<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q FINANCIAL INFORMATION*
--------------------------------
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 1997
-------------
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: 33-88496*
--------
S.D. WARREN COMPANY
-------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2366983
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S.
incorporation or organization) Employer Identification No.)
225 Franklin Street, Boston, Massachusetts 02110
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(617) 423-7300
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 __ No __ Not Applicable X*
---
===============================================================================
*This report is being voluntarily filed with the Securities and Exchange
Commission (the "Commission") pursuant to the registrant's contractual
obligations to file with the Commission all financial information that would be
required to be filed on a Form 10-Q. The registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JULY 2, 1997
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that this Report on Form 10-Q for S.D.
Warren Company (the "Company") contains certain "forward-looking statements" as
that term is defined under the Private Securities Litigation Reform Act of 1995.
The words "believe," "anticipate," "intend," "estimate," "plan," "assume" and
other similar expressions which are predictions of or indicate future events and
future trends which do not relate to historical matters identify forward-looking
statements. Reliance should not be placed on forward-looking statements because
they involve known and unknown risks, uncertainties and other factors which are
in some cases beyond the control of the Company and may cause the actual
results, performance or achievements of the Company to differ materially from
anticipated future results, performance or achievements expressed or implied by
such forward-looking statements. Certain factors that may cause such
differences include but are not limited to the following: global economic and
market conditions; production and capacity in the United States and Europe;
production and pricing levels of pulp and paper; any major disruption in
production at the Company's key facilities; alterations in trade conditions in
and between the United States and other countries where the Company does
business; and changes in environmental, tax and other laws and regulations.
These and other factors that might cause differences between actual and
anticipated results, performance, and achievements are discussed in greater
detail in this Report on Form 10-Q. See also "Market Overview" under Item 2,
Management's Discussion and Analysis of Results of Operations and Financial
Condition.
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<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JULY 2, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
--------
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations for the
three and nine months ended
July 3, 1996 and July 2, 1997 4,5
Condensed Consolidated Balance Sheets at October 2, 1996
and July 2, 1997 6
Condensed Consolidated Statements of Cash Flows for the
nine months ended
July 3, 1996 and July 2, 1997 7
Notes to Unaudited Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES 25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURE 26
-3-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
JULY 3, 1996 JULY 2, 1997
(RESTATED)
------------------ ------------------
<S> <C> <C>
Sales $346.2 $349.1
Cost of goods sold 297.4 283.1
------ ------
Gross profit 48.8 66.0
Selling, general and administrative expense 34.1 34.3
------ ------
Income from operations 14.7 31.7
Other income (expense), net (2.0) 1.4
Interest expense 25.2 26.0
------ ------
Income (loss) before income taxes and extraordinary item (12.5) 7.1
Income tax expense (benefit) (5.0) 2.9
------ ------
Income (loss) before extraordinary item (7.5) 4.2
Extraordinary item, net of tax (2.0) -
------ ------
Net income (loss) (9.5) 4.2
Dividends and accretions on Warren Series B preferred stock 3.4 3.8
------ ------
Net income (loss) applicable to common stockholder $(12.9) $ 0.4
====== ======
Earnings per common share:
Income (loss) before extraordinary item $(0.08) $ 0.04
====== ======
Net income (loss) $(0.10) $ 0.04
====== ======
Net loss applicable to common stockholder $(0.13) $ 0.00
====== ======
Weighted average number of shares outstanding 100 100
====== ======
</TABLE>
See accompanying notes to unaudited condensed, consolidated financial
statements.
-4-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
JULY 3, 1996 JULY 2, 1997
(RESTATED)
------------------ ------------------
<S> <C> <C>
Sales $1,066.7 $1,009.3
Cost of goods sold 874.8 819.4
-------- --------
Gross profit 191.9 189.9
Selling, general and administrative expense 98.0 100.6
Restructuring - 10.0
-------- --------
Income from operations 93.9 79.3
Other income (expense), net (0.6) 3.4
Interest expense 84.3 77.8
-------- --------
Income before income taxes and extraordinary item 9.0 4.9
Income tax expense 3.6 1.8
-------- --------
Income before extraordinary item 5.4 3.1
Extraordinary item, net of tax (2.0) 0.9
-------- --------
Net income 3.4 4.0
Dividends and accretions on Warren Series B preferred stock 10.0 11.2
-------- --------
Net loss applicable to common stockholder $ (6.6) $ (7.2)
======== ========
Earnings per common share:
Income before extraordinary item $ 0.05 $ 0.03
======== ========
Net income $ 0.03 $ 0.04
======== ========
Net loss applicable to common stockholder $ (0.07) $ (0.07)
======== ========
Weighted average number of shares outstanding 100 100
======== ========
</TABLE>
See accompanying notes to unaudited condensed, consolidated financial
statements.
-5-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 2, JULY 2,
1996 1997
(UNAUDITED)
-------- -----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 49.0 $ 58.2
Trade accounts receivable, net 49.1 37.9
Other receivables 34.2 38.2
Inventories 195.7 208.0
Deferred income taxes 18.0 17.3
Other current assets 9.4 9.0
-------- --------
Total current assets 355.4 368.6
Plant assets, net 1,114.7 1,082.8
Timber resources, net 95.3 95.3
Goodwill, net 94.1 91.1
Deferred financing fees, net 44.8 39.2
Other assets, net 21.1 19.4
-------- --------
Total assets $1,725.4 $1,696.4
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 46.4 $ 59.2
Accounts payable 101.6 111.7
Accrued and other current liabilities 98.0 100.8
-------- --------
Total current liabilities 246.0 271.7
-------- --------
Long-term debt:
Term loans 411.4 344.0
Senior subordinated notes 375.0 375.0
Other 116.1 119.5
-------- --------
902.5 838.5
-------- --------
Deferred income taxes 34.6 37.0
-------- --------
Other liabilities 98.2 101.1
-------- --------
Total liabilities 1,281.3 1,248.3
-------- --------
Commitments and contingencies (Notes 7 and 8)
Warren Series B redeemable exchangeable preferred stock (liquidation
value, $96.2 and $106.9, respectively) 88.0 99.2
-------- --------
Stockholder's equity:
Common stock - -
Capital in excess of par value 331.8 331.8
Retained earnings 24.3 17.1
-------- --------
Total stockholder's equity 356.1 348.9
-------- --------
Total liabilities and stockholder's equity $1,725.4 $1,696.4
======== ========
</TABLE>
See accompanying notes to unaudited condensed, consolidated financial
statements.
