related to the impaired claims discussed above,
which would remain as unimpaired obligations of the reorganized Debtors). In
addition, in

25

consideration of their waiver of insurance rights, the Debtors' affiliates would
be protected by a channeling injunction against present and future liability for
asbestos personal injury claims arising from the Debtors' operations. If
resources later become depleted, and the Debtors' Asbestos PI Trust can no
longer pay claims that are due and owing, the Debtors' Amended Plan contemplates
that the injunction may be lifted as to MI, MII and certain other affiliates.
The Debtors' Amended Plan also provides for a release of the affiliates from
claims related to transactions with the Debtors that were generally outside the
ordinary course of business and did not include the operations or management of
the Debtors' present businesses, assets or obligations.

The Debtors' Amended Plan provides that, under certain conditions involving a
continuing uncured adjudicated payment default of the Funding Facility's
obligations to fund the Debtors' Asbestos PI Trust, the Funding Facility would
be required to transfer to the Debtors' Asbestos PI Trust all of the shares of
The Babcock & Wilcox Company. If that should occur, we would lose our ownership
interest in The Babcock & Wilcox Company. The Debtors' Amended Plan also
contemplates that, commencing in the fifth year after the effective date of the
Debtors' Amended Plan, and on an annual basis thereafter, the Funding Facility
would have the opportunity to make a lump-sum payment to the Debtors' Asbestos
PI Trust in an amount, approved by the Bankruptcy Court, of the then estimated
present and future liability on account of Asbestos PI Claims, and upon making
such payment would have no further obligation to fund the Debtors' Asbestos PI
Trust. If that should occur, the financial results of B&W would be
reconsolidated with MII and MII would have access to the cash flows of B&W. A
third possible alternative would be the satisfaction of all claims against the
Debtors by the Funding Facility, which would also result in the financial
results of B&W being reconsolidated with MII and MII having access to the cash
flows of B&W.

ACC/FCR Plan of Reorganization

On July 3, 2002, the ACC and the FCR filed a joint Chapter 11 Plan and
accompanying Disclosure Statement (the "ACC/FCR Plan"). The ACC/FCR Plan
contemplates that, on its effective date, all of the shares of B&W presently
owned by BWICO, will be canceled and new shares will be issued to (1) a trust
(the "Asbestos PI Trust") established under the ACC/FCR Plan for the benefit of
asbestos personal injury claimants against the Debtors; and (2) certain general
unsecured creditors of the Debtors. The ACC/FCR Plan further contemplates that
MII and its affiliates (other than the Debtors and their subsidiaries) would be
enjoined from any continuing access to the insurance rights that presently cover
the Debtors' putative liability on account of asbestos personal injury claims.
Those insurance rights would be assigned to the Asbestos PI Trust. The ACC/FCR
Plan, however, does not contemplate that, absent a settlement, MII and its
affiliates (other than the Debtors and their subsidiaries) would receive the
protection of any injunction against present or future claims based on the
Debtors' putative asbestos liability.

26

The ACC/FCR Plan generally contemplates that (1) asbestos personal injury
claimants asserting claims arising from cases of severe asbestosis and
malignancies would have access to 55% of the Asbestos PI Trust's resources; (2)
asbestos personal injury claimants asserting claims based on cases involving
nonmalignant asbestosis and pleural disease would have access to 45% of the
Asbestos PI Trust's resources; and (3) all asbestos personal injury claimants
would be entitled to a "quick pay" option of $250. The trustees of the trust
will have the discretion to assert defenses to putative asbestos personal injury
claims.

Under the ACC/FCR Plan, the Asbestos PI Trust and general unsecured creditors
with allowed claims would share pro rata in a pool of assets consisting of the
new stock of B&W issued on the effective date of the ACC/FCR Plan, excess cash
of the Debtors and the monetary value of certain tax benefits that may be
created upon effectuation of the ACC/FCR Plan. In addition, certain general
unsecured creditors of the Debtors would be entitled to recover the full amount
of insurance proceeds arising from the allowance of their claims. B&W and
certain of its affiliates may have general unsecured claims that would be
entitled to participate in the foregoing pool of assets.

The ACC/FCR Plan also contemplates that a separate trust would be created to pay
the Apollo/Parks Township claims. This trust would be funded by access to
separate insurance and a contribution from the Debtors that would be reimbursed
out of insurance proceeds. MII and its affiliates (other than the Debtors and
their subsidiaries) would not be protected by an injunction from the assertion
of such claims against them, but would be enjoined from access to the insurance
rights relating to such claims.

We believe that we have defenses and valid objections to the ACC/FCR Plan, which
we intend to assert if the ACC and FCR ultimately seek to have the ACC/FCR Plan
confirmed. In addition, B&W has filed first sets of omnibus objections to the
overwhelming majority of personal injury claims and asbestos property damages
claims. B&W believes that rulings on those objections would affect the ultimate
ability of the ACC and the FCR to obtain confirmation of the ACC/FCR Plan.

Litigation may ensue regarding objections by the Debtors and others to the
ACC/FCR Plan, objections by the ACC/FCR to the Debtors' Amended Plan and related
issues concerning the confirmation and effectuation of either plan, or some
alternative that may emerge in those proceedings. As of the date of this report,
the Bankruptcy Court and District Court presiding over the Debtors' Chapter 11
proceedings have taken no action to schedule further proceedings in connection
with confirmation of the ACC/FCR Plan, the Debtors' Amended Plan or the Debtors'
first sets of omnibus objections to asbestos personal injury and property
damages claims. Confirmation of the Debtors' Amended Plan or the ACC/FCR Plan
will require a finding that such plan satisfies all the conditions set forth in
the Bankruptcy Code as well as the conditions specified in the plan. We cannot
assure that either

27

of these requirements will be met with respect to either plan. In the event the
Bankruptcy Court were to find that more than one submitted plan meets the tests
set forth in the Bankruptcy Code for confirmation, the Court may confirm only
one plan and, in exercising its discretion to do so, is required to consider the
preferences of creditors and equity security holders. As a result of all these
factors, confirmation of either plan is uncertain.

