ML19305A373

Annual Rept Form 10K Submitted to Sec Detailing Financial Activities for 1977

ML19305A373
Person / Time
Site:	Lynchburg Research Center
Issue date:	03/07/1979
From:	BABCOCK & WILCOX CO.
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ML19305A372	List: ML19305A371 ML19305A373
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NUDOCS 7903130415
Download: ML19305A373 (50)

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{{#Wiki_filter:SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31,1977 Commission File Number 1-3669 The Babcock & Wilcox Company Exact name of registrant as specified in its charter New Jersey 13-1675427 State of incorporation or organization I.R.S. Employer Identification No. 161 East 42nd Street, New York, N.Y. 10017 Address of principal executive offices Zip Code (212) 687-6700 Telephone number of principal executive offices Securities registered pursuant to Section 12 (b) of Act: Name of each exchange Title of each class on which registered Common stock with par value New York Stock Exchange $4.50 per share Pacific Coast Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requiremants for the past 90 days. Yes _V_. No ___ indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the close of the period covered by this report. Common stock, par value $4.50, outstanding at December 31,1977: 12,276,040 shares 7903130416

Combination of The Babcock & Wilcox Company with J. Ray McDermott & Co.. Inc. At Special Meetings of Stockholders of The Babcock & Wilcox Company and J. Ray McDermott & Co., Inc. (McDermott) held on March 30, 1978, the stockholders of each company approved a proposal pursuant to which Babcock & Wilcox would be merged into a wholly-owned subsidiary of McDermott. The Merger is to be effected in accordance with an Agreement and Plan of Reorganization, dated as of February 15, 1978, pursuant to which each outstanding share of common stock (par value $4.50) of Babcock & Wilcox (other than shares owned by McDermott) will be converted into one share of Series A $2.20 Cumulative Convertible Preferred Stock and one share of Series B $2.60 Cumulative Preferred Stock of McDermott. The Merger and the terms of the Preferred Stock are more particularly described in the Joint Proxy Statement, dated February 22, 1978, of Babcock & Wilcox and McDermott which has previously been sent to stockholders. 1

Item 1. Business (a) Except where the context otherwise requires, all references to the " Company" in this report refer to The Babcock & Wilcox Company and its subsidiaries. The Company is engaged in the design, manufacture and sale of products which are classified into the following industry segments: steam generating and associated equipment, tubular products, refractory products, automated machines and machine tools and control valves. Recently, the Company has also formed a unit to manufacture advanced composite materials for industrial use. The unit is essentially in the development stage. Steam generating and associated equipment and tubular products are the two major industry segments of the Company and together accounted for 93% of the consolidated sales and 91% of the consolidated income from operations for the year ended December 31, 1977. (b) Listed belcw are the sales and approximate percentage contribution to income frcm operations of steam generating and associated equipment and tubular p"oducts for each of the four years ended December 31, 1976: For the Calendar Year 1976 1975 1974 1973 (In Thousands) Steam generating and associated equipment: Sales to unaffiliated customers. $1,308,000 $1,132,000 $913,100 $791,000 Intersegment sales.... 1,900 1,200 1,300 1,400 Total fales.... $1,309,900 $1,133,200 $914,400 $792,400 Approximate percentage contribution to income from operations. 53% 34% 281 39% Tubular products: Sales to unaffiliated customers............ $ 280,200 $ 323,400 $271,800 $198,200 Intersegment sales... 77,900 85,200 64,300 40,300 Total Sales......... $ 358,100 $ 408,600 $336,100 $238,500 Approximate peleentage contribution to income from operations...... 36% 54% 70% 54% 2 o

Item 1. Business (continued) (c) Products Steam generating equipment includes individually engineered complete fossil fbel boilerc, nuclear steam systems, and nuclear fuel and nuclear fuel assemblies for electric utility and marine applications as well as fossil fuel boilers for industrial processes and power generation. Steam generating equip-ment alco includes specially engineered accessories and components, such as air heaters, fanc, precipitators, cleaning cystems for heat transfer surfaces, nuclear reactor components, control and performance computers, automatic controls and instruments and nuclear control-rod drives. Associated equipment includes individually engineered recovery processes and pollution control cyctems for the process and utility industries, tubular hoods for basic oxygen and electric furnaces, heavy pressure vessels and heat exchangers, hollow forginge for steam piping and other uses and reflective metallic thermal insulation. In addition to designing and manufacturing the foregoing steam generating and associated equipment, the Company through a separate construction unit also is engaged in the erection of certain of this and other equipment. During each of the years 1973 through 1977 (other than 1974) fossil-fbeled steam generating and associated equipment accounted for approximately one-half of total cales and nuclear fueled steam generating and acsociated equipment and nuclear Ibel accounted for approximately one-quarter of cuch sales. In 1974 the respective contributions were approximately two-fifths and one-third of such sales. The Company's total nuclear business was profitable in these years with the exception of 1973 covernment nuclear business was profitable in all these years; however, the commercial nuclear activity custained losses in these years particularly as a result of operations of BBR in 1975, 1976 and 1977 (see Item 1.(d) below). Tubular products include stainless, alloy and carbon steel, seamless and welded tubes and pipe, tubular and solid shapes, extrucions, special metal tubes, welding fittings and flanges, and seamless rolled rings. These are principally " specialty" products of high quality and engineered for special appli cati ons. Material amounts of tubec are manufactured by the Company to catistly its own requirements as well as those of other manufacturers of steam generating equipment; however, the maj or portion of the Company's tubes are sold to others for use in the bearing industry, the petroleum industrv, the machinery industry, the primary metal inductry, the fabricated metal industry and the construction industry. Refractory products include kaclin clays, cpecially engineered and vacuum formed ceramic fiberc, insulating and cpecialty firebrick, plastics, mortars, castables and special oxide refractories. These refractories are used in high temperature furnaces for various heating and heat treating purposes and in other applications where the temperatures and rates of combustion or chemical reactions are unusually demanding. Automated machines and machine tools include individually engineered transfer or multi-station machines for production lines, precision boring machines, broaching machines and broaches, large grinders, cutting tools, hydraulic accessories, production tracer lathes and numerical control machines. This equipment is coid to manufacturern in various industries for use in their manufacturing processes and in the products manufactured by them. 4

Item 1. Business - (continued) For a discussion of the factors which have affected sales and cperating income of steam generating and associated equipment and tubular products, see the Management Discussion and Analysis of the Summary of Operations. Transfers between segments included in intersegment sales are priced in a manner comparable to products sold to unaffiliated customers. There is set forth below for the year ended December 31, 1977 certain information for industry segments: (In Thousands) Steam Adj ustments Generating Tubular Other and Equipment Products Products Eliminations Consolidated Sales to unaffil-iated customers.... $1,434,500 $319,200 $123,500 $ $1,877,200 Intersegment sales.. 1,500 74,300 14,900 (90,700) Total revenue..... 1,436,000 393,500 136,400 (90,700) 1,o77,200 Costs and operating expenses........... 1,322,200 359,200 130,800 (97,600) 1,714,600 Allocated general corporate expenses. 17,100 6,300 2,000 25,400 - ',339,300 365,500 132,c00 (97,600) 1,740,000 l Income from operations......... 96,700 $ 28,000 $ 5,600 $ 6,900(1) $ 137,200 Identifiable assets at December 31, 1977............... $ 655,800 $348,700 $140,200 $ (600) $1,144,100 Corporate assets (2). ~ $ 165,600 Total assets at December 31, 1977........... $1,309,700 Additions to PP&E(3) 40,500 $ 14,300 $ 6,800 61,600 Corporate additions t o PP&E( 3)......... 100 Total additions to PP&E (3)......... 61,700 Depreciation........ 23.300 $ 9.900 $ 3,700 36,900 Corporate depre-ciation............ 100 Total depreciation 37,000 NOTE: (1) Frimarily attributable to chare of other joint venturer in losses of Babcock-Brown Boveri Reaktor, GmbH. ( BBR). (2) Cnrporate nosets are principally casb and marketnhle securities. (3) Property, plant and equipment 3

Item 1. Business - (continued) (c) Competition (cont'd) significantly exceed those of the Company, but which do not compete with it in the sale of fossil fuel boilers. In the sale of nuclear fuel, the Company competes with each of the other manufacturers of nuclear steam generating equipment as well as with independent suppliers of nuclear fuel, including several large petroleum and mining companies. A number of companies are in competition with the Company in small industrial boilers, tubular pr oducts, refractory products, automated machines and machine tools and control valves. Backlog The backlog of orders believed to be firm as of December 31, 1977 was $4,305,400,000, as compared with $h,125,800,ooo as of December 31, 1976. Substantially all of this backlog consists of steam generating and associ-ated equipment. of the backlog of orders at December 31, 1977, it is expected that there will be recorded as sales (principally on the percentage of completion method) approximately 32% in 1978, approximately 46% in 1979-81, and approximately 22% thereafter. The Company expects that there will be a drop-off in production of commercial nuclear components during the 1978-80 period. The three contracts for nuclear supply systems awarded in the industry and received by the Company in 1976 have been delayed. Because of the uncertainty and delays affecting nuclear energy, there is a possibility of further cancella-tions and stretch-outs in production of existing orders. See Hote 9. of Notes to Consolidated Financial Statements. The Company attempts to cover increased costs of anticipated changes in general labor rates and material costs on long-term contracts either throagh an estimation of such changes which is reflected in the original fixed price or through price escalation clauses. All utility proposals since late 1973 and virtually all new contracts entered since that time contain escalation clauses, which are designed to protect the Company against increasing costs of material and labor. The Company's nuclear and fossil steam system contracts are subject to possible delays due to governmental requirements, environmental restraints, the ections of intervenors and financial conditions currently impacting utility companies. As to each deferment or cancelation, the Company is entitled to a financial settlement related to the individual circumstances of the contract. Raw Materials The principal raw materials used by the Company to construct steam gener-ating and associated equipment consist of carbon and alloy steels in various forms, such as plate. structurals, bars, sheet, strip, heavy wall pipe and tubes. Significant amounts of components are also purchased for assembly into the equipment. These raw materials and components generally are purchased by the Company as needed for individual contracts except that its requirements for tubes are supplied mainly by the Company itself. In periods of high demand for steel and other metal products, a short supply in certain raw materials required to be purchased by the Company has existed from time to time. 6

Item 1. Business - (continued) (c) Products (cont'd) Control valves employ the Self-DRAG

• concept and include manual and automatic control valves, regulators and other valves for the problem valve market. Problem valve applications occur where conventional products encounter performance problems such as noise, cavitation, destructive vibration and other conditions due to high fluid velocity and mass flow rates.