-6-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS, UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
JULY 3, 1996 JULY 2, 1997
(RESTATED)
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 3.4 $ 4.0
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, cost of timber harvested and amortization 85.9 88.6
Loss on force majeure events - 7.5
Deferred income taxes - 3.1
Inventory market value adjustments 10.5 -
Other 2.0 (4.6)
Changes in assets and liabilities:
Trade and other accounts receivable, net 91.6 16.9
Inventories (4.6) (12.3)
Accounts payable, accrued and other current liabilities (42.6) 11.5
Other assets and liabilities 1.2 (6.1)
------- ------
Net cash provided by operating activities 147.4 108.6
------- ------
Cash Flows from Investing Activities:
Proceeds from disposals of plant assets 2.2 0.1
Investment in plant assets and timber resources (32.2) (38.8)
Refurbishment of plant assets - (42.8)
Insurance proceeds to refurbish plant assets - 27.5
------- ------
Net cash used in investing activities (30.0) (54.0)
------- ------
Cash Flows from Financing Activities:
Issuance of debt - 38.1
Repayments of debt (177.8) (78.4)
Defeasance of debt - (4.4)
Debt issue costs - (0.7)
------- ------
Net cash used in financing activities (177.8) (45.4)
------- ------
Net change in cash and cash equivalents (60.4) 9.2
Cash and cash equivalents, beginning of period 62.2 49.0
------- ------
Cash and cash equivalents, end of period $ 1.8 $ 58.2
======= ======
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest $ 98.6 $ 80.3
======= ======
Income Taxes $ 4.5 $ 1.2
======= ======
</TABLE>
See accompanying notes to unaudited condensed, consolidated financial
statements.
-7-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
Basis of Presentation
The accompanying unaudited condensed, consolidated financial statements include
the accounts of S.D. Warren Company and its subsidiaries ("S.D. Warren",
"Warren", or the "Company"). Intercompany balances and transactions have been
eliminated in the preparation of the accompanying unaudited condensed,
consolidated financial statements.
During 1996, the Company reviewed its accounting policy with respect to
accounting for certain costs relating to compliance with safety and other
governmental laws and regulations. These costs were previously accounted for on
an accrual basis, and the Company revised its accounting policy to reflect these
costs on an "as incurred" basis. Accordingly, the financial statements for the
three months and nine months ended July 3, 1996 have been restated to reflect
the effect of this change in accounting for these costs. The effects of the
restatement were not material to the financial statements for the three and nine
months ended July 3, 1996.
In addition to the aforementioned restatement, certain prior period items have
been reclassified to conform to the current presentation followed by the
Company.
Business
The Company manufactures printing, publishing and specialty papers and has pulp
and timberland operations vertically integrated with certain of its
manufacturing facilities which represent the Company's single line of business.
The Company currently operates four paper mills, a sheeting facility and several
distribution facilities and owns approximately 911,000 acres of timberlands in
the State of Maine.
Unaudited Interim Condensed, Consolidated Financial Statements
In the opinion of management, the accompanying unaudited condensed, consolidated
financial statements include all adjustments, consisting of only normal
recurring adjustments, necessary for the fair presentation of the Company's
financial position and results of operations. The accompanying unaudited
condensed, consolidated financial statements should be read in conjunction with
the audited financial statements included in Company's Annual Report on Form
10-K for the fiscal year ended October 2, 1996. The unaudited condensed,
consolidated results of operations for the three and nine months ended July 2,
1997 are not necessarily indicative of results that could be expected for a full
year.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings per
Share", and FAS No. 129, "Disclosure of Information about Capital Structure",
both of which will be effective for the Company in fiscal year 1998. FAS No. 128
replaces the presentation of primary earnings per share with basic earnings per
share, which excludes dilution, and requires the dual presentation of basic and
diluted earnings per share. FAS No. 129 establishes standards for disclosing
information about an entity's capital structure and applies to all entities. The
implementation of FAS No. 128 and FAS No. 129 will not have a material effect on
the Company's earnings per share or financial statements.
-8-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income", and
FAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", both of which will be effective for the Company in fiscal year
1999. FAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. FAS No. 131 establishes
standards for the way that public business enterprises report selected
information about operating segments. FAS No. 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The implementation of FAS No. 130 and FAS No. 131 is not expected to
have a material effect on the Company's financial statements.
NOTE 2. RELATED PARTY TRANSACTIONS
During the three and nine months ended July 2, 1997, the Company sold products
to certain subsidiaries of Sappi ("Affiliates"), at market prices, primarily in
U.S. Dollars. These Affiliates then sold the Company's products to external
customers. Proceeds from sales to Affiliates are remitted to the Company net of
sales commissions. The Company sold approximately $32.1 million and $107.5
million to Affiliates and incurred fees of approximately $2.1 million and $6.4
million relating to these sales for the three and nine months ended July 2,
1997, respectively. Similar sales for the corresponding period in the prior
year were $28.9 million and $71.1 million, respectively. Related fees were $1.6
million and $4.3 million, respectively, for the three and nine months ended July
3, 1996. Trade accounts receivable from Affiliates at July 2, 1997 were
approximately $25.3 million compared to $24.3 million at July 3, 1996. The
Company has formalized substantially all of these agreements and is in the
process of formalizing the remainder.
During fiscal year 1996, the Company began purchasing products from certain
Affiliates in U.S. Dollars, primarily for sale to external customers. The
Company receives commissions from the Affiliates on such sales. These
transactions to date have not been material.
NOTE 3. INVENTORIES (IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 2, 1996 JULY 2, 1997
--------------- ------------
<S> <C> <C>
Finished products $92.8 $107.4
Work in process 34.5 37.3
Pulp, logs and pulpwood 25.8 23.7
Maintenance parts and other supplies 42.6 39.6
------ ------
$195.7 $208.0
====== ======
</TABLE>
NOTE 4. LONG-TERM DEBT
The current maturities of long-term debt balance of $59.2 million at July 2,
1997 primarily represents the principal payments due in December 1997 and June
1998 under Warren's term loan facilities.
On February 7, 1997, the Company amended certain provisions of its credit
agreement with a syndicate of banks, including the interest coverage covenant,
the optional prepayment terms and, in order to permit the granting of senior
liens in connection with the refinancing of certain of the Company's industrial
revenue bonds, the covenant restricting certain liens.
On March 5, 1997, pursuant to a loan agreement with the town of Skowhegan,
Maine, the Company expanded and refinanced certain environmental and solid waste
projects at its Somerset, Maine mill by redeeming or refunding revenue bonds
aggregating $23.7 million, defeasing revenue bonds aggregating
-9-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
$4.4 million and issuing new bonds aggregating $38.1 million. The new bonds are
due from 2000 to 2015 and bear interest at rates ranging from 6.65% to 8.00% per
annum. The extraordinary gain resulting from the extinguishment of the original
bonds, net of taxes of $0.6 million, was $0.9 million. In connection with this
transaction, an outstanding letter of credit was reduced by $19.7 million. The
agreement under which the $4.4 million in bonds was defeased required the
Company to purchase U.S. Treasury securities to be held by a trustee in an
amount that will cover the interest payments required to be paid to the holders
of these bonds until the first call date on the bonds, as well as the principal
due at that date. In the event that the U.S. Treasury securities, together with
income earned on these securities, do not cover interest and principal on the
defeased bonds, the Company will be liable for such deficiency.
NOTE 5. RESTRUCTURING
In October 1996, the Company commenced a restructuring plan which resulted in a
pretax charge of $10.0 million taken during the quarter ended January 1, 1997 to
cover the costs related to the reduction of approximately 200 salaried
positions, or approximately 14% of the Company's salaried work force.