Recent Developments in Negotiations

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

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

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

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

o MII or one of its domestic subsidiaries would issue $85 million
aggregate principal amount of promissory notes to the trusts. The
notes would be unsecured obligations and would provide for
payments of principal of $8.5 million per year to be payable over
10 years, with interest payable on the outstanding balance at the
rate of 7.5% per year.

28

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

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

As the settlement discussions remain in their early stages, we expect that some
of the court proceedings in or relating to the B&W Chapter 11 case will continue
and that the parties will continue to maintain their previously asserted
positions. The process of finalizing and implementing the settlement could take
up to a year, depending on, among other things, the nature and extent of any
objections or appeals in the bankruptcy case.

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

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

Remaining Issues to be Resolved

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

29

o the ultimate asbestos liability of the Debtors;

o the outcome of negotiations with the ACC, the FCR and other
participants in the Chapter 11 proceedings, concerning, among
other things, the size and structure of a trust to satisfy the
asbestos liability and the means for funding that trust;

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

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

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

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

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

B&W has provided $1.3 billion for asbestos products liability claims at June 30,
2002. It is not possible to estimate the range of loss under the strategy
proposed in the Debtor's Amended Plan or the ACC/FCR Plan. However, amounts
claimed by the asbestos claimants are in a wide range and exceed the value of
B&W and certain assets transferred by B&W to its parent in a corporate
reorganization completed in fiscal year 1999 and our known available products
liability and property damage insurance coverages.

Any changes in (1) the estimates of the Debtors' nonemployee asbestos liability
and insurance, (2) the differences between the proportion of those liabilities
covered by insurance and that experienced in the past and (3) the ultimate
resolution of the Transfer Case could result in material adjustments to B&W's
financial statements and negatively impact our ability to realize our net
investment in B&W, which we wrote off in the three months ended June 30, 2002,
and certain assets transferred by B&W to BWICO in the corporate

30

reorganization. In addition, any settlement involving MII could have a material
adverse impact on our consolidated financial position, results of operations and
cash flow.

Debtor-In-Possession Financing

In connection with the bankruptcy filing, the Debtors entered into the DIP
Credit Facility with a group of lenders providing for a three-year term. The
Bankruptcy Court approved the full amount of this facility, giving all amounts
owed under the facility a super-priority administrative expense status in
bankruptcy. The Debtors' obligations under the facility are (1) guaranteed by
substantially all of B&W's other domestic subsidiaries and B&W Canada Ltd. and
(2) secured by a security interest on B&W Canada Ltd.'s assets. Additionally,
B&W and substantially all of its domestic subsidiaries granted a security
interest in their assets to the lenders under the DIP Credit Facility upon the
defeasance or repayment of MI's public debt. The DIP Credit Facility generally
provides for borrowings by the Debtors for working capital and other general
corporate purposes and the issuance of letters of credit, except that the total
of all borrowings and non-performance letters of credit issued under the
facility cannot exceed $100 million in the aggregate. The DIP Credit Facility
also imposes certain financial and non-financial covenants on B&W and its
subsidiaries. There were no borrowings under this facility at June 30, 2002 or
December 31, 2001. A permitted use of the DIP Credit Facility is the issuance of
new letters of credit to backstop or replace pre-existing letters of credit
issued in connection with B&W's and its subsidiaries' business operations, but
for which MII, MI or BWICO was a maker or guarantor. As of February 22, 2000,
the aggregate amount of all such pre-existing letters of credit totaled
approximately $172 million (the "Pre-existing LCs"), $9.9 million of which
remains outstanding at June 30, 2002. MII, MI and BWICO have agreed to indemnify
and reimburse the Debtors for any customer draw on any letter of credit issued
under the DIP Credit Facility to backstop or replace any Pre-existing LC for
which they already have exposure and for the associated letter of credit fees
paid under the facility. As of June 30, 2002, approximately $113.0 million in
letters of credit has been issued under the DIP Credit Facility of which
approximately $59.7 million was to replace or backstop Pre-existing LCs.

31

Financial Results and Reorganization Items
Summarized financial data for B&W is as follows:

INCOME STATEMENT INFORMATION

BALANCE SHEET INFORMATION

(1) Includes liabilities subject to compromise of approximately $1.436
billion which primarily result from asbestos-related issues.

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

In the course of the conduct of B&W's and its subsidiaries' business, MII and MI
have agreed to indemnify two surety companies for B&W's and its subsidiaries'
obligations under surety bonds issued in connection with their customer
contracts. At June 30, 2002, the total value of B&W's and its subsidiaries'
customer contracts yet to be completed covered by such indemnity arrangements
was approximately $124.6 million, of which approximately $46.5 million relates
to bonds issued after February 21, 2000.