Markets The Company's steam generating and associated equipment is sold to its customers in the United States and Canada through its own sales force and to its customers in foreign countries principally through independent sales cgents. Tubu'ar Products are sold principsily to the Company's customers through its own sales force, but also are sol, to distributors. Substantially all of the Company's refractory products and control valves are sold directly to its customers by its own sales force. Automated machines and machine tools are sold to the Company's customers principally through its own sales forces, but are also sold through independent sales agents. The approximate distribution of 1977 and 1976 shipments by markets was as follows: 1977 1976 Electric Utilities 52% 50% Government 12 13 Warehouse and Distributors 8 7 Machinery 7 7 Transportation 4 4 Pulp and Paper 4 3 Chemical and Petroleum 3 5 Fabricated Metal Products 3 3 Primary Metals 1 3 Miscellaneous 6 5 100% 100% Sales to domestic government agencies, including sales to government owned utilities which are included with Electric Utilities above, amounted to $331,400,000 in 1977. These sales were primarily shipments of steam generating and associated equipment products. Competition All principal products of the Company are sold under highly competitive conditions. Steam generating equipment orders are customarily awarded in response to competitive bids submitted pursuant te proposals lased on the estimated cost of each j ob. A relatively small number of companies special-izing in large steam generating equipment compete with the Company in the fossil fuel field. The Company also competes with manufacturers of gas tur-bines for utility, industrial and marine use. In sales of nuclear steam gen-erating equipment the Company also competes with a small number of companies, including two maj or manufacturers whose reported sales of this equipment 5

Item 1. Business - (continued) (c) Raw Materials (cont'd) The principal raw materials used by the Company in the manufacture of nuclear fuel consist of uranium, plutonium, zircalloy and nickel. Although certain of the Company's commercial nuclear fuel contracts provide for it to furnish the uranium, the responsibilities under most of its recent nuclear contracts are generally limited to fabrication and the customer is to furnish the uranium. The Company presently owns or has under contract sufficient uranium to satisfy the requirements under the nuclear fuel contracts where it is supplying uranium. The principal raw materials used by the Company in the manufacture of tubular products consist of steel, steel scrap, special metals and alloying materials. Most of the steel and special metals used for seamless tube-making purposes is produced by the Company's own electric furnace facilities, but the Company purchases its requirements for strip steel in the open market. Most of the steel scrap and alloying materials consumed are also purchased in the open market. A shortage in raw materials, such as nickel and molybdenum, has existed from time to time, although no such shortage exists at the present time. The principal raw material used to produce the Company's refractory products is kaolin clay which it obtains from its own mine. Also used are bauxite, alumina, silicon carbide, gypsum, plaster and wood chips, which are purchased on the open market. The principal raw material used by the Company in the manufacture of automated machines and machine tools and control valves is steel in various forms. The Company purchases from other manufacturers certain components for assembly into its automated machines and machine tools. It also purchases actuators and other control mechanisms for inclusion in control valves. The shortage of natural gas impacts the manufacture of tubular products, refractory products and certain steam generating products. The Company has developed alternate sources of energy to substitute for natural gas in the affected operations; however, the result is to increase significantly its energy costs. The impact of the pending National Energy Act on natural gas supplies which may be available to the Company is not determinable at this time. Patents Many United States and foreign patents have been issued to the Company. In additien, many patent applications are outstanding and patent licenses have been acquired when advantageous to the Company. While the Company regards its patents and licenses as of value, no single patent or group of related patents is believed to be material in relation to its business as a whole. 7

Item 1. Business - (continued) (c) Research and Development The Company maintains research and development centers in Alliance, Ohio and Lynchburg, Virginia and also conducts developmental activities at its various manufacturing plants. During the fiscal year ended December 31, 1977, approximately $34,700,000 ($34,500,000 in 1976) was spent by the Company on research activities, of which approximately $8,300,000 ($7,100,000 in 1976) was paid for by customers of the Company. Research activities sponsored by the Company were related to both the development of new products and the improvement of existing products, while the majority of customer sponsored research activities were related to the development of new products. Government Regulation The Company's compliance with Federal, state and local environmental protection regulations necessitated capital expenditures of $3,100,000 in 1977 ($3,400,000 in 1976), and it expects to spend another $20,000,000 over the next five years. However, the Company cannot predict all the environ-mental requirements or circumstances which will exist in the future. The recurring cost of complying with environmental regulations was a charge against income before taxes of $5,700,000 in 1977 ($3,100,000 in 1976). Reports on business subject to the Renegotiation Act of 1951 have been cleared by the Renegotiation Board through the year 1970. Reports have been filed for the years 1971 to 1975 In addition, due to the uncertain status of the future of the renegotiation process, contractors have been granted an extension until July 15, 1978 to file the 1976 report. The 1976 report will cover the period January 1 through September 30, 1976, the date the Board's statutory authority over Government contracts ended, unless Congress extends the Board's authority prior to filing. The Company has or the years 1971 through 1975 It is the been assigned for renegotiation c opinion of the Company that it had no excessive profits subject to recapture under renegotiation in the years under review. Insurance The Company maintains general liability and property insurance coverage that it considers normal in its industry. In addition to coverage under nuclear liability and property insurance with respect to its five nuclear facilities, two of these facilities are covered by the limitations of liability and indemnity provisions of the Price-Anderson Act described below. The Company's insurance policies do not cover liability and property datige losses resulting from nuclear incidents at facilities of its utility customers. To protect against such losses, the Company has obtained con-tractual indemnification from such customers and waivers of their insurers' rights of subrogation and generally has been named as an additional insured under its customers' nuclear property insurance policies. In addition, the Company's third-party nuclear liability is an insured risk under such customer's nuclear liability policies and the Price-Anderson indemnity discussed below. 8

Item 1. Business - (continued) (c) Insurance (cont'd) Provisions of the Atomic Energy Act of 1954, as amended, commonly referred to as the Price-Anderson Act, among other things, limit the liability of manufacturers of licensed nuclear facilities and other indemnified parties to an aggregate of $560 million per nuclear incident and indemnify such persons in an aggregate amount which when added to amounts available under commercially available liability insurance policies will total $560 million. In March 1977, the United States District Court for the Western District of North Carolina, in a case involving nuclear plants of Duke Power Company, declared the Price-Anderson Act unscenstitutional as violative of the due process and equal protection clauses of the United States Constitution. (Carolina Environmental Study Group, Inc. v. United States Atomic Energy Commission (431F. Supp. 203)). The decision has been appealed by the Nuclear Regulatory Commission (successor to the Atomic Energy Commission) and Duke Power Company. Employees At December 31, 1977, the Company and its subsidiaries had approximately 39,000 employees. At that date approximately 17,000 hourly manufacturing employees in North America were members of labor union 1. (d) The following table sets forth certain financial information by geo-graphic area. Intercompany transfers to other geographical areas are primarily shipments of steam generating and associated products from U.S. based operations to foreign subsidiaries and are priced in a manner compara-ble to products sold to unaffiliated customers. Year Ended December 31, 1977 (In lousands) A dj us tments Adjustments and United and Canada Germany Other Eliminatiens Fcreign States Eliminations Censolidated unaf filiated customers. $157,300 $ 57,100 $12,100 $226,500 $1,650,700 $ $1,877,200 Transfers tetween geographical areas 2,h00 1,000 (600) 2,80 33,900 (36,700) Total... @ 0,700 $ 57,100 $1?,100 $(600) $3 1 E $1,6?h,600 $(3_(7_0]0 $1,877,200 Income (loss) from operations. $ 7 M $(20,OJ0) $ 1,200 Identifiable assets $(11,500) $ IL3,400 }_ 5,100(1) ~[ 137,200 at recember 31, 1977... , 3 82,100 $ 16,300 $11,700 $(10]0 1107,P00 {1,0k5, BOO $(11,100] $ 1,lLL,100 Corporate assets (2) 165,600 Total assets at recember 31, 1977.. $1,3'$,700 Note: (1) Primarily attributable to sh Are of other jcint venturer in losses cf BBR. (2) Corporate assets are principally cash and marketable securities. 9

Item 1. Business - (continued) (d) (cont'd) Export sales from the Company's United States operations to unaffiliated foreign customers did not exceed 65 of coasolidated sales for any of the five years ended December 31, 1977. A significant portion of the Company's shipments arose from foreign operations, primarily in Canada and Germany. The Canadian operations are profitable, principally reflecting the results of B%W Canuda Ltd. The German operations continued to be unprofitable in 1977. The Company entered the nuclear market in Germany in 1971 with the formation of BBR, owned jointly by the Company and Brown Boveri of Germany. It was expected that the nuclear program would continue to develop and utilize its existing technology and know-how to expand not only in Germany, but also in other areas of the continent. BBR received its first order in 1972 for a 1300 Mw systet for the Mulheim-Ksrlich plant of Rheinisch-WestfHlisches ElektrizitMtswerk (AG) in Essen. BBR's financial performance has been unfavorable and has had a signifi-cant impact on the Compan 's results for 1977 and 1976. This unfavorable f performance resulted primarily from two factors-(1) BBR has only a single contract and the volume of its business is insufficient to absorb its costs and (2) unanticipated cost overruns, in part attributable to major changes in licensing requirements which have been adopted in West Germany since BBR received the Mulheiu-Khrlich contract. BBR is entitled to recover some of these additional costs and is actively pursuing its claims. The Company's 1977 results assume the completion of arrangements with respect to BBR which would limit the liabilities (other than contingent liabilities) of the Company attributable to BBR to amounts which do not exceed those recorded in the accounts. These arrangements have been approved by the managements and the Boards of Directors of the Company, Brown Baveri of Switzerland and Brown Boveri of Germuny, the j oint owner. Formal agreements reflecting these arrangements are currently being prepared. The Company's share in BBR's loss from operations was $14,400,000 for 1977 and $18,100,000 for 1976, which resulted in a total loss from operations of foreign subsidiaries of $11,500,000 and $10,700,000 for the respective pericds. 10

Item 2. Summary of rTern tinrs T!E BABCOCK & '4IIfoX CCf6ANY IJD C'J33IDIARY CG'FANIE3 CCN30LIDATED CU!O'ARY CF OPERATIONS For the Calendar Year 1(77 / 1&> 1975 19 % 1973 Sales. $1,877,200,000 $1,691,800,000 $1,565,000,000 $1,277,200,000 $1,063,700,000 Income frm operations. 137,200,000 111,400,000 105,600, COO 75,200,000 43,100,000 Interest expense. 14,700,000 14,800,000 23,900,000 22,100,000 10,200,000 U.S. and fcreign taxes en income. 63,600,000 47,200,TO 40,700,000 24,700,000 14,500,000 Net inccce.._ 61,800,000 53,100,000 42,300,000 34,100,000 22,100,000 Ter share (a) Net incctne en average shares cutstanding. $5,06 $4.37 $3.49 $2.82 $1.82 Cash :iviiends declared. 3.93 1.05 .80 .90 .80 (a) Earnings per share are computed cn a weighted average of shares cutstanding durira the year - 12,213,391 in 1977; 12,140.867 in 1976; 12,110,6k6 in 1975,12,105,748 in 1974; 12,146,573 in 1973 Shares under options outstandirs; are not used in determining earnings per share since they have no caterial dilutive effect 11

Item 2. Summary of Operations - (continued) Management Discussion and Analysis of the Summary of operations Comparison of 1977 with 1976 Sales - Sales of $1,877,200,000 increased 114 from $1,691,800,000 in 1976. The increased sales were primarily attributable to increased shipments of steam generating equipment, principally to utilities, and a higher volume of tubular produc ts. Income from operations - Income from operations was $137,200,000 in 1977 or 23% higher than the $111,400,000 recorded in 1976. Income from operations as a percent of sales was 7.3% in 1977 compared with 6.6% in 1976. The increased income from operations and improved profitability was due to the higher volume of shipments of steam generating and associated equipment primarily to utilities. In addition, 1976 income frcm operations was reduced an estimated $10,500,000 by strikes at various plants, principally related to steam generating and associated equipment. Income from operations from the Company's nuclear business continued profit-able in 1977 and was substantially higher than in 1976. Government nuclear business continued to be profitable and the commercial nuclear business would have been profitable except for the operations of BBR (see Item 1.(d)). The improved results from steam generating and associated equipment were partially offset by lower earnings from tubular products despite higher shipments. While tubular products continued to make a substantial contribution, profitability was lower because of an unfavorable mix of products shipped together with insufficient price relief to offset cost increases including substantially higher energy costs. In addition, the total income from operations of all other industry segments was lower in 1977 due to increased manufacturing and other costs without adequate price relief. Interest Expense - Interest expense was $14,700,000 in 1977, approximately the same as the $14,000.000 in 1976 as lower average interest rates in 1977 offset higher average borrowings. U.S. and Foreign Income Tax - Income tax expense of $63,600,000 was 35% higher than 1976 tax expense of $47,200,000 dae to a 25% increase in income before taxes and a higher effective tax rate. The higher effective tax rate of 50.5% in 1977 compared to 46.9% in 1976 was principally due to lower investment tax credits in 1977. Net Income - Net income increased 16% to $61,800,000 or $5.06 per share in 1977 frem $53,100.000 or $h.37 a share in 1976. The higher net income resulted, primarily, from the increase in income from operations partially offset by a higher effective tax rate. Comparison of 1976 to 1975 and 1975 to 1974 Sales - Sales of $1,691,800,000 in 1976 increased 8% from $1,565,000,000 in 1975 Sales in 1975 were 23% higher than sales of $1,277,200,000 in 1974. The increase in 1976 was principal 13 due to a higher level of shipments in steam 12

