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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FINANCIAL INFORMATION*
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
(MARK ONE)*
/ / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
/ / 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--NOT APPLICABLE*
S.D. WARREN COMPANY
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
PENNSYLVANIA 23-2366983
(State or other jurisdiction (I.R.S. Employer
of Identification
incorporation or organization) No.)
225 FRANKLIN STREET, BOSTON, 02110
MA
(Address of principal (Zip Code)
executive offices)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (617) 423-7300
Securities registered pursuant to Section 12(b) of the Act:
NONE
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 the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes / /* 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. / /*
The number of shares of Common Stock outstanding as of December 1, 1998 was
100 shares.
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*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 by Section 13 or 15(d) of the Securities Exchange Act of
1934. The registrant is not required to file reports pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934.
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PART I
ITEM 1. BUSINESS
Intentionally Omitted.*
ITEM 2. PROPERTIES
Intentionally Omitted.*
ITEM 3. LEGAL PROCEEDINGS
Intentionally Omitted.*
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Intentionally Omitted.*
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Intentionally Omitted.*
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* 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 by Section 13 or
15(d) of the Securities Exchange Act of 1934. The registrant is not required
to file reports pursuant to Section 13 and 15(d) of the Securities Exchange
Act of 1934.
2
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ITEM 6. SELECTED FINANCIAL DATA
On December 20, 1994, SDW Acquisition Corporation ("SDW Acquisition"), a
wholly owned subsidiary of SDW Holdings Corporation ("Holdings"), a Delaware
corporation, acquired (the "Acquisition") from Scott Paper Company ("Scott") all
of the outstanding capital stock of S.D. Warren Company ("Warren" or the
"Company"), then a wholly owned subsidiary of Scott, and certain related
affiliates of Scott (the "Predecessor Corporation"). Immediately following the
Acquisition, SDW Acquisition merged with and into Warren, with Warren surviving.
In December 1995, Scott was acquired by Kimberly-Clark Corporation
("Kimberly-Clark").
The following table sets forth selected consolidated statement of operations
data, consolidated share data and consolidated balance sheet data for S.D.
Warren Company and its subsidiaries and the Predecessor Corporation. The
selected financial data for the nine months ended September 24, 1994 and the
period September 25, 1994 through December 20, 1994 are derived from the audited
combined financial statements of the Predecessor Corporation. The selected
financial data for the period December 21, 1994 through September 27, 1995, the
year ended October 2, 1996 (which includes 53 weeks) and the years ended October
1, 1997 and September 30, 1998 are derived from the audited consolidated
financial statements of Warren. Operating data for any periods less than one
year is not necessarily indicative of the results that may be expected for the
full year. Further, data for the Predecessor and Successor Corporations are not
necessarily comparable as a result of a new basis of accounting for the
Successor Corporation and the adoption of certain accounting policies. The
following table should be read in conjunction with the consolidated financial
statements and related footnotes included in Item 8 of this Form 10-K.