B&W's ability to continue as a going concern depends on its ability to settle
its ultimate asbestos liability from its net assets, future profits and cash
flow and available insurance proceeds, whether through the

32

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

NOTE 10 - LIQUIDITY

MI and JRM and their respective subsidiaries are limited, as a result of
covenants in debt instruments, in their ability to transfer funds to MII and its
other subsidiaries through cash dividends or through unsecured loans or
investments. As a result, we have assessed our ability to continue as a going
concern and have concluded that we can continue to fund our operating activities
and capital requirements for the foreseeable future. In this regard, management
will be required to address several significant issues:

o Negative Cash Flows. MI has experienced and we expect MI to continue
to experience negative cash flows in 2002, primarily due to tax
payments on the exercise of MI's rights under an Intercompany
Agreement referred to below. MI expects to meet its cash needs through
short-term borrowings by BWXT on the MII Credit Facility, the cash
flow of BWXT, obtaining a loan from MII, a capital contribution from
MII or some combination of those sources. While we expect MI's cash
flow to improve in 2003, MI's lack of liquidity poses substantial risk
in the short term. In addition, we expect JRM to experience negative
cash flows primarily due to working capital requirements during 2002.
JRM expects to meet its cash needs through its cash and cash
equivalents and short-term borrowings.

o Upcoming Maturity of Our Credit Facilities. The MII and JRM credit
facilities are scheduled to expire in February 2003. We plan to
refinance or extend these facilities. However, our current credit
rating has impacted our access to and cost of capital. In addition,
due to current market conditions within the energy industry, our
available financing alternatives may be limited. Further, our ability
to obtain a successful and timely resolution to the B&W Chapter 11
filing could also impact our ability to obtain additional financing.
If we are unable to refinance or extend these credit facilities, this
will impact our ability to pursue additional projects at JRM, which
require letters of credit, as well as our liquidity.

During the six months ended June 30, 2002, MI repurchased or repaid the
remaining $208.8 million in aggregate principal amount of its 9.375% Notes due
March 15, 2002 for aggregate payments of $208.3 million, resulting in an

33

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

NOTE 11 - SUBSEQUENT EVENTS

On July 10, 2002, we sold HPC, a wholly owned subsidiary of BWICO, to an
affiliate of Chicago-based Madison Capital Partners. The sale price of $40
million consists of $38 million in cash and a $2 million subordinated promissory
note, subject to certain post-closing adjustments. On July 16, 2002, we entered
into an agreement with the ACC and FCR which limits the use of $36.5 million of
the sales proceeds to business expenses of BWICO and its subsidiaries. We do not
expect this to have a material adverse impact on MI's liquidity.

On July 11, 2002, a mechanical failure of the crane on JRM's derrick barge 60
(DB60) occurred while preparing for regularly scheduled maintenance. JRM is
investigating the causes of the mechanical failure, the cost to replace and/or
repair the crane and other financial impacts of this incident. No injuries or
fatalities resulted from the incident. The total cost to replace or repair the
crane is currently estimated between $12 and $15 million. JRM has insurance
policies which provide coverage for all but approximately $4 million of that
cost. The crane repair is estimated to take four to five months from August 1,
2002. As a result of this incident, JRM believes that approximately $7 to $9
million of operating income expected to be recognized in the third and fourth
quarters of 2002 from the activities of the DB60 will be deferred to 2003. We
expect that the negative cash flow impacts relating to this incident will be
absorbed through JRM's available cash and/or lines of credit.

On July 12, 2002, AE Energietechnic GmbH ("Austrian Energy") applied for the
appointment of a receiver in the Bankruptcy Court of Graz, Austria. Austrian
Energy is a subsidiary of Babcock-Borsig AG which filed for bankruptcy on July
4, 2002 in Germany. Our Babcock and Wilcox Volund APS ("Volund") subsidiary is
jointly and

34

severally liable with Austrian Energy pursuant to both their consortium
agreement as well as their contract with the ultimate customer, SK Energi, for
construction of a biomass boiler facility in Denmark. Volund was notified by the
receiver on July 30, 2002 that the Creditors Committee will meet on August 6,
2002 to determine which projects will be completed by Austrian Energy. If
Austrian Energy ceases operation on its scope of work under the contract, the
cost to Volund is currently estimated at $2 million to $3 million.

On July 15, 2002, Global Energy Company Limited ("GEC") filed two instruments
with the High Court of Lagos State, Nigeria against J. Ray McDermott West
Africa, Inc. ("JRMWA"), a subsidiary of JRM, and Citibank: (1) an application
for injunction to restrain Citibank from remitting the sum of $10.2 million to
JRMWA; and (2) a lawsuit seeking a declaration that GEC is entitled to specific
performance and that the $10.2 million held by Citibank can only be exchanged
for shares representing a 12.75 % interest in Nigerdock Nigeria PLC. These
matters are set for hearing on September 9, 2002. Also on July 15, 2002, JRMWA
filed an application for injunction to restrain Citibank from remitting $1.3
million to GEC. We believe the GEC actions are without basis in law or fact, and
we will seek all available remedies to secure the release of the escrowed
amounts and invoices due to JRMWA. These actions are related to a joint venture
agreement entered into in February 2002 by GEC and JRMWA and an associated
escrow agreement pursuant to which JRMWA deposited $10.2 million into an escrow
account at Citibank. The joint venture agreement provides that under certain
circumstances of termination, GEC would be entitled to $1.3 million from the
escrow account and such transfer would constitute a full and final release of
JRMWA from all obligations, and JRMWA would retain the remainder of the escrowed
funds. We believe that $8.9 million in escrowed funds should be returned to
JRMWA as required by the escrow agreement and applicable law. However, there is
uncertainty that the Nigerian Court will follow the terms of the escrow
agreement and applicable law with respect to the return of the $8.9 million.

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

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

From time to time, our management or persons acting on our behalf make
forward-looking statements to inform existing and potential security holders
about our company. These statements may include projections and estimates
concerning the timing and success of specific projects and our future backlog,
revenues, income and capital spending. Forward-looking statements are generally
accompanied by words such as "estimate," "project," "predict," "believe,"
"expect," "anticipate," "plan," "goal" or other words that convey the
uncertainty

35

of future events or outcomes. In addition, sometimes we will specifically
describe a statement as being a forward-looking statement and refer to this
cautionary statement.

