<PAGE>
 
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                           Washington, D. C.  20549
                                   FORM 10-K

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

                   For the fiscal year ended March 31, 1998
                                      OR
[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission File Number. 1-4095

                            McDERMOTT INCORPORATED
--------------------------------------------------------------------------------
            (Exact name of registrant as specified in its charter)

            DELAWARE                                   74-1032246
--------------------------------------------------------------------------------
(State or Other Jurisdiction of             (I.R.S. Employer Identification No.)
Incorporation or Organization)

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

       Registrant's Telephone Number, Including Area Code (504) 587-4411
          Securities Registered Pursuant to Section 12(b) of the Act:
                                        
        Title of each class            Name of each Exchange on which registered
        -------------------            -----------------------------------------
Series A $2.20 Cumulative Convertible           New York Stock Exchange
Preferred Stock, $1 Par Value

Series B $2.60 Cumulative Preferred             New York Stock Exchange
Stock, $1 Par Value

       Securities registered pursuant to Section 12(g) of the Act:  None

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

                            YES    [X]       NO    [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this  Form 10-K or any amendment to
this Form 10-K.                                                              [X]

None of the Common Stock, voting or non-voting, of the registrant is held by
non-affiliates of the registrant.

3,000 shares of voting of Common Stock, par value $1 per share, and 600 shares
of non-voting Common Stock, par value $1 per share, were outstanding as of May
14, 1998.

                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Information Statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14C under the Securities and Exchange
Act of 1934 in connection with action to be taken by the Company without a
meeting of stockholders on August 11, 1998 is incorporated by reference into
Part III of this report.
<PAGE>
 
                  M c D E R M O T T  I N C O R P O R A T E D
                          I N D E X - F O R M 10 - K

<TABLE> 
<CAPTION> 
                                                                           PAGE 

                                    PART I
<S>          <C>                                                           <C>
Items 1. &  2. BUSINESS AND PROPERTIES

   A. General                                                                1
   B. Power Generation Systems
         General                                                             4
         Foreign Operations                                                  4
         Raw Materials                                                       5
         Customers and Competition                                           5
         Backlog                                                             5
         Factors Affecting Demand                                            6
   C. Government Operations
         General                                                             7
         Raw Materials                                                       7
         Customers and Competition                                           7
         Backlog                                                             7
         Factors Affecting Demand                                            8
   D. Engineering and Construction Operations
         General                                                             8
         Foreign Operations                                                  8
         Raw Materials                                                       9
         Customers and Competition                                           9
         Backlog                                                             9
         Factors Affecting Demand                                            9
   E. Other Operations
         General                                                            10
         Raw Materials                                                      10
         Customers and Competition                                          10
         Backlog                                                            10
         Factors Affecting Demand                                           11
   F. Patents and Licenses                                                  11
   G. Research and Development Activities                                   11
   H. Insurance                                                             11
   I. Employees                                                             13
   J. Environmental Regulations and Matters                                 13
   K. Transactions with Related Parties                                     15

Item 3. LEGAL PROCEEDINGS                                                   15

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                 17
</TABLE>

                                       i
<PAGE>
 
                        I N D E X  --  F O R M  1 0 - K

<TABLE> 
<CAPTION> 
                                                                           PAGE 

                                    PART II
<S>          <C>                                                           <C>
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND
        RELATED STOCKHOLDER MATTERS                                         18
 
Item 6. SELECTED FINANCIAL DATA                                             19
 
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS
 
        General                                                             20
        Fiscal Year 1998 vs. Fiscal Year 1997                               21
        Fiscal Year 1997 vs. Fiscal Year 1996                               24
        Effects of Inflation and Changing Prices                            26
        Liquidity and Capital Resources                                     26
        Impact of the Year 2000                                             29
        New Accounting Standard                                             30
 
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY
        DATA
 
        Report of Independent Auditors                                      31
        Consolidated Balance Sheet - March 31, 1998 and 1997                32
        Consolidated Statement of Income (Loss) for the Three Fiscal
        Years ended March 31, 1998                                          34
        Consolidated Statement of Stockholder's Equity for the
        Three Fiscal Years ended March 31,1998                              35
        Consolidated Statement of Cash Flows for the Three Fiscal
        Years ended March 31, 1998                                          36
        Notes to Consolidated Financial Statements                          38
 
Item 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON
        ACCOUNTING AND FINANCIAL DISCLOSURE                                 70
</TABLE>

                                       ii
<PAGE>
 
                        I N D E X  -   F O R M  1 0 - K

<TABLE> 
<CAPTION> 
                                                                           PAGE 

                                   PART III
<S>          <C>                                                           <C>

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                 71
 
Item 11. EXECUTIVE COMPENSATION                                             71
 
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
         AND MANAGEMENT                                                     71
 
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                     71
 

                                    PART IV


Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
         ON FORM 8-K                                                       72
 
Signatures                                                                 74
 
Exhibit 21 - SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT                    76
 
Exhibit 23 - CONSENT OF INDEPENDENT AUDITORS                               77
 
Exhibit 27 - FINANCIAL DATA SCHEDULE                                       78
</TABLE>

                                      iii
<PAGE>
 
                                   P A R T  I


ITEMS 1. AND 2. BUSINESS AND PROPERTIES

A.  GENERAL

McDermott Incorporated was incorporated in 1946 as a successor to a business
which had been providing construction services to the oil and gas industry since
the 1920's.  McDermott International, Inc. ("International") is the parent
company of the McDermott group of companies, which includes McDermott
Incorporated and J. Ray McDermott, S.A. ("JRM").  International's Common Stock,
McDermott Incorporated's Series A $2.20 Cumulative Convertible Preferred Stock
and Series B $2.60 Cumulative Preferred Stock and JRM's Common Stock and 9-3/8%
Senior Subordinated Notes due July 2006 are publicly traded.

Unless the context otherwise requires, hereinafter "International" means
McDermott International, Inc., a Panama corporation; "JRM" means J. Ray
McDermott, S.A., a Panama corporation, a majority owned subsidiary of
International, and its consolidated subsidiaries; and "McDermott International"
means the consolidated enterprise.

McDermott Incorporated operates in three business segments:

 .  Power Generation Systems includes the results of the operations of the
   Babcock & Wilcox Power Generation Group, which provide services, equipment
   and systems to generate steam and electric power at energy facilities
   worldwide.

 .  Government Operations includes the results of the operations of BWX
   Technologies, Inc. and B&W Services, Inc., formerly, the Babcock & Wilcox
   Government Group, which supplies nuclear reactor components and nuclear fuel
   assemblies to the U.S. Navy, various other equipment and services to the U.S.
   Government and manages various U.S. Government owned facilities.

 .  Engineering and Construction Operations includes the results of the
   operations of McDermott Engineers & Constructors (Canada) Ltd. which provides
   services including project management, conceptual and process design, front-
   end engineering and design, detailed engineering, procurement, construction
   management and contract maintenance.

Other Operations includes the results of small operations not included above.

The business of the Power Generation Systems and Government Operations segments
are conducted primarily through a subsidiary of McDermott Incorporated, Babcock
& Wilcox Investment Company, the principal subsidiary of which is The Babcock &
Wilcox Company.  Unless the context otherwise requires, hereinafter "B&W" means
Babcock & Wilcox Investment Company and its consolidated subsidiaries, including
The Babcock & Wilcox Company.

                                       1
<PAGE>
 
McDermott Incorporated has a continuing program of reviewing joint venture,
acquisition and disposition opportunities.

The following tables show revenues and operating income (loss) of McDermott
Incorporated for the three fiscal years ended March 31, 1998.  See Note 15 to
the consolidated financial statements for additional information with respect to
McDermott Incorporated's business segments and operations in different
geographic areas.


                                    REVENUES
                             (Dollars in Millions)
<TABLE>
<CAPTION>
                                             FOR FISCAL YEARS ENDED MARCH 31,
                                        1998              1997               1996
                                  ----------------   ---------------   ----------------
<S>                               <C>         <C>    <C>        <C>    <C>         <C>
Power Generation Systems          $1,142.7    62%     $985.1    55%    $1,144.8    57%
Government Operations                370.5    20%      373.1    21%       369.7    18%
Engineering and Construction
 Operations                          198.7    11%      270.0    15%       353.1    17%
Other Operations                     139.7     8%      188.9    10%       184.5     9%
Eliminations                          (8.9)   (1%)     (20.8)   (1%)      (24.1)   (1%)
--------------------------------------------------------------------------------------- 

Total Revenues                    $1,842.7   100%   $1,796.3   100%    $2,028.0   100%
=======================================================================================
</TABLE> 

                                       2
<PAGE>
 
                            OPERATING INCOME (LOSS)
                             (Dollars in Millions)
<TABLE>
<CAPTION>
                                        FOR FISCAL YEARS ENDED MARCH 31,
                                          1998         1997        1996
                                       ----------   ----------   ---------
<S>                                    <C>          <C>          <C>
Segment Operating Income (Loss):
 Power Generation Systems                $  84.5      $ (33.9)     $ 22.2
 Government Operations                      35.8         32.5        25.9
 Engineering and Construction
   Operations                               (0.5)       (13.3)      (19.9)
 Other Operations                            7.1        (16.8)       (8.7)
-------------------------------------------------------------------------- 

   Total                                 $ 126.9      $ (31.5)     $ 19.5
--------------------------------------------------------------------------
 
Gain (Loss) on Asset Disposals
   and Impairments - Net:
 Power Generation Systems                $  (6.1)     $ (18.9)     $  4.3
 Government Operations                        .5           .4          .3
 Engineering and Construction
   Operations                               (8.1)         1.1        (0.3)
 Other Operations                           35.6         (1.4)        3.3
-------------------------------------------------------------------------- 

   Total                                 $  21.9      $ (18.8)     $  7.6
--------------------------------------------------------------------------
 
Income (loss) from Investees:
 Power Generation Systems                $   3.1      $    .6      $ 31.2
 Government Operations                       4.3          3.6         2.3
 Engineering and Construction
   Operations                                 .3         (0.9)         .2
 Other Operations                            1.6          3.7         2.6
--------------------------------------------------------------------------

   Total                                 $   9.3      $   7.0      $ 36.3
--------------------------------------------------------------------------
 
Segment Income (Loss):
 Power Generation Systems                $  81.5      $ (52.2)     $ 57.7
 Government Operations                      40.6         36.5        28.5
 Engineering and Construction
   Operations                               (8.3)       (13.1)      (20.0)
 Other Operations                           44.3        (14.5)       (2.8)
-------------------------------------------------------------------------- 

Total Segment Income (Loss)                158.1        (43.3)       63.4
--------------------------------------------------------------------------

Other Unallocated Items                     (9.1)       (58.3)      (29.4)
General Corporate Expenses - Net           (15.0)       (21.0)      (23.2)
--------------------------------------------------------------------------

Total Operating Income (Loss)            $ 134.0      $(122.6)     $ 10.8
==========================================================================
</TABLE> 

                                       3
<PAGE>
 
B.  POWER GENERATION SYSTEMS

GENERAL
-------

The Power Generation Systems segment supplies engineered-to-order services,
products and systems for energy conversion worldwide, which includes the
manufacturing of heavy pressure equipment, including boilers fueled by coal,
oil, bitumen, natural gas, solid municipal waste, biomass, and other fuels; and
related industrial equipment, such as burners, pulverizer mills, soot blowers
and ash handlers.   The Power Generation Systems segment also fabricates steam
generators for nuclear power plants and designs and supplies environmental
control systems, including both wet and dry scrubbers for flue gas
desulfurization; modules for selective catalytic reduction of the oxides of
nitrogen; and electrostatic precipitators and similar devices.

The Power Generation Systems segment supports operating plants with a wide
variety of services, including the installation of new systems and replacement
parts, engineered upgrades, construction, maintenance, and field technical
services such as condition assessment.  It also provides inventory services to
help customers respond quickly to plant interruptions and to construction crews
to maintain and repair operating equipment. The segment also provides power
through cogeneration, refuse-fueled power plants, and other independent power
producing facilities.  It participates in this market as a contractor for
engineer-procure-construct services, as an equipment supplier, as an operations
and maintenance contractor, and through ownership interests.

The principal manufacturing plants of this segment, which are owned by B&W, are
located at West Point, Mississippi; Paris, Texas; Lancaster, Ohio; and
Cambridge, Ontario, Canada.  After extensive study, B&W has elected to close its
Paris, Texas plant. The closure is expected to be completed by late summer 1998.
This segment also operates independent power facilities located in Ebensburg,
Pennsylvania and Sunnyside, Utah.  All of these plants are well maintained, have
suitable equipment and are of adequate size.

FOREIGN OPERATIONS
------------------

The amounts of Power Generation Systems' revenues, net of intersegment revenues,
and segment income (loss) derived from operations located outside of the United
States, and the approximate percentages to McDermott Incorporated's total
revenues,  follow:
<TABLE>
<CAPTION>
 
                      REVENUES         SEGMENT INCOME (LOSS)
FISCAL YEAR       AMOUNT    PERCENT            AMOUNT

                            (Dollars in Thousands)
<S>              <C>         <C>             <C>
 
      1998       $200,332        11%         $ 23,343
      1997        298,852        17%          (32,022)
      1996        559,549        28%           36,908
</TABLE>

Products for international installation are engineered and built in B&W's United
States and Canadian facilities.

                                       4
<PAGE>
 
RAW MATERIALS
-------------

The principal raw materials used by this segment to construct power generation
systems and equipment consist of carbon and alloy steels in various forms, such
as plates, forgings, structurals, bars, sheets, strips, heavy wall pipes and
tubes.  Significant amounts of components and accessories are also purchased for
assembly into the supplied systems and equipment.  These raw materials and
components generally are purchased as needed for individual contracts. Although
shortages of certain of these raw materials have existed from time to time, no
serious shortage exists at the present time. This segment is not sole source
dependent for any significant raw materials.

CUSTOMERS AND COMPETITION
-------------------------

The principal customers of this segment are the electric power generation
industry (including government-owned utilities and independent power producers);
the pulp and paper industry; process industries such as petrochemical plants,
oil refineries and steel mills; and other steam-using industries and
institutions.  The electric power generation industry accounted for
approximately 47%, 39% and 36% of McDermott Incorporated's total revenues for
fiscal years 1998, 1997 and 1996, respectively.

Customers normally purchase services, equipment or systems from the Power
Generation Systems segment after an extensive evaluation process based on
competitive bids.  Proposals are submitted based on the estimated cost of each
job.

Within the United States, a number of domestic and foreign-based companies
specializing in steam generating systems, equipment and services compete with
the Power Generation Systems segment.  Examples include ABB Asea Brown Boveri,
Ltd., Ahlstrom Corporation, DB Riley, Inc., Foster Wheeler Corporation, Kvaerner
ASA, and other companies.  In international markets, this segment competes
against these companies, plus additional foreign-based companies.  A number of
additional companies compete in environmental control equipment, related
specialized industrial equipment and the independent power producing business.
Other suppliers of steam systems, as well as many other businesses, compete for
replacement parts, repair and alteration, and other services required to backfit
and maintain existing systems.

BACKLOG
-------

Backlog as of March 31, 1998 and 1997 for the Power Generation Systems segment
was $1,071,094,000 and $1,495,787,000, or approximately 50% and 61%,
respectively, of McDermott Incorporated's backlog.  Backlog decreased primarily
as a result of delays and cancellations of power projects in Southeast Asia due
to the current Asian economic crisis and management's focus on higher margin
projects.  Of the March 31, 1998 backlog, management expects that approximately
$704,698,000 will be recognized in revenues in fiscal year 1999, $170,447,000 in
fiscal year 2000 and $195,949,000 thereafter, of which approximately 70% will be
recognized in fiscal years 2001 through 2003.

During fiscal year 1998, the Power Generation Systems segment received contract
awards  valued at $710,732,000.  This included two contracts with a combined
value of $53,000,000 for cyclones (a type of boiler that burns crushed fuel) at
Commonwealth Edison's State Line and Kincaid Stations.  B&W is the only company
to successfully fabricate and put into service

                                       5
<PAGE>
 
these products for utility boilers in the United States. This segment also
received a $35,000,000 contract for the design and manufacture of components for
eight steam generators to be installed at the Qinshan nuclear project in China;
a contract valued at $33,000,000 to upgrade two plants for American Electric
Power;  and a contract valued at $23,300,000 to convert an idle ABB-CE recovery
boiler at Bowater, Inc.'s Calhoun, Tennessee newsprint facility to a bubbling
fluid bed boiler.

If in management's judgment it becomes doubtful whether contracts will proceed,
the backlog is adjusted accordingly.  If contracts are deferred or cancelled,
the Power Generation Systems segment is usually entitled to a financial
settlement related to the individual circumstances of the contract.  Operations
and maintenance contracts, which are performed over an extended period, are
included in backlog based upon an estimate of the revenues from these contracts.

The Power Generation Systems segment attempts to cover increased costs of
anticipated changes in labor, material and service costs of long-term contracts
either through an estimation of such changes, which is reflected in the original
price, or through price escalation clauses.  Most long-term contracts have
provisions for progress payments.

FACTORS AFFECTING DEMAND
------------------------

Electric utilities in parts of Asia and the Middle East are current purchasers
of new baseload generating units and environmental control systems, due to the
growth of their economies and to the small existing stock of electrical
generating capacity in most developing countries.  The currency crisis, which
began in Southeast Asia in the summer of 1997, has slowed the number of
inquiries and orders from the level of the previous year.  This segment is also
expected to be adversely affected by the economic and political instability in
Indonesia and political turmoil on the Indian subcontinent.

Electrical consumption has grown moderately in the United States in recent years
and competition within the electric power industry in the United States has
intensified.  The Energy Policy Act of 1992 deregulated the electric power
generation industry by allowing independent power producers access to the
electric utilities' transmission and distribution systems. Several states have
changed their laws to encourage competition among generators of electricity.
The modest growth in demand and the changes associated with this transition from
a regulated to a competitive industry have caused electric power companies to
defer ordering new baseload power plants in the United States.  When electric
utilities are in need of peaking capacity, many are purchasing combustion
turbines with short lead-times or they are purchasing electricity from other
utilities and non-regulated sources, such as cogenerators and independent power
producers.

Substantially all the customers of the Power Generation Systems segment are
affected by environmental regulations of the countries in which their facilities
are located.  In the United States, the Clean Air Act requires many customer
industries to implement systems to limit or remove emissions. These mandated
expenditures have caused some customers to defer refurbishments of existing
plants. The same requirements have caused other customers to purchase
environmental control equipment from this segment.  Future changes in
environmental regulations will continue to affect demand for this segment's
products and services.

                                       6
<PAGE>
 
The systems, products and services of the Power Generation Systems segment are
capital intensive.  As such, demand for the company's products is heavily
affected by the variations in the business cycles of our customers and by the
overall economies of their countries.  Availability of funds for project
financing, investment and maintenance at this segment's customers varies with
the conditions of their domestic businesses.

C. GOVERNMENT OPERATIONS

GENERAL
-------

The Government Operations segment provides nuclear fuel assemblies and nuclear
reactor components to the U.S. Navy for the Naval Reactors Program.  This
activity has made contributions to operating income of McDermott Incorporated in
all three fiscal years and management expects it to do so in the foreseeable
future.  This segment, in addition to its Naval Reactors Program business,
supplies other equipment and services to the U.S. Government and is proceeding
with new Government projects and exploring new programs which require the
technological capabilities it developed as a Government contractor.   Examples
of these markets include environmental restoration services and the management
of government-owned facilities, primarily within the United States Department of
Energy's ("DOE") nuclear weapons complex.

The principal plants of this segment are located in Lynchburg, Virginia and
Barberton, Ohio.

RAW MATERIALS
-------------

This segment is not sole source dependent for any significant raw materials
except for uranium, which is furnished and owned by the U.S. Government and used
in the nuclear fuel assemblies supplied to the U.S. Navy for the Naval Reactors
Program.

CUSTOMERS AND COMPETITION
-------------------------

This segment is the sole supplier to the U.S. Navy of all major nuclear steam
system equipment and all nuclear fuel assemblies and reactor components for the
Naval Reactors Program.  There are a small number of suppliers of small nuclear
components with B&W being the largest based on revenues.  This segment is
involved along with other companies in the operation of the Idaho National
Engineering and Environmental Laboratory located near Idaho Falls, Idaho; the
Rocky Flats Environmental Technology Site located near Boulder, Colorado; the
Savannah River Site located in Aiken, South Carolina, and the Hanford Site
located in Richland, Washington.  During fiscal year 1998, the Government
Operations segment received a contract  from the DOE as the prime contractor to
manage the environmental remediation and site transition project at the DOE's
Mound site in Miamisburg, Ohio.  A B&W subsidiary, Babcock & Wilcox of Ohio,
Inc., began performance under the several hundred million dollar multi-year
contract in October 1997, which contract is subject to annual funding.  For
fiscal years 1998, 1997 and 1996, the U.S. Government accounted for
approximately 19% of McDermott Incorporated's total revenues, including 15%, 17%
and 16%, respectively, related to nuclear fuel assemblies and reactor components
for the U.S. Navy.

                                       7
<PAGE>
 
BACKLOG
-------

Backlog as of March 31, 1998 and 1997 for the Government Operations segment was
$810,230,000 and $791,981,000, or approximately 38% and 32%, respectively, of
McDermott Incorporated's backlog.  Of the March 31, 1998 backlog, management
expects that approximately $309,251,000 will be recognized in revenues in fiscal
year 1999, $215,841,000 in fiscal year 2000 and $285,138,000 thereafter, of
which approximately 91% will be recognized in fiscal years 2001 through 2003.
At March 31, 1998, this segment's backlog with the U. S. Government was
$799,967,000 (of which $40,376,000 had not yet been funded), or approximately
37% of McDermott Incorporated's total backlog.  The March 31,1998 U.S.
Government backlog includes only the current year funding for the DOE Mound site
in Miamisburg, Ohio.  During fiscal year 1998, this segment was awarded
approximately $250,000,000 in new orders for aircraft carrier components and
prototypical steam generation equipment for the newest submarine design.