Item 2. Summary of operations - (continued) Management Discussion and Analysis of the Summary of Operations generating and associated equipment. In 1975 and 1976, there was cubstantici demand for all of the principal classes of the Company's prvJucts. H owever, tubular products sales decreased in 1976 from the level of 1975 as a result of reduced activity in the markets these products serve. Income from Operations - Income from operations of $111,400,000 in 1976 increased 5% from $105,600,000 in 1979 The principal contributor to increased income from operations in 1976 was steam generating and associated equipment, despite strikes of various durations at certain plants manufacturing these products. Also in 1976, the fossil utility and industrial boiler business experienced significantly higher earnings on increased shipments. The Company was also relieved in 1976 of the impact of inflationary cost increases on fixed price contracts uhich affected results in 1974 and 1975 In addition, there were substantial increases in fossil repair and replacement parts business. In 1976 the Company changed the actuarial cost method used in determining pension expense and funding of major pension funds from projected cost methods to the accrued benefit cost method with projected final compensation. This change added approximately $3,500,000 to income from operations in 1976. It is estimated that the strikes at various plants reduced income from operations by approximately $10,500,000 in 1976. In addition, tubular products earnings were down substantially from the record earnings of 1975 as a result of lower shipments and increased manufacturing costs without adequate price relief. Refractories and automated machines and machine tools earnings were also lower than the 1975 results. Income from operations in 1975 was 40% higher than in 1974, when income from operations teteled $75,200,000. Income from operations in 1975 reflected increased earnings for tubular products, refractories, automated machines and machine tools and increased profitability of the fossil utility and industrial boiler business. In addition, in 1975 the Company obtained some relief on various fixed price fossil steam generating contracts. Material shortages experienced in 1974 eased sanewhat during 1975 and purchased scrap costs were lower in 1975 than 1974. Increased energy costs during 1975 and 1976 adversely affected the profitabil-ity of all industry segments, despite the substantial conservation efforts try the Company to reduce energy consumption. Conversion of facilities to use fuels other than natural gas prevented curtailment of operations, but resulted in substantially higher energy costs. Repair and maintenance expenses increased in both 1975 and 1+,5 to higher levels due to continued high ratca of production in most operations. The increase in 1975 resulted primarily from higher rates of production of tubular products. Other costs, including labor, fringe benefits and administrative expenses also increased, reflecting a more complex business environment. Lhe impact of regulatory requirements and continued inflation. 13

Item 2. Summary of Operations (continued) Management Discussion and Analysis of the Summary of Operations The Company's total nuclear business was profitable in 1975 and 1976. Profitable government nuclear business was, however, substantially offset in 1976 by losses in the Company's commercial nuclear activity, particularly from operations of BBR. Lack of new business for BBR beyond its one utility contract, which was taken at unfavorable prices and, in addition, cost increases due to delays and to regulatory requirements, were largely responsible for these losses. Income from operations as a percent of sales was 6.6% in 1976, approximately the same as the 6.7% in 1975 but higher than the 5.9% in 1974. The 6.6% return on sales in 1976 was achieved despite the impact of the strikes and lower ship-ments of more profitable tubular products. In both 1975 and 1976, the improve-ment in income from operations as a percent of sales over 1974 reflected the enhanced profitability of the fossil boiler business and continued management efforts to implement cost reduction programs and to improve operating efficiency throughout the Company. Interest Expense - Interest expense in 1976 of $14,800,000 was 38% lower than 1975 This significant decrease resulted from a combination of substantially reduced average total debt levels in 1976 and lower interest rates. Interest expense in 1975 of $23,900,000 was 8% higher than 1974. Average outstanding debt in 1975 was somewhat higher than 1974, which resulted in increased interest costs despite the fact that rates trended lower during the year. The higher average debt levels were due to continuing high capital expenditures, which reached a record level of $69,700,000 in 1975, and to higher working capital requirements to support increased volume. The higher earnings in 1976 and improved cash flow allowed the Company to reduce outstanding debt by 59% to $101,100,000 at December 31, 1976, compared with $246,700,000 at the end of 1975 and $273,100,000 at the end of 1974. As a result of improved cash flow fran higher earnings and the sale of the Company's interest in its British affiliate, Babcock & Wilcox Ltd., in 1975, the Company was able to reduce its term loan by $25,000,000. This term loan was completely repaid in 1976 and the related revolving credit agreement was cancelled. In addition, in 1976 the Company improved its working capital position by refinancing certain bank lines of credit of its Janadian subsidiary, Babcock & Wilcox Canada Ltd., with $25,000,000 aggregate principal amount of 9% cuaranteed Notes due December 1, 1996. Under the note agreements pursuant to which the Guaranteed Hotes were issued, Babcock & Wilcox Canada Ltd. will repay the Guaranteed Notes in annual installments of $1,650,000 beginning December 1,1982. In January 1977, the Company issued $60,000,000, in aggregate principc1 amount of 81/2% Notes due January 1,1997 to various institutional lenders. Payments on the Notes will be made in annual installments of $3,960,000 beginning January 1, 1983 The Company secured the long-term loan to take advantage of favorable money market conditions to meet projected long-term capitn i rm eds. Interest costs in 1975 and 1974 were substantially higher than in 1973 and 1972. In 1971 and 1972, the Company was able to reduce debt from the relatively 14

I tem 2. Summary of Operations - (continued) Manar7 ment Discussion and Analysis of the Summary of Operations high levels of 1969 and 1970 due to improved earnings, somewhat lower capital cxpenditures and stable vorking capital requi rements. Interest rates in 1971 and 1972 were also relatively lower than in the preceding two years. In 1972, the Company embarked on a substantial capital program in response to demand for its products, particularly tubular products, and to satisfy pollution control and OSHA requirements. At the same time, working capital needs increased with the higher sales volume. In 1973 the Company made a significant investment in Babcock & Wilcox Ltd. These factors increased the need for higher debt levels. In addition, interest rates climbed to unprecedented levels during 1974. The combination of increased debt levels and higher interest rates resulted in the significantly increased interest costs in the 197h-1975 period. U.S. and Foreign Income Tax - U.S. and foreign income taxes were $47,200,000 in 1976 or 16% higher than 1975 U.S. and foreign income taxes in 1975 were $40,700,000 or 65% higher than in 1974. The increase in taxes in 1976 resulted from the 21% increase in pre-tax earnings, partially offset by a lower effective tax rate of 46.9% in 1976, compared with 49% in 1975. The effective tax rate in 1974 was h1 9%. The principal reasons for the lower effective tax rate in 1976, as compared with 1975, were significantly increased investment tax credits and the sale of the Company's investment in Babcock & Wilcox Ltd. in 1975 The effect of the sale of this investment was to increase the effective rate. Because the proceeds of the sale were lower than its carrying value at equity, but higher than the cost to the Company (and its tax basis in the investment), the sale gave rise to a book loss without a corresponding reduction in tax expense. Mcwever, since the proceeds were higher than the tax basis, it was necessary to make a provision for the taxable capital gain as measured from the cost basis of the investment. This sale was also a principal reason for the higher effective tax rate in 1975 as compared with 197h. In addition, in 1975 BBR incurred higher losses than in 1974, which increased the effective tax rate as a tax benefit was not available because of the uncertainty of the utilization of a loss carryforward tax credit. Increased losses in 1976 over 1975 at BBR partially offset the higher investment credits and the impact of the sale of Babcock & Wilcox Ltd. on the 1975 effective tax rate. In 1974 and 1973 the effective tax rate was lower than the statutory rate. The differences between the effective rates and the statutory rate in those years relate principally to investment tax credits and the net effect on the composite tex rate of operations of the Ccmpany's subsidiaries and affiliates not subject to the U.S. statutory rate. Net Income - Net income in 1976 was $53,100,000 or $h.37 per share and inerensed 25% over the previous year. The record shipments and operating income, together with the reduced interest costs, were the principal reasons for the increased earnings. The lower effective tax rate and higher investment income, due primarily to interest on short-term investments as a result of the Company's favorable cash position, also contributed to. earnings performance in 1976. In addition, the change in accounting for pensions in 1976 resulted in an increase 15

Item 2. Summary of Operations - (continued) Management Discussion and Analysis of the Summary of Operations in net income of approximately $1,800,000, or $.15 per share. These increases were partially offset by the impact of strikes at various Company plants in 1976 which was estimated to have reduced net income by approximately $5,500,000, or $.45 a share. In 1975, net income was $42,300,000, or $3.49 per share, and increased 24% over 197k. This increase was partially offset by increased interest expense and the sharply increased effective tax rate. In addition, the sale of the Company's investment in Babcock & Wilcox Ltd. reduced 1975 net income by approximately $3,400,000, or $.28 per share, including a provision for the capital gains tax on the sale. Earnings in 1974, improved over 1973 earnings which were depressed by approximately $.40 per share by a strike at the Barberton, Ohio plant. Earnings in 1974, however, were adversely impacted by fixed price fossil steam generating contracts, material shortages and high scrap costs. Price controls caused a cost-price squeeze on profit margins in 1972 and 1973, as the company could not fully recover substantially higher costs of steel scrap and other material and labor cost increases. Item 3 Properties The principal plants of the Company and its subsidiaries manufacturing steam generating and associated equipment are situated at Barberton, Canton, Lancaster and Wickliffe, Ohio; Mount Vernon, Indiana; Lynchburg, Virginia; Cambridge, Ontario and Apollo, Pennsylvania. The Company's principal plants manufacturing tubular products are located at Beaver Falls and Ambridge, Pennsylvania; Alliance, Ohio and Milwaukee, Wisconsin. The Company manufactures automated machines and machine tools principally at Rockford, Illinois and Rochester, Michigan. It manufactures refractory products principally at Augusta, Georgia and Ponce, Puerto Rico and mines kaolin clay at Hepzibah, Georgia. Control valves are manufactured at Irvine, California. The plants and properties mentioned above are held in fee and are not subject to title defects, liens or encumbrances which, in the Company's opinion, interfere with the conduct of operations. The Company's lease of its principal executive office in New York City expires April 30, 1979; how-ever, it is in the process of renewing the lease until April 30, 1984. In the opinion of the Company, all of the foregoing properties are well maintained, have suitable equipment and are of adequate size for present needs. If utilities resume ordering steam generating equipment at historical rates, additional capacity may be needed in future years. 16

Item 4. Parents and Subsidiaries of Registrant Percentage State (Country) ownership of Incorporation Bailey Meter Company 100.0 Delaware Babcock & Wilcox Canada, Ltd. 100.0 Dominion of Canada Diamond Power Specialty Corporation 100.0 Ohio Babcock-Brown Boveri Reaktor, GmbH 74.0 West Germany All of these subsidiaries are included in the consolidated financial state-ments of the Company. See Item 1.(d) with respect to the Company's ownership of Babcock-Brown Boveri Reaktor GmbH. The subsidiaries omitted from the foregoing list do not, considered in the aggregate, constitute a significant subsidiary. Item 5. Legal Proceedings On October 31, 1974 the Board of Directors amended all outstanding stock options under the Company's 1972 Stock Option Plan to reduce the purchase price to $13.625 per share. This action applied to options covering 238,900 chares of the Company's common stock, including options covering 9,375 shares to Mr. George G. Zipf, 6,000 shares to Mr. Raymond J. Cantwell, 5,000 shares to Mr. Walter M. Vannoy, and 59,875 shares to all officers and directors as a group. The original option prices were from $23.75 to $26.625 This action was taken pursuant to the provisions of the Plan approved by the stockholders in 1972 which authorize the Board to reduce the exercise price of outstanding options. A stockholder of the Company brought suit in February 1976, derivatively on behalf of the Company, in Supreme Court, New York County, State of New York, against all of the directors then serving, charging that the reduction of option prices was invalid and unlawful since allegedly it was an improper amendment of the 1972 Plan without stockholder approval and resulted in a material increase in its cost to the Company in violation of the 1972 Plan and the New Jersey Business Corporation Act. The suit seeks to have the named directors account to the Company for damages and to have the reduction in option exercise prices cancelled. The directors have vigorously defended the suit inasmuch as they believe that the substantive allegations of the complaint are unfounded because the directors were specifically authorized under the 1972 Plan to reduce the exercise price of the outstanding options. At the outset of this suit, motions to dismiss the complaint and for summary judgment against the defendants were made by the directors and the plaintiff, respectively, and both motions were denied. On appeal, the Appellate Division of the Supreme Court, State of New York, First Department, reversed the lower court's denial of the directors' motion and ordered the complaint dismissed. The plaintiff has appealed the dismissal of her complaint to the new York Court of Appeals. In January 1978 a stockholder of the Ccmpany filed an alleged class action, Osofsky v. Zipf, et. al. in the United States District Court for the Southern District of New York against J. Ray McDermott, Inc. (McDermott), the Company, the directors of the Company, Smith Barney, Harris Upham & Co. Incorporated and Morgan Stanley & Co. Incorporated alleging violations of Federal securities laws prohibiting fraudulent or misleading statements and state common law in connection with the proposed merger between the Company and McDermott. Plaintiff, 17