In addition, various statements this Quarterly Report on Form 10-Q contains,
including those that express a belief, expectation or intention, as well as
those that are not statements of historical fact, are forward-looking
statements. These forward-looking statements speak only as of the date of this
report, we disclaim any obligation to update these statements 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:

o general economic and business conditions and industry trends;

o the continued strength of the industries in which we are involved;

o decisions about offshore developments to be made by oil and gas
companies;

o the deregulation of the U.S. electric power market;

o the highly competitive nature of our businesses;

o our future financial performance, including availability, terms and
deployment of capital;

o the continued availability of qualified personnel;

o operating risks normally incident to offshore exploration, development
and production operations;

o the ability of JRM to maintain its forecasted financial performance
which supports its appraised value (failure to achieve that forecast
could result in material adjustments to, including a write-off of,
$313 million of goodwill currently associated with JRM);

o changes in, or our failure or inability to comply with, government
regulations and adverse outcomes from legal and regulatory
proceedings, including the results of ongoing governmental
investigations and related civil lawsuits involving alleged
anticompetitive practices in our marine construction business;

o estimates for pending and future nonemployee asbestos claims against
B&W and potential adverse developments that may occur in the Chapter
11 reorganization proceedings and related settlement discussions
involving B&W, certain of its subsidiaries and MII;

o the ultimate resolution of 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, and the appeals
from these rulings;

o the potential impact on available insurance due to the recent
increases in bankruptcy filings by asbestos-troubled companies;

o the potential impact on our insurance subsidiaries of B&W
asbestos-related claims under policies issued by those subsidiaries;

o changes in existing environmental regulatory matters;

o rapid technological changes;

o realization of deferred tax assets;

o consequences of significant changes in interest rates and currency
exchange rates;

o difficulties we may encounter in obtaining regulatory or other
necessary approvals of any strategic transactions;

36

o social, political and economic situations in foreign countries where
we do business, including, among others, countries in the Middle East;

o effects of asserted and unasserted claims;

o our ability to obtain surety bonds and letters of credit;

o our ability to negotiate extensions to or refinancings of our credit
facilities maturing on February 3, 2003;

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

o our ability to maintain builder's risk, liability and property
insurance in amounts we consider adequate at rates that we consider
economical, particularly after the impact on the insurance industry of
the September 11, 2001 terrorist attacks.

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 and in our annual report on Form 10-K for
the year ended December 31, 2001. 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.

GENERAL

The amount of revenues we generate from our Marine Construction Services segment
largely depends on the level of oil and gas development activity in the world's
major hydrocarbon-producing regions. Our revenues from this segment reflect the
variability associated with the timing of significant oil and gas development
projects. Although oil and gas prices remain lower than we anticipated for 2002,
we expect revenues to increase at our Marine Construction Services segment for
2002, primarily for deepwater projects. We believe the oil and gas industry is
focused on deepwater projects and that the deepwater floater market will be
robust over the next several years. JRM's future is heavily weighted to the
continued success of the deepwater market. However, timing of award of many
marine construction projects is uncertain. In addition, the Marine Construction
Services market remains competitive, which may have a significant impact on our
anticipated segment income in future periods.

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. We expect a significant increase in backlog
by the end of this

37

year. After this year's increased bookings, we expect this segment's backlog
will remain relatively constant in the next several years. Additionally, with
BWXT's unique capability of full life-cycle management of special nuclear
materials, facilities and technologies, BWXT is poised to participate in the
continuing cleanup and management of the Department of Energy's nuclear sites
and weapons complexes.

The results of operations of our Industrial Operations segment include only the
results of McDermott Engineers & Constructors (Canada) Ltd., which we sold in
October 2001. The results of our Hudson Products Corporation ("HPC") subsidiary
are reported in discontinued operations. We sold our interest in HPC in July
2002. See Note 2 to the condensed consolidated financial statements for further
information on discontinued operations. In addition, we have included the
results of McDermott Technology, Inc. ("MTI") in Government Operations. MTI was
previously included in our Industrial Operations segment.

As a result of the Chapter 11 reorganization proceedings involving B&W and
several of its subsidiaries, we no longer consolidate B&W's and its
subsidiaries' results of operations in our condensed consolidated financial
statements and we have been presenting our investment in B&W on the cost method.
The Chapter 11 filing, along with subsequent filings and negotiations, have led
to increased uncertainty with respect to the amounts, means and timing of the
ultimate settlement of asbestos claims and the recovery of our investment in
B&W. Due to this increased uncertainty, we wrote off our net investment in B&W
in the three months ended June 30, 2002. The total impairment charge of $224.7
million included our investment in B&W of $187.0 million and other related
assets totaling $37.7 million, primarily consisting of accounts receivable from
B&W, for which we provided an allowance of $18.2 million. This non-cash charge
was precipitated by a combination of factors including a change in our
expectations regarding our ability to retain our equity in B&W. Subsequent to
June 30, 2002, we have reached an agreement in principle with representatives of
the present and future asbestos claimants in the Chapter 11 proceedings on
several key terms, although a number of significant issues and numerous details
remain to be negotiated and resolved. See Note 9 for information regarding
recent developments in negotiations relating to the B&W Chapter 11 proceedings.

In general, our business segments are composed of capital-intensive businesses
that rely on large contracts for a substantial amount of their revenues.