FACTORS AFFECTING DEMAND
------------------------

The systems, products and services of the Government Operations segment are
generally capital intensive.  This segment may be impacted by U. S. Government
budget restraints.

Even with the maturing of the U. S. Navy's shipbuilding program and U. S.
Government defense budget reductions,  the demand for nuclear fuel assemblies
and reactor components for the U. S. Navy has continued to comprise a
substantial portion of this segment's backlog. Management expects orders for 
U.S. Navy nuclear fuel assemblies and nuclear reactor components to continue to
be a significant part of backlog since this segment is the sole source provider
of these nuclear fuel assemblies and nuclear reactor components.

D. ENGINEERING AND CONSTRUCTION OPERATIONS

GENERAL
-------

The business activities of Engineering and Construction Operations segment are
conducted through McDermott Engineers & Constructors (Canada), Ltd.

McDermott Engineers and Constructors (Canada), Ltd., which is located in
Calgary, Alberta, Canada, provides services including project management,
conceptual and process design, front-end engineering and design, detailed
engineering, procurement, construction management and contract maintenance.

FOREIGN OPERATIONS
------------------

The amount of Engineering and Construction Operations' revenues, net of
intersegment revenues, and segment operating loss derived from operations
located outside of the United States, and the approximate percentages to
McDermott Incorporated's total revenues, follow:

                                       8
<PAGE>
 
<TABLE>
<CAPTION>
 
                      REVENUES             SEGMENT LOSS
FISCAL YEAR       AMOUNT    PERCENT            AMOUNT

                            (Dollars in Thousands)
<S>              <C>         <C>             <C>
 
      1998       $192,725        10%       $ (9,101)
      1997        260,399        14%        (13,982)
      1996        323,391        16%        (16,408)
</TABLE>

RAW MATERIALS
-------------

The principal raw materials used by Engineering and Construction Operations are
purchased directly for its customers.

CUSTOMERS AND COMPETITION
-------------------------

The principal customers of Engineering and Construction Operations include oil
and natural gas producers, the electric power generation industry, petrochemical
and chemical processing industries in Canada, the United Kingdom and the Middle
East.

The majority of Engineering and Construction Operations' contracts are awarded
in a competitive market in which both price and quality are considerations.

BACKLOG
-------

As of March 31, 1998 and 1997, the Engineering and Construction Operations'
backlog amounted to $200,652,000 and $104,617,000, or approximately 9% and 4%,
respectively, of McDermott Incorporated's total backlog. Of the March 31, 1998
backlog, management expects that approximately $169,707,000 will be recognized
in revenues in fiscal year 1999, $25,545,000 in fiscal year 2000 and $5,400,000
thereafter.

During fiscal year 1998, Engineering and Construction Operations received a
contract award  for Novagas Canada Limited, valued at $49,000,000, to engineer
and construct a natural gas treatment plant in northwestern British Columbia,
Canada.

FACTORS AFFECTING DEMAND
------------------------

The services provided by Engineering and Construction Operations are somewhat
capital intensive and the demand for its services are affected by variations in
the business cycles (which are affected by the price of oil) in the customers'
industries and economies in both Canada and the United Kingdom.  Availability of
funds for investment and maintenance at various customers' facilities varies
partly due to seasonal plant outages and the economic condition of regional
businesses.

                                       9
<PAGE>
 
E. OTHER OPERATIONS

GENERAL
-------

Other Operations includes the results of Hudson Products Corporation and
McDermott Technology, Inc., formerly B&W's Research & Development Division and
Contract Research Division and other small businesses.  The business activities
of Other Operations are primarily conducted through Hudson Products Corporation
and McDermott Technology, Inc.

Hudson Products Corporation products include air-cooled heat exchangers,
combination water and air-cooled systems, air-cooled vacuum steam condensers,
fiber-glass reinforced axial flow fans for air-cooled heat exchangers and wet
cooling towers and fan control systems.  McDermott Technology, Inc.'s Research &
Development Division performs research activities for internal operating
segments of McDermott International, while its Contract Research Division
markets, negotiates and administers contracts that leverage company research and
development technology needs with external funds.

The principal plant of Hudson Products Corporation is located in Beasley, Texas.
This plant is well maintained, has suitable equipment and is of adequate size.
McDermott Technology, Inc's research and development facilities are located in
Alliance, Ohio and Lynchburg, Virginia.

RAW MATERIALS
-------------

The principal raw materials used by Other Operations consist of carbon and alloy
steels in various forms, such as plates, bars, sheets, and pipes, and aluminum
pipes, aluminum strips, fiberglass cloth and epoxy resins.  The majority of raw
materials and components are purchased as needed for individual contracts.
Additional quantities of raw material are carried as base stock for jobs
requiring quick turnaround.   Although extended lead time of certain raw
materials have existed from time to time, no serious shortage exists at the
present, nor does management expect any shortage in the foreseeable future.
Other Operations are not sole source dependent for any significant raw
materials.

CUSTOMERS AND COMPETITION
-------------------------

The principal customers of Other Operations include petrochemical and chemical
processing  and electric power generation industries, state and federal
government agencies and non-profit utility groups.

Equipment orders for items such as air-cooled heat exchangers are customarily
awarded after competitive bids have been submitted as proposals to customers
based on the estimated cost of each job.  In both the U.S. and international
markets, a number of domestic and foreign-based companies specializing in air-
cooled heat exchanger equipment compete with this segment.

BACKLOG
-------

As of March 31, 1998 and 1997, the Other Operations' backlog amounted to
$61,171,000 and $60,068,000, respectively, or approximately 3% of McDermott
Incorporated's total

                                       10
<PAGE>
 
backlog. Of the March 31, 1998 backlog, management expects that approximately
$59,424,000 will be recognized in revenues in fiscal year 1999 and $1,747,000
thereafter.

During fiscal year 1998, Other Operations received a contract award valued at
$12,717,000 to supply 113 air-cooled heat exchanger units to TransCanada
Pipelines.

FACTORS AFFECTING DEMAND
------------------------

The equipment and services provided by Other Operations are somewhat capital
intensive and the demand for its equipment and services are affected by
variations in the business cycles (which are affected by the price of oil) in
the customers industries and the overall United States economy.  Other
Operations is also effected by legislative issues such as environmental
regulations and fluctuations in U.S. Government funding patterns.  Availability
of funds for investment and maintenance at various customers' facilities varies
with the economic conditions of these businesses.

F.  PATENTS AND LICENSES

Many U.S. and foreign patents have been issued to McDermott Incorporated and it
has many pending patent applications.  Patents and licenses have been acquired
and licenses have been granted to others when advantageous to McDermott
Incorporated.  While McDermott Incorporated regards its patents and licenses to
be of value, no single patent or license or group of related patents or licenses
is believed to be material in relation to its business as a whole.

G.  RESEARCH AND DEVELOPMENT

McDermott Incorporated conducts its principal research and development
activities at its research centers in Alliance, Ohio and Lynchburg, Virginia;
and also conducts development activities at its various manufacturing plants and
engineering and design offices.  During the fiscal years ended March 31, 1998,
1997 and 1996, approximately $35,574,000, $49,012,000, and $66,597,000,
respectively, was spent by McDermott Incorporated on research and development
activities, of which approximately $22,803,000, $34,170,000, and $45,106,000,
respectively, was paid for by customers of McDermott Incorporated.  Research and
development activities were related to development and improvement of new and
existing products and equipment and conceptual and engineering evaluation for
translation into practical applications.  McDermott Incorporated's multi-million
dollar clean environment development facility in Alliance, Ohio was constructed
in response to present and future emission pollution standards in the U.S. and
worldwide.  Approximately 160 employees were engaged full time in research and
development activities at March 31, 1998.

H.  INSURANCE

McDermott Incorporated maintains liability and property insurance against such
risk and in such amounts it considers adequate.  However, certain risks are
either not insurable or insurance is available only at rates which McDermott
Incorporated considers uneconomical.  Among such risks are war and confiscation
of property in certain areas of the world, pollution liability in excess of
relatively low limits and, in recent years, asbestos liability.  Depending on
competitive conditions and other factors, McDermott Incorporated endeavors to
obtain

                                       11
<PAGE>
 
contractual protection against uninsured risks from its customers.  However,
there is no assurance that insurance or contractual indemnity protection, when
obtained, will be sufficient or effective under all circumstances or against all
hazards to which McDermott Incorporated may be subject.

McDermott Incorporated's insurance policies do not insure against liability and
property damage losses resulting from nuclear accidents at reactor facilities of
its utility customers.  To protect against liability for damage to a customer's
property, McDermott Incorporated obtains waivers of subrogation from the
customer and its insurer and is generally named as an additional insured under
the utility customer's nuclear property policy.  To protect against liability
from claims brought by third parties, McDermott Incorporated is insured under
the utility  customer's nuclear liability policies and has the benefit of the
indemnity and limitation of any applicable liability provision of the Price-
Anderson Act, as amended ("the Act").  The Act limits the public liability of
manufacturers and operators of licensed nuclear facilities and other parties who
may be liable in respect of, and indemnifies them against, all claims in excess
of an amount which is determined by the sum of commercially available liability
insurance plus certain retrospective premium assessments payable by operators of
commercial nuclear reactors.  For those sites where McDermott Incorporated
provides environmental remediation services, it seeks the same protection from
its customers as it does for its other nuclear activities.

Although McDermott Incorporated does not own or operate any nuclear reactors, it
has coverage under commercially available nuclear liability and property
insurance for three of its four facilities which are licensed to possess special
nuclear materials.  The fourth facility operates primarily as a conventional
research center.  This facility is licensed to possess special nuclear material
and has a small and limited amount of special nuclear material on the premises.
Two of the four owned facilities are located at McDermott Incorporated's
Lynchburg, Virginia site.  These facilities are insured under a nuclear
liability policy which also insures the facility of B&W Fuel Company ("BWFC")
that was sold during fiscal year 1993.  All three facilities share the same
nuclear liability insurance limit as the commercial insurer would not allow BWFC
to obtain a separate nuclear liability insurance policy.  Due to the type or
quantity of nuclear material present, two of the four facilities have the
benefit of the indemnity and limitation of liability provisions of the Act,
pursuant to Indemnity Agreements entered into with the U.S. Government.  In
addition, contracts to manufacture and supply nuclear fuel or nuclear components
to the U.S. Government generally contain contractual indemnity clauses, which
become effective at the time of shipment, whereby the U.S. Government has
assumed the risks of public liability claims.

The insurance coverage of McDermott Incorporated for products liability and
employers' liability claims is subject to varying insurance limits which are
dependent upon the year involved.  The Babcock & Wilcox Company has agreements
with the majority of its principal insurers concerning the method of allocation
of products liability asbestos claim payments to the years of coverage.
Pursuant to those agreements, The Babcock & Wilcox Company negotiates and
settles these claims and bills these amounts to the appropriate insurers.  For
financial reporting purposes, a provision has been recognized to the extent that
recovery of these amounts from McDermott Incorporated's insurers has not been
determined to be probable.  Estimated liabilities for pending and future non-
employee products liability asbestos claims are derived from McDermott
Incorporated's claims history and constitute

                                       12
<PAGE>
 
management's best estimate of such future costs.  Estimated insurance recoveries
are based upon analysis of insurers providing coverage of the estimated
liabilities.  Inherent in the estimate of such liabilities and recoveries are
expected trends in claim severity and frequency and other factors, including
recoverability from insurers (see Note 11 to the consolidated financial
statements), which may vary significantly as claims are filed and settled.
Accordingly, the ultimate loss may differ materially from the amount provided in
the consolidated financial statements.

I.  EMPLOYEES

At March 31, 1998, McDermott Incorporated employed, under its direct
supervision, approximately 12,900 persons compared with 12,600 at March 31,
1997. Approximately 5,700 employees were members of labor unions at March 31,
1998 as compared with approximately 5,200 at March 31, 1997. The majority of
B&W's manufacturing facilities operate under union contracts which customarily
are renewed every two to three years. During the next twelve months, six union
contracts covering approximately 1,800 B&W hourly workers will expire. Five of
these contracts have been successfully renegotiated. B&W expects to renew the
remaining contract without incident. McDermott Incorporated considers its
relationships with its employees to be satisfactory.

J.  ENVIRONMENTAL REGULATIONS AND MATTERS

McDermott Incorporated is subject to the existing and evolving legal and
regulatory standards relating to the environment.  These laws include the
Comprehensive Environmental Response, Compensation, and Liability Act of 1980
("CERCLA"), and similar laws which provide for responses to and liability for
releases of hazardous substances into the environment; and the Clean Air Act,
the Clean Water Act, the Resource Conservation and Recovery Act and other
federal laws, each as amended, and similar foreign, state or local counterparts
to these federal laws, which regulate air emissions, water discharges, hazardous
substances and wastes, and require public disclosure related to the use of
various hazardous substances.  McDermott Incorporated's operations are also
governed by laws and regulations relating to workplace safety and worker health,
primarily the Occupational Safety and Health Act and regulations promulgated
thereunder.  McDermott Incorporated believes that its facilities are in
substantial compliance with current regulatory standards.

McDermott Incorporated's compliance with U.S. federal, state and local
environmental control and protection regulations necessitated capital
expenditures of $351,000 in fiscal year 1998, and management expects to spend
another $2,580,000 on such capital expenditures over the next five years.
Management cannot predict all of the environmental requirements or circumstances
which will exist in the future but anticipates that environmental control and
protection standards will become increasingly stringent and costly.  Complying
with existing environmental regulations resulted in pretax charges of
approximately $7,530,000 in fiscal year 1998.

McDermott Incorporated has been identified as a potentially responsible party at
various cleanup sites under CERCLA.  McDermott Incorporated has not been
determined to be a major contributor of wastes to these sites.   However, each
potentially responsible party or contributor may face assertions of joint and
several liability.  Generally, however, a final allocation of costs is made
based on relative contribution of wastes to each site.  Based on

                                       13
<PAGE>
 
its relative contribution of waste to each site, McDermott Incorporated's share
of the ultimate liability for the various sites is not expected to have a
material adverse effect on McDermott Incorporated's consolidated financial
position, results of operations or liquidity in any given year.

Remediation projects have been or may be undertaken at certain of McDermott
Incorporated's current and former plant sites, and, during fiscal year 1995, B&W
completed, subject to Nuclear Regulatory Commission ("NRC") certification, the
decommissioning and decontamination of its former nuclear fuel processing plant
at Apollo, Pennsylvania.  All fabrication and support buildings have been
removed, and all contaminated soil has been shipped to authorized disposal
facilities.  In fiscal year 1997, B&W was notified by the NRC that the Apollo
plant site had been released for unrestricted use.  The Apollo plant site is the
first major nuclear fuel facility in the U.S. to achieve "green-field" status
after remediation, and will now be removed from the NRC's Site Decommissioning
Management Plan.  The nuclear license for the plant was terminated.

During fiscal year 1995, management decided to close B&W's nuclear manufacturing
facilities in Parks Township, Armstrong County, Pennsylvania (the "Parks
Facilities"), and a provision of $41,724,000 for the decontamination,
decommissioning, and the closing of these facilities was recognized.
Previously, decontamination and decommissioning costs were being accrued over
the facilities' remaining expected life.  Decontamination is proceeding as
permitted by the existing NRC license. A decommissioning plan was submitted to
the NRC for review and approval during January 1996.  During fiscal year 1998,
these facilities were transferred to B&W's subsidiary, BWX Technologies, Inc.
("BWXT"). BWXT expects to reach an agreement with the NRC in fiscal year 1999 on
a plan that provides for the completion of facilities dismantlement and soil
restoration by 2001 and license termination by 2002.  BWXT expects to request
approval from the NRC to release the site for unrestricted use at that time.

At March 31, 1998 and 1997, McDermott Incorporated had total environmental
reserves (including provision for the facilities discussed above) of $44,675,000
and $30,949,000, of which $8,446,000 and $10,352,000, respectively, were
included in current liabilities.  Estimated recoveries of these costs are
included in environmental and products liabilities recoverable at March 31,
1998.  Inherent in the estimates of such reserves and recoveries are expected
levels of contamination, decommissioning costs, and recoverability from other
parties, which may vary significantly as decommissioning activities progress.
Accordingly, changes in estimates could result in a material adjustment to
operating results and the ultimate loss may differ materially from amounts
provided in the consolidated financial statements.

The Department of Environmental Protection of the Commonwealth of Pennsylvania,
("PADEP"), by letter dated March 19, 1994, advised The Babcock & Wilcox Company
that it would seek monetary sanctions, and remedial and monitoring relief,
related to the Parks Facilities.  The relief sought related to potential
groundwater contamination of the previous operations of the facilities.  These
facilities are now a part of BWXT.  PADEP has advised BWXT that it does not
intend to assess any monetary sanctions provided that BWXT continues its
remediation program of the Parks Facilities.

                                       14
<PAGE>
 
McDermott Incorporated performs significant amounts of work for the U.S.
Government under both prime contracts and subcontracts and operates certain
facilities that are licensed to possess and process special nuclear materials
and thus is subject to continuing reviews by governmental agencies, including
the Environmental Protection Agency and the NRC.

Decommissioning regulations promulgated by the NRC require BWXT to provide
financial assurance that it will be able to pay the expected cost of
decommissioning its facilities at the end of their service lives.  BWXT will
continue to provide financial assurance of $20,439,000 during fiscal year 1999
by issuing letters of credit  for the ultimate decommissioning of all its
licensed facilities, except one.  This facility, which represents the largest
portion of BWXT's eventual decommissioning costs, has provisions in its
government contracts pursuant to which all of its decommissioning costs and
financial assurance obligations are covered by the U.S. Government (DOE).

Compliance with existing government regulations controlling the discharge of
materials into the environment, or otherwise relating to the protection of the
environment (including decommissioning), does not have, nor does management
expect it to have, a material adverse effect upon McDermott Incorporated's
consolidated financial position or results of operations.

K.  TRANSACTIONS WITH RELATED PARTIES

McDermott Incorporated has material transactions occurring during the normal
course of operations, including the performance of certain general and
administrative services, with International and other affiliated companies.
McDermott Incorporated has also entered into various financial agreements with
International and its subsidiaries, including a Stock Purchase and Sale
Agreement.  (See Note 5 to the consolidated financial statements.)

While McDermott Incorporated's employee liability, comprehensive, general
liability, property, and other insurance programs are placed through commercial
insurance carriers, substantially all of such employee liability exposure is
reinsured, and significant deductibles under McDermott Incorporated's other
insurance programs are insured, by wholly owned insurance subsidiaries of
McDermott International.  The premiums charged by such insurance companies of
McDermott International for such insurance are based upon the claims experience
and forecasted activities of McDermott Incorporated and its subsidiaries.
Management believes this approach is more cost effective as there is generally
no commercial market for insurance on the same economic terms for these types of
exposure.

ITEM 3. LEGAL PROCEEDINGS

In March 1997, International and JRM, with the help of outside counsel, began an
investigation into allegations of wrongdoing by a limited number of former
employees of International and JRM and others. The allegations concerned the
heavy-lift business of the HeereMac joint venture.  Upon becoming aware of these
allegations, International and JRM notified authorities, including the Antitrust
Division of the U. S. Department of Justice and the European Commission.  As a
result of International's and JRM's prompt disclosure of the allegations, both
companies and the individuals who were officers, directors and employees of
International or JRM at the time of the disclosure were granted immunity from
criminal

                                       15
<PAGE>
 
prosecution by the Department of Justice for any anti-competitive acts involving
worldwide heavy-lift activities.

After receiving the allegations, JRM initiated action to terminate its interest
in HeereMac, and on December 19, 1997, JRM's partner in the joint venture,
Heerema Offshore Construction Group, Inc. ("Heerema"), acquired JRM's interest
in exchange for $318,500,000 in cash and title to several pieces of equipment,
including launch barges and the derrick barge 101, a 3,500 ton lift capacity
semi-submersible derrick barge. On December 21, 1997, HeereMac and a HeereMac
employee pled guilty to criminal charges by the Department of Justice that they
and others had participated in a conspiracy to rig bids in connection with the
heavy-lift business of HeereMac in the Gulf of Mexico, North Sea and Far East.
HeereMac was fined $49,000,000 and the employee $100,000.  As part of the plea,
both HeereMac and certain employees of HeereMac agreed to cooperate fully with
the Department of Justice  investigation. Neither International, JRM nor any of
their officers, directors or employees was a party to those proceedings.

International and JRM have cooperated and are continuing to cooperate with the
Department of Justice in its investigation.  Near the end of calendar 1997, the
Department of Justice requested additional information from the companies
relating to possible anti-competitive activity in the marine construction
business of McDermott-ETPM East, Inc., one of the operating companies within
JRM's former McDermott-ETPM joint venture with ETPM S.A., a French company.
Pursuant to the termination of the McDermott-ETPM joint venture on April 3,
1998, JRM assumed 100% ownership of McDermott-ETPM East, Inc., which has been
renamed J. Ray McDermott Middle East, Inc.  Subsequent to the formation of JRM
and its acquisition of Offshore Pipelines, Inc. in January 1995, McDermott
Incorporated no longer participates in the heavy-lift barge service business nor
the marine construction business, which is the subject of this investigation.

International and JRM are also cooperating with the Securities and Exchange
Commission ("SEC"), which also requested information and documents from the
companies with respect to certain of the foregoing matters.  International and
JRM are subject to a judicial order entered in 1976, with the consent of
McDermott Incorporated (which at that time was the parent of the McDermott group
of companies), pursuant to an SEC complaint ("Consent Decree").  The Consent
Decree prohibits the companies from making false entries in their books,
maintaining secret or unrecorded funds or using corporate funds for unlawful
purposes.  Violations of the Consent Decree could result in substantial civil
and/or criminal penalties to the companies.