Item 5. Legal Proceedings - (continued) who seeks to represent all Company stockholders, alleges, among other things, that McDermott plans to violate its " promise" in its tender offer that the con-sideration to be received by the Company's stockholders in the merger wculd have to approximate the price paid pursuant to the tender offer by offering securities which the plaintiff claims have a market value of $61 or less, that the other defendants aided and abetted McDermott with respect to this violation, and that such violation constitutes a breach of fiduciary duty owed to the stockholders of the Company by McDermott, the Company and the directors of the Company. Plaintiff seeks specific performance of McDermott's alleged promise to pay the stockholders of the Company the approximate sum of $65 per Common Share or damages in a minimum sum of $5 per Common Share upon the issuance by McDermott of Preferred Stock having the terms announced on December 8,1977, which terms were the same as those set forth on page 1. herein, except that the dividend on the Cumulative Preferred Stock was $2.50 instead of $2.60, plus attorneys' fees and costs. The Company and its directors have not yet responded to the complaint. Lewis v. Graves, et al. is an action commenced on or about Msrch 28, 1978 in the United States District Court for the Southern District of New York alleging violations of the Federal securities laws, the breach by the individual defendants of alleged fiduciary and statutory duties to J. Ray McDermott & Co., Inc. and fraud and abuse of discretion by such individual defendants. The plaintiff demands judgment: declaring the Agreement and Plan of Reorganization dated February 15, 1978 null and void and enjoining performance of such Agreement, or in the alternative rescinding such Agreement; directing defendants other than The Babcock & Wilcox Company to account to J. Ray McDermott & Co., Inc. for damages in an unspecified amount; and canceling certain shares of stock received by defendants Graves, Bailey, Cunningham, Richie and Davis. Plaintiff also prays for exemplary damages. We were informed of this complaint by counsel for J. Ray McDermott & Co., Inc. following the conclusion of the Special Meeting of Stockholders of The Babcock & Wilcox Ccepany. Item 6. Increases and Decreases in Outstanding Securities and Indebtedness (a) Increase in chares of Common Stock; par value $4.50 per share, out standing: Shares of Common Stock outstanding at December 31, 1976 12,156,939 Options exercised during 1977 under the 1972 Stock Option Plan 119,101 Shares of Common Stock outstanding at December 31, 1977 12,276,040 (b) As described in Item 5. of Part II of the Company's report on Form 10-Q for the quarter ended March 31, 1977, on January 11, 1977, the Company entered into a Note Agreement with several insurance companies under which the Company sold and the insurance companies purchased $60,000,000 8-1/2% Notes due January 1,1997. (c) Not applicable Item 7. Changes in Securities and Changes in Security for Registered Securities Not applicable Ttem 8. Defaults Upon Senior Securities Not applicable 18

Item 9. Approximate Number of Equity Security Holders December 31, 1977 Title of Class Number of Record Holders Common stock with par value $4.50 per share 16,035 Item 10. Submission of Matters to a Vote of Security Holders Not applicable Item 11. Executive Officers of the Registrant George G. Zipf Age: 57 Date of Birth: 10/12/20 Seniority Dnte: 7/20/42 4-24-73 tiamed to Additional Position of Chairman of the Board 9-26-68 Elected Chief Executive Officer 12-28-67 Elected President Raymond J. Cantwell Age: 61 Late of Birth: 7/14/16 Seniority Date: 11/ 1/46 4-28-76 Elected Senior Executive Vice-President, Finance and Administration 4-25-73 Elected Senior Vice-President and Chief Financial Officer 12-29-66 Elected to Board of Directors 4-28-65 Elected Vice-President & Chief Financial Officer H oward D. Kurt Age: 50 Date of Birth; h/28/27 Seniority Date: 5/ 1/72 h-28-76 Elected Executive Vice-President, Industrial Products 5-1-72 Elected Group Vice-President, Industrial Products Group Prior Experience: General Electric Company (21 years) 1970-72 Vice-President and General Manager, Manufacturing and Process Automation Business Division 1968-70 Deputy Division General Manager, Process Measurement and Control Industrial Process Control Divisi on 19

Walter M. Vannoy Age: 50 Date of Birth: 1/13/28 Seniority Date: 9/ 3/57 4-28-76 Elected Executive Vice-President, Power Generation 3-1-73 Elected Group Vice-President, Power Generation Group 8-1-70 Vice-President, Naval Nuclear Fuel Division 9-1-68 General. Manager, Naval Nuclear Puel Division h-1-68 Plant Manager, Nuclear Facilities Plant Louis M. Favret Age: 49 Date of Birth: 6/ 5/28 Seniority Date: 7/2/51 10-25-73 Elected Corporate Vice-President 10-16-73 Named Vice-President, Nuclear Divisions (Nuclear Power Gener.ation Division, Nuclear Equipment Division and Nuclear Materials Division), Power Generation Group 6-1-71 Division Vice-President, Nuclear Equipment Division 10- 1-70 General Manager, Nuclear Equipment Department 2-1-70 Manager, Nuclear Equipment Department 10- 1-69 Planning & Commercial Manager, Nuclear Power Generation Department William H..Tackson Age: 63 Date of Birth: 1/23/15 Seniority Date: 8/ 3/36 2-22-72 Elected Corporate Vice-President and effective 3/1/72 named head of Marketing for the Power Generation Group 5-13-64 Elected President and Chief Executive Officer, Diamond Power Specialty Corporation George W. Kress, Jr. Age: 57 Date of Birth: 6/20/20 Seniority Date: h/1/47 1-25-78 Appointed Executive Vice-President, Materials Group h-28-76 Elected Executive Vice-President, Tubular Products 12-29-66 Elected Corporate Vice-President 10- 5-66 Named General Manager, Tubular Products Division Wallace Markert, Jr. Age: 53 Date of Birth: 8/L3 /24 Seniority Date: 4/29/46 7-1-77 Appointed Corporate Vice-President Research & Development Division 4-27-77 Elected Corporate Vice-President, Corporate Planning " Development 20

Hustace H. Poor Age: 63 Date of Birth: 11/ 9/14 Seniority Date: 9/6/38 7-1-77 Appointed Corporate Vice-President Contract Research 4-28-71 Elected Corporate Vice-President 3-1-67 ceneral Manager, Research & Development Divisior. Arthur C. Tendler Age: h6 Date of Birth: 3/ 3/32 Seniority Date: 7/31/67 12-28-72 Elected Corporate Vice-President, International 2-1-71 Coordinator, International Operations and Assistant Secretary 8-14-69 Assistant Secretary and Administrator Commercial Agreements Martin Victor Age: 64 Date of Birth: lo/3/13 Seniority Date: 2/ 2/53 4-28-71 Elected Corporate Vice-President and Secretary 4 4-56 Elected Secretary Leon B. Wohlgemuth Age: 63 Date of Birth: 8/ 3/14 Seniority Date: 8/ 6/36 4-28-65 Elected Corporate Vice-President in charge of Tubular Products Sales 7-1-58 Hamed General Sales Manager, Tubular Products Division Harold D. Kenney Age: 58 Date of Birth: 11/21/19 Seniority Date: 7/ 1/53 4-24-7h Elected Corporate Vice-President and Controller 4-28-65 Elected Controller Walter P. Catterson Age: 58 Date of Birth: 12/14/19 Seniority Date: 9/19/55 4-24-74 Elected Corporate Vice-President and Treasurer 11-29-(>2 Elected Treasurer 21

Robert C. Bassett Age: 53 Date of Birth: 12/24/24 Seniority Date: 1/2/62 5-1-74 Elected Corporate Vice-President, Purchasing and Traffic 4-1-71 Corporate Director, Purchasing 5-1-64 Division Purchasing Agent, Tubular Products Division Sothern W. Boone Age: 61 Date of Birth: 7/ 7/16 Seniority Date: 3/31/47 5-1-74 Elected Corporate Vice-President, Public Affairs 4-1-68 Corporate Manager, Public Relations Richard E. Woolbert Aga: 44 Date of Birth: 12/18/33 Seniority Date: 7/ 5/55 5-1-74 Elected Corporate Vice-President, Employee Relations 4-1-67 Corporate Director, Employee Relations Item 12. Indemnification of Directors and Officers Unchanged from information given in Form 10-K for the fiscal year ended December 31, 1970. Item 13. Financial Statements and Exhibits (a) 1. Financial statements See accompanying index to financial statements 2. Exhibits Exhibit I - Company By-Laws, as amended to February 23, 1978 (b) Not applicable Part II of this Report on Form 10-K for the year ended December 31, 1977 has been omitted pursuant to General Instruction H of Form 10-K. On February 24, 1978 the Company filed with the Commission pursuant to Rule 14a-6(c) a definitive proxy statement relating to a Special Meeting of the Stockholders of the Company with respect to the merger of the Company into a wholly-owned subsidiary of J. Ray McDermott & Co., Inc. ("McDe rmott" ). Pursuant to Note A of Schedule 14A, the solicitation of proxies in connection with a merger specifi ad in Item 14 of Schedule 14A is deemed to involve the election of directors in the circumstances contemplated by the Company's proposed merger into the wholly-owned subsidiary of McDermott. With respect to those directors of the Company who were nominees for election to the Board of Directors of McDermott, the de?initive proxy statement complied with the informaticnal and disclosure requirements of Schedule 14A. 22

SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. TIE BABCOCK & WILCOX COMPANY (Registrant) Date March 31, 1978 BY /s/ R.J. Cantwell R.J. Cantwell Senior Executive Vice-President 23

THE BABCOCK & WILCOX C0!&ANY AND SUBSIDIARY CCleANIES INDEX TO FINANCIAL STATEMENTS Page Report of independent accountants 25 Financial statements: Consolidated balance sheets 26 Consolidated statement of income and retained earnings 27 Consolidated statement of changes in financial position 28 Summary of significant accounting policies 29 Notes to consolidated financial statements 31 Schedules: Property, plant and equipment (Schedule V) 46 Accumulated depreciation, depletion and amortization of property, plant and equipment (Schedule VI) 47 Valuation and qualifying accounts and reserves (Schedule XII) 48 Supplementary income statement information (Schedule XVI) 49 Schedules not listed above have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. The individual financial statements of the registrant have been omitted since it is primarily an operating company and all subsidiaries included in the consolidated financial statements being filed, in the aggregate, do not have minority equity interests and/or indebtedness to any person other than the registrant or its consolidated subsidiaries, excluding indebtedness incurred in the srdinary course of business which is not overdue and which matures within one year from the date of its creation, whether evidenced by securities or not, and indebtedness which is collateralized by the registrant by guarantee, pledge, assignment or otherwise, in amounts which together exceed 5% of total assets as shown by the most recent year-end consolidated balance sheet. Separate financial statements of subsidiaries not consolidated and 50% or less owned persons accounted for by the equity method have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary. 24