Effective January 1, 2002, based on a review performed by us and our independent
consultants, we changed our estimate of the useful lives of new major marine
vessels from 12 years to 25 years to better reflect the service lives of our
assets and industry norms. Consistent with this change, we also extended the
lives of major upgrades to existing vessels. We continue to depreciate our major
marine vessels using the units-of-production method, based on the utilization of
each vessel. The change in estimated useful lives improved

38

our operating income by approximately $0.9 million and $1.3 million for the
three and six months ended June 30, 2002, respectively.

Due to recent events affecting JRM's operating results, we have reviewed the
$313 million carrying value of goodwill associated with JRM as of June 30, 2002
and determined that it is not impaired. Based on our current three-year forecast
of JRM's financial performance, a valuation by an independent investment bank
has estimated that the fair value of JRM is greater than its book value.

For a summary of our accounting policies that we believe are important to an
understanding of our financial statements, please refer to Item 7 included in
Part II of our annual report on Form 10-K for the year ended December 31, 2001.
We also consider our policy on accounting for change orders to be significant.
The important aspects of this policy are as follows: (1) expenses incurred
outside of the scope of a contract which are intended to be included in a change
order are recognized as expenses at the time they are incurred; (2) when a
customer acknowledges acceptance of a change order, although agreement on the
specific price of that change order has not been reached, we recognize revenue
on the change order equal to the expenses incurred; and (3) we recognize profit
on a change order when the customer has agreed to a final price for the change
order in excess of the expenses incurred. In addition, due to the adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," our policy on accounting for goodwill is also considered
significant. SFAS No. 142 requires that we no longer amortize goodwill, but
instead perform periodic testing for impairment.

See Note 1 to the condensed consolidated financial statements for information on
new accounting standards.

RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2002 VS. THREE MONTHS ENDED
JUNE 30, 2001

Marine Construction Services

Revenues increased 55% to $318.8 million. The increase is a result of new
offshore construction contracts primarily for the deepwater market. Also
contributing to the increase are two topside fabrication and pipeline
installation projects in the Azerbaijan sector of the Caspian Sea.

Although revenues increased, segment operating income (loss), which is before
income from investees, declined to a loss of $20.9 million compared with income
of $8.4 million in the quarter ended June 30, 2001. The loss in the quarter
ended June 30, 2002 is due primarily to charges totaling $33.9 million relating
to cost overruns on our EPIC Spar projects, principally the Medusa project.
These cost overruns primarily relate to additional costs arising from design
delays and changes on this first-of-a-kind project, productivity losses from the
start-up of previously dormant fabrication yards and schedule delays resulting
from these factors. Also negatively

39

impacting the quarter ended June 30, 2002 were non-reimbursable costs due to
weather delays from unseasonably bad weather in the Persian Gulf and the Timor
Sea. We have two other EPIC Spar projects in our backlog. One is estimated to be
37% complete while the other is less than 10% complete at June 30, 2002. While
the projected-to-completion costs of these two projects have increased, both of
these projects are expected to be profitable at completion. During the quarter
ended June 30, 2002, we recorded operating income of $2.5 million from the
project that is 37% complete while profit recognition has been deferred on the
other project. For the quarter ended June 30, 2001, segment operating income
included goodwill amortization expense of $4.5 million.

Equity in income from investees decreased to $0.2 million from $1.3 million,
primarily due to lower operating results from our Spars joint venture. In
addition, we recorded lower equity income from our Mexican joint venture. Losses
associated with our U.K. joint venture in the prior period partially offset
these decreases.

Government Operations

Revenues increased $8.4 million to $131.1 million, primarily due to higher
volumes from management and operating contracts for U.S. Government-owned
facilities and the manufacture of nuclear components for certain U.S. Government
programs. Lower volumes from commercial nuclear environmental services partially
offset these increases.

Segment operating income, which is before income from investees, increased $2.2
million to $9.7 million, primarily due to higher margins from management and
operating contracts for U.S. Government-owned facilities and commercial work.
Costs associated with the termination of our information technology arrangement
with AT&T Solutions in the quarter ended June 30, 2001 and lower variable
stock-based compensation expense in the quarter ended June 30, 2002 also
contributed to the improved results. However, we experienced lower margins from
nuclear component manufacturing for certain U.S. Government programs due to
higher facility management oversight costs. In addition, we increased spending
on fuel cell research and development.

Equity in income from investees decreased $1.0 million to $5.1 million,
primarily due to higher general and administrative expenses in the quarter ended
June 30, 2002. Higher operating results from our joint ventures partially offset
these costs.

Power Generation Systems

Revenues increased $2.8 million to $15.8 million, primarily due to higher
volumes from the fabrication of utility and industrial boilers. Lower volumes
from after-market service activities partially offset these increases.

40

Segment operating loss decreased $0.7 million to $0.5 million, primarily due to
lower general and administrative expenses.

Equity in income from investees decreased $3.3 million to a loss of $2.8
million, primarily due to a $3.3 million non-cash charge related to the
impairment of our investment in a foreign joint venture located in India.

Corporate

Corporate expenses decreased $3.2 million to $3.3 million, primarily due to
lower legal and professional service expenses related to the B&W Chapter 11
proceedings and lower corporate departmental expenses. Also, the performance of
our captive insurance subsidiaries improved for the quarter ended June 30, 2002
compared to the quarter ended June 30, 2001. However, we recognized expense from
our overfunded pension plans in the current quarter compared to income from
those plans in the quarter ended June 30, 2001.

Other Income Statement Items

Interest income decreased $2.9 million to $1.9 million, primarily due to a
decrease in investments and prevailing interest rates.

Interest expense decreased $7.3 million to $2.4 million, primarily due to
reduced debt obligations and prevailing interest rates.

Other-net declined $0.9 million from income of $0.6 million to expense of $0.3
million, primarily due to increases in foreign currency transaction losses.