NOTE 6. FORCE MAJEURE EVENTS
On October 17, 1996 a fire occurred at an outside warehouse location in
Muskegon, Michigan, which resulted in the loss of approximately 8,000 tons of
inventory valued in excess of $6.0 million. On March 26, 1997, the Company
reached an agreement with its insurance carrier pursuant to which it recovered
substantially all the lost inventory value, excluding the deductible of $0.5
million.
Due to exceptionally heavy rains, the Presumpscot River flooded the Westbrook
mill on October 21, 1996. The flooding resulted in the temporary closure of the
mill. Damage to mill equipment has since been repaired and normal operating
mill conditions have been restored. Total losses will not exceed the Company's
insurance coverage limits, which include both business interruption and property
loss coverage. As of July 2, 1997, the Company had accrued an estimate of $44.7
million for costs to refurbish plant assets at the Westbrook facility, of which
$27.5 million has been received as insurance proceeds at July 2, 1997, with the
remainder, net of a deductible of $3.5 million, included in other receivables in
the condensed consolidated balance sheet at July 2, 1997. In addition, the
Company accrued $9.0 million during the quarter ended April 2, 1997,
representing a portion of the business interruption claim submitted for the
disruption caused by the Westbrook flood, which primarily took place during the
quarter ended January 1, 1997. At July 2, 1997, the Company had received $7.5
million as business interruption insurance proceeds.
NOTE 7. ENVIRONMENTAL AND SAFETY MATTERS
The Company is subject to a wide variety of increasingly stringent environmental
laws and regulations relating to, among other matters, air emissions, wastewater
discharges, past and present landfill operations and hazardous waste management.
These laws include the Federal Clean Air Act, the Clean Water Act, the Resource
Conservation and Recovery Act and their respective state counterparts. The
Company will continue to incur significant capital and operating expenditures to
maintain compliance with applicable federal and state environmental laws. These
expenditures include costs of compliance with federal worker safety laws,
landfill expansions and wastewater treatment system upgrades.
In addition to conventional pollutants, minute quantities of dioxins and other
chlorinated organic compounds may be contained in the wastewater effluent of the
Company's bleached kraft pulp mills in Somerset and Westbrook, Maine and
Muskegon, Michigan. The most recent National Pollutant
-10-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Discharge Elimination System ("NPDES") wastewater permit limits proposed by the
EPA would limit dioxin discharges from the Company's Somerset and Westbrook
mills to less than the level of detectability. The Company is presently meeting
the EPA's proposed dioxin limits but it is not meeting the proposed limits for
other parameters (e.g., temperature and color) and is attempting to revise these
other wastewater permit limits for its facilities. While the permit limitations
at these two facilities are being challenged, the Company continues to operate
under existing EPA permits, which have technically expired, in accordance with
accepted administrative practice. In addition, the Muskegon mill is involved, as
one of various industrial plaintiffs, in litigation with the County of Muskegon
(the "County") regarding a 1994 ordinance governing the County's industrial
wastewater pretreatment program. The lawsuit challenges, among other things, the
treatment capacity availability and local effluent limit provisions of the
ordinance. In July 1996, the Court rendered a decision substantially in favor of
the Company and other plaintiffs, but the County has appealed the Court's
decision. If the Company and the other plaintiffs do not prevail in that appeal
or are not successful in ongoing negotiations with the County, the Company may
not be able to obtain additional treatment capacity for future expansions and
the County could impose stricter permit limits. In June 1997, the EPA sued the
County for failure to enforce permit limits associated with its operation of the
wastewater facility. The Company is uncertain as to the effect, if any, of this
action on its current dispute with the County. The imposition of currently
proposed permit limits or the failure of the Muskegon lawsuit could require
substantial additional expenditures, including short-term expenditures, and may
lead to substantial fines for any noncompliance.
In November 1993, the EPA announced proposed regulations that would impose new
air and water quality standards aimed at further reductions of pollutants from
pulp and paper mills, particularly those conducting bleaching operations
(generally referred to as the "cluster rules"). Final promulgation of the
cluster rules is expected to occur in late 1997, with compliance with the rules
required beginning in 2000. The Company believes that compliance with the
cluster rules, if adopted as currently proposed, may require aggregate capital
expenditures of approximately $70.0 million to $90.0 million through 2000. The
ultimate financial impact to the Company of compliance with the cluster rules
will depend upon the nature of the final regulations, the timing of required
implementation and the cost and availability of new technology. The Company
also anticipates that it will incur an estimated $10.0 million to $20.0 million
of capital expenditures through 1999 related to environmental compliance other
than as a result of the cluster rules.
The Company's mills generate substantial quantities of solid wastes and by-
products that are disposed of at permitted landfills and solid waste management
units at the mills. The Company is currently planning to expand the landfill at
the Somerset mill at a projected total cost of approximately $16.0 million, of
which $7.0 million is expected to be incurred prior to the year 2000 with the
remainder being spent subsequent to 2004.
The Muskegon mill has had discussions with the Michigan Department of
Environmental Quality ("DEQ") regarding a wastewater surge pond adjacent to the
Muskegon Lake. The DEQ presently is considering whether the surge pond is in
compliance with Michigan Act 451 (Part 31 of the Natural Resources and
Environmental Protection Act) regarding potential discharges from that pond.
The matter is now subject to the results of a pending engineering investigation.
There is a possibility that, as a result of DEQ requirements, the surge pond may
be closed in the future. The Company estimates the cost of closure will be
approximately $2.0 million. In addition, if it is necessary to replace the
functional capacity of the surge pond with above-grade structures, the Company
estimates that up to an additional $8.0 million may be required for such
construction costs.
-11-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company has been identified as a potentially responsible party under the
Federal Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended ("CERCLA" or "Superfund"), or analogous state law, for cleanup
of contamination at seven sites. Based upon the Company's understanding of the
total amount of liability at each site, its calculation of its percentage share
in each proceeding, and the number of potentially responsible parties at each
site, the Company presently believes that its aggregate exposure for these
matters is not material. Moreover, as a result of the acquisition of the
Company by Sappi from Scott Paper Company ("Scott"), now Kimberly-Clark, Scott
agreed to indemnify and defend the Company for and against, among other things,
the full amount of any damages or costs resulting from the off-site disposal of
hazardous substances occurring prior to the date of closing, including all
damages and costs related to these seven sites. Since the date of closing of
the acquisition, Scott has been performing under the terms of this environmental
indemnity and defense provision and, therefore, the Company has not expended any
funds with respect to these seven sites.
The Company currently has a demolition project in progress at its Westbrook
facility for health and safety reasons which is expected to be completed in the
year 2001. Total costs of the project are estimated to be approximately $9.0
million, of which approximately $5.7 million had been spent as of July 2, 1997.
The Company recognizes these costs as they are incurred.