In June 1998, Phillips Petroleum Company (individually, and on behalf of certain
co-venturers) and certain related entities filed a complaint in the United
States District Court for the Southern District of Texas against McDermott
Incorporated, International, JRM, McDermott-ETPM, Inc., certain JRM
subsidiaries, HeereMac, Heerema, certain Heerema affiliates, and others.  The
complaint alleges that the defendants engaged in anti-competitive acts in
violation of Sections 1 and 2 of the Sherman Act and Sections 15.05 (a) and (b)
of the Texas Business and Commerce Code, engaged in fraudulent activity and
tortiously interfered with the plaintiffs' businesses in connection with certain
offshore transportation and installation projects in the Gulf of Mexico, North
Sea and Far East.  In addition to seeking actual damages and attorneys' fees,
the plaintiffs have requested punitive as well as treble damages.

                                       16
<PAGE>
 
It is not possible to predict the ultimate outcome of the Department of Justice
investigation, the SEC inquiry, the companies' internal investigation, the above
referenced lawsuit, or the actions that may be taken by others as a result of
HeereMac's guilty plea or otherwise.  However, these matters could result in
civil and/or criminal liability and have a material adverse effect on McDermott
Incorporated's consolidated financial position and results of operations.

In addition to the foregoing, McDermott Incorporated and certain of its
officers, directors and subsidiaries are defendants in numerous other legal
proceedings.  Management believes that the outcome of these proceedings will not
have a material adverse effect upon McDermott Incorporated's consolidated
financial position or results of operations.

See Item 1H and Note 11 to the consolidated financial statements regarding
McDermott Incorporated's potential liability for non-employee products liability
asbestos claims.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted during the fourth quarter of the fiscal year covered by
this report to a vote of security holders, through the solicitation of proxies
or otherwise.

                                       17
<PAGE>
 
                                 P A R T   I I



ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
        MATTERS

All of McDermott Incorporated's outstanding Common Stock is owned by McDermott
International and, consequently, there is no market for McDermott Incorporated's
Common Stock.  For restrictions on McDermott Incorporated's present or future
ability to pay dividends, see Item 7 Liquidity and Capital Resources and Note 6
to the consolidated financial statements.

                                       18
<PAGE>
 
ITEM 6.  SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
 
                                       FOR THE FISCAL YEARS ENDED MARCH 31,
                           1998         1997          1996          1995          1994
                        ----------   -----------   -----------   -----------   -----------
                                                  (In thousands)
<S>                     <C>          <C>           <C>           <C>           <C>
Revenues                $1,842,659   $1,796,257    $2,027,975    $2,222,390    $2,243,366
Income (Loss) before
 Cumulative Effect
 of Accounting
 Changes                $   40,390   $ (174,805)   $  (27,143)   $  (73,880)   $  (26,316)
Net Income (Loss)       $   40,390   $ (174,805)   $  (27,143)   $  (74,392)   $ (127,066)
Total Assets            $2,862,818   $3,137,170    $3,019,780    $3,386,429    $3,500,726
Long-Term Debt          $  352,360   $  379,487    $  423,882    $  423,150    $  584,532
Redeemable
 Preferred Stocks          155,358      170,983       173,301       179,251       196,672
                        ----------   ----------    ----------    ----------    ----------
        Total           $  507,718   $  550,470    $  597,183    $  602,401    $  781,204
</TABLE>

See Note 16 to the consolidated financial statements for significant items
included in fiscal year 1998 and 1997 results.  Fiscal year 1996 results include
an equity income gain of $30,612,000 resulting from the sale of two power
purchase contracts, a favorable workers' compensation cost adjustment of
$5,746,000, and a write-off of an insurance claim of $12,600,000 due to an
unfavorable arbitration ruling related to the recovery of cost incurred for
corrective action in certain utility and industrial installations.  Fiscal year
1995 results include a $46,489,000 charge for the decontamination,
decommissioning and closing of certain nuclear manufacturing facilities and the
closing of a manufacturing facility, a $14,478,000 charge for the reduction of
estimated products liability asbestos claims recoveries from insurers and a
$26,300,000 benefit for a reduction in accrued interest expense due to the
settlement of outstanding tax issues.

Fiscal year 1995 includes the sale of a portion of McDermott Incorporated's
marine construction services business to International and the cumulative effect
of the adoption of Statement of Accounting Standards ("SFAS") No. 112.  Fiscal
year 1994 includes the cumulative effect of the adoption of Emerging Issues Task
Force Issue No. 93-5.   See Note 11 regarding the uncertainty as to the ultimate
loss relating to products liability asbestos claims and the results of the
ongoing investigation by International, JRM and the U.S. Department of Justice
into possible anti-competitive practices by International and JRM, and a related
lawsuit filed in federal court in June 1998.

All of the Common Stock of McDermott Incorporated is owned by McDermott
International and, therefore, no per share data is shown above.

                                       19
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

GENERAL
-------

Revenues of the Power Generation Systems segment are largely a function of
capital spending by the electric power generation industry. This segment has
recently experienced weak and difficult markets in nearly all of its product
lines.  Domestic utility original equipment markets remain sluggish as growth in
demand remains modest and the electric power industry transitions from a
regulated to a competitive environment.   However, demand for services and
replacement nuclear steam generators to the domestic utility industry continue
at significant levels.  In addition, most foreign markets for industrial and
utility boilers remain strong.  However, the currency crisis, which began in
Southeast Asia in the summer of 1997, has slowed the number of inquiries and
orders from the level of the previous year.  This segment is also expected to be
adversely affected by the economic and political instability in Indonesia and
political turmoil on the Indian subcontinent.

Revenues of the Government Operations segment are largely a function of capital
spending by the U. S. Government.  Management does not expect this segment to
experience any significant growth because of reductions in the defense budget
over the past several years; however, management does expect the segment to
remain relatively constant since it is the sole source provider of nuclear fuel
assemblies and nuclear reactor components to the U. S. Government.

In general, McDermott Incorporated's Power Generation Systems and Government
Operations segments are capital intensive businesses that rely on large
contracts for a substantial amount of their revenues.

Revenues of the Engineering and Construction Operations segment are somewhat
capital intensive and the demand for its services are affected by variations in
the business cycles in the customers' industries and economies in both Canada
and the United Kingdom.

Revenues of Other Operations are somewhat capital intensive and the demand for
its equipment and services are affected by variations in the business cycles in
the customers' industries and the overall United States economy. Other
Operations is also affected by legislative issues such as environmental
regulations and fluctuations in U. S. Government funding patterns.

A significant portion of McDermott Incorporated's revenues and operating results
are derived from its foreign operations, which are primarily located in Canada.
As a result, McDermott Incorporated's operations and financial results are
affected by international factors, such as changes in foreign currency exchange
rates.  McDermott Incorporated attempts to minimize its exposure to changes in
foreign currency  exchange rates by attempting to match foreign currency
contract receipts with like foreign currency disbursements.  To the extent that
it is unable to match the foreign currency receipts and disbursements related to
its contracts, its practice of entering into forward exchange contracts to hedge
foreign currency transactions reduces the impact of foreign exchange rate
movements on operating results.

                                       20
<PAGE>
 
Statements made herein which express a belief, expectation or intention, as well
as those which are not historical fact, are forward looking. They involve a
number of risks and uncertainties which may cause actual results to differ
materially from such forward looking statements.  These risks and uncertainties
include, but are not limited to: the deregulation of the U.S. energy market;
governmental regulation and the continued funding of McDermott Incorporated's
contracts with U.S. governmental agencies; estimates for pending and future non-
employee asbestos claims; the highly competitive nature of McDermott
Incorporated's businesses; economic and political instability in Indonesia;
political turmoil on the Indian subcontinent; and the results of the ongoing
investigation by International and JRM and the U.S. Department of Justice into
possible anti-competitive practices by International and JRM, and a related
lawsuit filed in federal court in June 1998.

During fiscal years 1998 and 1997, McDermott Incorporated's Canadian operations
contributed $406,920,000 and $515,389,000 to total revenues and $6,144,000 and
($31,405,000) to operating income (loss), respectively.  These results reflect
activity on contracts performed at B&W's Cambridge, Ontario location,
principally for the supply of replacement recirculating steam generators to
domestic and foreign utilities and work for government owned utilities located
in the Middle and Far East.

FISCAL YEAR 1998 VS. FISCAL YEAR 1997

Power Generation Systems
------------------------

Revenues increased $157,656,000 to $1,142,721,000, primarily due to higher
revenues from fabrication and erection of fossil fuel steam and environmental
control systems, plant enhancement projects, boiler cleaning equipment and
engineering, procurement and construction of cogeneration plants.  These
increases were partially offset by lower revenues from replacement nuclear steam
generators.

Segment operating income (loss) increased $118,392,000 from a loss of
$33,930,000 to income of $84,462,000, primarily due to higher volume and margins
from fabrication and erection of fossil fuel steam and environmental control
systems, plant enhancement projects, boiler cleaning equipment and engineering,
procurement and construction of cogeneration plants.  In addition, there were
higher margins from replacement nuclear steam generators and replacement parts
and lower selling and general and administrative expenses.

Loss on asset disposals and impairments - net decreased $12,821,000 to
$6,079,000, primarily due to the write-down of an equity investment in a
domestic cogeneration joint venture and an asset impairment loss on a domestic
manufacturing facility in the prior year.

Income from investees increased $2,513,000 to $3,150,000.  This represents the
results of approximately six joint ventures.  The increase was primarily due to
a provision for a loss on a Canadian joint venture in the prior year.  This
increase was partially offset by a favorable termination agreement of a domestic
joint venture in the prior year.

Backlog for the Power Generation Systems segment at March 31, 1998 and 1997 was
$1,071,094,000 and $1,495,787,000, respectively.  Backlog decreased primarily as
a result

                                       21
<PAGE>
 
of delays and cancellations of power projects in Southeast Asia due to the
current Asian economic crisis and management's focus on higher margin projects.

Government Operations
---------------------

Revenues decreased $2,532,000 to $370,519,000, primarily due to lower revenues
from nuclear fuel assemblies and reactor components for the U.S. Government,
commercial nuclear environmental services and other government related
operations.  These decreases were partially offset by higher revenues from
management and operation contracts for U.S. Government owned facilities.

Segment operating income increased $3,358,000 to $35,816,000, primarily due to
higher volume from management and operation contracts for U.S. Government owned
facilities and higher margins from nuclear fuel assemblies and reactor
components for the U.S. Government and other government related operations.
These increases were partially offset by lower volume and margins from
commercial nuclear environmental services and higher operating expenses.

Backlog for the Government Operations segment at March 31, 1998 and 1997 was
$810,230,000 and $791,981,000, respectively.  At March 31, 1998, this segment's
backlog with the U.S. Government was $799,967,000 of which $40,376,000 had not
been funded.

Engineering and Construction Operations
---------------------------------------

Revenues decreased $71,338,000 to $198,689,000, primarily due to lower revenues
from engineering and construction activities.  These decreases were partially
offset by higher revenues from plant maintenance activities.

Segment operating loss decreased $12,745,000 to $536,000, primarily due to cost
overruns on an engineering and construction contract in the prior year and lower
selling and general and administrative expenses in the current year.  These
increases were partially offset by lower margins from plant maintenance
activities.

Gain (loss) on asset disposals and impairments - net decreased $9,155,000 from a
gain of $1,091,000 to a loss of $8,064,000, primarily due to an impairment loss
relating to goodwill associated with McDermott Engineers & Constructors (Canada)
Ltd.

Income (loss) from investees increased $1,215,000 from a loss of $923,000 to
income of $292,000, primarily due to the write-down of three joint ventures in
the prior period.

Backlog for the Engineering and Construction Operations' segment at March 31,
1998 and 1997 was $200,652,000 and $104,617,000, respectively.  The increase in
backlog is primarily due to higher awards for engineering contracts.

                                       22
<PAGE>
 
Other Operations
----------------

Revenues decreased $49,148,000 to $139,712,000, primarily due to the disposition
of non-core businesses (domestic shipyard and ordnance operations).  These
decreases were partially offset by higher revenues from air cooled heat
exchangers.

Operating income (loss) increased $23,924,000 from a loss of $16,773,000 to
income of $7,151,000, primarily due to prior year losses in non-core businesses
(shipyard and ordnance operations), higher volume on air-cooled heat exchangers
and lower selling and general and administrative expenses in the current year.

Gain on asset disposals and impairments - net increased $36,916,000 from a loss
of $1,376,000 to a gain of $35,540,000, primarily due to the sale of McDermott
Incorporated's interest in Universal Fabricators Incorporated.

Income from investees decreased $2,078,000 to $1,632,000, primarily due to lower
operating results from a domestic joint venture.

Backlog for Other Operations at March 31, 1998 and 1997 was $61,171,000 and
$60,068,000, respectively.  At March 31, 1998, Other Operations' backlog with
the U. S. Government was $8,029,000 (all of which had been funded).

Other Unallocated Items
-----------------------

Other unallocated items decreased $49,244,000 to expense of $9,064,000,
primarily due to provisions for estimated future non-employee products asbestos
claims in the prior year.

General Corporate Expenses - Net
--------------------------------

General corporate expenses - net decreased $5,966,000 to $15,036,000, primarily
due to staff reductions, other economic measures, and certain one-time costs
incurred in the prior period, which were partially offset by gains on sales of
certain corporate aircraft in the prior period.

Other Income Statement Items
----------------------------

Interest income increased $2,233,000 to $4,754,000, primarily due to income in
the current year for delinquent payment of amounts due from a joint venture.

Interest expense decreased $5,292,000 to $51,029,000, primarily due to changes
in debt obligations and interest rates prevailing thereon.

Other-net expense decreased $16,720,000 to $7,300,000.  This increase was
primarily due to bank fees and discounts on the sale of certain accounts
receivable and a loss of $19,446,000 for insolvent insurers providing coverage
for estimated future non-employee asbestos claims, both in the prior year.
These decreases were partially offset by increased minority interest expense due
to improved results of McDermott Engineers & Constructors (Canada) Ltd.

                                       23
<PAGE>
 
The provision for (benefit from) income taxes increased $65,644,000 from a
benefit of $25,586,000 to a provision of $40,058,000 while income (loss) before
the provision for (benefit from) income taxes increased $280,839,000 from a loss
of $200,391,000 to income of $80,448,000.  The increase in income taxes is due
primarily to the increase in income.

FISCAL YEAR 1997 VS. FISCAL YEAR 1996

Power Generation Systems
------------------------

Revenues decreased $159,714,000 to $985,065,000, primarily due to lower revenues
from fabrication and erection of fossil steam and environmental control systems,
replacement nuclear steam generators, nuclear services, boiler cleaning
equipment and replacement parts.  These decreases were partially offset by
higher revenues from plant enhancement projects.

Segment operating income (loss) decreased $56,166,000 from income of $22,236,000
to a loss of $33,930,000, primarily due to lower volume and margins from
fabrication and erection of fossil fuel steam and environmental control systems
and replacement parts.  There were also lower volumes on replacement nuclear
steam generators and boiler cleaning equipment, lower margins on plant
enhancement projects and higher net operating expenses.

Gain (loss) on asset disposals and impairments-net decreased $23,150,000 from a
gain of $4,250,000 to a loss of $18,900,000, primarily due to the write-down of
an equity investment in a domestic cogeneration joint venture and an asset
impairment loss on a domestic manufacturing facility.

Income from investees decreased $30,548,000 to $637,000.  This represents the
results of approximately 7 active joint ventures.  The income in fiscal year
1996 was primarily due to the gain on the sale of power purchase contracts back
to a local utility.

Government Operations
---------------------

Revenues increased $3,346,000 to $373,051,000, primarily due to higher revenues
from commercial nuclear environmental services and management and operation
contracts for U.S. Government owned facilities.  These increases were partially
offset by lower revenues from nuclear fuel assemblies and reactor components for
the U.S. Government.

Segment operating income increased $6,589,000 to $32,458,000, primarily due to
higher volume and margins from commercial nuclear environmental services and
higher volume from management and operation contracts for U.S. Government owned
facilities.  These increases were partially offset by lower volume and margins
from nuclear fuel assemblies and reactor components for the U.S. Government.

Income from investees increased $1,371,000 to $3,630,000, primarily due to the
favorable operating results from a domestic joint venture.

                                       24
<PAGE>
 
Engineering and Construction Operations
---------------------------------------

Revenues decreased $83,055,000 to $270,027,000, primarily due to lower revenues
from engineering and construction activities in Canadian operations and
construction activities from domestic operations.

Segment operating loss decreased $6,635,000 to $13,281,000, primarily due to
higher volume and margins from plant maintenance activities and lower selling
and general and administrative expenses.  These increases were partially offset
by cost overruns on a contract for a cogeneration plant.

Gain (loss) on asset disposals and impairments-net increased $1,316,000 from a
loss of $225,000 to a gain of $1,091,000, primarily due to a gain on the sale of
assets.

Income from investees decreased $1,128,000 from income of $205,000 to a loss of
$923,000, primarily due to the write-down of three joint ventures.

Other Operations
----------------

Revenues increased $4,312,000 to $188,860,000, primarily due to higher revenues
from barge construction activities in shipyard operations and increased
shipbuilding activities.  These increases were partially offset by lower
revenues from domestic engineering operations.

Operating loss increased $8,087,000 to $16,773,000, primarily due to cost
overruns on domestic barge and ordnance operations and lower volume and margins
from domestic engineering operations.  These decreases were partially offset by
lower general and administrative expenses.

Gain (loss) on asset disposals and impairments-net decreased $4,664,000 from a
gain of $3,288,000 to a loss of $1,376,000, primarily due to an asset impairment
loss on an office building, partially offset by the gain on the sale of the
shipyard operations.

Income from investees increased $1,078,000 to $3,710,000, primarily due to
higher operating results from a domestic engineering joint venture, partially
offset by lower operating results from a domestic fabrication joint venture.

Other Unallocated Items
-----------------------

Other unallocated items increased $28,866,000 to expense of $58,308,000,
primarily due to provisions for estimated future non-employee products asbestos
claims, partially offset by the write-off of an insurance claim of $12,600,000
due to an unfavorable arbitration ruling in the prior year.

                                       25
<PAGE>
 
General Corporate Expenses - Net
--------------------------------

General corporate expenses - net decreased $2,190,000 to $21,002,000, primarily
due to increased allocations of cost to International and JRM, partially offset
by certain one-time costs in the current year.  In addition, there were gains on
the sales of certain corporate aircraft in the current year.

Other Income Statement Items
----------------------------

Interest income decreased $9,277,000 to $2,521,000, primarily due to decreased
investments in government obligations and other investments.

Interest expense increased $3,411,000 to $56,321,000, primarily due to changes
in debt obligations and interest rates prevailing thereon.

Other-net expense increased $21,976,000 to $24,020,000, primarily due to a loss
of $19,446,000 in the current year for insolvent insurers providing coverage for
estimated future non-employee asbestos claims and gains on the sales of
investments in the prior year.

The benefit from income taxes increased $20,317,000 to $25,586,000 while loss
before the benefit from income taxes increased $167,979,000 to $200,391,000.
The increase in the benefit from income taxes is due primarily to the increase
in loss from operations, offset, in part, due to a limitation on the recognition
of income tax benefits in the U.S.

EFFECT OF INFLATION AND CHANGING PRICES
---------------------------------------

McDermott Incorporated's financial statements are prepared in accordance with
generally accepted accounting principles, using historical dollar accounting
(historical cost).  Statements based on historical cost, however, do not
adequately reflect the cumulative effect of increasing costs and changes in the
purchasing power of the dollar, especially during times of significant and
continued inflation.

In order to minimize the negative impact of inflation on its operations,
McDermott Incorporated attempts to cover the increased cost of anticipated
changes in labor, material and service costs, either through an estimation of
such changes, which is reflected in an original price, or through price
escalation clauses in its contracts.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

During fiscal year 1998, McDermott Incorporated's cash and cash equivalents
increased $1,409,000 to $58,191,000 and total debt decreased $227,991,000 to
$465,188,000, primarily due to  a net reduction in short-term borrowings of
$182,691,000 and repayment of long-term debt of $45,164,000. During this period,
McDermott Incorporated provided cash of $232,388,000 from operating activities;
received cash of $54,220,000 from assets disposals and $2,500,000 from the
redemption of International stock; and used cash of $17,869,000 for the purchase
of property, plant and equipment, $15,406,000 for the repurchase of McDermott
Incorporated's preferred stock to satisfy current and future sinking fund
requirements, $12,821,000 for cash dividends on preferred stocks and $6,627,000
for acquisitions.

                                       26
<PAGE>
 
Pursuant to agreement with the majority of its principal insurers, McDermott
Incorporated negotiates and settles products liability asbestos claims from non-
employees and bills these amounts to the appropriate insurers.  As a result of
collection delays inherent in this process and the effect of agreed payment
schedules with specific insurers, reimbursement is usually delayed for three
months or more.  The average amount of these claims (historical average of
approximately $6,400 per claim over the last three years) has continued to rise.
Claims paid during the fiscal year ended March 31, 1998 were $196,091,000, of
which $179,251,000 has been recovered or is due from insurers.  At March 31,
1998, receivables of $101,680,000 were due from insurers for reimbursement of
settled claims, including $20,988,000 classified as long-term receivables.
Estimated liabilities for pending and future non-employee products liability
asbestos claims are derived from McDermott Incorporated's claims history and
constitute management's best estimate of such future costs.  Settlement of the
liability is expected to occur over approximately the next 15 years.  Estimated
insurance recoveries are based upon an analysis of insurers providing coverage
of the estimated liabilities.  Inherent in the estimate of such liabilities and
recoveries are expected trends in claim severity and frequency and other
factors, including recoverability from insurers, which may vary significantly as
claims are filed and settled.  Accordingly, the ultimate loss may differ
materially from amounts provided in the consolidated financial statements.  The
collection delays, and the amount of claims paid for which insurance recovery is
not probable, have not had a material adverse effect upon McDermott
Incorporated's liquidity, and management believes, based on information
currently available, that they will not have a material adverse effect on
liquidity in the future.