For the quarter ended June 30, 2002, the write-off of our investment in B&W and
other related assets with little associated tax benefit contributed to an
effective tax benefit of approximately 1.4% on our pre-tax loss. The provision
for income taxes for the three months ended June 30, 2001 reflects nondeductible
amortization of goodwill of $4.9 million, of which $4.5 million was attributable
to the premium we paid on the acquisition of the minority interest in JRM in
June 1999. Income taxes in the three months ended June 30, 2001 included a tax
benefit of $1.4 million primarily related to favorable tax settlements in
foreign jurisdictions. 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.

41

RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2002 VS. SIX MONTHS ENDED
JUNE 30, 2001

Marine Construction Services

Revenues increased 72% to $583.0 million. The increase is a result of new
offshore construction contracts primarily for the deepwater market. Revenues for
the six months ended June 30, 2002 include revenues from our three EPIC Spar
projects and two topside fabrication and pipeline installation projects in the
Azerbaijan sector of the Caspian Sea.

Although revenues increased, segment operating loss, which is before income from
investees, increased to a loss of $31.2 million, primarily as a result of cost
overruns on our first EPIC Spar project, Medusa. We have two other EPIC Spar
projects in our backlog, which we estimate to be 37% and less than 10% complete
at June 30, 2002. During the six months ended June 30, 2002, we recorded
operating income of $4.8 million from the project that is 37% complete while
profit recognition has been deferred on the other project. For the six months
ended June 30, 2001, segment operating loss included goodwill amortization
expense of $9.0 million.

Government Operations

Revenues increased $4.8 million to $252.9 million, primarily due to higher
volumes from other government operations, management and operating contracts for
U.S. Government-owned facilities and commercial work. Lower volumes from
commercial nuclear environmental services partially offset these increases.

Segment operating income, which is before income from investees, increased $3.2
million to $21.6 million, primarily due to higher volumes and margins from other
government operations and commercial work and higher margins from management and
operating contracts for U.S. Government-owned facilities. These improvements
reflect the effects of a buyout of a lease at our Mount Vernon facility in the
six months ended June 30, 2002 and the recognition of certain contract reserves
in the quarter ended March 31, 2001. In addition, we received an insurance
settlement relating to environmental restoration costs. However, we experienced
lower margins from nuclear component manufacturing for certain U.S. Government
programs due to higher facility management oversight costs. In addition, we
increased spending on fuel cell research and development.

Power Generation Systems

Revenues increased $7.6 million to $29.0 million, primarily due to higher
volumes from the fabrication of utility and industrial boilers.

Segment operating loss decreased $0.7 million to $1.1 million, primarily due to
lower general and administrative expenses.

42

Equity in income of investees decreased $3.5 million to a loss of $2.8 million,
primarily due to a $3.3 million non-cash charge related to the impairment of our
investment in a foreign joint venture located in India.

Corporate

Corporate expenses increased $5.8 million to $14.0 million, primarily due to the
recognition of expense from our overfunded pension plans in the current period
compared to income from those plans in the six-month period ended June 30, 2001.
Lower legal and professional service expenses related to the B&W Chapter 11
proceedings and lower corporate departmental expenses partially offset these
increases. In addition, the performance of our captive insurance subsidiaries
improved for the six months ended June 30, 2002 compared to the six months ended
June 30, 2001.

Other Income Statement Items

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

Interest expense decreased $10.2 million to $9.5 million, primarily due to
changes in debt obligations and prevailing interest rates.

Other-net improved $3.0 million from expense of $1.6 million to income of $1.4
million, primarily due to gains on sales of investment securities in the current
period compared to losses on sales of investment securities in the six-month
period ended June 31, 2001.

For the six months ended June 30, 2002, the write-off of our investment in B&W
and other related assets with little associated tax benefit contributed to an
effective tax benefit of approximately 2.3% on our pre-tax loss. The provision
for income taxes for the six months ended June 30, 2001 reflects nondeductible
amortization of goodwill of $9.9 million, $9.0 million of which was attributable
to the premium we paid on the acquisition of the minority interest in JRM in
June 1999. Income taxes for the six months ended June 30, 2001, also include tax
benefits primarily related to favorable tax settlements in foreign jurisdictions
totaling approximately $3.7 million. 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.

43

Backlog

Backlog for the Marine Construction Services segment increased primarily because
of awards of new offshore construction projects in the Gulf of Mexico, Southeast
Asia and the Middle East. At June 30, 2002, the Marine Construction Services
backlog includes $456 million related to uncompleted work on our three EPIC Spar
projects.

At June 30, 2002, Government Operations' backlog with the U. S. Government was
$947.4 million (of which $24.6 million had not been funded).

Liquidity and Capital Resources

During the six months ended June 30, 2002, our cash and cash equivalents
decreased $98.1 million to $98.8 million, and our total debt decreased $204.4
million to $105.5 million, primarily due to payments of long-term debt of $208.4
million. During this period, we received cash of $997.7 million from sales and
maturities of investments. We used cash of $841.4 million for the purchase of
investments, $26.4 million for additions to property, plant and equipment and
$20.8 million for operating activities.

At June 30, 2002 and December 31, 2001, we had available various uncommitted
short-term lines of credit from banks totaling $9.2 million and $8.9 million,
respectively. We had no borrowings against these lines at June 30, 2002 or
December 31, 2001.