The Company does not believe that it will have any liability under recent
emergency legislation enacted by the State of Maine to cover a significant
shortfall in the Maine workers' compensation system through assessments of
employers and insurers; however, there can be no assurance that the existing
legislation will fully address the shortfall or that any additional measures
necessary to fund the shortfall will not result in material increases in the
Company's workers' compensation premiums.
The Company believes that none of these matters, individually or in the
aggregate, is expected to have a material adverse effect on its financial
position, results of operations or cash flows.
NOTE 8. COMMITMENTS AND CONTINGENCIES
The Mobile, Alabama paper mill was historically operated by Scott as part of an
integrated facility (including a tissue mill, a pulp mill and energy facility).
In connection with the acquisition of the Company from Scott, Warren entered
into long-term (25 years initially, subject to mill closures and certain force
majeure events) supply agreements with Scott for the supply of pulp and water
and the treatment of effluent at the Mobile mill. Wood pulp is supplied
generally at market prices. Pulp prices are discounted due to the elimination
of freight costs associated with delivering pulp to Warren's Mobile paper mill
and pulp quantities are subject to minimum (170,000 to 182,400 tons per year)
and maximum (220,000 to 233,400 tons per year) limits. Prices for other
services to be provided by Scott are generally based upon cost. Prior to the
acquisition of the Company by Sappi from Scott, Scott sold its energy facility
at Mobile to Mobile Energy Services Corporation ("MESC"). In connection with
the sale of the energy facility, MESC entered into a long-term agreement with
Warren to provide electric power and steam to the paper mill at rates generally
comparable to market tariffs, including fuel cost and capital recovery
components. Scott, MESC and Warren have also entered into a long-term shared
facilities and services agreement (the "Shared Facilities Agreement") with
respect to medical and security services, common roads and parking areas, office
space and similar items and a comprehensive master operating agreement providing
for the coordination of services and integration of operations among the energy
facility, the paper mill, the pulp mill and the tissue mill. Annual fees under
the Shared Facilities Agreement are expected to be approximately $1.5 million
per year through the 25 year term of the
-12-
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
agreement. Warren has the option to cancel certain non-essential services
covered by the Shared Services Agreement at any time prior to the end of the 25
year term.
The Company's power requirements at Somerset and Westbrook have historically
been satisfied through cogeneration agreements ("Power Purchase Agreements" or
"Agreements") whereby the mills each cogenerate electricity and sell the output
to Central Maine Power Company ("CMP") at above market rates. The Agreements
also provide that the mills purchase electricity from CMP at the standard
industrial tariff rate. The effect of these Agreements has been to reduce the
Company's historical cost of power. However, the Westbrook Agreement expires on
October 31, 1997, and the Somerset Agreement expires in the year 2012, with the
favorable pricing element of the Somerset Agreement ending on November 30, 1997.
The impact from the change in the Somerset Agreement is not material; however,
the expiration of the Westbrook Agreement could have a material adverse impact
if a replacement market for excess power generated at the Westbrook mill is not
found. The Company is currently soliciting bids for such excess power and
anticipates that given current capacity constraints in Northeast power markets,
any material adverse impact should be mitigated. To reflect the fair market
value of the acquired Power Purchase Agreements in accordance with APB No. 16,
as of the date of the acquisition of the Company by Sappi from Scott, the
Company established a deferred asset of approximately $32.3 million. For the
three months and nine months ended July 2, 1997, amortization expense related to
this asset approximated $3.0 million and $9.0 million, respectively.
The Company is also involved in various other lawsuits and administrative
proceedings. The relief sought in such lawsuits and proceedings include
injunctions, damages and penalties. Although the final results in these suits
and proceedings cannot be predicted with certainty, it is the present opinion of
the Company, after consulting with legal counsel, that they will not have a
material effect on the Company's financial position, results of operations or
cash flows.
On November 5, 1996, a proposed binding referendum measure to eliminate
clearcutting in unincorporated areas in the State of Maine was defeated. A
competing measure, which could establish new forestry standards stricter than
current law, but which would not completely ban clearcutting, received a
plurality vote. This competing measure was supported by the Company, other
major timber interests in Maine, several environmental groups as well as the
Governor of Maine. Under Maine law, this competing measure will not
automatically become law unless it receives a simple majority of the votes cast
in a special election to be held in 1997. If this competing measure does become
law, the consequence to the Company is not expected to be material, because such
measure generally reflects sustainable forestry initiatives already voluntarily
adopted by the Company.
NOTE 9. SUBSEQUENT EVENTS
On July 25, 1997, the Company amended certain provisions of its credit agreement
with a syndicate of banks, including the prepayment provisions and the
limitation on indebtedness clause. At this time the lenders waived certain
provisions of the credit agreement thereby allowing the Company to enter into a
sale/leaseback arrangement with General Electric Capital Corporation ("GECC")
pertaining to one of the Company's paper machines at its Somerset facility. In
addition, Warren obtained consent from the lenders for utilization of a portion
of the proceeds of such sale/leaseback other than as required by the credit
agreement, including the payment from time to time of dividends to its parent,
SDW Holdings Corporation ("Holdings"), on or prior to September 30, 1998 for the
purpose of redeeming Holdings preferred stock, subject to certain conditions and
limitations.
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S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On July 29, 1997, the Company entered into a sale/leaseback arrangement with
GECC. The transaction involved the sale of one of the paper machines at the
Company's Somerset mill for $150.4 million to State Street Bank and Trust
Company of Connecticut, National Association (the "Trustee"), as Trustee for
GECC. In connection with the transaction, the Company entered into a 15 year
lease with the Trustee to lease back the paper machine. Rental payments of
approximately $7.6 million will be made semi-annually in arrears in January and
July. The sale/leaseback arrangement will be accounted for as an operating
lease. The gain on the transaction of approximately $20.8 million will be
deferred and amortized as an adjustment to future rent payments. The Company
used approximately $100.3 million of the proceeds from the sale to make a
mandatory prepayment on its term loans. The write off of deferred financing
fees related to the early extinguishment of this debt resulted in an
extraordinary loss of $1.0 million, net of a related tax benefit of $0.6
million, and will be recorded in the fourth quarter of fiscal year 1997.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion is a summary of the key factors management considers
necessary in reviewing the Company's results of operations, liquidity and
capital resources. The Company wishes to caution readers that this discussion
and analysis contains certain " forward looking statements" as that term is
defined under the Private Securities Litigation Reform Act of 1995. Reliance
should not be placed on forward-looking statements because they involve known
and unknown risks, uncertainties and other factors which are in some cases
beyond the control of the Company and may cause the actual results, performance
or achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such forward-
looking statements. This discussion should be read in conjunction with the
financial statements and related notes of the Company included in this Form 10-
Q, as well as the Consolidated Financial Statements and related notes included
in the Company's Annual Report on Form 10-K for the fiscal year ended October 2,
1996. See "Note Regarding Forward - Looking Statements" on Page 2 of this
report.
MARKET OVERVIEW
Coated free market demand increased over the prior year and mill inventories,
which peaked at approximately 600,000 tons in May of 1996, were reduced to
456,000 by the end of June 1997. The Company's coated sales volume was up over
8% compared with the same three months of last year. The increase has been
assisted by new product introductions, which include Strobe, a new product
targeted at the higher margin segment of the coated free marketplace.