McDermott Incorporated's expenditures for property, plant and equipment
decreased $8,794,000 to $17,869,000 in fiscal year 1998.  The majority of fiscal
year 1998 expenditures were to maintain and replace and upgrade existing
facilities and equipment.  McDermott Incorporated has committed to make capital
expenditures of approximately $13,743,000 during fiscal year 1999.

At March 31, 1998 and 1997, The Babcock & Wilcox Company had sold, with limited
recourse, an undivided interest in a designated pool of qualified accounts
receivable of approximately $82,783,000 and $93,769,000, respectively, under an
agreement with a U.S. bank.  During fiscal year 1998, the maximum sales limit
available under the agreement was reduced from $125,000,000 to $100,000,000.
Depending on the amount of qualified accounts receivable available for the pool,
the amount sold to the bank can vary (but not greater than the maximum sales
limit available) from time to time.  The existing agreement will expire on July
31, 1998; however, B&W's management is currently negotiating a new receivables
sales agreement.  McDermott Incorporated currently accounts for these sales as
secured borrowings.

Effective February 1, 1989, McDermott Incorporated and a subsidiary of
International, McDermott International Investments Co., Inc. ("MIICO"), entered
into a reverse repurchase agreement whereby either party acting as a "buyer"
would purchase for cash certain U. S. Government obligations owned by the other
party acting as a "seller", and, at the date of purchase, the "seller" would
agree to repurchase the same securities at a set price (including accrued
interest) at a future specified date.  There were no transactions under this
agreement during fiscal year 1998.

                                       27
<PAGE>
 
McDermott Incorporated and MIICO are parties to an agreement pursuant to which
McDermott Incorporated may borrow up to $150,000,000 from MIICO at interest
rates computed at the applicable federal rate determined by the IRS.  There were
no borrowings against this agreement at March 31, 1998 or 1997.

At March 31, 1998 and 1997, McDermott Incorporated and its consolidated
subsidiaries had available various uncommitted short-term lines of credit from
banks totalling $100,328,000 and $134,695,000, respectively. Borrowings against
these lines of credit at March 31, 1998 and 1997 were $2,849,000 and
$24,555,000, respectively.  In addition, The Babcock & Wilcox Company had
available to it a $150,000,000 unsecured committed revolving credit facility
(the "B&W Revolver").  There were no borrowings against this facility at March
31, 1998, while at March 31, 1997, $150,000,000 was outstanding.  As a condition
to borrowing under the B&W Revolver, The Babcock & Wilcox Company must meet or
exceed certain financial covenant requirements.  Negotiations are in progress to
replace the current B&W Revolver with a $200,000,000 three year unsecured
committed revolving credit and letter of credit facility (the "BWICO Revolver")
to be issued jointly to the Babcock & Wilcox Investment Company, The Babcock &
Wilcox Company and BWXT.  Borrowing by the three companies against the facility
cannot exceed an aggregate amount of $50,000,000.  The remaining $150,000,000
will be reserved for the issuance of letters of credit. During fiscal year 1999,
borrowings against the BWICO Revolver are expected to be minimal as management
expects The Babcock & Wilcox Company to be able to fund itself from operating
cash flow.

McDermott Incorporated is restricted, as a result of covenants in certain
agreements, in its ability to transfer funds to International and its
subsidiaries through cash dividends or through unsecured loans or investments.
Substantially all of the net assets of McDermott Incorporated are subject to
such restrictions.  At March 31, 1998, the most restrictive of these covenants
with respect to the payment of dividends by McDermott Incorporated would
prohibit the payment of dividends other than current dividends on outstanding
preferred stock.

Subsequent to March 31, 1998, McDermott Incorporated amended its public debt
indentures to permit the call for redemption of its preferred stock provided
that any cash outlay is funded by a capital infusion from International.
Management has called for redemption on July 17, 1998, all of McDermott
Incorporated's outstanding Series B Cumulative Preferred Stock.  Management is
also considering calling for redemption the outstanding Series A Cumulative
Convertible Preferred Stock.

Working capital decreased to $69,900,000 at March 31, 1998 from $71,284,000 at
March 31, 1997.  During 1998, McDermott Incorporated expects to obtain funds to
meet capital expenditure, working capital and debt maturity requirements from
operating activities, additional borrowings and capital contributions from
International (if required).  Leasing agreements for equipment, which are short-
term in nature, are not expected to impact McDermott Incorporated's liquidity or
capital resources.

McDermott Incorporated's quarterly dividends of $0.55 per share on the Series A
$2.20 Cumulative Convertible Preferred Stock and $0.65 per share on the Series B
$2.60 Cumulative Preferred Stock were the same in 1998 and 1997.

                                       28
<PAGE>
 
McDermott Incorporated has provided a valuation allowance ($51,861,000 at March
31, 1998) for deferred tax assets which cannot be realized through carrybacks
and future reversals of existing taxable temporary differences.  Management
believes that remaining deferred tax assets at March 31, 1998 are realizable
through carrybacks and future reversals of existing taxable temporary
differences and, if necessary, the implementation of tax planning strategies
involving sales  of appreciated assets.   An uncertainty that affects the
ultimate realization of deferred tax assets is the possibility of declines in
value of appreciated assets involved in identified tax planning strategies.
This factor has been considered in determining the valuation allowance.
Management will continue to assess the adequacy of the valuation allowance on a
quarterly basis.

IMPACT OF THE YEAR 2000
-----------------------

The Year 2000 issue is the result of computer systems being written using two
digits rather than four to define the applicable year.  This could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, an inability to process transactions, send invoices, or
engage in similar normal business activities.  McDermott Incorporated has
established a Year 2000 risk management program to identify and correct problems
associated with the Year 2000 issue.  The scope of McDermott Incorporated's Year
2000 risk management program covers computer systems, process control systems,
and products liability.

Based on assessments, McDermott Incorporated has determined that it will be
required to modify or replace significant portions of its business system
software so that those systems will function properly with respect to dates in
the Year 2000 and thereafter.  McDermott Incorporated presently believes that
with modifications to existing software and conversions to new software, the
Year 2000 issue will not pose significant operational problems for its computer
systems.  McDermott Incorporated has several hardware and operating systems
software environments.  The mainframe computing environment is provided by a
third party.  Operating system upgrades, application remediation and application
replacement projects are in progress.  If modifications and conversions are not
made, or are not completed timely, the Year 2000 issue could have a material
impact on the operations of McDermott Incorporated.

McDermott Incorporated has initiated a program to determine the nature of
potential exposure related to the Year 2000 issue for products it has sold, to
develop a communication program for customers potentially impacted, and to
assess process control systems.  McDermott Incorporated does not expect this
exposure to have a material adverse effect on its results of operations.

McDermott Incorporated will use both internal and external resources to
reprogram, replace, and test the software for Year 2000 modifications.
McDermott Incorporated's business units and its Corporate Office are
anticipating having all critical systems Year 2000 compliant no later than June
30, 1999, which is prior to any anticipated impact on their business.  The total
cost of the Year 2000 projects is estimated at $24,000,000 and is being funded
through operating cash flows.  Of the total project cost, $6,000,000 is
attributable to the purchase of software which will be capitalized and the
$18,000,000 will be expensed as incurred.  Costs to date include $3,000,000
capital and $5,000,000 of expense.

                                       29
<PAGE>
 
The costs of the project and the dates on which McDermott Incorporated believes
it will complete its Year 2000 project are based on management's best estimates.
These estimates were derived using numerous assumptions of future events,
including continued availability of resources, third party modification plans,
and other factors.  However, there can be no assurance that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel, the ability to identify and
correct all Year 2000 impacted areas, and other similar uncertainties.

NEW ACCOUNTING STANDARD
-----------------------

In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which is effective for fiscal years beginning
after December 15, 1997. SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements.  McDermott Incorporated has not yet finalized its
review of the impact of this statement, but management does not expect it to
have a material impact on the consolidated financial statements.

                                       30
<PAGE>
 
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
        --------------------------------------------------------

 
                         REPORT OF INDEPENDENT AUDITORS
                         ------------------------------


The Board of Directors and Stockholders
McDermott Incorporated


We have audited the accompanying consolidated balance sheet of McDermott
Incorporated as of March 31, 1998 and 1997, and the related consolidated
statements of income (loss), stockholder's equity and cash flows for each of the
three years in the period ended March 31, 1998.  These financial statements are
the responsibility of the Company's management.  Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of McDermott
Incorporated at March 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
March 31, 1998, in conformity with generally accepted accounting principles.



                                      ERNST & YOUNG LLP

New Orleans, Louisiana
May 19, 1998, except for the
fifth and sixth paragraphs of
Note 11, as to which the date
is June 1, 1998

                                       31
<PAGE>
 
                             MCDERMOTT INCORPORATED
                           CONSOLIDATED BALANCE SHEET
                            MARCH 31, 1998 AND 1997
                                     ASSETS
<TABLE>
<CAPTION>
                                                          1998        1997
                                                        --------   ----------
                                                            (In thousands)
<S>                                                     <C>        <C>
Current Assets:
 Cash and cash equivalents                              $ 58,191   $   56,782
 Accounts receivable - trade                             328,813      286,011
 Accounts receivable - other                              99,281      139,949
 Products liabilities recoverable - current              143,588      183,000
 Contracts in progress                                   168,014      244,231
 Inventories                                              60,526       59,894
 Deferred income taxes                                    76,489       56,359
 Other current assets                                      6,853       15,053
--------------------------------------------------------------------------------
 
      Total Current Assets                               941,755    1,041,279
--------------------------------------------------------------------------------
Property, Plant and Equipment, at Cost:
 Land                                                      8,183        9,036
 Buildings                                               121,289      131,853
 Machinery and equipment                                 358,093      377,167
 Property under construction                              13,115       15,886
--------------------------------------------------------------------------------
                                                         500,680      533,942
      Less accumulated depreciation                      310,656      314,600
--------------------------------------------------------------------------------

Net Property, Plant and Equipment                        190,024      219,342
--------------------------------------------------------------------------------

Environmental and Products Liabilities Recoverable       604,870      720,913
--------------------------------------------------------------------------------

Investment in McDermott International, Inc.              592,312      595,982
--------------------------------------------------------------------------------
Excess of Cost Over Fair Value of Net
 Assets of Purchased Businesses Less Accumulated
 Amortization of $99,272,000 at March 31, 1998
 and $104,960,000 at March 31, 1997                      104,924      119,077
--------------------------------------------------------------------------------

Prepaid Pension Costs                                    282,348      266,837
--------------------------------------------------------------------------------

Other Assets                                             146,585      173,740
--------------------------------------------------------------------------------

      TOTAL                                           $2,862,818   $3,137,170
================================================================================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       32
<PAGE>
 
                     LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
                                                               1998        1997
                                                             --------    --------
                                                               (In thousands)
<S>                                                          <C>        <C>
Current Liabilities:
 Notes payable and current maturities of long-term debt      $112,828   $  313,692
 Accounts payable                                             135,070      116,452
 Accounts payable to McDermott
   International, Inc.                                         27,506        9,182
 Environmental and products liabilities - current             179,746      210,352
 Accrued employee benefits                                     98,872       79,573
 Accrued liabilities - other                                  137,064      130,329
 Advance billings on contracts                                177,219      109,736
 U.S. and foreign income taxes                                  3,550          679
----------------------------------------------------------------------------------
 
      Total Current Liabilities                               871,855      969,995
----------------------------------------------------------------------------------

Long-Term Debt                                                352,360      379,487
----------------------------------------------------------------------------------

Accumulated Postretirement Benefit Obligation                 365,012      373,232
----------------------------------------------------------------------------------

Environmental and Products Liabilities                        751,620      903,379
----------------------------------------------------------------------------------

Other Liabilities                                             102,119       95,500
----------------------------------------------------------------------------------

Contingencies
----------------------------------------------------------------------------------

Redeemable Preferred Stocks:
 Series A $2.20 cumulative convertible, $1.00 par value;
  at redemption value                                          88,084       88,087
 Series B $2.60 cumulative, $1.00 par value;
  at redemption value                                          67,274       82,896
----------------------------------------------------------------------------------

      Total Redeemable Preferred Stocks                       155,358      170,983
----------------------------------------------------------------------------------
 
Stockholder's Equity:
 Common stock, par value $1.00 per share, 3,700 shares
   authorized and issued, 3,600 shares outstanding                  4            4
 Capital in excess of par value                               691,520      691,605
 Deficit                                                     (394,455)    (422,123)
 Minimum pension liability                                     (4,521)      (1,655)
 Currency translation adjustments                             (28,054)     (23,237)
----------------------------------------------------------------------------------
      Total Stockholder's Equity                              264,494      244,594
----------------------------------------------------------------------------------

 TOTAL                                                     $2,862,818   $3,137,170
==================================================================================
</TABLE> 

                                       33
<PAGE>
 
                            McDERMOTT INCORPORATED
                    CONSOLIDATED STATEMENT OF INCOME (LOSS)
                FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1998

<TABLE>
<CAPTION>
 
 
                                                      1998         1997         1996
                                                   ----------   ----------   ----------
                                                              (In thousands)
<S>                                                <C>          <C>          <C>
 
Revenues                                           $1,842,659   $1,796,257   $2,027,975
-----------------------------------------------------------------------------------------  
 Costs and Expenses:
   Cost of operations (excluding depreciation
     and amortization)                              1,588,634    1,722,129    1,862,504
  Depreciation and amortization                        45,628       45,991       50,280
  Selling, general and
     administrative expenses                          102,103      140,117      147,153
----------------------------------------------------------------------------------------- 
                                                    1,736,365    1,908,237    2,059,937
-----------------------------------------------------------------------------------------
Gain (Loss) on Asset Disposals and
 Impairments - net                                     18,419      (17,645)       6,425
-----------------------------------------------------------------------------------------

Operating Income (Loss) before
 Income from Investees                                124,713     (129,625)     (25,537)

Income from Investees                                   9,310        7,054       36,281
-----------------------------------------------------------------------------------------

   Operating Income (Loss)                            134,023     (122,571)      10,744
----------------------------------------------------------------------------------------- 
Other Income (Expense):
  Interest income                                       4,754        2,521       11,798
  Interest expense                                    (51,029)     (56,321)     (52,910)
  Other-net                                            (7,300)     (24,020)      (2,044)
----------------------------------------------------------------------------------------- 
 
                                                      (53,575)     (77,820)     (43,156)
----------------------------------------------------------------------------------------- 
Income (Loss) before Provision for
   (Benefit from) Income Taxes                         80,448     (200,391)     (32,412)
 
Provision for (Benefit from) Income Taxes              40,058      (25,586)      (5,269)
----------------------------------------------------------------------------------------- 

Net Income (Loss)                                   $  40,390    $(174,805)    $(27,143)
=========================================================================================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       34
<PAGE>
 
                             MCDERMOTT INCORPORATED
                 CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
                FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1998
                                 (In thousands)
<TABLE>
<CAPTION>
 
 
                                               Capital       Retained    Minimum      Currency        Total
                                  Common      in Excess      Earnings    Pension     Translation   Stockholder's
                                 Stock(1)    of Par Value    (Deficit)  Liability    Adjustments     Equity
                                -------------------------------------------------------------------------------- 
<S>                             <C>          <C>             <C>        <C>          <C>           <C>
Balance March 31, 1995            $  4         $620,981      $(193,341)  $   (39)      $(15,070)     $ 412,535
---------------------------------------------------------------------------------------------------------------- 

Division of pension plan             -            4,585              -         -              -          4,585
Redemption of preferred
 shares                              -              206              -         -              -            206  
Tax benefit on stock options         -               69              -         -              -             69
Net loss                             -                -        (27,143)        -              -        (27,143)
Preferred stock dividends            -                -        (13,539)        -              -        (13,539)
Minimum pension liability            -                -              -      (724)             -           (724)
Loss on investments                  -                -            (52)        -              -            (52)
Translation adjustments              -                -              -         -         (3,018)        (3,018)
---------------------------------------------------------------------------------------------------------------- 

Balance March 31, 1996               4          625,841       (234,075)     (763)       (18,088)       372,919
----------------------------------------------------------------------------------------------------------------  

Sale of assets to International      -            4,655              -         -              -          4,655
Capital contribution from
 International                       -           61,000              -         -              -         61,000
Redemption of preferred
 shares                              -               68              -         -              -             68
Tax benefit on stock options         -               41              -         -              -             41
Net loss                             -                -       (174,805)        -              -       (174,805)
Preferred stock dividends            -                -        (13,243)        -              -        (13,243)
Minimum pension liability            -                -              -      (892)             -           (892)
Translation adjustments              -                -              -         -         (5,149)        (5,149)
----------------------------------------------------------------------------------------------------------------  

Balance March 31, 1997               4          691,605       (422,123)   (1,655)       (23,237)       244,594
---------------------------------------------------------------------------------------------------------------- 

Sale of assets to International      -           (5,220)             -         -              -         (5,220)
Redemption of preferred
 shares                              -              219              -         -              -            219
Tax benefit on stock options                      4,916              -         -              -          4,916
Net income                           -                -         40,390         -              -         40,390
Preferred stock dividends            -                -        (12,722)        -              -        (12,722)
Minimum pension liability            -                -              -    (2,866)             -         (2,866)
Translation adjustments              -                -              -         -         (4,817)        (4,817)
----------------------------------------------------------------------------------------------------------------  

Balance March 31, 1998            $  4         $691,520      $(394,455)  $(4,521)      $(28,054)     $ 264,494
================================================================================================================ 
</TABLE> 
(1) There were 3,600 common shares outstanding at March 31, 1998, 1997, and
     1996 consisting of 3,000 voting shares entitled to 12,000 votes per share
     and 600 non-voting shares.

See accompanying notes to the consolidated financial statements.

                                       35
<PAGE>
 
                            McDERMOTT INCORPORATED
                     CONSOLIDATED STATEMENT OF CASH FLOWS
                FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1998
               INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
                                                              1998         1997         1996
                                                           ----------   ----------   ----------
                                                                      (In thousands)
<S>                                                        <C>          <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)                                          $  40,390    $(174,805)   $ (27,143)
------------------------------------------------------------------------------------------------- 
Adjustments to reconcile net income (loss) to net
  cash provided by (used in) operating activities:
   Depreciation and amortization                              45,628       45,991       50,280
   Income or loss of investees,
     less dividends                                            1,657        5,648        3,453
   (Gain) loss on asset disposals and
      impairments-net                                        (18,419)      17,645       (6,425)
   Provision for deferred taxes                                6,675        8,617       10,361
   Other                                                        (470)         567       (4,984)
   Changes in assets and liabilities, net of effects
      from acquisitions and divestitures:
       Accounts receivable                                   (23,191)      65,584      (76,598)
       Accounts payable                                       39,064      (26,807)     (39,001)
       Inventories                                              (610)         854        3,252
       Net contracts in progress and advance billings        142,681      (10,461)     (29,085)
       Environmental and products liabilities                 11,525       86,561       16,989
       Income taxes                                            7,640       (4,528)     (25,230)
       Accrued liabilities                                     7,825      (21,455)      20,310
       Other, net                                             10,428       15,448      (52,264)
Proceeds from insurance for products liabilities
 claims                                                      157,656      153,141      107,481
Payments of products liabilities claims                     (196,091)    (188,205)    (151,961)
-------------------------------------------------------------------------------------------------  
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES                                                   232,388      (26,205)    (200,565)
-------------------------------------------------------------------------------------------------  
 
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions                                                  (6,627)           -      (13,083)
Proceeds from asset disposals                                 54,220       48,345       29,465
Purchases of property, plant and equipment                   (17,869)     (26,663)     (39,111)
Purchases of long-term investments                                 -            -     (196,610)
Sales and maturities of short and
 long-term investments                                             -            -      560,455
Proceeds from redemption of International stock                2,500        2,500        2,500
Investments in equity investees                               (4,178)      (8,266)        (299)
Other                                                            294            8        1,379
-------------------------------------------------------------------------------------------------  
NET CASH PROVIDED BY INVESTING ACTIVITIES                     28,340       15,924      344,696
------------------------------------------------------------------------------------------------- 
</TABLE> 

                                       36
<PAGE>
 
                                                                       Continued

                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
                                                     1998        1997         1996
                                                  ----------   ---------   ----------
                                                            (In thousands)
<S>                                               <C>          <C>         <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of long-term debt                         $ (45,164)   $   (165)   $(150,165)
Increase (decrease)  in short-term borrowing       (182,691)     57,240      (37,967)
Increase (decrease) in short-term borrowing
from McDermott International, Inc.                        -     (65,363)      65,363
Dividends paid                                      (12,821)    (13,291)     (13,663)
Capital contribution from International                   -      68,162            -
Redemption of preferred stock                       (15,406)     (2,250)      (5,743)
Other                                                (3,425)       (281)        (439)
--------------------------------------------------------------------------------------- 
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES                                         (259,507)     44,052     (142,614)
---------------------------------------------------------------------------------------  

EFFECTS OF EXCHANGE RATE CHANGES ON CASH                188         125          355
--------------------------------------------------------------------------------------- 

NET INCREASE IN CASH AND CASH EQUIVALENTS             1,409      33,896        1,872
--------------------------------------------------------------------------------------- 

CASH AND CASH EQUIVALENTS AT BEGINNING
  OF YEAR                                            56,782      22,886       21,014
--------------------------------------------------------------------------------------- 

CASH AND CASH EQUIVALENTS AT END
  OF YEAR                                          $ 58,191    $ 56,782     $  22,886
=======================================================================================

SUPPLEMENTAL DISCLOSURES OF CASH
  FLOW INFORMATION:

Cash paid during the period for:
  Interest (net of amount capitalized)             $ 54,670    $ 50,341     $ 57,305
  Income taxes (net of refunds)                    $(15,232)   $ (8,607)    $ 24,697
=======================================================================================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       37
<PAGE>
 
                            MCDERMOTT INCORPORATED
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1998

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
---------------------------

The consolidated financial statements include the accounts of McDermott
Incorporated and all its subsidiaries.  Investments in joint venture and other
entities in which McDermott Incorporated has a 20% to 50% interest are accounted
for on the equity method.  Differences between the cost of equity method
investments and the amount of underlying equity in net assets of the investees
are amortized systematically to income.  All significant intercompany
transactions and accounts have been eliminated.  Certain amounts previously
reported have been reclassified to conform with the presentation at March 31,
1998.