). p}{g 153 E AST 53RD STREET [aterhouse aoct NEW YORK. NEW YORK 10022 February 28, 1978 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Directors of The Babcock & Wilcox Company In our opinion, the consolidated financial statements listed in the accompanying index present fairly the financial position of The Babcock & Wilcox Company and its subsidiaries at December 31, 1977 and 1976, and the results of their operations and the changes in their financial position for the years then erded, in conformity with generally accepted accounting principles consistently applied. Our examinations of these statements were made in accordance with generally accepted auditing standards and accordingly included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. PRICE WATERHOUSE & CO. 25

UE BABCOCK & WILCCX CCFPANY AND SUB3IDIARY CD'CANIES CCNOCLIDATED BALANCE C3EEIS ACSETS At December 31 CURRENT ASCETS 1977 1976 Cash (includira time and certificates of deposit: $39,000,000 in 1977).. $ 63,300,000.$ 30,500,000 Marketable securities, at cost which approximstes market (includirg U.S. Treasury obligations held under repurchase agreements: 1977-$61,k00.000; 1976-$35.000,000)... 80 '00,000 33,700,000 Accounts receivable (net of allowance for doubtful accounts: 1977-$7,400,000; 1976-$5,000,000) (Note 1)... 233,100,000 171,300,000 215,700,000 176,600,000 Unbilled sales (Note 1)... Inventcries, including long-term contract coste (less progrese payments nn contracts) (Note 2)... 287,100,000 310,600,000 c a,53u,0u0 72d,7.0,Ou0 TOTAL CURRE*IT ASSET 0. II. F"..Fl;T0.... 9,000,000 8,hoo, COO FRCFERT.', FIANT AND EQUIF"ENT, at c cst less accu =ulated depreciation (Note 3)... 379,'m,000 359,200,000 PREFAID EXFINCE3 AND OME ACCE"3. kl,00,010 27,f00,000 & 30), M,0M & lN,100,000 TC#IA L ACMTS..... LIABILTTIES AND STOCKHCIIER3' FOUI"( At Dece: ber il CUFFFNT LIABILITIES 11/7 1970 33,900,0 N $ 8,200,000 Notes payable (Note k). Accounts psyable - trade.. 73,600,00-69,k00,000 Frovision for wstranty expence. 71,300,07 69,100,000 A d v an c e p ayme n t s on c ont r ac t s........................................ 166,100,000 167,900,000 Accrued salaries and w*tges. 43,200,000 38,400,000 Other accrued liabilities.. 67,000,000 50,200,000 k,600,000 3,600,000 Cash dividends payable.. U.S. and foreign inccme taxes (including deferr ed taxes: 1977-$234,k00.000; 1976-$181,9Jo,000) (Note 7).. 2'n,600,000 154,'00,000 61),E00,003 531,100,000 TOTAL CURRENT LIABILITIEC. NONCUFSENT INLE32D';EG3 (Note 4).. Ik7,k00,000 92,900,000 DFFERFED IN0NE 3XE3 (Note 7).. 26,P00,000 E2,500,000 MIERi rY INTERESTS IN SUB3ITIARY CTTANIES.. 3,100,000 2,000,000 TOTAL LIABILITIEC.. c76,500,000 700,5M,000 GTOCKHOLDER3' EQUITY Capital stack: Freferred, cumulative, no par; authcrized and unissued 2,000,030 shares Commen, par value $4.50; authorized 18,000,000 shares, issued: (1977 and 1976-12,604,906 shsres)..... 56,700,000 56,700,000 32,E00,000 31,800,000 Capitsi r2rplus (Note 5).. Retained earnings (Note k).. E l,700,000 933,000,000 M 1,000,000 C 6,500,0>0 Less: Treasury stock, at cost: (Note 5).. 8,000,000 10,900,000 1977 - 328,666 shares 1976 kk7,967 shares TOTAL STTIGiCLEERS' EQL'ITY... k B,200,000 bl5,f,00,000 TCTAL LIABILITIES AND STTEHOLDERC' E;t'ITY.. }l2 09,/00,000_ $1,12..!00.000 See su=tary of significant accounting pol'.cies and notes to consolidated financial statements. 26

THE BABCOCK #c WI!fCX CCTANY AND C"BOILIAT<Y CC!CANIES CCNSOUCATED STATEMENT OF INCCfG AND RETAINED EARNIN33 Fcr the Calendar Year 1977 1976 Sales (on percentage of ccupletion methoa for long-term contracts)..... 41,877,200,000 $1,691,8CO,Oro Costs and expenses: Costs and operating expenses (excluding depreciation)....... 1,576,100,000 1A43,000,000 26,400,000 27,400,000 Besearch and development expenses........... 100,500,000 77,L00,000 Selling, general and administrative.. 17,000,000 12,600,000 Depreciation of plant and equipment....... 1,740,000,0u0 1,500,400,000 137,250,000 111, @,0v] Inctne from operations... 3,500,000 3,900,000 Incme from invest =ents... (14,700,000) (1k,803,000) Interest expense. Inecce before taxes and minority interests.... 326,[>0,000 100,500,000 U.S. and foreign taxes cn inccne: (Note 7) 4,400,000 3,900,000 Current.. Deferred.. 59,200,000 kl,300,000 ra,000,000 47,2Ou,000 02,400,000 53,330,000 Inctne applicable to mincrity interests... (600,000) (200,000) Net income for the year 61,800,000 53,100,000 (per share: 1977-$5.06; 1976-$4.37).... Cash dividends declared h8,100,000 12,800,000 (per share: 1977- $ 3.93 ; 1976- $1.05)........... 13,700,000 40,3 4,000 Bemainder, to retained earnings... Retained earnings at beginning of year. _ _ 338,000,000 297,700,000 $ 351,700,000 4 330,000,000 Retained earnings at end of year (Note 4 ).... See summary of significant accounting policies and notes to consolidated financial statements. 27

THE BAlf'OCK & WIlfCX COMPANY AND S"BSIDIARY CCt'JANIES CGISOLICATED STATE'E'iT CF CHANGES IN FINA'iCIAL PCSITICN Far the Calendar Year 1977 1976 WCPKING CAPITAL AT BEGIN'ilNG CF THE YEAR.............................. $137,600,000 $220,300,000 FINMiCIAL RESOURCES WEPE PRCVILED BY: Net ine me. 61,800,000 53,100,000 Add cr (deduct) items not affecting working capital: I'epre ciation. 37,000,000 32,600,000 Amount due to subsidiary company by joint venturer far its share of icsses. (6,200,000) (7,200,000) Deferred income taxes, noncurrent.. 4,300,000 600,000 600,000 200,000 Income applicable to cincrity interests... Equity in undistributed earnings of affiliated compsnies... (400,000) (500,000) Working capital provided by operations fcr the period. 77,100,00] 70,000,000 66,600,000 27,600,000 Additicaal noncurrent borrowings. Exercise of stock cptiens... 3,900,000 900,000 167,600,000 107,300,000 FINANCIAL RESCURCES WERE USED FCR: Additions to property, plant and equipment.. 61.700,000 62,000,000 Cash dividends declared.. 48,100,000 12,800,000 Reductions of noncurrent indebtedness... 12,100,000 105,700,000 Peelassification of amornt due to subsidiary company by joint venturer for its share of priar years' losses... 6,100,000 1.000,000 3,400,000 Other, net.. 129,'r00,000 190,000,000 NET INCREASE (CECFEASE) IN WJKING CAPITAL............... 42,700,000 (c2,700,000) WCRKING CAPI TAL AT FND CF YEAB.................. $180,300,000 $137,600,000 The changes in the cceponents of wrking capital. are summarized as follows: Increase (decrease) in current assets: $ 32,800,000 $ 8,700,000 Cash.. 40,600,000 (300,000) Marketable securities. Accounts receivable. 61,800,000 (36,800,000) 39,100,000 3.400,000 Unbilled sales.. Inventories... (23, W,000) (32,900,000) 150,b00,0' ; 57,900,000 Increase (decrease) in current liabilities: Notes payable. 25,600,000 (67,500,000) Accounts payable - trade.. 4,200,000 7,600,000 Provision for warranty expense.. 2,200,000 13,200,000 Advance payments on contracts. (1,800,000) 24,700,000 Accr ted s alaries ana wages..... 4,800,000 h 300,000 Other accrued liabilities... 16,800,000 (1,700,000) Cash dividends payable... 1,000,000 1,200,000 U.S. and foreign income taxes. 55,300,000 43,000,000 100,100,000 24.c03,000 Net increase (decrease) in werking capital................ I.2,700,000 $ ( S2,700,00';) See summary of significant accounting policies and notes to consolidated financial statements. 28

THE BABCOCK & WILCOX COMPAtri AND SUBSIDIARY COMPANIES

SUMMARY

OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation: The consolidated financial statements include The Babcock & Wilcox Company and all subsidiary companies including those outside the United States (princi-pally Canada and Germany). Investments in which the Company owns 20% or more, but less than a majority, of voting stock are accounted for under the equity method. In 1976, the Company changed its method of translating the financial statements of its foreign subsidiaries to comply with the requirements of Financial Accounting Standard No. 8, " Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements." This change did not have a material effect on the net income of the Company. Long-term contracts: A significant part of the Company's business is done under contracts re-quiring long periods to perform, in many cases several years. For financial accounting purposes, the Company records sales and cost of sales by the percentage of completion method related principally to physical shipments, direct labor or cost incurred, as applicable to the product or the activity involved. Sales so recorded are carried in unbilled sales until invoiced to customers under terms of the contracts. The costs recorded on uncompleted individual long-term contracts within each fiscal period are based upon estimates to complete. Under certain contracts, sales p-ices are subject to adjustment, primarily related to escalation. Contract price and cost estimates are reviewed periodically as the work progresses and adjustments proportionate to the percentage of completion are reflected in the period when such estimates are revised. Under the foregoing accounting for long-term contracts, inventories are stated at accumulated production costs less estimated cost of sales. Production costs include raw materials, direct labor, manufacturing overhead and contract engineer-ing. The amount at which such inventories are carried does not exceed realizable value. In conformance with industry practice, inventories include mncunts realizable after one year. Progress payments applicable to inventories are deducted for balance sheet presentution. Other inventories: Inventories are siated at the lower of cost or market. Cost is determined on the average basis for raw materials and supplies and accumulated production costs for work in process and finished products. Warranty expense: The Company provides, as sales are recorded, for estimated future expenditures which may be required to satisfy warranties. 29

TIIE BABC0CK & WILCOX CO'FAITY AIID SUBSIDIARY COIFANIES SU?&ARY OF SIGIiTFICAIIT ACCOUFTIIIG POLICIES (CO:ITINUED) Depreciation: For financial accounting purpoces, depreciation is computed on the straight-line method, ucing estimated useful lives cf 10 to 40 years for buildings and 3 to 20 yearc for machinery and equipment. Income taxen-The Company provides in its income tax provicion for the timing differences between financial and tax reporting. These relate principally to the use for tax purposes of the completed contract method for long-term contractc, and to a leccer degree, accelerated depreciation and to warranty expences which are not deductible for income tax purpoces until incurred. Investment tax credits are recognized fully as reductionc of tax provisions under the flow-through method. Research and development: The coct of research and development which is not performed on specific contractc is charged againct operations as incurred. Pension planc: The Company has several non-contributory pension plans covering cubstantially all employees. Effective January 1,1976, the method for funding and determining pension cocts was changed to the accrued benefit method with projected final com-pencation. Prior to 1976, funding and pension costs were determinul for some planc under the attained age method and for other plans under the entry age me th od. Prior service costs are amortized over a period not to exceed 40 years. Earnings per share: Earnings per chare are computed on a weighted eterage of shares outstanding during the year which do not include shares held in treasury. Shares under optionc outstanding are not used in determining earnings per share since they have no material dilutive effect. 30