North American supply/demand imbalances, inventory shifts and, to a lesser
degree, the availability and pricing of imported products have historically
caused price fluctuations in the market for coated paper. In the quarter ended
July 2, 1997, coated groundwood shipments were up significantly over 1996
shipments, and pricing firmed. Since coated groundwood pricing can provide a
floor for coated free sheet pricing, the upward trend in coated groundwood
shipments and pricing, as well as the increase in coated free paper shipments
over the prior year, supported a firming in the coated free sheet price. During
the quarter ended July 2, 1997, the Company announced a price increase for all
its coated web and No. 3 sheet fed products which was also adopted by the
majority of coated free sheet producers.
As the Company operates within a cyclical industry, a weakening in the market
for any of the Company's products in the future may adversely affect the
Company's financial position, results of operations and cash flows. The new
coated paper capacity scheduled for the end of calendar year 1997 in Europe, as
well as certain machine conversions during 1997 to coated free sheet manufacture
in the United States, will impact this market supply/demand balance and may
constrain upward movement of coated prices which could have an adverse effect
upon the Company.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED JULY 2, 1997 COMPARED TO THREE MONTHS ENDED JULY 3, 1996
Sales
Sales for the three months ended July 2, 1997 were $349.1 million compared to
$346.2 million for the three months ended July 3, 1996, an increase of $2.9
million or 0.8%. The increase was primarily due to a 6.9% increase in paper
shipment volume during the period, partially offset by a 5.7% decrease in
average net revenue per paper ton.
Cost of Goods Sold
Cost of goods sold for the three months ended July 2, 1997 decreased $14.3
million, or 4.8%, to $283.1 million compared to $297.4 million for the three
months ended July 3, 1996. Cost of goods sold on a per paper ton basis
decreased to $819 per ton from $919 per ton for the corresponding prior year
quarter. The decrease was primarily due to the impact of cost reduction
initiatives, including more efficient maintenance spending and staffing levels.
Selling, General and Administrative Expense
Selling, general and administrative expense increased slightly from $34.1
million for the quarter ended July 3, 1996 to $34.3 million for the quarter
ended July 2, 1997.
Interest Expense and Taxes
Interest expense for the three months ended July 2, 1997 was $26.0 million
compared to $25.2 million for the three months ended July 3, 1996. The $0.8
million increase was primarily due to the effect of higher interest rates,
partially offset by the impact of lower levels of outstanding debt. Interest
expense includes the amortization of deferred financing fees.
Income tax expense was $2.9 million for the three months ended July 2, 1997
compared to a benefit of $5.0 million for the corresponding period in the prior
year, primarily reflecting the change in the Company's earnings level.
NINE MONTHS ENDED JULY 2, 1997 COMPARED TO THE NINE MONTHS ENDED JULY 3, 1996
Sales
Sales for the nine months ended July 2, 1997 were $1,009.3 million compared to
$1,066.7 million for the nine months ended July 3, 1996, a decrease of $57.4
million or 5.4%. The decrease is primarily due to a 9.6% decrease in average
net revenue per paper ton, partially offset by a 4.7% increase in paper shipment
volume during such period.
Cost of Goods Sold
Cost of goods sold for the nine months ended July 2, 1997 was $819.4 million
compared to $874.8 million for the nine months ended July 3, 1996, a decrease of
$55.4 million or 6.3%. Cost of goods sold on a per paper ton basis decreased to
$842 per ton from $945 per ton for the corresponding prior year
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period. The decrease was primarily due to lower fiber input costs and, to a
lesser extent, the impact of cost reduction initiatives including more efficient
maintenance and staffing levels, and decreased chemical and other material
procurement costs.
Selling, General and Administrative Expense
Selling, general and administrative expense was $100.6 million for the nine
months ended July 2, 1997 compared to $98.0 million for the nine months ended
July 3, 1996, an increase of $2.6 million. The increase is due primarily to the
opening of additional regional distribution centers, professional services
supporting the Company's profit improvement initiatives, and other
administrative expenses.
Interest Expense and Taxes
Interest expense for the nine months ended July 2, 1997 was $77.8 million
compared to $84.3 million for the nine months ended July 3, 1996. The $6.5
million reduction in interest expense was primarily due to lower levels of
outstanding debt, partially offset by the impact of higher interest rates.
Interest expense includes the amortization of deferred financing fees.
Income tax expense was $1.8 million for the nine months ended July 2, 1997
compared to $3.6 million for the corresponding period in the prior year,
primarily reflecting the change in the Company's earnings level.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $108.6 million for the nine months
ended July 2, 1997 as compared to $147.4 million for the nine months ended July
3, 1996. The decrease is due mainly to $90.0 million of proceeds received in
the quarter ended July 3, 1996 resulting from the sale of the Company's accounts
receivable. This decrease was partially offset by the impact of increases in
accounts payable, accrued and other liabilities, net of increases in inventory
and other assets and liabilities. The increase in accounts payable, accrued and
other liabilities at July 2, 1997 compared to October 2, 1996 was primarily
attributable to increased purchasing activity at the mills and accrued and
unpaid restructuring charges.
The Company's operating working capital decreased to $71.6 million at July 2,
1997 compared to $79.4 million at October 2, 1996. Operating working capital is
defined as trade accounts receivable, other receivables and inventories less
accounts payable and accrued and other current liabilities. This decrease
primarily resulted from an increase in accounts payable and accrued and other
current liabilities and a decrease in trade receivables, offset by an increase
in inventory.
Capital expenditures for the nine months ended July 2, 1997 were $38.8 million,
up from $32.2 million for the nine months ended July 3, 1996. Capital
expenditures are estimated to approximate $65.0 million during fiscal year 1997.
In addition, due to a wide variety of environmental laws and regulations,
including compliance with the cluster rules, the Company anticipates that
aggregate capital expenditures related to environmental compliance could amount
to approximately $90.0 million to $110.0 million through the end of fiscal year
2000, assuming the cluster rules are adopted. The Company believes that cash
generated by operations and amounts available under its revolving credit
facility will be sufficient to meet its ongoing operating and capital
expenditure requirements. (See also Force Majeure Events.)
Net cash used in financing activities was $ 45.4 million for the nine months
ended July 2, 1997 as compared to $177.8 million for the corresponding period of
the previous year, primarily due to the refinancing and issuance of industrial
revenue bonds and differences in optional and excess cash flow prepayments made
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with respect to the Company's term loan facilities. One of these previous
optional prepayments was made in April 1996 when the Company utilized the
proceeds received from the sale of its accounts receivable to make an optional
prepayment of its term loans equaling $100.0 million, with another repayment of
$74.9 million being made in December 1995 due to an excess cash flow requirement
under its bank credit agreement. During the nine months ended July 2, 1997, the
Company made an optional prepayment of $24.0 million.