On February 21, 2000, B&W and certain of its subsidiaries entered into the DIP
Credit Facility to satisfy their working capital and letter of credit needs
during the pendency of their bankruptcy case. As a condition to borrowing or
obtaining letters of credit under the DIP Credit Facility, B&W must comply with
certain financial covenants. B&W had no borrowings outstanding under this
facility at June 30, 2002 or December 31, 2001. Letters of credit outstanding
under the DIP Credit Facility at June 30, 2002 totaled approximately $113
million. This facility is scheduled to expire in February 2003. We plan to
renegotiate this facility and expect to be successful. See Note 9 to the
condensed consolidated financial statements for further information on the DIP
Credit Facility.

44

At June 30, 2002, MII was a maker or guarantor on $9.9 million of letters of
credit issued in connection with B&W operations prior to its Chapter 11 filing.
In addition, MII, MI and BWICO have agreed to indemnify B&W for any customer
draw on $59.7 million in letters of credit which have been issued under the DIP
Facility to replace or backstop letters of credit on which 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,
MII, MI and BWICO do not currently have sufficient cash or other liquid
resources available, either individually or combined, to satisfy their maker,
guarantor or indemnity obligations to letter of credit issuers of B&W should
customer draws occur on a significant amount of these letters of credit.

On the day before B&W's Chapter 11 filing, February 21, 2000, we also entered
into other financing arrangements providing financing to the balance of our
operations. This financing, as amended through the date of this report, consists
of a $100 million credit facility for MII and BWXT (the "MII Credit Facility")
and a $200 million credit facility for JRM and its subsidiaries (the "JRM Credit
Facility"). Each facility is with a group of lenders, for which Citibank, N.A.
is acting as the administrative agent. These facilities are scheduled to expire
in February 2003. We plan to refinance or extend these facilities. However, our
current credit rating has impacted our access to and cost of capital. In
addition, due to current market conditions within the energy industry, our
available financing alternatives may be limited. Further, our ability to obtain
a successful and timely resolution to the B&W Chapter 11 proceeding could also
impact our ability to obtain additional financing. If we are unable to refinance
or extend these credit facilities, this will impact our ability to pursue
additional projects at JRM, which require letters of credit, as well as our
liquidity.

The MII Credit Facility serves as a revolving credit and letter of credit
facility. Borrowings under this facility may be used for working capital and
general corporate purposes. The aggregate amount of loans and amounts available
for drawing under letters of credit outstanding under the MII Credit Facility
may not exceed $100 million. This facility is secured by a collateral account
funded with various U.S. government securities with a minimum marked-to-market
value equal to 105% of the aggregate amount available for drawing under letters
of credit and revolving credit borrowings outstanding. We had no borrowings
against this facility at June 30, 2002 or December 31, 2001. Letters of credit
outstanding at June 30, 2002 were approximately $56.1 million.

The JRM Credit Facility consists of two tranches. One is a revolving credit
facility that provides for up to $100 million for advances to borrowers.
Borrowings under this facility may be used for working capital and general
corporate purposes. The second tranche provides for up to $200 million of
letters of credit. The aggregate amount of loans and amounts available for
drawing under letters of credit outstanding under the JRM Credit Facility may
not exceed $200 million. The facility is subject to certain financial and
non-financial covenants. We had no borrowings against this facility at June 30,
2002 or December 31, 2001. Letters of credit outstanding under the JRM Credit
Facility at June 30, 2002 totaled approximately $94.7 million.

45

At June 30, 2002, we had total cash, cash equivalents and investments of $273.1
million. Our investment portfolio consists primarily of government obligations
and other investments in debt securities. The fair value of our investments at
June 30, 2002 was $174.3 million. As of June 30, 2002, we had pledged
approximately $46 million fair value of these investments to secure a letter of
credit in connection with certain reinsurance agreements. In addition, as of
June 30, 2002, we had pledged investment portfolio assets having a fair market
value of approximately $106 million to secure our obligations under the MII
Credit Facility. At June 30, 2002, our liquidity position was as follows (in
millions):

Cash and cash equivalents $ 99
Investments in debt securities 174
--------
273
Less: Pledged securities (152)
Captive insurer requirements (53)
JRM cash in escrow (10)
Restricted foreign cash (8)
--------
Total free cash available 50
Amount available: JRM Credit Facility 100
MII Credit Facility 44
--------
Total available liquidity $ 194
========

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

We anticipate continuing to incur negative cash flows in 2002. We expect to meet
capital expenditure, working capital and debt maturity requirements from cash
and cash equivalents and short-term borrowings. We also expect MI to continue to
experience negative cash flows in 2002, primarily due to payments of taxes
resulting from the exercise of MI's rights under the Intercompany Agreement. MI
expects to meet its cash needs through short-term borrowings by BWXT on the MII
Credit Facility, the cash flow of BWXT, obtaining a loan from MII, a capital

46

contribution from MII or some combination of those sources. While we expect MI's
cash flow to improve in 2003, MI's lack of liquidity poses substantial risk to
us and to the holders of its outstanding debt securities in the short term. In
addition, we expect JRM to experience negative cash flows primarily due to
working capital requirements during 2002. JRM expects to meet its cash needs
through its cash and cash equivalents and short-term borrowings.

MI and JRM and their respective subsidiaries are restricted, as a result of
covenants in debt instruments, in their ability to transfer funds to MII and its
other subsidiaries through cash dividends or through unsecured loans or
investments. At June 30, 2002, substantially all the net assets of MI were
subject to those restrictions. In addition, MI and its subsidiaries are unable
to incur additional long-term debt obligations under one of MI's public debt
indentures, other than in connection with certain extension, renewal or
refunding transactions. At June 30, 2002, JRM and its subsidiaries could make
unsecured loans to or investments in MII and its other subsidiaries of
approximately $71 million.