Unless the context otherwise requires, hereinafter, "International" means
McDermott International, Inc., a Panama corporation; "JRM" means J. Ray
McDermott, S.A., a majority owned subsidiary of International, and its
consolidated subsidiaries; and "McDermott International" means the consolidated
enterprise.  International is the parent company of McDermott Incorporated.

Use of Estimates
----------------

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

Accounting Changes
------------------

Transfers of Financial Assets - During the fiscal year ended March 31, 1997,
McDermott Incorporated adopted Statement of Financial Accounting Standards
("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities."  Accordingly, beginning January 1, 1997,
transfers of accounts receivable previously accounted for as sales are accounted
for as secured borrowings.  Other-net expense includes expenses of $4,737,000
and $8,518,000 in fiscal years 1997 and 1996, respectively, on receivables
accounted for as sales.  Adoption of the new standard was not material to
results for the three months ended March 31, 1997.

Segments - During the fiscal year ended March 31, 1998, McDermott Incorporated
adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. SFAS No. 131
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. The adoption of SFAS No. 131 did not
affect results of operations or financial position, but did affect the
disclosure of segment information.

                                       38
<PAGE>
 
Foreign Currency Translation
----------------------------

Assets and liabilities of foreign operations, other than operations in highly
inflationary economies, are translated into U. S. Dollars at  current exchange
rates and income  statement items are translated at average exchange rates for
the year.  Adjustments resulting from the translation of foreign currency
financial statements are recorded in a separate component of equity.  Foreign
currency transaction adjustments are reported in income.  Included in Other
Income (Expense) are transaction gains (losses) of $(135,000), $801,000, and
$(750,000) for fiscal years 1998, 1997 and 1996, respectively.

Contracts and Revenue Recognition
---------------------------------

Contract revenues and related costs are principally recognized on a percentage
of completion method for individual contracts or components thereof based upon
work performed or a cost to cost method, as applicable to the product or
activity involved.  Revenues and related costs so recorded, plus accumulated
contract costs that exceed amounts invoiced to customers under the terms of the
contracts, are included in Contracts in Progress.  Billings that exceed
accumulated contract costs and revenues and costs recognized under percentage of
completion are included in Advance Billings on Contracts.  Most long-term
contracts have provisions for progress payments.  There are no unbilled revenues
which will not be billed.  Contract price and cost estimates are reviewed
periodically as the work progresses and adjustments proportionate to the
percentage of completion are reflected in income in the period when such
estimates are revised.  Provisions are made currently for all known or
anticipated losses.  Variations from estimated contract performance could result
in a material adjustment to operating results for any fiscal quarter or year.
Claims for extra work or changes in scope of work are included in contract
revenues when collection is probable.  Included in Accounts Receivable and
Contracts in Progress are approximately $4,177,000 and $39,346,000 relating to
commercial and U. S. Government contracts claims whose final settlement is
subject to future determination through negotiations or other procedures which
had not been completed at March 31, 1998 and 1997, respectively.

<TABLE>
<CAPTION>
                                                      1998       1997
                                                     -------   --------
                                                       (In thousands)
<S>                                                  <C>       <C>
Included in Contracts in Progress are:
Costs incurred less costs of revenue recognized      $68,041   $ 51,775
Revenues recognized less billings to customers        99,973    192,456
-------------------------------------------------------------------------

Contracts in Progress                               $168,014   $244,231
=========================================================================

Included in Advance Billings on Contracts are:
Billings to customers less revenues recognized      $204,836   $130,428
Costs incurred less cost of revenue recognized       (27,617)   (20,692)
-------------------------------------------------------------------------

Advance Billings on Contracts                       $177,219   $109,736
=========================================================================
</TABLE> 

                                       39
<PAGE>
 
McDermott Incorporated is usually entitled to financial settlements relative to
the individual circumstances of deferrals or cancellations of Power Generation
Systems contracts.  McDermott Incorporated does not recognize such settlements
or claims for additional compensation until final settlement is reached.

Included in accounts receivable - trade are amounts representing retainages on
contracts as follows:

<TABLE> 
<CAPTION> 
                                                          1998            1997
                                                      ------------    ------------
                                                            (In thousands)
<S>                                                   <C>             <C> 
Retainages                                            $ 55,470           $ 51,623
==================================================================================

Retainages expected to be collected after one year    $ 33,567           $ 29,159
=================================================================================
</TABLE> 

Of its long-term retainages at March 31, 1998, McDermott Incorporated
anticipates collection of $14,699,000 in fiscal year 2000, $17,261,000 in fiscal
year 2001 and $1,607,000 in fiscal year 2002.

Inventories
-----------

Inventories are carried at the lower of cost or market.  Cost is determined on
an average cost basis except for certain materials inventories, for which the
last-in-first-out (LIFO) method is used.  The cost of approximately 17% and 12%
of total inventories was determined using the LIFO method at March 31, 1998 and
1997, respectively.  Inventories at March 31, 1998 and 1997 are summarized
below:

<TABLE>
<CAPTION>
                                 1998      1997
                                -------   -------
                                 (In thousands)
<S>                             <C>       <C>
Raw Materials and Supplies      $44,595   $44,395
Work in Progress                  6,720     8,498
Finished Goods                    9,211     7,001
------------------------------------------------- 
                                $60,526   $59,894
=================================================
</TABLE> 

Warranty Expense
----------------

Estimated warranty expense which may be required to satisfy contractual
requirements, primarily of the Power Generation Systems segment, is accrued
relative to revenue recognition on the respective contracts.  In addition,
specific provisions are made where the costs of warranty are expected to
significantly exceed such accruals.

Environmental Clean-up Costs
----------------------------

McDermott Incorporated accrues for future decommissioning of its nuclear
facilities that will permit the release of these facilities to unrestricted use
at the end of each facility's life, which is a condition of its licenses from
the Nuclear Regulatory Commission, except for one facility which has provisions
in its government contracts pursuant to which all of its decommissioning costs
are covered by the U.S. Government.  Such accruals, based on the estimated cost
of those activities, are over the economic useful life of each facility, which
is estimated at 40

                                       40
<PAGE>
 
years.  Estimated costs are adjusted as further information develops or
circumstances change.  Costs of future expenditures for environmental clean-up
are not discounted to their present value.  Recoveries of environmental clean-up
costs from other parties are recognized as assets when their receipt is deemed
probable.

Research and Development
------------------------

The cost of research and development which is not performed on specific
contracts is charged to operations as incurred.  Such expense was approximately
$12,771,000, $14,842,000 and $21,491,000 in fiscal years 1998, 1997 and 1996,
respectively.  In addition, expenditures on research and development activities
of approximately $22,803,000, $34,170,000 and $45,106,000 in fiscal years 1998,
1997 and 1996, respectively, were paid for by customers of McDermott
Incorporated.

Depreciation, Maintenance and Repairs
-------------------------------------

Property, plant and equipment is depreciated on the straight-line method, using
estimated economic useful lives of 8 to 40 years for buildings and 2 to 28 years
for machinery and equipment.  Maintenance, repairs and renewals which do not
materially prolong the useful life of an asset are expensed as incurred.

Amortization of Excess of Cost Over Fair Value of Net Assets of Purchased
-------------------------------------------------------------------------
Businesses
----------

Excess of the cost over fair value of net assets of purchased businesses
primarily pertains to the acquisition of The Babcock & Wilcox Company, which is
being amortized on a straight-line basis over 40 years.  Management periodically
reviews goodwill to access recoverability, and impairments would be recognized
in operating results if permanent diminution in value were to occur.

Capitalization of Interest Cost
-------------------------------

In fiscal years 1998, 1997 and 1996, total interest cost incurred was
$51,030,000, $56,428,000 and $53,511,000, respectively, of which $1,000,
$107,000 and $601,000, respectively, was capitalized.

Cash Equivalents
----------------
Cash equivalents are highly liquid investments, with maturities of three months
or less when purchased.

Derivative Financial Instruments
--------------------------------

Derivatives, primarily forward exchange contracts, are utilized to minimize
exposure and reduce risk from foreign exchange fluctuations in the regular
course of business.  Gains and losses related to qualifying hedges of firm
commitments are deferred and are recognized in income or as adjustments of
carrying amounts when the hedged transactions occur.  Gains and losses on
forward exchange contracts which hedge foreign currency assets or liabilities
are recognized in income as incurred.  Such amounts effectively offset gains and
losses on the foreign currency assets or liabilities that are hedged.

                                       41
<PAGE>
 
Stock-Based Compensation
------------------------

McDermott Incorporated follows Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25")  and related
Interpretations in accounting for its participation in International's employee
stock plans.  Under APB 25, if the exercise price of the Company's employee
stock options equals or exceeds the fair value of the underlying stock on the
measurement date, no compensation expense is recognized.  If the measurement
date is later than the date of grant, compensation expense is recorded to the
measurement date based on the quoted market price of the underlying stock at the
end of each period.


NOTE 2 - ACQUISITION

During fiscal year 1998, McDermott Incorporated acquired the minority ownership
in Diamond Power Specialty U.K. for $6,627,000.

During fiscal year 1996, McDermott Incorporated acquired the assets of Joy
Environmental Technologies, which specialized in technologies used by electric
utilities and other industrial companies to comply with clean air regulations.
The purchase price was $13,083,000, of which approximately $6,457,000 was
assigned to excess of cost over the fair value of net assets acquired, and is
being amortized over a period of twenty years.  Operating results have been
included in the Consolidated Statement of Loss from the acquisition date.  Pro
forma results of operations have not been presented because the effects were not
significant.


NOTE 3   - INVESTMENTS IN JOINT VENTURES AND OTHER ENTITIES

Investments in entities which are accounted for on the equity method were
$21,347,000 and $31,434,000 at March 31, 1998 and 1997, respectively.
Transactions with entities for which investments are accounted for on the equity
method included sales to ($14,182,000, $22,043,000 and $37,487,000 in fiscal
years 1998, 1997 and 1996, respectively) and purchases from ($8,000, $11,921,000
and $378,000 in fiscal years 1998, 1997 and 1996, respectively) these entities.
Included in Accounts receivable - trade at March 31, 1998 and 1997 are
$2,134,000 and $2,390,000, respectively of receivables from unconsolidated
affiliates.  Included in Accounts payable at March 31, 1998 and 1997 are
$6,143,000 and $39,000, respectively, of payables to unconsolidated affiliates.
Dividends received from unconsolidated investees were $10,967,000, $12,702,000
and $39,734,000 in fiscal years 1998, 1997 and 1996, respectively.
Undistributed earnings of unconsolidated affiliates accounted for by the equity
method were $12,204,000 and $15,700,000, respectively, at March 31, 1998 and
1997.

                                       42
<PAGE>
 
Summarized combined balance sheet and income statement information, based on the
most recent financial information, for investments accounted for by the equity
method are presented below:

<TABLE>
<CAPTION>
                                                                1998       1997
                                                              --------   --------
                                                                 (In thousands)
<S>                                                           <C>         <C>
Current Assets                                                $ 32,136    $ 69,087
Non-Current Assets                                             102,200     259,108
----------------------------------------------------------------------------------- 

   Total Assets                                               $134,336    $328,195
=================================================================================== 
 
Current Liabilities                                           $ 20,483    $ 50,501
Non-Current Liabilities                                         70,687     196,112
Owners' Equity                                                  43,166      81,582
----------------------------------------------------------------------------------- 
Total Liabilities and Owners'
     Equity                                                   $134,336    $328,195
 ==================================================================================
 
                                                1998            1997        1996
                                              --------        --------    --------
                                                           (In thousands)
 
Revenues                                      $301,146        $316,178    $119,753
Gross Profit                                  $ 27,689        $ 34,124    $ 38,343
Income before Provision for Income Taxes      $ 28,957        $ 35,225    $ 92,734
Provision for Income Taxes                       2,127           3,935       4,843
----------------------------------------------------------------------------------- 

   Net Income                                 $ 26,830        $ 31,290    $ 87,891
===================================================================================
</TABLE>

                                       43
<PAGE>
 
NOTE 4 - INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences
between the financial and tax bases of assets and liabilities.  Significant
components of deferred tax assets and liabilities as of March 31, 1998 and 1997
were as follows:
 
                                                               1998       1997
                                                             --------   --------
                                                               (In thousands)
Deferred tax assets:
 Accrued warranty expense                                    $ 15,582  $ 15,915
 Accrued vacation pay                                           8,985     8,013
 Accrued liabilities for self-insurance (including
     postretirement health care benefits)                     161,444   162,481
 Accrued liabilities for executive and
  employee incentive compensation                              24,114    15,397
 Investments in joint ventures and affiliated companies         6,959     6,705
 Environmental and products liabilities                       363,598   434,852
 Operating loss carryforwards                                   7,363     5,535
 Other                                                         18,545    23,987
-------------------------------------------------------------------------------
  Total deferred tax assets                                   606,590   672,885
-------------------------------------------------------------------------------
 Valuation allowance for deferred tax assets                  (51,861)  (53,192)
-------------------------------------------------------------------------------
 Deferred tax assets                                          554,729   619,693
-------------------------------------------------------------------------------
Deferred tax liabilities:
 Property, plant and equipment                                 15,325    19,419
 Prepaid pension costs                                        107,413   101,982
 Investments in joint ventures and affiliated companies        13,921    10,483
 Insurance and other recoverables                             291,899   353,579
 Other                                                          2,644     4,028
------------------------------------------------------------------------------- 
 Total deferred tax liabilities                               431,202   489,491
------------------------------------------------------------------------------- 
 Net deferred tax assets                                    $ 123,527  $130,202
=============================================================================== 

Income (loss) before provision for (benefit from) income taxes was as follows:
 
                                               1998           1997        1996
                                             --------       ---------  ---------
                                                          (In thousands)
 
U. S.                                          $78,364   $   (156,922) $(33,241)
Other than U. S.                                 2,084        (43,469)      829
------------------------------------------------------------------------------- 
                                               $80,448   $   (200,391) $(32,412)
=============================================================================== 

                                       44
<PAGE>
 
The provision for (benefit from) income taxes consists of:
                                              1998            1997       1996
                                           ---------       --------   ---------
                                                       (In thousands)
Current:
 Federal                                       $26,992      $ (29,113) $(18,163)
 State and local                                 5,695         (2,301)   (3,810)
 Foreign                                           696         (2,789)    6,343
------------------------------------------------------------------------------- 
   Total current                                33,383        (34,203)  (15,630)
------------------------------------------------------------------------------- 
Deferred:
 Federal                                         1,416         14,398    14,703
 State and local                                  (108)           723    (3,009)
 Foreign                                         5,367         (6,504)   (1,333)
------------------------------------------------------------------------------- 
  Total deferred                                 6,675          8,617    10,361
-------------------------------------------------------------------------------
  Provision for (Benefit from) Income Taxes    $40,058      $ (25,586) $ (5,269)
=============================================================================== 

The effective income tax rate is reconciled to the statutory federal income tax
rate as follows:
 
                                         1998       1997       1996
                                       PERCENT    PERCENT    PERCENT
                                       --------   --------   --------
Statutory federal tax rate                35.0      (35.0)     (35.0)
State and local income tax effect          4.6        0.2       (8.5)
Foreign operations                        (2.2)       2.2       10.6    
Excess of cost over fair value of net 
   assets of purchased businesses          6.7        2.1        7.3
Non-deductible business expenses           1.2        0.6        4.9
Dividends from affiliates                  4.4        0.9        1.7
Minority interest                          1.0       (1.1)      (6.9)
Federal valuation allowance               (0.1)      16.3        3.8
Other                                     (0.8)       1.0        5.8
------------------------------------------------------------------------------- 
Effective Income Tax Rate                 49.8      (12.8)     (16.3)
=============================================================================== 

Undistributed earnings of foreign subsidiaries amounted to approximately
$43,000,000 at March 31, 1998.  These earnings are considered to be indefinitely
reinvested and, accordingly, no provision for U.S. federal and state and local
income taxes has been provided.  Upon distribution of those earnings, McDermott
Incorporated would be subject to both U.S. income taxes (subject to an
adjustment for foreign tax credits) and withholding taxes payable to the foreign
jurisdictions.  The unrecognized deferred income tax liability is estimated to
be approximately $16,700,000.  Withholding taxes of approximately $4,000,000
would be payable upon remittance of all previously unremitted earnings at March
31, 1998.

Settlements were reached with the Internal Revenue Service ("IRS") concerning
McDermott Incorporated's U.S. income tax liability through the fiscal year ended
March 31, 1988,

                                       45
<PAGE>
 
disposing of all U.S. federal income tax issues.  A preliminary agreement has
been reached between McDermott Incorporated and the IRS for the fiscal years
ended March 31, 1989 and March 31, 1990, subject to review by the joint
committee on taxation. The IRS has issued notices for fiscal years ended March
31, 1991 and March 31, 1992 asserting deficiencies in the amount of taxes
reported.  The deficiencies are based on issues substantially similar to those
of earlier years.  McDermott Incorporated believes that any income taxes
ultimately assessed will not exceed amounts already provided.

McDermott Incorporated has provided a valuation allowance ($51,861,000 at March
31, 1998) for deferred tax assets which cannot be realized through carrybacks
and future reversals of existing taxable temporary differences.  Management
believes that remaining deferred tax assets at March 31, 1998 are realizable
through carrybacks and future reversals of existing taxable temporary
differences and, if necessary, the implementation of tax planning strategies
involving sales  of appreciated assets.   An uncertainty that affects the
ultimate realization of deferred tax assets is the possibility of declines in
value of appreciated assets involved in identified tax planning strategies.
This factor has been considered in determining the valuation allowance.
Management will continue to assess the adequacy of the valuation allowance on a
quarterly basis.

NOTE 5 - RELATED PARTY TRANSACTIONS

McDermott Incorporated has material transactions with International and its
other subsidiaries occurring in the normal course of operations.  Related party
transactions reflected in McDermott Incorporated's revenues include the sales of
engineering and design services and fabrication services ($6,439,000,
$12,838,000, and $40,718,000 in fiscal years 1998, 1997 and 1996 respectively).
Other related party transactions include the allocation of general and
administrative and other costs to International ($20,074,000, $21,488,000 and
$11,900,000 in fiscal years 1998, 1997 and 1996, respectively), placing certain
insurance coverage (at prices determined on an annual basis of $3,283,000,
$4,287,000, and $15,213,000 in fiscal years 1998, 1997 and 1996, respectively)
through commercial insurance carriers, which in turn substantially reinsure such
exposure to a wholly-owned subsidiary of International, and the management of
certain of the investments of McDermott Incorporated and its pension plans by a
wholly-owned subsidiary of International for which McDermott Incorporated paid
fees of $2,642,000, $2,746,000 and $2,901,000 in fiscal years 1998, 1997 and
1996, respectively.

McDermott Incorporated had sales to unconsolidated affiliates of International
of $9,199,000, $5,649,000 and $6,138,000 in fiscal years 1998, 1997 and 1996,
respectively.  Purchases from these affiliates were $16,533,000, $19,021,000 and
$29,538,000 in fiscal years 1998, 1997 and 1996, respectively.  Included in
Accounts receivable - trade at March 31, 1998 and 1997 are $3,613,000 and
$2,887,000, respectively, of receivables due from unconsolidated affiliates of
International.  Included in non-current Other Assets at March 31, 1998 and 1997
are $3,733,000 and $5,976,000, respectively, of receivables from these
affiliates.  Included in Accounts payable at March 31, 1998 and 1997 are
$2,633,000 and $3,204,000, respectively, of payables to these affiliates.

During fiscal year 1998, McDermott Incorporated sold its investment in McDermott
Engineering Houston, LLC having a net book value of $6,035,000 to International
for

                                       46
<PAGE>
 
$2,909,000.  The excess of the net book value over the sales price was included
in Capital in Excess of Par Value.

During fiscal year 1997, McDermott Incorporated sold certain property, plant and
equipment having a net book value of $1,440,000 to International for $8,602,000.
The excess of the sales price over the net book value of net assets sold to
International of $4,655,000 (net of tax of $2,507,000) was included in Capital
in Excess of Par Value.  During fiscal year 1998, a purchase price adjustment of
$2,094,000 (net of taxes of $1,128,000) was made on the above sale.  The
purchase price adjustment was included in Capital in Excess of Par Value.

McDermott Incorporated and MIICO are parties to an agreement pursuant to which
McDermott Incorporated may borrow up to $150,000,000.  There were no borrowings
against this agreement at March 31, 1998 or 1997.