Debt and Preferred Stock
At July 2, 1997, long-term debt was $838.5 million compared to $902.5 million at
October 2, 1996, a decrease of $64.0 million. The current maturities of long-
term debt balance of $59.2 million at July 2, 1997 primarily represents the
amounts payable in December 1997 and June 1998 under the Company's term loan
facilities.
Warren has a $250.0 million revolving credit facility to finance working capital
needs. At July 2, 1997, Warren did not have any borrowings outstanding under
this facility, resulting in an unused borrowing capacity of approximately $249.0
million, after giving effect to outstanding letters of credit, which may be used
to finance working capital needs. Warren is required to pay a commitment fee,
which is based on the achievement of a certain financial ratio, of between
0.375% and 0.5% per annum on the average daily unused commitment available under
the revolving credit facility.
In addition, Warren had approximately $150.8 million and $170.5 million of
letters of credit outstanding under its letter of credit facility at July 2,
1997 and October 2, 1996, respectively. Warren pays a commission, which is based
on the achievement of a certain financial ratio, of between 1.00% and 2.50% on
outstanding letters of credit and an issuance fee of between 0.125% and 0.25%
per annum on letters of credit issued.
On February 7, 1997, the Company amended certain provisions of its credit
agreement with a syndicate of banks, including the interest coverage covenant,
the optional prepayment terms and, in order to permit the granting of senior
liens in connection with the refinancing of certain of the Company's industrial
revenue bonds, the covenant restricting certain liens.
On March 5, 1997, pursuant to a loan agreement with the town of Skowhegan,
Maine, the Company expanded and refinanced certain environmental and solid waste
projects at its Somerset mill by redeeming or refunding revenue bonds
aggregating $23.7 million, defeasing revenue bonds aggregating $4.4 million and
issuing new bonds aggregating $38.1 million. The new bonds are due from 2000 to
2015 and bear interest at rates ranging from 6.65% to 8.00% per annum. The
extraordinary gain resulting from the extinguishment of the original bonds, net
of taxes of $0.6 million, was $0.9 million. In connection with this
transaction, an outstanding letter of credit was reduced by $19.7 million. The
agreement under which the $4.4 million in bonds was defeased required the
Company to purchase U.S. Treasury securities to be held by a trustee in an
amount that will cover the interest payments required to be paid to the holders
of these bonds until the first call date on the bonds, as well as the principle
due at that date. In the event that the U.S. Treasury securities, together with
income earned on these securities, do not cover interest and principal on the
defeased bonds, the Company will be liable for such deficiency.
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Environmental and Safety Matters
The Company is subject to a wide variety of increasingly stringent environmental
laws and regulations relating to, among other matters, air emissions, wastewater
discharges, past and present landfill operations and hazardous waste management.
These laws include the Federal Clean Air Act, the Clean Water Act, the Resource
Conservation and Recovery Act and their respective state counterparts. The
Company will continue to incur significant capital and operating expenditures to
maintain compliance with applicable federal and state environmental laws. These
expenditures include costs of compliance with federal worker safety laws,
landfill expansions and wastewater treatment system upgrades.
In addition to conventional pollutants, minute quantities of dioxins and other
chlorinated organic compounds may be contained in the wastewater effluent of the
Company's bleached kraft pulp mills in Somerset and Westbrook, Maine and
Muskegon, Michigan. The most recent National Pollutant Discharge Elimination
System ("NPDES") wastewater permit limits proposed by the EPA would limit dioxin
discharges from the Company's Somerset and Westbrook mills to less than the
level of detectability. The Company is presently meeting the EPA's proposed
dioxin limits but it is not meeting the proposed limits for other parameters
(e.g., temperature and color) and is attempting to revise these other wastewater
permit limits for its facilities. While the permit limitations at these two
facilities are being challenged, the Company continues to operate under existing
EPA permits, which have technically expired, in accordance with accepted
administrative practice. In addition, the Muskegon mill is involved, as one of
various industrial plaintiffs, in litigation with the County of Muskegon (the
"County") regarding a 1994 ordinance governing the County's industrial
wastewater pretreatment program. The lawsuit challenges, among other things,
the treatment capacity availability and local effluent limit provisions of the
ordinance. In July 1996, the Court rendered a decision substantially in favor
of the Company and other plaintiffs, but the County has appealed the Court's
decision. If the Company and the other plaintiffs do not prevail in that appeal
or are not successful in ongoing negotiations with the County, the Company may
not be able to obtain additional treatment capacity for future expansions and
the County could impose stricter permit limits. In June 1997, the EPA sued the
County for failure to enforce permit limits associated with its operation of the
wastewater facility. The Company is uncertain as to the effects, if any, of
this action on its current dispute with the County. The imposition of currently
proposed permit limits or the failure of the Muskegon lawsuit could require
substantial additional expenditures, including short-term expenditures, and may
lead to substantial fines for any noncompliance.
In November 1993, the EPA announced proposed regulations that would impose new
air and water quality standards aimed at further reductions of pollutants from
pulp and paper mills, particularly those conducting bleaching operations
(generally referred to as the "cluster rules"). Final promulgation of the
cluster rules is expected to occur in late 1997, with compliance with the rules
required beginning in 2000. The Company believes that compliance with the
cluster rules, if adopted as currently proposed, may require aggregate capital
expenditures of approximately $70.0 million to $90.0 million through 2000. The
ultimate financial impact to the Company of compliance with the cluster rules
will depend upon the nature of the final regulations, the timing of required
implementation and the cost and availability of new technology. The Company
also anticipates that it will incur an estimated $10.0 million to $20.0 million
of capital expenditures through 1999 related to environmental compliance other
than as a result of the cluster rules.
The Company's mills generate substantial quantities of solid wastes and by-
products that are disposed of at permitted landfills and solid waste management
units at the mills. The Company is currently planning to expand the landfill at
the Somerset mill at a projected total cost of approximately $16.0 million, of
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which $7.0 million is expected to be incurred prior to the year 2000 with the
remainder being spent subsequent to 2004.
The Muskegon mill has had discussions with the Michigan Department of
Environmental Quality ("DEQ") regarding a wastewater surge pond adjacent to the
Muskegon Lake. The DEQ presently is considering whether the surge pond is in
compliance with Michigan Act 451 (Part 31 of the Natural Resources and
Environmental Protection Act) regarding potential discharges from that pond. The
matter is now subject to the results of a pending engineering investigation.
There is a possibility that, as a result of DEQ requirements, the surge pond may
be closed in the future. The Company estimates the cost of closure will be
approximately $2.0 million. In addition, if it is necessary to replace the
functional capacity of the surge pond with above-grade structures, the Company
estimates that up to an additional $8.0 million may be required for such
construction costs.