THE BABCOC7 < WILCOX Crf7r, Ann gr331pIAny c,3"'r;Iyg h0TES TD CO: GOLIDATFE FINANCIAL CT/ME;TC Note 1. Included in concolidated accounte receivable are amcunte representing hilled retainages on long-term contractc which are collectible upon acceptance by the cuctomer, as follows: 1977 1976 Retainagec.. $ 19,100,000 $ 8,200,000 Retainagec expected to be collected after $_j,100,000 [ 2.800,000 one year... Unbilled calec include amounts expected to be collected af ter ene year - $40,400,000 at recember 31, 1977 and $33,400,000 at December 31, 1976. Hote 2. The consolidated inventories at December 31 are summariced belcw: 1977 1976 Raw materiale and cupplies... $141,700,000 $146,100,000 Work in procecc.. 217,600,000 251,500,000 einiched products.... 40,000,000 41.000,000 400,300,000 43o,000,000 Lecc: Progrecc paymenta..... 121,200,000 128,000,000 $267.100,000 $310,600,000_ Inventoriec relating to long-term contracts included in the above...................... jlo3,700 000 $118,900,000 t Inventories at the beginniN of each year.... flg, 00,000 (M7,700,ooo Note 3 Conco11 dated property, plant and equipment at recember 31 are summarized below: 1977 1976 Land.............. $ 8,600,000 $ 8,700,000 Buildings.... 168,300,000 162,500,000 Machinery and equipment...................... 515,900,000 471,100,000 Construction in progress. 27.300,000 26,000,000 720,100,000 6bd.300,000 Lecc: Accumulated depreciation.. 340,200,000 309,100,000 1379.000,000 4359,200,000 Rental expence and lence commitments are not material. 31

THE BABCOCK & WILCOX COMPAirl AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTIITJED) Note 4. Consolidated obligations at December 31 consisted of the following: 1977 1976 Current: Bank borrowings, at various rates........... $ 26,500,000 $ 2,800,000 Other, including current portion of long-term debt................................. 7,300,000 5,400,000 33,600,000 8,200,000 Noncurrent: 9% Promissory Notes, payable in annual installments of $3,300,000 beginning October 1, 1977........................... 43,400,000 46,700,000 9% Guaranteed Notes, payable in annual installments of $1,650,000 beginning December 1, 1982.......................... 25,000,000 25,000,000 Rental obligations relating to secured industrial revenue mortgage for pollution control equipment - 41/2% with interest adjustments related to the prime rate; payable in installments through 1983...... 6,300,000 7,400,000 81/2% Notes, payable in annual installments of $3,960,000 beginning January 1, 1983... 60,000,000 other....................................... 12,700,000 13,800,000 147,400,000 92,900,000 $161,200,000 $101,100,000 The weighted average short-term borrowings outstanding during 1977 were $15,700,000 (1976-$29,700,000) at a weighted average interest rate of 5.5% (1976-9.0s). The highest short-term borrowings for any month-end during 1977 were $40,600,000 (1976-$37,000,000). During 1976, the Company repaid its outstanding term loan of $100,000,000 and cancelled a related revolving credit agreement. In December 1976, the Company converted borrowings on certain bank lines of credit for its Canadian subsidiary Babcock & Wilcox Canada Ltd. to a $25,000,000 note agreement payable in annual installments of $1,650,000 beginning December 1, 1982. In January 1977, the Company issued $60.000,000 in aggregate principal amount of 81/2% Notes due January 1,1997, to various lenders. Payments will be made in annual installments of $3,960,000 beginning January 1,1983 Payments due during the succeeding five years on noncurrent indebtedness and the current portion thereof are as follows: $7,300,000 in 1978; $7,400,000 in 1979; $6,600,000 in 1980; $6,400,000 in 1981 and $7,800,000 in 1982. The Company had unused lines of credit at December 31, 1977 and 1976 of $207,700,000 and $215,800,000, respectively. 32

THE BABCOCK & '4ILCoX Co??ANY AND SUBSIDIARY CC??ANIES NOTES To CCNSoLIDATED FINANCIAL STATELENTS (CONTINUED) "ote 4. (continued) Certain of the agreements contain, among other thinge, requirements as to consolidated capitalization, ac defined, and dividend declarations. At December 31, 1977 and 1976, all such requiremente have been met. Under the most rectrictive dividend provision, unrestricted retained earnings at December 31, 1977 and 1976 were $106,500,000 and $90,900,000, respectively. Note 5. The stockholders on April 26, 1972 approved a stock option plan for key employees of the Company and its subsidiaries, who have not attained the age of 60 at the time of grant. A total of 500,000 shares of either authorized but uniscued or previously issued and reacquired shares of common otock may be uced for optionc granted under this plan. The plan covers both options qualified under Section 422 of the Internal Revenue Code and non-qualified options. options are granted at an option price, equal to at least 100,$ of the fai market value on the date of the grant (adjusted to october 31, 1974 closing w ice for options issued prior to that date). No options were granted in 1977 or.n 1976. Qualified and non-qualified options shall expire not more than five years and ten years, respectively, after the date of grant. options are exercisable one year after the date of grant in installments determined by the Board of Directors. Shares not purchased on the inctallment date may be purchased at any time prior to final expiration of the option. During 1977 and 1976 options lapsed in the amounta of 5,275 and 5,525, respectively. Market Value at dates of Grant, Exercisability Number of option Price or Exercise Shares Per Share Total Per Share Total options outstanding At December 31, 1977.... 277,391 $13-20 $4,800,000 $13-20 $4,800,000 At December 31, 1976.... 401,767 13-20 6,800,000 13-20 6,800,000 options which became exercisable: 1977................... 99,367 $13-20 $1,700,000 $35-58 $4,900,000 1976.................... 113,019 13-20 1,900,000 23-35 3,300,000 options exercised: 1977.................... 119,101 $13-20 $1,800,000 $30-61 $6,100,000 1976.................... 40,783 14-20 600,000 20-37 1,200,000 of the total option price, $2,900,000 was credited to treasury stock in 1977 (1976-$1,000,000); and, net of the tax benefit credited thereto, a credit was made to capital surplus of $1,000,000 in 1977 (1976-a charge of $100,000). 33

EE BABCOCK & WILCOX COMPANY AND SUBSIDIARY CCMPANIES NOTES To CONSOLIDATED FINANCIAL STATE'ENTS (CONTINUED) Note 5. (continued) At December 31,1977 and 1976 options exercisable amounted to 133,941 and 153,825, respectively. Ihere were 51,475 and 46,200 shares available for grant of options at December 31,1977 and 1976, respectively. On April 27, 1977, the stockholders approved a stock option and stock appre-ciation rights plan for key employees of the Company and its subsidiaries. A total of 700,000 shares of either authorized but unissued or previously issued and reacquired shares of common stock may be used for options granted under this plan. options granted under this plan will be non-qualified stock options. options may be granted at an option price equal to at least 100% of the fair market value of the common stock on the date the option is granted. Stock appre-ciation rights may be granted in connection with the grant of options under the 1977 Plan, either at the time the option is granted or subsequently while the option is outstanding. A stock appreciation right entitles the optionee to surrender to the Company unexercised the related stock option and to receive from the Company in exchange therefor an amount equal to the excess of the fair market value of the Company's common chares over the option price per share times the number of shares covered by the stock option surrendered. Payment may be made in shares of the Company's common shares valued at fair market value or in cash or in a combination of cash and stock. Each stock option shall expire no later than lo years from the date of grant. options are exercisable one year after the date of grant in installments determined by the Board of Directors. Shares not purchased on the installment date may be purchased any time prior to final expiration of the option. No stock options or stock appreciation rights have been granted under this plan. Note 6. Total pension expense charged to income was $36,500,000 in 1977 and $33,400,000 in 1976. Based upon the latest actuarial valuation, unfunded prior service costs at December 31, 1977 were approximately $218,500,000 (1976- $205,600,000). The actuarially canputed value of vested benefits for all plans as of December 31, 1977 exceeded the total of the pension funds and balance sheet accruals by approximately $78,900,000 (1976-$45,700,000). Effective January 1,1976, the Company changed the actuarial cost method it uses for determining pension costs for all its major plans to the accrued benefit cost method with projected final compensation. Previously the Company used the attained age method for some plans and the entry age method for other plans. In addition to conforming the actuarial method for all of the Company's major plans to a single actuarial method, the change was made to better relate pension costs to the period the benefits are earned by the participants and to be on a more comparable basis with other industrial companies. This change had the effect in 1976 of reducing pensi on expense by approximately $3,500,000 and increasing net income by approximately $1,800,000 or $.15 per share. In addition, the change to the accrued benefit cost method reduced unfunded prior service cost by approxi-mately $19.300.000. 34

THE BABCOCK "c WILCOX CCWANY A?;D SUBSIDI A C T Ai!IES NOTEE TO CONSOLIDATED FIHANCIAL STATF'E c (CC"TIITED) Note 6. (continued) During 1976, the Company made modificationc to its pencion planc in order to comply with the provicions of the Employee Retirement Income Security Act of 1974 (ERISA). Thece modifications are principally related to the vesting and funding schedules. The effect of these itemc did not have a material effect on net income. Note 7. As a result of the tax timing differences referred to under accounting policies, the Company for Federal income tax reporting has tax loss carry-forwards which together with unused foreign tax credits and unuced investment tax credits, are available to be applied againct future taxable income or taxec payable over the next two to ceven tax years. The deferred tax provision relates for the most part to allowed tining differ-ences arising from the reporting of income from long-term contracts of $57,800,000 in 1977 and $35,200,000 in 1976. The use of accelerated depreciation increaced the 1977 deferred tax provision by $4,300,000 but was not cignificant in 1976. Specified timing differences related to warranty expence, which were not significant in 1977, decreased the 1976 deferred tax provi cion by $3,900,000. Other net timing di fferences decreased the 1977 deferred tax provision by $2,900,000 and increased the 1976 provision by $12,000,000. The 1977 income tax provision is net or $4,200,000 ($6,000,000 in 1976) investment tax credits. The 1977 income tax provicion includes foreign taxes of $2,700,000 ($2,600,000 in 1976). The effective rate of the provision for income t1xes, ac chown in the concol-idated statement of income was 2.5% more th1n the statutory rate in 1977 and 1.1% less than the statutory rate in 1976. These differences are due to the following: 1977 1976 Statutory tax rate.... hS.01 48.0$ Investment tax credits.................................. (3.h) (6.8) Effect on the composite tax rate on the operations of cubsidiaries and affiliates not cubject to the U.S. statutory rate...... 5.1 7.h All other... 0.8 (1.7) E f fec tive tax rate........ 50.5f 46.95 Note 8. The Company is engaged in the design, manufacture and cales of products which are classified into the following industry segments: steam generating and associated equipment, tubular products, refractory products, automated machines and machine tools and control valves. Recently, the Company has also formed a unit to manufacture advanced composite materials for industrial use. This unit is essentially in the development stage. The principal segments of the Company are steam generating and associated equipment and tubular products. The following table presents certa n financial 35