Under a reorganization during the fiscal year ended March 31, 1983,
International became the parent of the McDermott group of companies, which
includes McDermott Incorporated which prior to the reorganization was the parent
company.  McDermott Incorporated's investment in International represents its
right to the undistributed earnings of International existing at the time of the
reorganization less subsequent distributions by International to McDermott
Incorporated.  In order to preserve  McDermott Incorporated's right to the
undistributed earnings and provide for the distribution of such earnings to
McDermott Incorporated should either McDermott Incorporated or International
elect not to keep these earnings invested with International, McDermott
Incorporated retained its ownership of 100,000 shares of International Common
Stock, received 100,000 shares of International Series A Participating Preferred
Stock and 100,000 shares of International Series B Non-Voting Preferred Stock,
and entered into a Stock Purchase and Sale Agreement with International (the
"Intercompany Agreement").  Both Series A and Series B Preferred Stocks have
certain rights in the event of liquidation of International.  Series B Preferred
Stock is currently callable by International at $275 per share and 10,000 shares
are being redeemed by International each year at $250 per share. Such redemption
began in November 1992.  The Series A and Series B Preferred Stocks are entitled
to annual per share dividends of $10 (but no more than ten times the amount of
per share dividends paid by International on its Common Stock) and $20,
respectively, and such dividends are cumulative to the extent not paid.  Shares
of Series A Preferred Stock are also entitled to additional dividends whenever
dividends in excess of $3 per International Common Share are declared in any
fiscal year.  Dividends and proceeds from redemption of Series B Preferred Stock
received from International have been accounted for as a reduction of McDermott
Incorporated's investment in International.

Pursuant to the Intercompany Agreement, McDermott Incorporated  has the right to
sell to International and International has the right to buy from McDermott
Incorporated, 100,000 units, each unit consisting of one share of International
Common Stock and one share of International Series A Participating Stock, at a
price based primarily upon the stockholders' equity of McDermott International
at the close of the fiscal year preceding the date at which the right to sell or
buy, as the case may be, is exercised, and, to a limited extent, upon the price-
to-book value of the Dow Jones Industrial Average.  If a unit is sold to
International upon McDermott Incorporated's exercise of its right to sell under
the Intercompany Agreement, the purchase price of such unit will be 90% of the
then current value of the unit (the "current unit value").  If a unit is sold to
International pursuant to an exercise by International of its right

                                       47
<PAGE>
 
to purchase under the Intercompany Agreement, the purchase price of such unit
will be 110% of the current unit value.  At April 1, 1998, the current unit
value was $2,424 and the aggregate current unit value for McDermott
Incorporated's 100,000 units was $242,357,000.  Both parties intend to preserve
McDermott Incorporated's right to the undistributed earnings by not exercising
any rights under the Intercompany Agreement that would result in a loss to
McDermott Incorporated.  The net proceeds to McDermott Incorporated from the
exercise of any rights under the Intercompany Agreement would be subject to U.S.
federal, state and other applicable taxes.  No tax provisions have been
established, since there is no present intention by either party to exercise
such rights.

McDermott Incorporated maintains the Thrift Plan for Employees of McDermott
Incorporated and Participating Subsidiary and Affiliated Companies (the "Thrift
Plan"), which is a defined contribution plan that includes a cash or deferred
arrangement.  Monthly employer contributions are equal to 50% of the first 6% of
compensation (as defined in the plan) contributed by participants, and may be
made, at the discretion of McDermott Incorporated, in cash or in Common Stock of
International.  When monthly employer contributions are made in stock, McDermott
Incorporated pays cash to International and shares of Common Stock of
International are issued to the Thrift Plan from the authorized but unissued
share capital of International.  The number of such shares is determined based
on the closing price on the last business day of the month as reported on the
New York Stock Exchange Composite Tape with fractional shares paid in cash.
During fiscal years 1998, 1997 and 1996, respectively, 191,058, 306,089 and
300,951 shares were purchased by McDermott Incorporated for $5,986,000,
$6,030,000 and $6,347,000.
 
                NOTE 6 - LONG-TERM DEBT AND NOTES PAYABLE

Long-term debt consists of:
                                                              1998        1997
                                                              ----        ----  
                                                               (In thousands)
 Unsecured Debt:
  Series A Medium-Term Notes (maturities ranging
   from 1 to 5 years; interest at various
   rates ranging from 8.20% to 9.00%)                       $ 40,000   $  75,000
  Series B Medium-Term Notes (maturities ranging
   from 1 to 25 years; interest at various
   rates ranging from 6.50% to 8.75%)                         91,000     101,000
  9.375% Notes due 2002 ($225,000,000 principal value)       224,665     224,598
  Other notes payable through 2009 (interest at
   various rates ranging to 10%)                              19,030      19,170
Secured Debt:
  Other notes payable through 2012 and
   capitalized lease obligations                               4,861       5,087
--------------------------------------------------------------------------------
                                                             379,556     424,855
Less: Amounts due within one year                             27,196      45,368
--------------------------------------------------------------------------------
                                                            $352,360   $ 379,487
================================================================================
 

                                       48
<PAGE>
 
Notes payable and current maturities of long-term debt consist of:
 
                                                            1998          1997
                                                            ----          ----
                                                             (In thousands)
Short-term lines of credit - unsecured                   $  2,849     $ 174,555
Secured borrowings                                         82,783        93,769
Current maturities of long-term debt                       27,196        45,368
------------------------------------------------------------------------------- 
                                                         $112,828     $ 313,692
=============================================================================== 
Weighted average interest rate on short-term borrowings      5.82%         6.26%
=============================================================================== 

The Indentures for the 9.375% Notes due 2002 and the Series A and B Medium Term
Notes contain certain covenants which restrict the amount of funded indebtedness
that McDermott Incorporated may incur, and place limitations on certain
restricted payments, certain transactions with International and its other 
subsidiaries, the creation of certain liens and the amendment of the
Intercompany Agreement.

Maturities of long-term debt during the five fiscal years subsequent to March
31, 1998 are as follows:  1999 - $27,196,000; 2000 - $30,673,000; 2001 -
$34,000; 2002 -$224,699,000; 2003 - $25,000.

McDermott Incorporated is restricted, as a result of covenants in certain credit
agreements, in its ability to transfer funds to International and its
subsidiaries through cash dividends or through unsecured loans or investments.
Substantially all of the net assets of McDermott Incorporated are subject to
such restrictions.  At March 31, 1998, the most restrictive of these covenants
with respect to the payment of dividends by McDermott Incorporated would
prohibit the payment of dividends other than the current dividends on
outstanding preferred stock.

The Babcock & Wilcox Company has an agreement with a U.S. bank whereby it can
sell, with limited recourse, an undivided interest in a designated pool of
qualified accounts receivable.  Under the terms of the agreement, which is
subject to annual renewal, new receivables are added to the pool as collections
reduce previously sold accounts receivable.  The maximum sales limit was reduced
during fiscal year 1998 from $125,000,000 to $100,000,000.  At March 31, 1998
and 1997, approximately $82,783,000 and $93,769,000, respectively, of
receivables had been sold under this agreement and are accounted for as secured
borrowings in the accompanying balance sheet.

At March 31, 1998 and 1997, McDermott Incorporated had available various
uncommitted short-term lines of credit from banks totalling $100,328,000 and
$134,695,000, respectively. Borrowings against these lines of credit at March
31, 1998 and 1997 were $2,849,000 and $24,555,000, respectively.  In addition,
at March 31, 1998, there were no borrowings under the $150,000,000 unsecured
committed revolving credit facility of The Babcock & Wilcox Company (the "B&W
Revolver"), while at March 31, 1997, $150,000,000 was outstanding.  As a
condition to borrowing under the B&W Revolver, The Babcock & Wilcox Company must

                                       49
<PAGE>
 
meet or exceed certain financial covenant requirements.  Negotiations are in
progress to replace the current B&W Revolver with a new three year unsecured
committed revolving credit and letter of credit facility to be issued jointly to
the Babcock & Wilcox Investment Company, The Babcock & Wilcox Company and BWX
Technologies, Inc. ("BWXT").

NOTE 7 - PENSION PLANS AND POSTRETIREMENT BENEFITS

Pension Plans - McDermott Incorporated provides retirement benefits, primarily
through non-contributory pension plans, for substantially all of its regular
full-time employees, except certain non-resident alien employees of foreign
subsidiaries who are not citizens of a European Community country or who do not
earn income in the United States, Canada, or the United Kingdom.  Salaried plan
benefits are based on final average compensation and years of service, while
hourly plan benefits are based on a flat benefit rate and years of service.
McDermott Incorporated's funding policy is to fund applicable pension plans to
meet the minimum funding requirements of the Employee Retirement Income Security
Act of 1974 (ERISA) and, generally, to fund other pension plans as recommended
by the respective plan actuary and in accordance with applicable law.  At
January 1, 1998 and 1997, approximately one-half of total plan assets were
invested in listed stocks and bonds.  The remaining assets were held in foreign
equity funds, U.S. Government securities and investments of a short-term nature.

U.S. Pension Plans
------------------

The net periodic pension benefit for fiscal years 1998, 1997 and 1996 included
the following components:
<TABLE>
<CAPTION>
                                                         1998         1997         1996
                                                      ----------   ----------   ----------
                                                                 (In thousands)
<S>                                                   <C>          <C>          <C>
Service cost - benefits earned during the period      $  19,189    $  20,317    $  18,475
Interest cost on projected benefit obligation            75,924       69,395       66,282
Actual return on plan assets                           (261,487)    (147,984)    (212,411)
Net amortization and deferral                           155,364       52,263      119,898
----------------------------------------------------------------------------------------- 
Net periodic pension benefit                          $ (11,010)   $  (6,009)   $  (7,756)
========================================================================================= 
</TABLE> 

                                       50
<PAGE>
 
The following table sets forth the U.S. plans' funded status and amounts
recognized in the  consolidated financial statements:




                                        
                                       1998         1997        1998      1997
                                       ----         ----        ----      ----
                                                (In thousands)
Actuarial present value of
 benefit obligations:
 Vested benefit obligation        $  922,699    $  806,533   $ 35,467  $ 30,063
===============================================================================
 Accumulated benefit obligation   $  995,426    $  870,713   $ 35,467  $ 30,063
===============================================================================
   Projected benefit obligation   $1,096,615    $  977,594   $ 36,497  $ 31,772
Plan assets at fair value          1,461,403     1,254,944          -         -
-------------------------------------------------------------------------------
Projected benefit obligation
 (in excess of) or less
 than plan assets                    364,788       277,350    (36,497)  (31,772)
Unrecognized net (gain) loss         (93,996)      (22,276)     8,368     4,955
Unrecognized prior service cost       15,267        21,738      2,629     2,862
Unrecognized transition asset        (19,405)      (25,873)      (173)     (148)
Adjustment required
 to recognize minimum
 liability                                 -             -     (9,836)   (5,960)
--------------------------------------------------------------------------------
Prepaid pension cost (pension
 liability)                       $  266,654    $  250,939   $(35,509) $(30,063)
===============================================================================

The assumptions used in determining the funded status of the U.S. plans were:
                                                      1998         1997    1996
                                                      -----       -----   -----
Actuarial assumptions:
  Discount rate                                        7.0%       7.5%     7.25%
===============================================================================
  Rate of increase in future
     compensation levels                               4.5%       5.0%      5.0%
===============================================================================
  Expected long-term rate of
      return on plan assets                            8.5%       8.5%      8.5%
===============================================================================

Effective April 1, 1995, McDermott Incorporated transferred to JRM an accrued
pension liability of approximately $4,585,000 relating to certain former
employees who are now covered under JRM's plan and transferred to JRM's plan
assets, which were equal to the projected benefit obligation, of approximately
$40,456,000.

The decrease in the discount rate for 1998 increased the projected benefit
obligation by $68,751,000 and the decrease in the rate of increase in future
compensation levels for 1998 decreased the projected benefit obligation by
$16,112,000 at March 31, 1998.

                                       51
<PAGE>
 
In accordance with the provisions of SFAS No. 87, "Employers' Accounting for
Pensions," McDermott Incorporated recorded, at March 31, 1998 and 1997, an
additional minimum liability of $9,836,000 and $5,960,000, respectively,
resulting in recognition of intangible assets of $2,878,000 and $3,414,000,
respectively, and reductions, net of tax, in stockholder's equity of $4,521,000
and $1,655,000, respectively.

The principal U.S. ERISA pension plans provide that, subject to certain
limitations, any excess assets in such plans would be used to increase pension
benefits if certain events occur within a 60-month period following a change in
control of International.

Non-U.S Pension Plans
---------------------

The net periodic pension cost for fiscal years 1998, 1997, and 1996 included the
following components:

<TABLE>
<CAPTION>
                                                         1998        1997            1996      
                                                         ----        ----            ----
                                                                 (In thousands)
<S>                                                   <C>          <C>           <C>
Service cost - benefits earned during the period      $  2,259    $  2,832         $  2,468
Interest cost on projected benefit obligation            6,780       6,425            6,068
Actual return on plan assets                           (19,673)    (15,317)         (16,579)
Net amortization and deferral                           10,744       7,188            9,669
------------------------------------------------------------------------------------------- 
Net periodic pension cost                             $    110    $  1,128         $  1,626
=========================================================================================== 
</TABLE> 

Due to curtailments of foreign pension plans, net income includes a loss of
$2,925,000 for fiscal year 1998 and net loss includes a loss of $1,584,000 for
fiscal year 1997.

The following table sets forth the non-U.S. plans' funded status (assets exceed
accumulated benefits) and amounts recognized in the consolidated financial
statements:
                                                           1998       1997
                                                           ----       ----
                                                          (In thousands)
Actuarial present value of benefit obligations:
 Vested Benefit Obligation                              $  89,466   $ 78,987
============================================================================
 Accumulated Benefit Obligation                         $  90,825   $ 80,532
============================================================================
 Projected Benefit Obligation                           $  98,242   $ 89,877
Plan assets at fair value                                 112,830    103,070
---------------------------------------------------------------------------- 
Plan assets in excess of projected benefit obligation      14,588     13,193
Unrecognized net loss                                        (476)     4,221
Unrecognized prior service cost                             2,866      3,439
Unrecognized transition asset                              (3,471)    (5,129)
---------------------------------------------------------------------------- 
Net prepaid pension cost                                 $ 13,507   $ 15,724
============================================================================

                                       52
<PAGE>
 
The assumptions used in determining the funded status of the non-U.S. plans
were:

                                                    1998      1997      1996
                                                    ----      ----      -----
Actuarial assumptions:
 Discount rate                                    6.75-7.0%   7.75%   7.75-8.25%
===============================================================================
 Rate of increase in future compensation levels    4.0-4.5%    5.0%         5.0%
===============================================================================
 Expected long-term rate of return on plan assets 7.5-8.25%    8.5%         8.5%
===============================================================================

Multiemployer Plans - One of McDermott Incorporated's subsidiaries contributes
to various multiemployer plans.  The plans generally provide defined benefits to
substantially all unionized workers in this subsidiary.  Amounts charged to
pension cost and contributed to the plans were $5,151,000, $4,552,000, and
$4,441,000 in fiscal years 1998, 1997 and 1996, respectively.

Postretirement Health Care and Life Insurance Benefits - McDermott Incorporated
offers postretirement health care and life insurance benefits to substantially
all of its retired regular full-time employees, including those associated with
discontinued operations, except certain non-resident alien retired employees who
are not citizens of a European Community country or who, while employed, did not
earn income in the United States, Canada or the United Kingdom.  McDermott
Incorporated shares the cost of providing these benefits with all affected
retirees, except for certain life insurance plans.  Postretirement health care
and life insurance benefits are offered under separate defined benefit
postretirement plans to union and non-union employees.  The health care plans
are contributory and contain cost-sharing provisions such as deductibles and
coinsurance; the life insurance plans are contributory and non-contributory.
McDermott Incorporated does not fund any of these plans.

The following table sets forth the amounts recognized in the consolidated
financial statements at March 31:

                                                      1998       1997
                                                    --------   --------
                                                       (In thousands)
Accumulated Postretirement Benefit Obligation:
 Retirees                                           $263,404   $284,067   
Fully eligible active participants                    22,256     20,303
 Other active plan participants                       38,660     42,318
----------------------------------------------------------------------- 
                                                     324,320    346,688
Unrecognized net gain                                 72,636     58,187
----------------------------------------------------------------------- 
Accrued postretirement benefit cost                $ 396,956   $404,875
=======================================================================
Weighted-average discount rate                          7.00%      7.50%
=======================================================================

                                       53
<PAGE>
 
The accumulated postretirement benefit obligation includes $281,792,000 and
$307,129,000 for health care plans and $42,528,000 and $39,559,000 for life
insurance plans at March 31, 1998 and 1997, respectively.  The changes in the
accumulated postretirement benefit obligation and the unrecognized net gain
(loss) at March 31, 1998 were primarily attributable to favorable claims
experience.

Net periodic postretirement benefit cost for fiscal years 1998, 1997 and 1996
included the following components:

                                     1998      1997       1996
                                   --------   -------   --------
                                          (In thousands)
Service cost                       $ 2,404    $ 3,414   $ 3,120
Interest cost                       24,699     28,584    29,895
Net amortization and deferral       (4,159)       705    (1,370)
--------------------------------------------------------------- 
Net periodic postretirement 
 benefit cost                      $22,944    $32,703   $31,645
=============================================================== 

For measurement purposes, a weighted-average annual assumed rate of increase in
the per capita cost of covered health care claims of 6-1/2% was assumed for
1998, 7-1/2% for 1997 and 10-3/4% for 1996.  For 1999, a rate of 5-1/2% was
assumed.  The rate was assumed to decrease gradually to 4% in 2005 and remain at
that level thereafter.  The health care cost trend rate assumption has a
significant effect on the amounts reported.  For example, increasing the assumed
health care cost trend rates by one percentage point in each year would increase
the accumulated postretirement benefit obligation as of March 31, 1998 by
$19,340,000 and the aggregate of the service cost and interest cost components
of net periodic postretirement benefit costs for fiscal year 1998 by $1,766,000.

Subsequent Event - Effective April 1, 1998, McDermott Incorporated terminated
all postretirement health care and life insurance benefits for salaried and non-
union hourly employees.  As a result of the termination, the total accumulated
postretirement benefit obligation of McDermott Incorporated will decrease.  On
the same date, the pension plans for the employees affected by the termination
were amended to increase the benefits payable to offset the cost of
postretirement health care and life insurance to the participants.  As a result
of the amendments to the plans, the total projected benefit obligation of
McDermott Incorporated will increase.  The decrease in the accumulated
postretirement benefit obligation will be measured against the increase in the
total projected benefit obligation of the pension plans and any resulting gain
or loss will be recognized in  the first quarter of fiscal year 1999.  The
actuarial calculations of the decrease in the total accumulated postretirement
benefit obligation and the increase in the projected benefit obligation of the
pension plans have not yet been finalized.

NOTE 8 - IMPAIRMENT OF LONG LIVED ASSETS

During fiscal year 1998, management concluded that a portion of the goodwill
associated with the acquisition of McDermott Engineers & Constructors (Canada)
Ltd. no longer had value due to reduced future asset utilization and
deteriorating market conditions and recorded a charge of $8,098,000.

                                       54
<PAGE>
 
During fiscal years 1998 and 1997, management identified certain long-lived
assets that are no longer expected to recover their entire carrying value
through future cash flows.  The assets include manufacturing facilities and
related equipment and goodwill in the Power Generation Systems' segment.  Fair
value was generally determined based on sales prices of comparable assets.
Impairment losses to write-down the property, plant and equipment to estimated
fair value and to write-off related goodwill totaled $10,315,000 and
$15,957,000, respectively, in fiscal years 1998 and 1997.

During fiscal year 1997, management began marketing a building and land which
was used as office space.  As a result, an impairment loss of $7,295,000 was
recognized to reduce the property to its estimated fair value less the cost to
sell.  Prior to recognition of the impairment loss, the carrying value of the
land and building was approximately $15,795,000.  The building was sold in
fiscal year 1998 resulting in a gain of $1,995,000.

NOTE  9 - STOCK PLANS

Certain officers and employees of McDermott Incorporated participate in benefit
plans of International which involve the issuance of International Common Stock.

Under International's 1996 Officer Long-Term Incentive Plan, a total of
1,996,301 shares of International Common Stock (including shares that were not
awarded under predecessor plans) are available for stock option grants and
restricted stock awards to officers and key employees under the 1996 Officer
Long-Term Incentive Plan at March 31, 1998.  The Plan permits the grant of
nonqualified stock options, incentive stock options and restricted stock.
Options to purchase shares are granted at not less than 100% of the fair market
value at date of grant, become exercisable at such time or times as determined
when granted, and expire not more than ten years after the date of the grant.
Under the Plan, eligible employees may be granted rights to purchase shares of
International Common Stock at par value ($1.00 per share), which shares are
subject to restrictions on transfer that lapse at such times and circumstances
as specified when granted.  As of March 31, 1998, 715,380 shares of
International Common Stock available for award may be granted as restricted
stock.  Through March 31, 1998, a total of 1,121,940 shares of restricted stock
(including 171,930 and 113,110 shares issued in fiscal years 1997 and 1996, with
a weighted average fair value per share of $19.92 and $25.13 per share,
respectively) have been issued under the Plan (and a predecessor plan). During
fiscal year 1998, performance-based awards represented by initial notional
grants totaling 86,400 rights (with a weighted average fair value of $33.00 per
right) to purchase restricted shares of International Common Stock were granted
to certain officers and key employees under the 1996 Officer Long-Term Incentive
Plan.  Under the provisions of the performance-based awards, no shares are
issued at the time of the initial award and the number of shares which will be
issued shall be determined based on the change in the market value of the
International Common Stock over a specified performance period.

Under International's 1992 Senior Management Stock Option Plan, senior
management employees may be granted options to purchase shares of International
Common Stock.  The total number of shares available for grant is determined by
the Board of Directors of International from time to time.  Options to purchase
shares are granted at not less than 100% of the fair market value on the date of
grant, become exercisable at such time or times as determined when granted, and
expire not more than ten years after the date of grant.

                                       55
<PAGE>
 
In the event of a change in control of International, both programs have
provisions that may cause restrictions to lapse and accelerate the
exercisability of options outstanding.