As of June 30, 2002, MII guaranteed previously issued surety bonds of $137.8
million, $124.6 million of which were issued in connection with 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. However,
MII does not currently have sufficient cash or other liquid resources available
if contract defaults require it to fund a significant amount of its surety
bonds.

As a result of its bankruptcy filing, B&W and its filing subsidiaries are
precluded from paying dividends to shareholders and making payments on any
pre-bankruptcy filing accounts or notes payable that are due and owing to any
other entity within the McDermott group of companies (the "Pre-Petition
Intercompany Payables") and other creditors during the pendency of the
bankruptcy case, without the Bankruptcy Court's approval.

As a result of the B&W bankruptcy filing, our access to the cash flows of B&W
and its subsidiaries has been restricted. In addition, MI and JRM and their
respective subsidiaries are limited, as a result of covenants in debt
instruments, in their ability to transfer funds to MII and its other
subsidiaries through cash dividends or through unsecured loans or investments.
As a result, we have assessed our ability to continue as a going concern and
have concluded that we can continue to fund our operating activities and capital
requirements for the foreseeable future.

As discussed in Note 9 to the condensed consolidated financial statements, we
are continuing our discussions with the ACC and FCR concerning a potential
settlement. As a result of those discussions, we have reached an agreement in
principle with representatives of the ACC and FCR on several key terms; however,
a number of significant issues and numerous details remain to be negotiated and
resolved. The parties are currently

47

working to address some of the remaining unresolved issues and details in a
memorandum of understanding. Should the remaining issues and details not be
negotiated and resolved to the mutual satisfaction of the parties, the parties
may be unable to resolve the B&W Chapter 11 proceedings through settlement.
Additionally, any settlement will be subject to various conditions, including
the requisite approval of the asbestos claimants, the Bankruptcy Court
confirmation of a plan of reorganization reflecting the settlement and the
approval by MII's stockholders. Among the key terms that serve as a basis for
further discussions are the following:

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

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

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

o MII or one of its domestic subsidiaries would issue $85 million
aggregate principal amount of promissory notes to the trusts. The
notes would be unsecured obligations and would provide for payments of
principal of $8.5 million per year to be payable over 10 years, with
interest payable on the outstanding balance at the rate of 7.5% per
year.

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

48

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

As the settlement discussions remain in their early stages, we expect that some
of the court proceedings in or relating to the B&W Chapter 11 case will continue
and that the parties will continue to maintain their previously asserted
positions. The process of finalizing and implementing the settlement could take
up to a year, depending on, among other things, the nature and extent of any
objections or appeals in the bankruptcy case.

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

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

As a result of the impact of the September 11, 2001 terrorist attacks, our
insurers have indicated that we will incur higher costs, higher deductibles and
more restrictive terms and conditions as we renew our historical insurance
coverages in the future. We expect to continue to maintain coverage that we
consider adequate at rates that we consider economical. However, some previously
insured risks may no longer be insurable, or insurance to cover them may be
available only at rates that we consider uneconomical.

We have evaluated and expect to continue evaluating possible strategic
acquisitions. At any given time, we may be engaged in discussions or
negotiations or enter into agreements relating to potential acquisition
transactions.

49

PART II
OTHER INFORMATION

Item 1. Legal Proceedings

For information regarding ongoing investigations and litigation see Note 5 to
the condensed consolidated financial statements in Part I of this report, which
we incorporate by reference into this Item. In addition, see Note 9 to the
condensed consolidated financial statements included in this report regarding
B&W's potential liability for non-employee asbestos claims and the Chapter 11
reorganization proceedings commenced by B&W and several of its subsidiaries on
February 22, 2000, which we incorporate by reference into this Item.

Item 4. Submission of Matters to a Vote of Security Holders
At our annual meeting of stockholders held on May 1, 2002, we submitted the
following matters to our stockholders, with voting as follows:

(a) The election of three directors:

Class II - For a three-year term

Philip J. Burguieres, Ronald C. Cambre, Bruce DeMars, Robert L. Howard,
John N. Turner and Bruce W. Wilkinson also continued as directors
immediately after the meeting. On May 2, 2002, Mr. Turner resigned from
our Board of Directors.

(b) A proposal to approve our 2001 Directors and Officers Long-Term
Incentive Plan:

(d) A proposal to retain PricewaterhouseCoopers LLP as our independent
accountants for the fiscal year ending December 31, 2002:

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibit 3.1*- McDermott International, Inc.'s Articles of
Incorporation, as amended (incorporated by reference herein to
Exhibit 3.1 to McDermott International, Inc.'s Annual Report
on Form 10-K for the fiscal year ended March 31, 1996 (File
No. 1-08430)).

Exhibit 3.2* - Amended and Restated By-Laws of McDermott
International, Inc. (incorporated by reference herein to
Exhibit 3.2 to McDermott International, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002 (File
No. 1-08430)).

50

Exhibit 3.3*- Amended and Restated Certificate of Designation of
Series D Participating Preferred Stock (incorporated by reference
herein to Exhibit 3.1 to McDermott International, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001 (File No.
1-08430)).

(b) Reports on Form 8-K

On June 26, 2002, we filed a report on Form 8-K dated June 25, 2002.
Our report included Item 5 - Other Events.

On July 23, 2002, we filed a report on Form 8-K dated July 22, 2002.
Our report included Item 5 - Other Events.

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*Incorporated by reference to the filing indicated.

51

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

McDERMOTT INTERNATIONAL, INC.

/s/ Francis S. Kalman
--------------------------------------
By: Francis S. Kalman
Executive Vice President and Chief
Financial Officer (Principal Financial
and Accounting Officer and Duly
Authorized Representative)

August 8, 2002

52

EXHIBIT INDEX

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*Incorporated by reference to the filing indicated.