' DIE BABCOCK & WILCOX COMPANY AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINtJED) Note 8. (continued) operating data for these segments while refractory products, automated machines and machine tools, control valves and advanced composite materials are grouped in other products. A detailed description of the products included in each of the industry segments follows the table. Transfers between segments included in inter-segment sales are priced in a manner comparable to products sold to unaffiliated customers. Sales to domestic government agencies, including sales to government owned utilities, amounted to $ 331,400,000 in 1977. These sales were primarily shipments of steam generating and associated equipment products. Certain information for the Company's industry segments for the year ended December 31, 1977 follows : (In Thousands) Steam Adjustments Generating Tubular Other and Equipment Products Products Eliminations Consolidated Sales to unaffiliated customers............... $1,434,500 $319,200 $123,500 $1,877,200 Intersegment sales........ 1,500 74,300 14,900 (90,700) Total revenue.......... 1,436,000 393,500 130,400 (90,700) 1,877,200 Costs and operating expenses................ 1,322,200 359,200 130,800 (97,600) 1,714,600 Allocated general corporate expenses................ 17,100 6,300 2,000 25,400 1,339,300 365,500 132,600 (97,600) 1,740,000 Income from operations.... T 96,700 $ 28,000 $ 5,600 $ 6,900 (1) $ 137,200 '~"" ~~ Identifiable assets at December 31, 1977....... $ 655,800 $348,700 $140.200 (600) 81,144,100 Corporate assets (2)....... 3 165,600 Total assets at December 31, 1977.... 31,309.700 Additions to PP&E( 3)...... 40,500 $ 14,300 $ 6,800 3 61,600 Corporate additions to PPLE( 3 )................. 100 Total additions to PP &E ( 3 )............. 61,700 Depreciation.............. 23,300 $ 9,900 $ 3,700 36,905 Corporate depreciation.... 100 Total depreciation. 37,000 NOTE: (1) Primarily attributable to share of other joint venturer in losses of Babcock-Brown Boveri Reaktor, GmbH. (BBR). (2) Corporate assets are principally cash and marketable securities. (3) Property, plant and equipment 36

THE BABCOCK & WILCOX COMPANY AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATE?ENTS (CONTINUED) Note 8. (continued) Steam generating equipment includes individually engineered complete fossil fuel boilern, nuclear steam systems, and nuclear fuel and nuclear fuel assemblies for electric utility and marine applications as well as fossil fuel boilers for industrial processes and power generation. Steam generating equipment also includes specially engineered accessories and components, such as air heaters, fans, precipitators, cleaning systems for heat transfer surfaces, nuclear reactor components, control and performance computers, automatic controls and instruments and nuclear control-red drives. Associated equipment includes individually engineered recovery processes and pollution control systems for the process and utility industries, tubular hoods for basic oxygen and electric furnaces, heavy pressure vessels and heat exchangers, hollow forgings for steam piping and other uses and reflective metallic thermal insulation. In addition to designing and manufacturing the foregoing steam generating and associated equipment, the Company through a separate construction unit also is engaged in the erection of certain of this and other equipment. Tubular products include stainlass, alloy and carbon steel, ceamless and welded tubes and pipe, tubular and colid shapes, extrusions, special metal tubes, welding fittings and flanges, and seamless rolled rings. These are principally " specialty" products of high quality and engineered for special applications. Material amounts of tubes are manufactured by the Company to satisfy its own requirements as well as those of other manufacturers of steam generating equip-ment; however, the major portion of the Company's tubes are sold to others for use in the bearing industry, the petroleum industry, the machinery industry, the primary metal industry, the fabricated metal industry and the construction industry. Refractory products include kaolin clays, specially engineered and vacuum formed ceramic fibers, insulating and specialty firebrick, plastics, mortars, castables and special oxide refractories. These refractories are used in high temperature furnaces for various heating and heat treating purposes and in other applications where the temperatures and rates of combustion or chetical reactions are unusually demanding. Automated machines and machine tools include individually engineered transfer or multi-station machines for production lines, precision boring machines, broaching machines and broaches, large grinders, cutting tools, hydraulic accessories, production tracer lathes and numerical control machines. This equipmant is sold to manufacturers in various industries for use in their manufacturing processes and in the products manufactured by them. Control valves employ the Self-DRAG S concept and include manual and automatic control valves, regulators and other valves for the problem valve market. Problem valve applications occur where conventional products enecunter performance problems such as noise, cavitation, destructive vibration and other conditions due to high fluid velocity and mass flow rates. 37

THE BABCOCK & WILCOX COMPANY AND SUBSIDIARY COMPAITIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 8. (continued) The Company has foreign operations which are primarily engaged in the production of steam generating and associated equipment. Transfers between geographical areas are primarily sales of steam generating and associated equip-ment products from United States based operations to foreign subsidiaries and are priced in a manner comparable to products sold to unaffiliated customers. The following table presents certain financial operating data for the Company's foreign and United States operations. Year Ended December 31, 1977 (In Thourands) Adj us tments A dju.s tments and United and Canads try Other Eliminations Fcreirn States Eliminations Consclidated unarfil!ated customers. $157,300 $ 57,100 $12,100 $226,500 $1,650,700 $ $1,877,200 ,ransfers between t rieographicsl arens ?.h00 1,000 (600) 2,800 37,900 (W;,700) Total. . $159,700 $ 57,100 $13,lon $(600) Incccie (loss) from $229,300 $1,6%,400 $(36,700 ) $1,877,P00 Identifiable assets {(11,500){ 1h3,k00 $ 5,700(1) $ 117,200 operations. { 7,300 $(20 g ) $ 1,I00 at recember 31, $ P?,100 Myl0] % 33 }{lg {l01.{0_0 $1,Chs, LOO {Qlfog $1,144,100 1977. Corparate assets (J) 165,600 Total assets at recemter 31, 1977.. $1,309,700 Note: (1) Primarily attributable to shsre of other joint venturer in Icsses cf BBR. (2) Corporate assets are princi;911y cash and marketable securities. 38

'IHE BABC0CK & WILCOX COMPANY AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 9. Starting in mid-1974, principally, as a result of utility financing problems related to general economic conditions, and to regulatory restraints on compen-sating rate increases and licensing approvals, and certain other causes of construction delays, numerous utilities deferred and in some instances cancelled plans for constructing nuclear and fossil power generating plants. As to each deferment or cancellation, the Company is entitled to a financial settlement related to the individual circumstances of the contract. Twelve of the Company's units on order have been cancelled from 1974 to date, and it is the expectation of management that the utilities will proceed with most of the deferred plants. Note 10. The Company has provided when determinable for actions required to alleviate delays and the effects of delays in carrying out some long-term nuclear contracts. Costs and expenses not provided for, including claims, may result from delays but management does not expect the amounts, if any, will be material. During 1971, the Company entered the nuclear market in Germany with the formation of a joint venture company, Babcock-Brown Boveri Reaktor, GmbH(BBR). In 1972 BER received an order for a 1300Mw system for the Mulheim-Ksrlich plant of Rheinisch-WestfElisches Elektrizitstswerk (AG) of Essen. Since 1972, the esticated direct costs to complete this contract have increased substantially. These increases are attributable, in part, to major changes in licensing requirements which have been adopted in West Germany since BBR received the contract. BBR is entitled to recover some of these costs and is actively pursuing its claims. Substantial losses have been recorded through December 31, 1977. The Company's share of BBR's net loss (including foreign exchange translation losses) was $17,800,000 and $20,300,000 for the years ended December 31, 1977 and 1976, respectively. The accompanying financial statements assume the completion of arrangements with respect to BBR which would limit the liabilities (other than contingent liabilities) of the Company attributable to BER to amounts which do not exceed those recorded in the accounts. These arrangements have been approved by the managements and the Boards of Directors of the Company, Brown Boveri of Switzerland and Brown Boveri of Germany, the joint owner. Formal agreements reflecting these arrangements are currently being prepared. Note 11. The Company performs significant amounts of work for the government under both prime contracts and subcontracts and thus is subject to continuing reviews by governmental agencies. 39

1EE BABCOCK & WILCOX COMPANY AID SUBSIDIARY COMPANIES NOTES TO CO?ISOLIDATED FINANCIAL STATEMFUTS (CONTIITUED) Note 12. The Company has entered into an Agreement and Plan of Reorganization providing for the merger of The Babcock & Wilcox Company into a wholly-owned subsidiary of J. Ray McDermott Co., Inc. ("McDermott") pursuant to which each outstanding share of common stock (par value $4.50) of the Company (other than shares owned by McDermott) will be converted into one share of Series A $2.20 Cumulative Convert-ible Preferred Stock and one share of Series B $2.60 Cumulative Preferred Stock of McDermott. Shareholders of the Company and McDermott will vote on the merger at special meetings to be held on March 30, 1978. Note 13. (Unaudited) Sum arized quarterly financial data follows: Table In Thou.cands (Except Ter Ehare Amounts) 1977 1976 Three months ended Three months ended March 31 June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 Dec. 31 sales. $k32.200 $b73,700 $434,100 $537,200 $k23,800 $ kh 3,600 $375,900 $LL8,500 costs and expenses: Costs and cperating expenses (excluding depreciation)........ 359,500 396,600 365,300 454,700 355,100 375,k00 317,500 395,000 Research and development 6,500 6,900 6,600 6,400 6,000 6,800 6,600 8,000 expenses.. Selling, general and administrative expenses 22,300 24,800 25,400 28,000 18,100 18,To 21,500 18,900 Depreciation of plant and equipirent. 8,00 9,000 9,200 9,900 8,100 8,200 8,200 8,100 377,200 437,300 400,500 4H.ovo 3c7,3co 909,300 353,000 u a.oco Incme frcan operations... $ 35,000 $ 36,400 $ 27,600 $ 38,200 $2 6,53 $ 3h,300 , 22,100 s 18,500 { y, -{TT T/- @ D s,300 $ 15 900 Q5900 l4 900 I(700 Net ine m e...... s 9,600 10,500 1 2 f +.T

41. 9 7T.T u.%

4.cl 4 65 Net inccce per share.... In the fourth quarter of 1976 the Cmpany changed the actuarial cost method used in determining pension costs (see Note 6). This change was made retroactive to January 1,1976 and had the effect of increasing the previously reported ineme from operations, net income and net income per share for each of the first three quarters of 1976 (all of which have been restated) by approximately $875,000, $455,000 and $.04, respectively. The effect of the change in 1976 cperations for the full year was to increase income frm operations, net ine se and net income per share by approximately $3,500,000, $1,820,000 and $.15, respectively. 40

THE BABCOCK & WILCOX COMPANY AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 14. (Unaudited) The replacement cost information in this footnote is supplied exclusively for compliance with Rule 3-17 of Securities and Exchange Commission (SEC) Regulation S-X. In adopting this rule, the SEC expressed its intent ".....to enable investors to obtain more relevant information about the current economics of a business enterprise in an inflationary economy...." While the intent has merit, particularly with respect to increasing the awareness of the impact of inflation upon earnings, taxes and capital formation, the concept of replacement cost accounting is subject to inherent weaknesses and theoretical problems in addition to complexities and lack of uniform methodology which preclude making comparisons between companies and industries. It does not measure the effect of price changes on assets and liabilities other than produc-tive capacity and inventories, or take into consideration the availability of capital or its cost in replacing those assets restated. Furthermore, the devel-opment of related savings from replacement of plant and equipment requires engineering judgments which are extremely difficult to quantify. For these reasons, replacement cost information should not be construed as showing the impact of inflation on the earnings of the Company. Also, the replacement cost data presented herein should not be interpreted as representing the current economic or disposal values of those assets presently in place. In addition, the Securities and Exchange Commission recognized that it was requiring c ompanies "... to make disclosures of costs which cannot be calculated with precision", and "... cautions investors and analysts against simplistic use of the data presented", and the Commission ".... intentionally determined not to require the disclosure of the effect on net income of calculating cost of sales and depreciation on a current replacement cost basis...because it did not believe that users should be encouraged to convert the data into a single revised net income figure." The Company's cost estimates for property, plant and equipment and inven-tories assumes replacement in the manner in which the Company would expect to replace these assets based upon the information which was obtainable on a practical basis at the date of valuation. Current capacity, utilizing the latest available technology, has been assumed. The cost of complying with known en-vironmental requirements has been included in these estimates, although the cost of complying with specific requirements cannot be isolated. These assumptions have been made without regard to the availability or cost of capital required for replacement. It is emphasized that asset replacement decisions will be made gradually in the future based upon detailed analyses of the technology, market conditions, availability of capital, the return on investment and other factors existing at hl