The Company has been identified as a potentially responsible party under the
Federal Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended ("CERCLA" or "Superfund"), or analogous state law, for cleanup
of contamination at seven sites. Based upon the Company's understanding of the
total amount of liability at each site, its calculation of its percentage share
in each proceeding, and the number of potentially responsible parties at each
site, the Company presently believes that its aggregate exposure for these
matters is not material. Moreover, as a result of the acquisition of the
Company by Sappi from Scott Paper Company ("Scott"), now Kimberly-Clark, Scott
agreed to indemnify and defend the Company for and against, among other things,
the full amount of any damages or costs resulting from the off-site disposal of
hazardous substances occurring prior to the date of closing, including all
damages and costs related to these seven sites. Since the date of closing of
the acquisition, Scott has been performing under the terms of this environmental
indemnity and defense provision and, therefore, the Company has not expended any
funds with respect to these seven sites.
The Company currently has a demolition project in progress at its Westbrook
facility for health and safety reasons which is expected to be completed in the
year 2001. Total costs of the project are estimated to be approximately $9.0
million, of which approximately $5.7 million had been spent as of July 2, 1997.
The Company recognizes these costs as they are incurred.
The Company does not believe that it will have any liability under recent
emergency legislation enacted by the State of Maine to cover a significant
shortfall in the Maine workers' compensation system through assessments of
employers and insurers; however, there can be no assurance that the existing
legislation will fully address the shortfall or that any additional measures
necessary to fund the shortfall will not result in material increases in the
Company's workers' compensation premiums.
The Company believes that none of these matters, individually or in the
aggregate, is expected to have a material adverse effect on its financial
position, results of operations or cash flows.
Labor Relations
In February 1997, the Company reached settlement on a new six-year labor
agreement with its three Somerset, Maine mill unions. The ratified contract
reflects more flexible work rule provisions and a 3% annual wage increase for
the term of the agreement. The Company's labor agreements at its Westbrook,
Maine and Mobile, Alabama sites expired on June 1, 1997. All but one of the
Westbrook unions ratified a new five year agreement in May 1997 with more
flexible work rule provisions. The Company is engaged in
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negotiations with the remaining union at Westbrook and the unions at Mobile.
Those affected employees are working under contract extensions which can be
terminated upon 10 days notice.
Force Majeure Events
On October 17, 1996 a fire occurred at an outside warehouse location in
Muskegon, Michigan, which resulted in the loss of approximately 8,000 tons of
inventory valued in excess of $6.0 million. On March 26, 1997, the Company
reached an agreement with its insurance carrier pursuant to which it recovered
substantially all the lost inventory value, excluding the deductible of $0.5
million.
Due to exceptionally heavy rains, the Presumpscot River flooded the Westbrook
mill on October 21, 1996. The flooding resulted in the temporary closure of the
mill. Damage to mill equipment has since been repaired and normal operating
mill conditions have been restored. Total losses will not exceed the Company's
insurance coverage limits, which include both business interruption and property
loss coverage. As of July 2, 1997, the Company had accrued an estimate of $44.7
million for costs to refurbish plant assets at the Westbrook facility, of which
$27.5 million has been received as insurance proceeds at July 2, 1997 with the
remainder, net of a deductible of $3.5 million, included in other receivables in
the condensed consolidated balance sheet at July 2, 1997. In addition, the
Company has accrued $9.0 million during the quarter ended April 2, 1997,
representing a portion of the business interruption claim submitted for the
disruption caused by the Westbrook flood, which primarily took place during the
quarter ended January 1, 1997. At July 2, 1997, the Company had received $7.5
million as business interruption insurance proceeds.
Long-Term Contracts
The Mobile, Alabama paper mill was historically operated by Scott as part of an
integrated facility (including a tissue mill, a pulp mill and energy facility).
In connection with the acquisition of the Company from Scott, Warren entered
into long-term (25 years initially, subject to mill closures and certain force
majeure events) supply agreements with Scott for the supply of pulp and water
and the treatment of effluent at the Mobile mill. Wood pulp is supplied
generally at market prices. Pulp prices are discounted due to the elimination
of freight costs associated with delivering pulp to Warren's Mobile paper mill
and pulp quantities are subject to minimum (170,000 to 182,400 tons per year)
and maximum (220,000 to 233,400 tons per year) limits. Prices for other
services to be provided by Scott are generally based upon cost. Prior to the
acquisition of the Company by Sappi from Scott, Scott sold its energy facility
at Mobile to Mobile Energy Services Corporation ("MESC"). In connection with
the sale of the energy facility, MESC entered into a long-term agreement with
Warren to provide electric power and steam to the paper mill at rates generally
comparable to market tariffs, including fuel cost and capital recovery
components. Scott, MESC and Warren have also entered into a long-term shared
facilities and services agreement (the "Shared Facilities Agreement") with
respect to medical and security services, common roads and parking areas, office
space and similar items and a comprehensive master operating agreement providing
for the coordination of services and integration of operations among the energy
facility, the paper mill, the pulp mill and the tissue mill. Annual fees under
the Shared Facilities Agreement are expected to be approximately $1.5 million
per year through the 25 year term of the agreement. Warren has the option to
cancel certain non-essential services covered by the Shared Services Agreement
at any time prior to the end of the 25 year term.
The Company's power requirements at Somerset and Westbrook have historically
been satisfied through cogeneration agreements ("Power Purchase Agreements" or
"Agreements") whereby the mills each cogenerate electricity and sell the output
to Central Maine Power Company ("CMP") at above market rates. The Agreements
also provide that the mills purchase electricity from CMP at the standard
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industrial tariff rate. The effect of these Agreements has been to reduce the
Company's historical cost of power. However, the Westbrook Agreement expires on
October 31, 1997, and the Somerset Agreement expires in the year 2012, with the
favorable pricing element of the Somerset Agreement ending on November 30, 1997.
The impact from the change in the Somerset Agreement is not material; however,
the expiration of the Westbrook Agreement could have a material adverse impact
if a replacement market for excess power generated at the Westbrook mill is not
found. The Company is currently soliciting bids for such excess power and
anticipates that given current capacity constraints in Northeast power markets,
any material adverse impact should be mitigated. To reflect the fair market
value of the acquired Power Purchase Agreements in accordance with APB No. 16,
as of the date of the acquisition of the Company by Sappi from Scott, the
Company established a deferred asset of approximately $32.3 million. For the
three months and nine months ended July 2, 1997, amortization expense related to
this asset approximated $3.0 million and $9.0 million, respectively.
The Company is also involved in various other lawsuits and administrative
proceedings. The relief sought in such lawsuits and proceedings include
injunctions, damages and penalties. Although the final results in these suits
and proceedings cannot be predicted with certainty, it is the present opinion of
the Company, after consulting with legal counsel, that they will not have a
material effect on the Company's financial position, results of operations or
cash flows.
Regulatory Matters
On November 5, 1996, a proposed binding referendum measure to eliminate
clearcutting in unincorporated areas in the State of Maine was defeated. A
competing measure, which could establish new forestry standards stricter than
current law, but which would not completely ban clearcutting, received a
plurality vote. This competing measure was supported by the Company, other
major timber interests in Maine, several environmental groups as well as the
Governor of Maine. Under Maine law, this competing measure will not
automatically become law unless it receives a simple majority of the votes cast
in a special election to be held in 1997. If this competing measure does become
law, the consequence to the Company is not expected to be material, because such
measure generally reflects sustainable forestry initiatives already voluntarily
adopted by the Company.