The following table summarizes activity for International's stock option plans
as it relates to employees of McDermott Incorporated (share data in thousands):
<TABLE>
<CAPTION>
 
                                  1998                   1997                   1996
                          --------------------   --------------------   --------------------
                                     Weighted-              Weighted-              Weighted-
                                      Average                Average                Average
                                     Exercise               Exercise               Exercise
                          Options      Price     Options      Price     Options      Price
--------------------------------------------------------------------------------------------
<S>                       <C>        <C>         <C>        <C>         <C>        <C>
Outstanding, April 1        5,229       $22.54     4,423       $22.71     3,913       $23.22
Granted                       359       $34.00       904       $21.65       701       $19.31
Exercised                  (1,440)      $20.65       (23)      $17.27       (76)      $18.75
Cancelled/forfeited          (268)      $32.00       (75)      $23.06      (115)      $22.32
-------------------------------------------------------------------------------------------- 
Outstanding, March 31       3,880      $ 23.65     5,229      $ 22.54     4,423       $22.71
============================================================================================
Exercisable, March 31       2,334      $ 22.93     3,399      $ 22.87     2,899       $22.87
============================================================================================
</TABLE> 


The following tables summarize the range of exercise prices and the weighted
average remaining contractual life of the International options outstanding and
the range of exercise prices for the options exercisable at March 31, 1998
(share data in thousands):

<TABLE>
<CAPTION>
 
                         Options Outstanding
--------------------------------------------------------------------------
                                           Weighted
                                           Average
                                           Remaining     Weighted
     Range of                              Contractual   Average
 Exercise Prices         Outstanding       Life          Exercise Price
-------------------------------------------------------------------------- 
<S>                      <C>                <C>           <C>
 $16.06 - $16.69           107              0.9           $16.48
 $19.31 - $23.69         1,975              7.1           $21.24
 $24.13 - $25.50         1,416              5.5           $24.86
 $26.50 - $34.00           382              4.8           $33.60
                         -----
 $16.06 - $34.00         3,880              6.1           $23.65
                         =====
 
                           Options Exercisable
--------------------------------------------------------------------------  
                                                             Weighted
     Range of                                                Average
 Exercise Prices                 Exercisable              Exercise Price
--------------------------------------------------------------------------  
 $16.06 - $16.69                     107                     $16.48
 $19.31 - $23.69                   1,113                     $21.64
 $24.13 - $25.50                   1,091                     $24.78
 $26.50 - $27.44                      23                     $27.28
                                   -----
 $16.06 - $27.44                   2,334                     $22.93
                                   =====
</TABLE>

                                       56
<PAGE>
 
As discussed in Note 1, McDermott Incorporated applies APB 25 and related
interpretations in accounting for its participation in International's stock-
based compensation plans.  Charges to income related to stock plan awards
totaled approximately $4,345,000, $5,141,000 and $1,974,000 for fiscal years
1998, 1997 and 1996, respectively.  If McDermott Incorporated had accounted for
its participation in International's stock option plans using the alternative
fair value method of accounting under SFAS No. 123 "Accounting for Stock-Based
Compensation," its net income (loss) would have been $39,719,000, $(175,592,000)
and $(27,223,000) for fiscal years 1998, 1997 and 1996, respectively.  This pro
forma net income (loss) information is not indicative of future pro forma
amounts.  SFAS No. 123 does not apply to awards prior to fiscal year 1996 and
additional awards in future years are anticipated.

The fair value of each option grant was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions:
 

                                                    1998    1997    1996
                                                    -----   -----   -----
Risk-free interest rate                             5.47%   6.27%   5.28%
Volatility factor of the expected market price
 of International's common stock                     .36     .36     .36
Expected life of the option in years                 3.5     5.0     5.0
Expected dividend yield of
  International's common stock                       0.6%    1.0%    1.0%

The weighted average fair value of the stock options granted in 1998, 1997 and
1996 was $10.77, $8.21 and $7.02, respectively.

NOTE 10 - REDEEMABLE PREFERRED STOCKS

At March 31, 1998 and 1997, 13,000,000 shares of McDermott Incorporated
Preferred Stock, with a par value of $1 per share, were authorized.  Of the
authorized shares, 2,818,679 and 2,818,780 shares of Series A Preferred Stock,
and 2,152,766 and 2,652,660 shares of Series B Preferred Stock, respectively,
were outstanding  (in each case, exclusive of shares owned by McDermott
Incorporated) at March 31, 1998 and 1997.  The outstanding shares are entitled
to $31.25 per share in liquidation.  Both series of Preferred Stock are entitled
to general voting rights of one-half vote for each share.  The Board of
Directors of McDermott Incorporated may designate additional series of Preferred
Stock, and may set terms of each new series except that McDermott Incorporated
cannot create any series of stock senior to the existing Series A and Series B
Preferred Stock without the consent of the holders of at least 50% of the shares
of each of these series.

Each share of the outstanding Series A Preferred Stock is convertible into one
share of International Common Stock plus $0.10 cash. Series A and Series B
Preferred Stock are redeemable at the option of McDermott Incorporated at $31.25
per share plus accrued dividends.  Pursuant to a mandatory sinking fund
requirement, on March 31, 1999 and each subsequent year through March  31, 2008,
McDermott Incorporated is obligated to redeem, at a redemption price of $31.25
plus accrued dividends, 313,878 shares of Series A Preferred Stock.  On March
31, 1999, McDermott Incorporated  is  obligated  to redeem 4,800 shares of
Series B Preferred Stock.  On March  31 of fiscal years 2000 through 2006, and
March 31

                                       57
<PAGE>
 
of fiscal years 2007 and 2008, McDermott Incorporated is obligated to redeem
252,702 and 189,526 shares, respectively, of Series B Preferred Stock.  For each
of the five fiscal years subsequent to March 31, 1998, the  annual cost of
McDermott Incorporated's obligation to redeem the Series A and Series B
Preferred Stock is $17,706,000.  McDermott Incorporated may apply to the
mandatory sinking fund obligations any share of Series A or Series B Preferred
Stock reacquired, redeemed or surrendered for conversion which have not been
previously credited against the mandatory sinking fund obligations. During
fiscal year 1998, McDermott Incorporated applied 313,878 shares of Series A
Preferred Stock and 251,991 shares of Series B Preferred Stock that it owned to
satisfy the March 31, 1998 mandatory sinking fund obligations and 247,902
shares  of  Series  B  Preferred  Stock  that  it  owned  to  satisfy a portion
of the March 31, 1999 mandatory sinking fund obligation.  During fiscal years
1998 and 1997, 151,374 and 74,200 shares, respectively, of Series B Preferred
Stock were purchased in the open market and 348,519 shares of Series B Preferred
Stock were purchased pursuant to a partial redemption.  At March 31, 1998,
49,737 shares of Series A Preferred Stock have been converted to date and
McDermott Incorporated owned 319,993 shares of Series A Preferred Stock.

NOTE 11 - CONTINGENCIES AND COMMITMENTS

Investigations and Litigation - In March 1997, International and JRM, with the
help of outside counsel, began an investigation into allegations of wrongdoing
by a limited number of former employees of International and JRM and others.
The allegations concerned the heavy-lift business of the HeereMac joint venture.
Upon becoming aware of these allegations, International and JRM notified
authorities, including the Antitrust Division of the U.S. Department of Justice
and the European Commission. As a result of International's and JRM's prompt
disclosure of the allegations, both companies and the individuals who were
officers, directors and employees of International or JRM at the time of the
disclosure were granted immunity from criminal prosecution by the Department of
Justice for any anti-competitive acts involving worldwide heavy-lift activities.

On December 21, 1997, following JRM's termination of its joint venture with
Heerema Offshore Construction Group, Inc. ("Heerema"), HeereMac and a HeereMac
employee pled guilty to criminal charges by the Department of Justice that they
and others had participated in a conspiracy to rig bids in connection with the
heavy-lift business of HeereMac in the Gulf of Mexico, North Sea and Far East.
HeereMac was fined $49,000,000 and the employee $100,000.  As part of the plea,
both HeereMac and certain employees of HeereMac agreed to cooperate fully with
the Department of Justice investigation.  Neither International, JRM nor any of
their officers, directors or employees was a party to those proceedings.

International and JRM have cooperated and are continuing to cooperate with the
Department of Justice in its investigation. Near the end of calendar 1997, the
Department of Justice requested additional information from the companies
relating to possible anti-competitive activity in the marine construction
business of McDermott-ETPM East, Inc., one of the operating companies within
JRM's former McDermott-ETPM joint venture with ETPM S.A., a French company.
Pursuant to the termination of the McDermott-ETPM joint venture on April 3,
1998, JRM assumed 100% ownership of McDermott-ETPM East, Inc., which has been
renamed J. Ray McDermott Middle East, Inc.  Subsequent to the formation of JRM
and its acquisition of Offshore Pipelines, Inc. in January 1995, McDermott
Incorporated no longer

                                       58
<PAGE>
 
participates in the heavy-lift barge service business nor the marine
construction business, which is the subject of this investigation.

International and JRM are also cooperating with the Securities and Exchange
Commission ("SEC"), which also requested information and documents from the
companies with respect to certain of the foregoing matters.  International and
JRM are subject to a judicial order entered in 1976, with the consent of
McDermott Incorporated (which at that time was the parent of the McDermott group
of companies), pursuant to an SEC complaint ("Consent Decree").  The Consent
Decree prohibits the companies from making false entries in their books,
maintaining secret or unrecorded funds or using corporate funds for unlawful
purposes.  Violations of the Consent Decree could result in substantial civil
and/or criminal penalties to the companies.

On June 1, 1998, Phillips Petroleum Company (individually, and on behalf of
certain co-venturers) and certain related entities filed a complaint in United
States District Court for the Southern District of Texas against McDermott
Incorporated, International, JRM, McDermott-ETPM, Inc., certain JRM
subsidiaries, HeereMac, Heerema, certain Heerema affiliates, and others.  The
complaint alleges that the defendants engaged in anti-competitive acts in
violation of Sections 1 and 2 of the Sherman Act and Sections 15.05(a) and (b)
of the Texas Business and Commerce Code, engaged in fraudulent activity and
tortiously interfered with the plaintiffs' businesses in connection with certain
offshore transportation and installation projects in the Gulf of Mexico, North
Sea and Far East.  In addition to seeking actual charges and attorneys' fees,
the plaintiffs have requested punitive as well as treble damages.

It is not possible to predict the ultimate outcome of the Department of Justice
investigation, the SEC inquiry, or the companies' internal investigation, the
above referenced lawsuit, or the action that may by taken by others as a result
of HeereMac's guilty plea or otherwise.  However, these matters could result in
civil and/or criminal liability and have a material adverse effect on McDermott
Incorporated's consolidated financial position and results of operations.

In addition to the foregoing, McDermott Incorporated and certain of its
officers, directors and subsidiaries are defendants in numerous  other legal
proceedings.  Management believes that the outcome of these proceedings will not
have a material adverse effect upon McDermott Incorporated's consolidated
financial position or results of operations.

Products Liability - At March 31, 1998 and 1997, the estimated liability for
pending and future non-employee products liability asbestos claims was
$886,691,000 (of which approximately $281,000,000 had been asserted) and
$1,082,782,000, respectively.  Estimated insurance recoveries are included in
environmental and products liabilities recoverable and comprise substantially
all of the March 31, 1998 balance and all of the March 31, 1997 balance.  The
number of non-employee claims, which had declined moderately since fiscal year
1990, increased in the second half of fiscal year 1995 and the first half of
fiscal year 1996, but decreased the second half of fiscal year 1996.  Based on
the information then currently available, management believed that the increase
represented an acceleration in the timing of receipt of claims but did not
represent an increase in the total liability.  The number of claims, however,
increased during the first nine months of fiscal year 1997 and during that
period, management was investigating and evaluating the basis for the

                                       59
<PAGE>
 
increase.   As a result of this investigation and evaluation, in the fourth
quarter of fiscal year 1997, McDermott Incorporated recorded an additional
estimated liability for future non-employee asbestos claims of $427,001,000,
estimated related insurance recoveries of $354,601,000 and a loss of $72,400,000
for estimated future claims for which recovery from insurers was not determined
to be probable.  The number of claims in fiscal year 1998 declined from previous
years' levels and was consistent with management's expectations.  Management
expects a continuing decline in the number of claims in fiscal year 1999.
Estimated liabilities for pending and future non-employee products liability
asbestos claims are derived from McDermott Incorporated's claims history and
constitute management's best estimate of such future costs.  Estimated insurance
recoveries are based upon analysis of insurers providing coverage of the
estimated liabilities. Inherent in the estimate of such liabilities and
recoveries are expected trends in claim severity and frequency and other
factors, including recoverability from insurers, which may vary significantly as
claims are filed and settled.  Accordingly, changes in estimates could result in
a material adjustment to operating results for any fiscal quarter or year,
including within the next year should expected declines in the number of claims
not occur, and the ultimate loss may differ materially from amounts provided in
the consolidated financial statements.

Environmental Matters - During fiscal year 1995, management decided to close
certain nuclear manufacturing facilities in Parks Township, Armstrong County,
Pennsylvania (the "Parks Facilities"), and a provision of $41,724,000 for the
decontamination, decommissioning and the closing of these facilities was
recognized.  Previously, decontamination and decommissioning costs were being
accrued over these facilities' remaining expected life.  Decontamination is
proceeding as permitted by the existing Nuclear Regulatory Commission ("NRC")
license.  A decommissioning plan was submitted to the NRC for review and
approval during January 1996.  These facilities were recently transferred to
BWXT, a subsidiary of The Babcock & Wilcox Company. BWXT's management expects to
reach an agreement with the NRC in fiscal year 1999 on a plan that provides for
the completion of facilities dismantlement and soil restoration by 2001 and
license termination in 2002.  BWXT expects to request approval from the NRC to
release the site for unrestricted use at that time.

At March 31, 1998 and 1997, McDermott Incorporated had total environmental
reserves (including provision for the facilities discussed above) of $44,675,000
and $30,949,000, respectively, of which $8,446,000 and $10,352,000 were included
in current liabilities.  Estimated recoveries of these costs are included in
environmental and products liabilities recoverable at March 31, 1998.  Inherent
in the estimates of such reserves and recoveries are expected levels of
contamination, decommissioning costs, and recoverability from other parties,
which may vary significantly as decommissioning activities progress.
Accordingly, changes in estimates could result in a material adjustment to
operating results and the ultimate loss may differ materially from amounts
provided in the consolidated financial statements.

McDermott Incorporated has been identified as a potentially responsible party at
various clean up sites under the Comprehensive Environmental Response,
Compensation and Liability Act, as amended.  McDermott Incorporated has not been
determined to be a major contributor of wastes to these sites.  However, each
potentially responsible party or contributor may face assertions of joint and
several liability.  Generally, however, a final allocation of costs is made
based on its relative contribution of wastes to each site.  Based on its
relative contribution of waste to each site, McDermott Incorporated's share of
the ultimate liability for the various

                                       60
<PAGE>
 
sites is not expected to have a material adverse effect on its consolidated
financial position or results of operations.

The Department of Environmental Protection of the Commonwealth of Pennsylvania,
("PADEP"), by letter dated March 19, 1994, advised The Babcock & Wilcox Company
that it would seek monetary sanctions, and remedial and monitoring relief,
related to the Parks Facilities.  The relief sought related to potential
groundwater contamination related to the previous operations of the facilities.
These facilities are now a part of BWXT.  PADEP has advised BWXT that it does
not intend to assess any monetary sanctions provided that BWXT continues its
remediation program of the Parks Facilities.

Operating Leases - Future minimum payments required under operating leases that
have initial or remaining noncancellable lease terms in excess of one year at
March 31, 1998 are as follows:  1999 - $8,330,000; 2000 - $7,014,000; 2001 -
$4,993,000; 2002 - $3,144,000; 2003 - $2,677,000; and thereafter - $759,000.
Total rental expense for fiscal years 1998, 1997 and 1996 was $17,988,000,
$22,934,000 and $21,937,000, respectively.  These expense amounts include
contingent rentals and are net of sublease income, neither of which are
material.

Other - McDermott Incorporated performs significant amounts of work for the U.S.
Government under both prime contracts and subcontracts and thus is subject to
continuing reviews by governmental agencies.

McDermott Incorporated maintains liability and property insurance against such
risk and in such amounts it considers adequate.  However, certain risks are
either not insurable or insurance is available only at rates which McDermott
Incorporated considers uneconomical.

Commitments for capital expenditures amounted to approximately $13,743,000 at
March 31, 1998, all of which relates to fiscal year 1999.

McDermott Incorporated is contingently liable under standby letters of credit
totaling $248,470,000 at March 31, 1998, all of which were issued in the normal
course of business.

NOTE 12 - FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK

McDermott Incorporated's Power Generation Systems segment's principal customers
are the electric power generation industry (including government-owned utilities
and independent power producers), and the pulp and paper and other process
industries, such as oil refineries and steel mills.  The primary customer of the
Government Operations segment is the U.S. Government (including its
contractors).  The principal customers of the Engineering and Construction
Operations segment are oil and natural gas producers, electric power generation
industry, and petrochemical and chemical processing industries.  The principal
customers of Other Operations are petrochemical and chemical processing and
electric power generation industries.  These concentrations of customers may
impact McDermott Incorporated's overall exposure to credit risk, either
positively or negatively, in that the customers may be similarly affected by
changes in economic or other conditions.  However, International's management
believes that the portfolio of receivables is well diversified and that this
diversification minimizes any potential credit risk.  Receivables are generally
not collateralized.

                                       61
<PAGE>
 
McDermott Incorporated believes that its provision for possible losses on
uncollectible accounts receivable is adequate for its credit loss exposure.  At
March 31, 1998 and 1997, the allowance for possible losses deducted from
Accounts receivable-trade on the accompanying balance sheet was $9,925,000 and
$13,417,000, respectively.

NOTE 13 - DERIVATIVE FINANCIAL INSTRUMENTS

McDermott Incorporated operates internationally giving rise to exposure to
market risks from changes in foreign exchange rates.  Derivative financial
instruments, primarily forward exchange contracts, are utilized to reduce those
risks.  McDermott Incorporated does not hold or issue financial instruments for
trading purposes.

Forward exchange contracts are entered into primarily as hedges of certain firm
purchase and sale commitments denominated in foreign currencies.  At March 31,
1998, McDermott Incorporated had forward exchange contracts to purchase
$103,249,000 in foreign currencies (primarily Canadian Dollars), and to sell
$31,792,000 in foreign currencies (primarily Canadian Dollars), at varying
maturities from fiscal year 1999 through 2000.  At March 31, 1997, McDermott
Incorporated had forward exchange contracts to purchase $90,686,000 in foreign
currencies (primarily Canadian Dollars), and to sell $48,546,000 in foreign
currencies (primarily Canadian Dollars), at varying maturities from fiscal year
1998 through 2000.

Deferred realized and unrealized gains and losses from hedging firm purchase and
sale commitments are included on a net basis in the balance sheet as a component
of either contracts in progress or advance billings on contracts.  They are
recognized as part of the purchase or sale transaction when it is recognized, or
as other gains or losses when a hedged transaction is no longer expected to
occur.  At March 31, 1998 and 1997, McDermott Incorporated had deferred gains of
$372,000 and $1,278,000, respectively, and deferred losses of $350,000 and
$363,000, respectively, related to forward exchange contracts which will be
recognized in accordance with the percentage of completion method of accounting.

McDermott Incorporated is exposed to credit-related losses in the event of
nonperformance by counterparties to derivative financial instruments, but it
does not anticipate nonperformance by any of these counterparties.  The amount
of such exposure is generally the unrealized gains in such contracts.

NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by McDermott Incorporated in
estimating its fair value disclosures for financial instruments:

Cash and cash equivalents: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximates their fair values.

Long and short-term debt: The fair value of debt instruments are based on quoted
market prices or, where quoted prices are not available, on estimated prices
based on current yields for debt issues of similar quality and terms.

Redeemable preferred stocks:  The fair values of the redeemable preferred stocks
are based on quoted market prices.

                                       62
<PAGE>
 
Foreign currency exchange contracts:  The fair values of foreign currency
forward exchange contracts are estimated by obtaining quotes from brokers.  At
March 31, 1998 and 1997, McDermott Incorporated had net forward exchange
contracts outstanding to purchase foreign currencies with notional values of
$71,457,000 and $42,140,000 and fair values of $72,943,000 and $48,098,000,
respectively.

The estimated fair values of McDermott Incorporated's financial instruments are
as follows:
<TABLE>
<CAPTION>
                                            March 31, 1998             March 31, 1997
                                   ------------------------------   ---------------------
                                      Carrying            Fair        Carrying     Fair
                                       Amount            Value         Amount     Value
                                   ---------------   --------------   --------   --------
                                                          (In thousands)
<S>                                <C>               <C>              <C>        <C>
Balance Sheet Instruments
--------------------------------
Cash and cash equivalents          $ 58,191          $ 58,191         $ 56,782   $ 56,782
Debt excluding capital leases       465,130           488,900          692,920    708,306
Redeemable preferred stocks         155,358           184,191          170,983    161,698

</TABLE>

NOTE 15 - SEGMENT REPORTING


McDermott Incorporated's reportable segments are Power Generation Systems,
Government Operations and Engineering and Construction Operations. These
segments are managed separately and are unique in technology, services and
customer class.

Power Generation Systems supplies engineered-to-order services, products and
systems for energy conversion, and fabricates replacement nuclear steam
generators and environmental control systems. In addition, this segment provides
aftermarket services including replacement parts, engineered upgrades,
construction, maintenance and field technical services to electric power plants
and industrial facilities. This segment also provides power through
cogeneration, refuse-fueled power plants and other independent power producing
facilities.

Government Operations supplies nuclear reactor components and nuclear fuel
assemblies to the U.S. Government, manages and operates government owned
facilities, supplies commercial nuclear environmental services and other
government and commercial nuclear services.