THE BABC0CK & WILCOX COMPANY AND SUBSIDIARY COMPANIES NOTES 'IO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 14. (Unaudited) - (continued) the time of replacement and not based upon the concept of replacing all assets at a single point in time without consideration of the multitude of factors required for intelligent investment decisions. Therefore, it is important that the user of this replacement cost data be aware that it is not necessarily indicative of the costs that will actually be incurred at the time of replacement or the manner in which assets will actually be replaced in the future. In conformance with SEC instructions, replacement costs are not presented for land, for additions and improvements in progress which are not productive capac-ity at December 31,1977 ar.d 1976 or for assets located outside of " North America and the European Economic Community" countries at December 31, 1976. Similarly, equipment which would not be replaced at December 31, 1977 rnd 1976 is not revalued as it is not considered part of the Company's productive capacity for this purpose. Replacement cost amounts related to foreign assets have been translated into U.S. dollars using year-end rates of exchange. Replacement cost enounts related to foreign costs and operating expenses and depreciation expense have been translated using average annual rates of exchange. Replacement costs for buildings generally were derived by applying an estimated current cost per square foot based upon published construction cost data adjusted as necessary by experience from recent construction activity within the C ompany. Exceptions to this approach were made for specially constructed buildings for which general construction cost information was not deemed to be appropriate. Replacement cost for these specially constructed buildings or special components, thereof, were derived generally by engineering estimates. Replacement costs for machinery and equipment were estimated on the basis of quoted market prices, recent purchase experience, engineering estimates or historical cost adjusted for published price indices as considered appropriate in the circumstances. Replacement cost depreciation expense has been based on the average of the estimated replacement cost of productive capacity for the year, computed on a straight-line basis, utilizing the same depreciable life as is current policy for the applicable assets for purposes of historical cost financial statements. As is the case with 31storical cost amounts, the replacement cost of fully depreciated assets which are still in use are reflected in both the gross asset and accumu-lated depreciation categories at the full replacement cost of such assets. Neither historical nor replacement cost depreciation expense has been calculated for these assets due to difficulty in estirnting their remaining economic lives. However, the amount of depreciation which would have been accrued if it were estimated on the basis of current replacement cost and current estimates of their economic life would be significant. 42

'IHE BABCCG & '<TILCOX CCTA!!Y A!ID SUBSIDIARY CC!SAITIES ? 0TES TO CGI!SOLIDATED FIIIA!!CIAL STATE?ENTS (CO::TI!!UED) IIote 11+. (Unaudited) - (centinued) Inventory replacement costs have been based upon estimates of the current costs of the cpplicable material, labor and overhead at December 31,1977 and 1976. Replacement costs for cost of sales have been based upon estimates of the average current costs for these elements for the year then ended. Such estimates have been made using sources such as vendor quotations, catalog prices, recent acquisition experience, price indices and cost analyses. A substantial portion of the Company's business relates to work done under cWracts for products designed to the unique specificationa of the customer and generally requiring long periods to perform. "aterials are generally purchased for such individual contracts and the inventories identified with them will never be replaced as such. Accordingly, replacement costs have not been provided for these inventories or the resultant cost of sales attributable to these contracts. Replacement cost estimates with comparative historical amounts are as follows: " R/ ' ' CE 4 W!T X C.M A ?: ' A'F ~ ?^!!IM Y "NA?i!F3 ME' 7 ' TOLITAUD Fi?;A';?I AL 03FEUS (C' wit ) ,'te 14 (Sa vi!ted) - ( cent irdedl At Teraeer 11 1#7 1 4 =*imated t r*. i ma ted Fisto*1 cal Ferlacerant Hist:riesl Fepiscerent 's

• F ~s t

'w* C: st Tfn Milli;ns) Pr7erty, plant sr.1 aquiren* T r%! 2c t h e esisc'+ f:r which rapisce~. ant c N* dsta are provid.1 $ // 2 $ 1,'11 $ /.1g $1,543 Accmis'ed depraat ati on (7d (1,0"r) (~n) (aka) f roductive cepsc' ty which w?21d r.ct be repiscei 15 13 F roducti ve espeel+y located out-sida ! or+h Ameries and +he Eurcreen can ric C rmunity 1 Csnstrt :t i:.n in prcgress 2" 3 Accumuisted depreciatien (10) /IM 271 35' Land 9 a L'e t pr pert, plan * *M equipen / as sh wn in the Acc rpsnying Ccnsclidated talsn-e rtacts $1% $ 19 w-- sn Inven* cries: FC-which replace 9*r.t cast dsts are previded gy, $ ya $ 237 g ch, er,--. -m F?r tinding ontrsets fer prcriucts bui.*+7 cust_rer specificati ms m 70 Lacsted m2tside '; orth Ameries ud the F,2rrpeen Fc a mic Cc e nity ? Totsl inventeries as shewn in the acccepsnying C'nsallisted balance sheets [r?7 $ 111 !+ 3

THE BABCOCK & WILCOX COWAIiY AND SUBSIDIARY COMPAITIES IiOTES TO COIISOLIDATED FIIIAIICIAL STATEMENTS (CONTIITUED) Note 14. (Unaudited) - (continued) For the Year Ended December 31 1977 1976 Estimated Estimated Historical Replacement Historical Replacement Cost Cost Cost Cost (In Millions) Depreciation expense: Applicable to productive capacity for which the replacement cost has been provided 35 $ 64 32 $ 57 Applicable to productive capacity which would not be replaced 2 1 Total depreciation expense as shown in the accompanying Consolidated statement of income and retained earnings 37 33 Costs and operating expenses (excluding depreciation): For which replacement cost data are provided $ 482 $490 $ 434 $440 For work done under binding contracts for products built to customer specifications 1,094 1,007 For operations outside North America and the European Economic Community 2 Total costs and expenses as shown in the accompanying Consolidated statement of income and retained earnings $1,576 $1,443 Rule 3-17 does not require consideration of the effects of inflation and other economic factors on assets and liabilities other than inventories and productive capacity, Accordingly, the Company has not attempted to quantify the total impact of these factors on its business. The replacement costs shown above do not reflect any of the operating cost savings which would be realized if actual replacement of existing assets were made. The savings would result as a consequence of such factors as increased productivity, lower energy costs and reduced repairs and maintenance. Although 44

'IHE BABCOCK & WILCOX Cot /PAffl AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 14. (Unaudited) - (continued) thece cavings cannot be precisely estimated, in many cases these benefits, over the life of an asset, may more than offset its increased cost. Purther, the above replacement cost information does not recognize the customary relcbionships between cost changes and changes in celling prices. The Company has also been able to mitigate the effectc of increased costs through in-creaced prices. A cubctantial portion of the Company's business relates to work done under contracts requiring long periods to perform. These contracts are individually negotiated as to price and generally contain escalation provisions which protect the Company against the effects of increasing costs. C ost increases affecting the Company's other business have also generally been allevi-ated by increaced selling prices, however, the extent to which this price relief is obtainable in dependcnt upon the market conditions existing at the time of shipment. Although the above replacement cost information has been developed to the best of the Company's ability, it is management's opinion that this infonnation ic of little use to it in making investment decisions. Management decisions on fixed asset replacement are based on an analysis of investment and replacement alternatives which reflect an adequate return to the Company. These evaluation techniques explicitly consider the cost and availability of capital and pro-jections of cash flows where applicable. Practicality, as well as the require-ments of Rule 3-17, prohibits cuch analyses from being made for this replacement cost determination exercise. Accordingly, the user of replacement cost data is again cautioned as to its limitations. This replacement coct information demonctrates that the cost of replacing present productive capacity at current prices is substantially higher than its carrying value. In most cases, ir replacement did occur using current technology, there would be increased productivity and significant cost benefits. The results of thic exercise also show that significant capital formation will be required just to maintain the current level of productive capacity. The needed invest-ments will not be made, however, unless an adequate return can be demonstrated. It is imperative that an appropriate framework and atmosphere be created that will encourage investment in productive assetc through a proper understanding of the role of profits and by tax policies that will increase the formation of capital. 45

2[E BABCOCK & WILCCX CC?GLf A?;D CUB 3IDIARY CC?TA!!IE3 CCHEIULE V - FRCFERTY, FLANT A'!D EQUIF?E';T FCR 2fE YEARS E!cED LECE!GER 31, 1977 A?;D 1976 Additions and capital-izations cf Balance at construction Balance at beginnirs; in progress Other changes end cf Clas si ficati en of period at cost Fetirements add (deduct) peri cxi Year ended Lece=ber ll,1977: Land $ 8,700,000 $ 100,000 $ $ 8,600,000 Buildings 162,500,000 7,100,000 1,500,000 200,000(1) 168,300,000 Machinery and equipment 471,100,000 43,900,000 8,000,000 9,100,000(1) 515,900,000 Construction in progress 06,000,000 1,400,000 100,000 27,300,000 Total $668,?00,000.$ 5?, LOO,000 L9200,000, $9,300 g 17?o,100,000 Year ended Lecember 31, 1976: Land $ 8,200,000 $ 500,000 $ $ 8,700,000 Buildings 158,400,000 4,300,000 200,000 162,500,000 Machinery and equip:ent 404,100,000 76,000,000 11,000,000 471,100,000 Construction in prcgress L5,000,000 (18,800,000) 200,000 26,000,000 Total $617,700,000 $62,000,000 $11,400,000 $ $668,300,000 NOTE: (1) Leases capitalized. 46

THE BABCOCK & WIlfCX CCtEANY AND OUBSIDIARY CofEANIES SCHErfJLE VI - ACCUMJIATED LEPRECIATICN, DEPLETICN AND AMORTIZATIGN CF FEOPERTY, PIANT AND EQUIP'ENT FCR THE YEARS ENLED DECE!GER 31, 1977 AND 1976 Additions Balance at charEeG to Balance at beginning costs and Cther changes end of rescription of period expenses Fetirements add (deduct) period Year ended December 31, 1977: Land 300,000 $ 300,J00 Buildings 67,200,000 4,500,000 1,400,000 70,300,000 Machinery and equipment ?!.1,600,000 32,500,000 6,800,000 2,300,000(1) 269,600,000 QP00o00 $P,300,000 $_340,200,000 Total $309,13000 $37,000,000 g Year ended December 31, 1976: Land 300,000 $ 300,000 &a11 dings 62,700,000 h,600,000 100,000 67,200,000 Machinery and equipment ???,500,000 28,000,000 8,900,'00 241,600,000 Total M5,500,000 $12 400 g $ h0 A003 $ p309,100,000 NOTE: (1) Accumulated depreciation throu6h December 31, 1976 on leases capitalized. 47

"JIE BABCOCK & WILCCX CPTANY AfD S'JBSIDIARY CCFSANIES CCHEDULE XII - VAII'ATICN AfD QUALIFYING ACCC11*ITG AND RESERVES FCR TIE YEARS E'.TED DECEEER 31,1977 AND 1976 Additions Balance at charged to Balance at beginning costs and end of of period expenses reductions period Year ended December 31, 1977: Reserves deducted frcra assets: Allowsnce for doubtfal accounts $ 5,000 000 $3,000,000 $ 600,000(1) $ 7,h00,000 1 Feserve for inventories $10,700,000 $3,700,000 $k,800,000(2) $ 9,600,000 Year ended recember 31, 1976: Reserves deducted fran assets: Allowance for doubtful accounts $ h,100,000 $1,000,000 $ 10L g (l) $ 5,000,000 Reserve for inventeries $ 8,000,000 $5,500,0J0 y 0C.00,0(2) $10,700,000, Notes: (1) Write-off cf accounts considered uncollectible, less recoveries. (2) Inventories written-off against reserve. 48

IfE BABOCCK & WILCOX CO?CA?."I AND S'JPSIDIARY CC!EANIEC 00HEDULE XVI - SUPPII?C;TARY I!!0C4G STATE?S?;T I?!?CF?'.AT!CN Charged to costs and expenses Tcr the Calender Yesr Tcem 1 F7 147 > Msintenance and repsirs (f;5,1000] {1gQJ Cg0 t Taxes other than U.S. and foreign income taxes: Payroll taxes $h0,/00,000 $35.500,000 Pesl estate, perscr.81 property and other taxes 10,001,090 10,500,000 Total $51,20,E0 125.eC3jfc Pents $_17.L 00 000A.== = P Iess than II of total sales and revenues. 49}}