Control by Sappi
On May 27, 1997 Western Ventures Limited ("WVL"), an indirect, wholly-owned
subsidiary of Sappi Limited ("Sappi"), the parent of Holdings, acquired the
minority common equity interests (including both Common Stock, and Class A
Warrants and Class B Warrants (the "Warrants")) in Holdings (the "Minority
Acquisition") held by a group of unaffiliated investors for an aggregate price
of $138.0 million, or $17.25 per share of Holdings Common Stock, or Common Stock
equivalent. WVL exercised all of the Warrants acquired in the Minority
Acquisition upon the consummation thereof. As part of the financing for the
Minority Acquisition, on June 27, 1997, WVL sold the Holdings Common Stock
acquired therein to Heritage Springer Limited ("HSL"), a British Virgin Island
Company, and HSL pledged such Holdings Common Stock to certain lenders. The
securities acquired by HSL are subject to an agreement (the "HSL Option
agreement"), pursuant to which Sappi has a right to purchase such securities at
any time prior to April 30, 2000, and HSL has a right to require Sappi to
purchase such securities upon the occurrence of certain events and at any time
between May 15, 2000 and May 30, 2000. Sappi has been granted an irrevocable
proxy to vote all such securities during the term of the HSL Option Agreement,
subject to compliance with its purchase obligations upon exercise of such
rights. Sappi also has been granted certain rights of first refusal by such
lenders in respect to such securities.
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CONSIDERATIONS RELATING TO HOLDINGS' CASH OBLIGATIONS
Because Holdings has no material assets other than the outstanding common stock
of Warren (all of which is pledged to the lenders under the Company's credit
agreement) and all of the operations of Holdings (other than the management of
its investment in Warren) are currently conducted through Warren and its
subsidiaries, Holdings' ability to meet its cash obligations is dependent upon
the earnings of Warren and its subsidiaries and the distribution or other
provision of those earnings to Holdings. Holdings has no material indebtedness
outstanding (other than advances that may be owed from time to time to Warren
and guarantees in respect of indebtedness of Warren and its subsidiaries) and
preferred stock, which was issued in connection with the acquisition of the
Company from Scott, is not mandatorily redeemable (except upon the occurrence of
certain specified events) and provides that dividends need not be paid in cash
until the year 2000. Holdings does, however, have various obligations with
respect to its equity securities (including in respect of registration rights
granted by Holdings) that have required and are likely to continue to require
cash expenditures by Holdings. The Company believes that the credit agreement,
the Indenture and the Warren Series B Preferred Stock permit Warren to pay a
dividend or otherwise provide funds to Holdings to enable Holdings to meet its
known cash obligations for the foreseeable future, provided that Warren meets
certain conditions. Among such conditions are that Warren maintain specified
financial ratios and comply with certain financial tests.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings per
Share", and FAS No. 129, "Disclosure of Information about Capital Structure",
both of which will be effective for the Company in fiscal year 1998. FAS No. 128
replaces the presentation of primary earnings per share with basic earnings per
share, which excludes dilution, and requires the dual presentation of basic and
diluted earnings per share. FAS No. 129 establishes standards for disclosing
information about an entity's capital structure and applies to all entities. The
implementation of FAS No. 128 and FAS No. 129 will not have a material effect on
the Company's earnings per share or financial statements.
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income", and
FAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", both of which will be effective for the Company in fiscal year
1999. FAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. FAS No. 131 establishes
standards for the way that public business enterprises report selected
information about operating segments. FAS No. 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The implementation of FAS No. 130 and FAS No. 131 is not expected to
have a material effect on the Company's financial statements.
SUBSEQUENT EVENTS
On July 25, 1997, the Company amended certain provisions of its credit agreement
with a syndicate of banks, including the prepayment provisions and the
limitation on indebtedness clause. At this time the lenders waived certain
provisions of the credit agreement thereby allowing the Company to enter into a
sale/leaseback arrangement with General Electric Capital Corporation ("GECC")
pertaining to one of the Company's paper machines at its Somerset facility. In
addition, Warren obtained consent from the lenders for utilization of a portion
of the proceeds of such sale/leaseback other than as required by the
-23-
<PAGE>
credit agreement, including the payment from time to time of dividends to
Holdings on or prior to September 30, 1998 for the purpose of redeeming the
Holdings preferred stock, subject to certain conditions and limitations.
On July 29, 1997, the Company entered into a sale/leaseback arrangement with
GECC. The transaction involved the sale of one of the paper machines at the
Company's Somerset mill for $150.4 million to State Street Bank and Trust
Company of Connecticut, National Association (the "Trustee"), as Trustee for
GECC. In connection with the transaction, the Company entered into a 15 year
lease with the Trustee to lease back the paper machine. Rental payments of
approximately $7.6 million will be made semi-annually in arrears in January and
July. The sale/leaseback arrangement will be accounted for as an operating
lease. The gain on the transaction of approximately $20.8 million will be
deferred and amortized as an adjustment to future rent payments. The Company
used approximately $100.3 million of the proceeds from the sale to make a
mandatory prepayment on its term loans. The write off of deferred financing
fees related to the early extinguishment of this debt resulted in an
extraordinary loss of $1.0 million, net of a related tax benefit of $0.6
million, and will be recorded in the fourth quarter of fiscal year 1997.
-24-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Intentionally omitted.*
ITEM 2. CHANGES IN SECURITIES
Intentionally omitted.*
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Intentionally omitted.*
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Intentionally omitted.*
ITEM 5. OTHER INFORMATION
Intentionally omitted.*
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Intentionally omitted.*
==============================================================================
* This report is being voluntarily filed with the Commission pursuant to the
registrant's contractual obligations to file with the Commission all financial
information that would be required to be filed on a Form 10-Q. The registrant
is not required to file reports pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
-25-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
S.D. Warren Company
Date: August 12, 1997 By: /s/ TREVOR LARKAN
-------------------------------------------
Trevor Larkan
Vice President (Principal Financial Officer)
-26-
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<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JULY 2, 1997, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-01-1997
<PERIOD-START> OCT-03-1996
<PERIOD-END> JUL-02-1997
<CASH> 58,200
<SECURITIES> 0
<RECEIVABLES> 44,100
<ALLOWANCES> (6,200)
<INVENTORY> 208,000
<CURRENT-ASSETS> 368,600
<PP&E> 1,301,800
<DEPRECIATION> (219,000)
<TOTAL-ASSETS> 1,696,400
<CURRENT-LIABILITIES> 271,700
<BONDS> 838,500
99,200
0
<COMMON> 0
<OTHER-SE> 348,900
<TOTAL-LIABILITY-AND-EQUITY> 1,696,400
<SALES> 1,009,300
<TOTAL-REVENUES> 1,009,300
<CGS> 819,400
<TOTAL-COSTS> 920,000
<OTHER-EXPENSES> 3,400
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<INCOME-PRETAX> 4,900
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<EPS-PRIMARY> (0.07)
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