Engineering and Construction Operations includes the engineering and
construction activities  and plant outage maintenance of certain Canadian
operations.

Other Operations is comprised of certain small businesses which primarily
includes the manufacturing of auxiliary equipment such as air-cooled heat
exchangers and replacement parts, shipbuilding activities and contract research.

Intersegment sales are accounted for at prices which are generally established
by reference to similar transactions with unaffiliated customers. Reportable
segments are measured based on operating income exclusive of general corporate
expenses, non-employee products liability asbestos claims provisions, insurance
claim provisions, legal expenses, employee benefit and insurance income and
expense and gain (loss) on sales of corporate assets. Other reconciling items to
income (loss) before provision for income taxes are interest income, interest
expense and other-net. Assets excluded from segment assets primarily include
insurance recoverable

                                       63
<PAGE>
 
for products liabilities, excess cost over fair values of net assets purchased,
McDermott Incorporated's investment in McDermott International and prepaid
pension costs.  Amortization of the excess of cost over fair value of net assets
purchased was allocated to the reportable segments for all years presented.

In fiscal years 1998, 1997 and 1996, the U. S. Government accounted for
approximately 19% of McDermott Incorporated's total revenues. These revenues are
principally included in the Government Operations segment.

In fiscal year 1998, asset impairment losses, primarily associated with
manufacturing facilities, resulted in a decrease in Power Generation Systems
segment income of $6,395,000. The write-off of goodwill associated with the
acquisition of McDermott Engineers & Constructors (Canada), Ltd. of $8,098,000
accounted for most of the segment loss of Engineering and Construction
Operations in fiscal year 1998. A net increase in Other Operations income of
$33,072,000 was a result of a gain on the sale of an interest in a joint
venture. In fiscal year 1997, the write-down of an equity investment and asset
impairment losses, partially offset by a gain from the sale of certain assets,
resulted in an increase in Power Generation Systems segment loss of $20,251,000.
 
Segment Information For the Three Fiscal Years Ended March 31, 1998.


1.  Information about McDermott Incorporated's Operations in Different Segments.

<TABLE> 
<CAPTION> 

                                                                                         1998         1997          1996
                                                                                      ----------    --------     ---------
                                                                                                    (In thousands)
REVENUES/(1)/
--------------
<S>                                                                                   <C>           <C>         <C>
Power Generation Systems                                                              $1,142,721  $  985,065    $1,144,779
Government Operations                                                                    370,519     373,051       369,705
Engineering and Construction Operations                                                  198,689     270,027       353,082
Other Operations                                                                         139,712     188,860       184,548
Adjustments and Eliminations                                                              (8,982)    (20,746)      (24,139)
-------------------------------------------------------------------------------------------------------------------------- 
 Total Revenues                                                                       $1,842,659  $1,796,257    $2,027,975
==========================================================================================================================

/(1)/ Segment revenues are net of the following intersegment transfers and other
adjustments:
 Power Generation Systems and Equipment Transfers                                     $    1,124  $    2,279    $    7,888
 Government Operations Transfers                                                           3,968       6,335         9,365
 Engineering and Construction Operations Transfers                                           518       1,214           145
 Other Operations Transfers                                                                3,988       9,101         8,377
 Adjustments and Eliminations                                                               (616)      1,817        (1,636)
-------------------------------------------------------------------------------------------------------------------------- 
 Total                                                                               $     8,982  $   20,746    $   24,139
==========================================================================================================================
</TABLE> 

                                       64
<PAGE>
 
<TABLE>
<CAPTION>
                                                             1998         1997        1996
                                                          ----------   ----------   ---------
                                                                    (In thousands)
<S>                                                       <C>          <C>          <C>
 
SEGMENT OPERATING INCOME (LOSS)
Power Generation Systems                                   $ 84,462     $(33,930)   $ 22,236
Government Operations                                        35,816       32,458      25,869
Engineering and Construction Operations                        (536)     (13,281)    (19,916)
Other Operations                                              7,151      (16,773)     (8,686)
-------------------------------------------------------------------------------------------- 
   Total Segment Operating Income (Loss)                   $126,893     $(31,526)   $ 19,503
============================================================================================
 
GAIN (LOSS) ON ASSET DISPOSALS AND IMPAIRMENTS - NET
-------------------------------------------------------
Power Generation Systems                                   $ (6,079)    $(18,900)   $  4,250
Government Operations                                           523          396         281
Engineering and Construction Operations                      (8,064)       1,091        (225)
Other Operations                                             35,540       (1,376)      3,288
--------------------------------------------------------------------------------------------  
   Total Gain (Loss) on Disposals/Impairments              $ 21,920     $(18,789)   $  7,594
============================================================================================
 
INCOME (LOSS) FROM INVESTEES
----------------------------
Power Generation Systems                                   $  3,150     $    637    $ 31,185
Government Operations                                         4,236        3,630       2,259
Engineering and Construction Operations                         292         (923)        205
Other Operations                                              1,632        3,710       2,632
--------------------------------------------------------------------------------------------  
     Total Income (Loss) from Investees                    $  9,310     $  7,054    $ 36,281
============================================================================================
 
SEGMENT INCOME (LOSS)
---------------------
Power Generation Systems                                   $ 81,533    $ (52,193)   $ 57,671
Government Operations                                        40,575       36,484      28,409
Engineering and Construction Operations                      (8,308)     (13,113)    (19,936)
Other Operations                                             44,323      (14,439)     (2,766)
--------------------------------------------------------------------------------------------  
     Total Segment Income (Loss)                            158,123      (43,261)     63,378
--------------------------------------------------------------------------------------------  
Other Unallocated Items/(1)/                                 (9,064)     (58,308)    (29,442)
General Corporate Expenses - net                            (15,036)     (21,002)    (23,192)
-------------------------------------------------------------------------------------------- 
 Total Operating Income (Loss)                             $134,023    $(122,571)   $ 10,744
============================================================================================
/(1)/Other Unallocated Items include the following:

 Non-Employee Products Asbestos Claim Provisions           $      -    $  55,692    $  4,000
 Insurance Claim Provisions                                       -            -      12,600
 Legal Expenses                                               4,571        2,427       3,717
 Employee Benefits and Insurance (Income) Expense            (1,206)      (1,056)      7,177
 Other                                                        5,699        1,245       1,948
--------------------------------------------------------------------------------------------  
 Total                                                     $  9,064    $  58,308    $ 29,442
============================================================================================
</TABLE> 
 

                                       65
<PAGE>
 
<TABLE>
<CAPTION>
                                                1998         1997         1996
                                             ----------   ----------   ----------
                                                        (In thousands)
<S>                                          <C>          <C>          <C>
SEGMENT ASSETS
--------------
Power Generation Systems                     $  533,084   $  513,898   $  630,962
Government Operations                           178,958      187,031      209,305
Engineering and Construction Operations          37,842       54,092       86,804
Other Operations                                 79,164      138,480      161,648
--------------------------------------------------------------------------------- 
 Total Segment Assets                           829,048      893,501    1,088,719
---------------------------------------------------------------------------------  
 Other Assets                                 1,278,006    1,414,556    1,238,722
 Corporate Assets                               755,764      829,113      692,339
---------------------------------------------------------------------------------  
   Total Assets                             $ 2,862,818   $3,137,170   $3,019,780
=================================================================================

CAPITAL EXPENDITURES
--------------------
Power Generation Systems                    $     9,315   $   14,812   $   17,625
Government Operations                             4,312        4,128        5,896
Engineering and Construction Operations             363          100        6,070
Other Operations                                  2,898        6,967        8,293
---------------------------------------------------------------------------------  
 Segment Capital Expenditures                    16,888       26,007       37,884
--------------------------------------------------------------------------------- 
Corporate and Other Capital Expenditures            981          656        1,227
--------------------------------------------------------------------------------- 
   Total Capital Expenditures               $    17,869   $   26,663   $   39,111
=================================================================================

DEPRECIATION AND AMORTIZATION
-----------------------------
Power Generation Systems                    $    19,483   $   14,842   $   15,316
Government Operations                            12,481       13,609       14,123
Engineering and Construction Operations           1,415        2,528        3,678
Other Operations                                  5,247        7,583        8,570
---------------------------------------------------------------------------------  
   Segment Depreciation and
      Amortization                               38,626       38,562       41,687
---------------------------------------------------------------------------------  
   Corporate and Other Depreciation
   and Amortization                               7,002        7,429        8,593
---------------------------------------------------------------------------------  
       Total Depreciation and
           Amortization                     $    45,628   $   45,991   $   50,280
=================================================================================
 
INVESTMENT IN UNCONSOLIDATED AFFILIATES
---------------------------------------
Power Generation Systems                    $    18,965   $   16,575   $   28,879
Government Operations                             2,090        2,017        2,947
Engineering and Construction Operations             174          556        1,354
Other Operations                                  3,118       15,286        7,778
---------------------------------------------------------------------------------  
       Total Investment in Unconsolidated
           Affiliates                       $    24,347   $   34,434   $   40,958
=================================================================================
</TABLE>

                                       66
<PAGE>
 
2. Information about McDermott Incorporated's Product and Service Lines.

<TABLE>
<CAPTION>
                                                           1998        1997        1996       
                                                         ---------   ---------   ---------
                                                                   (in thousands)
Revenues
<S>                                                      <C>          <C>        <C>         
  Power Generation Systems
    - Aftermarket Goods and Services                     $508,895    $477,391    $498,966
    - Original Equipment Manufacturers' Operations        471,363     385,000     465,324
    - Nuclear Equipment Operations                         89,816     108,498     168,281
    - Boiler Auxiliary Equipment                           86,355      54,013      59,848    
    - Operations and Maintenance                           37,988      29,260      30,640
    - Adjustments and Eliminations                        (51,696)    (69,097)    (78,280)
----------------------------------------------------------------------------------------- 
              Total                                     1,142,721     985,065   1,144,779
=========================================================================================
Government Operations
    - Naval Reactor Program                               202,126     222,697     231,977
    - Management and Operation Contracts
        of U.S. Government Facilities                      64,226      13,603       3,301
    - Nuclear Environmental Services                        26,177     42,709      28,868
    - Other Government Operations                           78,530     93,725     103,970
    - Other Commercial Operations                           10,951      9,001      10,730
    - Adjustments and Eliminations                         (11,491)    (8,684)     (9,141)
-----------------------------------------------------------------------------------------  
              Total                                        370,519    373,051     369,705
=========================================================================================
 
Engineering and Construction Operations
    - Plant Outage Maintenance                             151,050    144,207     141,605
    - Engineering Operations                                48,056    136,015     223,423
    - Adjustments and Eliminations                            (417)   (10,195)    (11,946)
-----------------------------------------------------------------------------------------  
              Total                                        198,689    270,027     353,082
=========================================================================================
Other Operations
    - Auxiliary Equipment                                   97,640     68,028      66,648
    - Contract Research                                     17,180     23,592      24,870
    - Engineering Operations                                14,392     10,010      37,515
    - Shipbuilding Operations                               10,746     80,152      42,289
    - All Others                                                29      9,369      15,275
    - Adjustments and Eliminations                            (275)    (2,291)     (2,049)
-----------------------------------------------------------------------------------------  
              Total                                        139,712    188,860     184,548
=========================================================================================
    Adjustments and Eliminations                            (8,982)   (20,746)    (24,139)
----------------------------------------------------------------------------------------- 
  Total Revenues                                        $1,842,659 $1,796,257  $2,027,975
=========================================================================================
</TABLE> 

                                       67
<PAGE>
 
3.  Information about McDermott Incorporated's Operations in Different
Geographic Areas.

<TABLE>
<CAPTION>
 
                                             1998            1997            1996       
                                             ----            ----            ----   
                                                        (In thousands)
<S>                                        <C>           <C>           <C>
Revenues/(1)/
            - United States                 $1,046,469    $1,004,628      $1,126,475
            - Canada                           264,802       257,285         387,996
            - China                            139,001       102,699          54,791
            - Indonesia                         87,181        49,828         162,299
            - South Korea                       52,000        35,796          15,589
            - Other Foreign Countries          253,206       346,021         280,825
------------------------------------------------------------------------------------ 
  Total                                     $1,842,659    $1,796,257      $2,027,975
====================================================================================

Property, Plant and Equipment, net
            - United States                 $  151,378    $  176,922      $  234,320
            - Canada                            36,265        40,440          42,001
            - Other Foreign Countries            2,381         1,980           2,724
------------------------------------------------------------------------------------  
  Total                                     $  190,024    $  219,342      $  279,045
====================================================================================
</TABLE> 

/(1)/Geographic revenues are allocated based on the location of the customer.

NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)

The following tables set forth selected unaudited quarterly financial
information for the fiscal years ended March 31, 1998 and 1997.
 
                                            1998
                                            ----    
                                   Q U A R T E R   E N D E D
                      -------------------------------------------------
                      JUNE 30,    SEPT. 30,     DEC. 31,      MARCH 31,
                        1997        1997          1997          1998
                      ---------   ---------   -------------   ---------
                                       (In thousands)
Revenues               $453,180    $422,868        $452,324    $514,287
Operating income         27,992      51,684          37,471      16,876
Net income                4,158      21,133          12,501       2,598


Pretax results for the quarter ended September 30, 1997 include a gain of
$33,072,000 from the sale of McDermott Incorporated's interest in Universal
Fabricators Incorporated.   Pretax results for the quarter ended March 31, 1998
include asset impairment losses of $10,315,000.

 

                                       68
<PAGE>
 
                                                      1997
                             -------------------------------------------------
                                          Q U A R T E R    E N D E D
                             -------------------------------------------------
                             JUNE 30,      SEPT. 30,     DEC. 31,    MARCH 31,
                               1996           1996         1996         1997
                             -----------   ----------   ----------   ---------
                                                (In thousands)

Revenues                        $482,510     $453,662     $424,629   $ 435,456
Operating income (loss)           (5,097)     (11,927)       5,799    (111,346)
Net loss                         (16,323)     (18,480)      (6,553)   (133,449)
 

Pretax results for the quarter ended September 30, 1996 include an asset
impairment loss of $7,295,000.  Pretax results for the quarter ended December
31, 1996 include favorable workers' compensation cost adjustments of
$12,088,000.  Pretax results for the quarter ended March 31, 1997 include gains
on asset disposals of $11,792,000, a provision of $72,400,000 for estimated
future non-employee products liability asbestos claims, an asset impairment loss
of $15,957,000, the write-down of an equity investment of $14,300,000  and a
provision of $5,396,000 for employee severance costs.

                                       69
<PAGE>
 
Item 9.  CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL
         DISCLOSURE


                                      None

                                       70
<PAGE>
 
                               P A R T    I I I

Item 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by this item is incorporated by reference to the material
appearing under the headings "Election of Directors" and "Executive Officers" in
the Information Statement for action to be taken by McDermott Incorporated
without a meeting of stockholders on August 11, 1998.

Item 11.   EXECUTIVE COMPENSATION

Information required by this item is incorporated by reference to the material
appearing under the heading "Compensation of Executive Officers" in the
Information Statement for action to be taken by McDermott Incorporated without a
meeting of stockholders on August 11, 1998.

Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by this item is incorporated by reference to the material
appearing under the headings "Security Ownership of Directors and Executive
Officers" and "Security Ownership of Certain Beneficial Owners" in the
Information Statement for action to be taken by McDermott Incorporated without a
meeting of stockholders on August 11, 1998.

Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by this item is incorporated by reference to the material
appearing under the heading "Certain Transactions" in the Information Statement
for action to be taken by McDermott Incorporated without a meeting of
stockholders on August 11, 1998.
 

                                       71
<PAGE>
 
                                  P A R T  I V

Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
(a) The following documents are filed as part of this Annual Report or
    incorporated by reference.

1.  CONSOLIDATED FINANCIAL STATEMENTS
     Report of Independent Auditors

     Consolidated Balance Sheet March 31, 1998 and 1997

     Consolidated Statement of Income (Loss) For the Three Fiscal
       Years Ended March 31, 1998

     Consolidated Statement of Stockholder's Equity For the Three
       Fiscal Years Ended March 31, 1998

     Consolidated Statement of Cash Flows For the Three Fiscal
       Years Ended March 31, 1998

     Notes to Consolidated Financial Statements For the Three Fiscal
       Years Ended March 31, 1998


2.  CONSOLIDATED FINANCIAL STATEMENT SCHEDULES

     All financial statement schedules are omitted because they are not required
     or the required information is shown in the registrant's consolidated
     financial statements or notes thereto.


3.  EXHIBITS

  Exhibit
  Number                     Description
  ------                     -----------

     3    Articles of Incorporation and By-Laws (Item 3(a) is incorporated by
          reference to Exhibit 3 to McDermott Incorporated's annual report on
          Form 10-K, as amended, for the fiscal year ended March 31, 1983; Item
          3(b) is incorporated by reference to Exhibit 3 to the Company's annual
          report on Form 10-K for the fiscal year ended March 31, 1981).

          (a) McDermott Incorporated's Restated Articles of Incorporation

          (b) McDermott Incorporated's By-Laws

                                       72
<PAGE>
 
     4    Indentures with respect to certain of McDermott Incorporated's long-
          term debt are not filed as exhibits hereto inasmuch as the securities
          authorized under any such Indenture do not exceed 10% of McDermott
          Incorporated's total assets.  McDermott Incorporated agrees to furnish
          a copy of each such Indenture to the Securities and Exchange
          Commission upon request.
 

     10   Material Contracts (Exhibit 10(b) is incorporated by reference to
          Exhibit 10 to McDermott Incorporated's annual report on Form 10-K for
          the fiscal year ended March 31, 1981; Exhibit 10(c) is incorporated by
          reference to Exhibit 10 to McDermott Incorporated's annual report on
          Form 10-K, as amended, for the fiscal year ended March 31, 1983; and
          Exhibit 10(d) is incorporated by reference to Exhibit 10 to McDermott
          Incorporated's annual report on Form 10-K, as amended, for the fiscal
          year ended March 31, 1987; Exhibit 10(e) is incorporated by reference
          to Exhibit 10 to McDermott Incorporated's annual report on Form 10-K
          for the fiscal year ended March 31, 1990).

          (a) Supplemental Executive Retirement Plan

          (b) Restoration of Retirement Income Plan for Certain
              Participants in the Retirement Plan for Employees
              of McDermott Incorporated

          (c) Intercompany Agreement

          (d) Trust for Supplemental Executive Retirement Plan
 
          (e) Variable Supplemental Compensation Plan

     21   Significant Subsidiaries of the Registrant
 
     23   Consent of Independent Auditors
 
     27   Financial Data Schedule



(b)  Reports on Form 8-K

  There were no reports on Form 8-K filed by McDermott Incorporated during the
  three months ended March 31, 1998.

                                       73
<PAGE>
 
                          SIGNATURES OF THE REGISTRANT

Pursuant to the requirements of Sections 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.

                                        McDERMOTT INCORPORATED
 


June 17, 1998                     By: /s/ Roger E. Tetrault
                                     ------------------------------   
                                     Roger E. Tetrault
                                     Chairman of the Board and
                                     Chief Executive Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.


     Signature                             Title
     ---------                             -----


/s/Roger E. Tetrault               Chairman of the Board
--------------------------         Chief Executive Officer and Director      
Roger E. Tetrault                  (Principal Executive Officer)             
                                       



/s/Daniel R. Gaubert               Senior Vice President and
--------------------------         Chief Financial Officer       
Daniel R. Gaubert                  (Principal Financial and     
                                    Accounting Officer)          
                                       


/s/Richard E. Woolbert             Director
--------------------------
Richard E. Woolbert



/s/ S. Wayne Murphy               Director
---------------------------
S. Wayne Murphy


June 17, 1998

                                       74
<PAGE>
 
                        INDEX TO EXHIBITS              
  Exhibit
  Number                     Description
  ------                     -----------

     3    Articles of Incorporation and By-Laws (Item 3(a) is incorporated by
          reference to Exhibit 3 to McDermott Incorporated's annual report on
          Form 10-K, as amended, for the fiscal year ended March 31, 1983; Item
          3(b) is incorporated by reference to Exhibit 3 to the Company's annual
          report on Form 10-K for the fiscal year ended March 31, 1981).

          (a) McDermott Incorporated's Restated Articles of Incorporation

          (b) McDermott Incorporated's By-Laws

     4    Indentures with respect to certain of McDermott Incorporated's long-
          term debt are not filed as exhibits hereto inasmuch as the securities
          authorized under any such Indenture do not exceed 10% of McDermott
          Incorporated's total assets.  McDermott Incorporated agrees to furnish
          a copy of each such Indenture to the Securities and Exchange
          Commission upon request.
 
     10   Material Contracts (Exhibit 10(b) is incorporated by reference to
          Exhibit 10 to McDermott Incorporated's annual report on Form 10-K for
          the fiscal year ended March 31, 1981; Exhibit 10(c) is incorporated by
          reference to Exhibit 10 to McDermott Incorporated's annual report on
          Form 10-K, as amended, for the fiscal year ended March 31, 1983; and
          Exhibit 10(d) is incorporated by reference to Exhibit 10 to McDermott
          Incorporated's annual report on Form 10-K, as amended, for the fiscal
          year ended March 31, 1987; Exhibit 10(e) is incorporated by reference
          to Exhibit 10 to McDermott Incorporated's annual report on Form 10-K
          for the fiscal year ended March 31, 1990).

          (a) Supplemental Executive Retirement Plan

          (b) Restoration of Retirement Income Plan for Certain
              Participants in the Retirement Plan for Employees
              of McDermott Incorporated

          (c) Intercompany Agreement

          (d) Trust for Supplemental Executive Retirement Plan
 
          (e) Variable Supplemental Compensation Plan

     21   Significant Subsidiaries of the Registrant
 
     23   Consent of Independent Auditors
 
     27   Financial Data Schedule
 

                                       75