<TABLE>
<CAPTION>
SEPTEMBER 25, DECEMBER 21,
NINE MONTHS 1994 1994 YEAR YEAR YEAR
ENDED THROUGH THROUGH ENDED ENDED ENDED
SEPTEMBER 24, DECEMBER 20, SEPTEMBER 27, OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1994 1994 1995 1996 1997 1998
--------------- --------------- ------------- ------------- ------------- -------------
S.D. WARREN S.D. WARREN
COMPANY AND COMPANY AND S.D. WARREN S.D. WARREN S.D. WARREN S.D. WARREN
CERTAIN RELATED CERTAIN RELATED COMPANY AND COMPANY AND COMPANY AND COMPANY AND
AFFILIATES AFFILIATES SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES
(PREDECESSOR) (PREDECESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR)
--------------- --------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
<CAPTION>
(IN MILLIONS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Sales......................... $ 828.8 $ 313.6 $ 1,155.8 $ 1,441.6 $ 1,405.6 $ 1,458.9
Gross profit.................. 106.4 49.9 269.8 255.0 290.2 340.5
Selling, general and
administrative expense...... 72.1 22.2 96.7 134.1 137.6 142.6
Restructuring................. -- -- -- -- 10.0 --
Income from operations........ 34.3 27.7 173.1 120.9 142.6 197.9
Gain on sale of pressure
sensitive business.......... -- -- -- -- -- 30.9
Other income (expense), net... 0.1 (0.5) 3.2 (0.1) 4.1 3.0
Interest expense.............. 6.4 2.3 106.0 108.9 99.0 71.3
Income tax expense............ 11.2 9.9 28.2 5.1 19.3 66.5
Extraordinary items, net of
tax......................... -- -- -- (2.0) -- (4.9)
Net income.................... 16.8 15.0 42.1 4.8 28.4 89.1
Dividends and accretion on
Warren Series B preferred
stock....................... -- -- 9.1 13.5 15.2 16.3
Net income (loss) applicable
to common stockholder....... 16.8 15.0 33.0 (8.7) 13.2 72.8
CONSOLIDATED SHARE DATA:
Net income (loss) applicable
to common stockholder....... $ -- $ -- $ 0.33 $ (0.09) $ 0.13 $ 0.73
Weighted average common shares
outstanding................. -- -- 100 100 100 100
CONSOLIDATED BALANCE SHEET DATA
(AT END OF PERIOD):
Cash and cash equivalents..... $ 4.7 $ 75.0 $ 62.2 $ 49.0 $ 180.7 $ 34.7
Working capital............... 156.2 233.2 177.6 109.4 179.9 67.4
Total assets.................. 1,676.9 1,737.1 1,887.6 1,725.4 1,632.0 1,507.5
Total debt (including current
maturities)................. 119.8 119.3 1,127.4 948.9 767.1 580.2
Warren Series B preferred
stock....................... -- -- 74.5 88.0 103.2 119.5
Parent's equity............... 1,136.5 1,219.1 -- -- -- --
Stockholder's equity.......... -- -- 364.8 356.1 369.3 383.3
</TABLE>
3
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The Company manufactures printing, publishing and specialty papers and has
pulp operations vertically integrated with certain of its manufacturing
facilities. The Company currently operates four paper mills with total annual
production capacity of approximately 1.5 million tons of paper. The Company also
owns a sheeting facility in Allentown, Pennsylvania, with annual sheeting
capacity of approximately 95,000 tons, and has other sheeting capabilities
located at its Muskegon, Michigan mill (162,000 tons annually) and Mobile,
Alabama mill (137,000 tons annually). The Company owns approximately 905,000
acres of timberlands in the State of Maine and operates several regional
distribution facilities. On November 12, 1998, the Company sold its timberlands
to Plum Creek Timber Company, L.P. ("Plum Creek"). (See "Other Items--Evaluation
and Sale of Noncore Assets.")
On December 20, 1994, SDW Acquisition acquired from Scott, which has since
been acquired by Kimberly-Clark, all of the outstanding capital stock of Warren.
Immediately following the Acquisition, SDW Acquisition merged with and into
Warren with Warren surviving.
Warren's parent company is an indirect subsidiary of Sappi Ltd. ("Sappi").
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. 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, Europe and the Far
East; 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; unanticipated expenses or delays in resolving Year 2000 issues by
either the Company or its significant business partners and changes in
environmental, tax and other laws and regulations.
SAPPI REORGANIZATION
On April 27, 1998, Sappi announced the integration of Warren and Sappi's
four international fine paper operations (Warren, KNP Leykam, Hannover Papier,
Sappi U.K.'s Blackburn mill and Sappi Fine Paper in South Africa) to create
Sappi Fine Paper plc. The Sappi Fine Paper Division has a corporate head office
in London. The purpose of the reorganization is to focus on Sappi's main
business sectors--fine paper and forest products. Warren products are being
marketed under the name Sappi Fine Paper North America. The legal entities of
Holdings, Warren and Warren's subsidiaries continue to remain in existence.
MARKET OVERVIEW
The market for coated paper has historically experienced price fluctuations
which are driven by global supply/demand imbalances, inventory shifts and the
availability and relative pricing of imported products. The coated freesheet
sector in the United States reported improved market demand during the final
quarter of fiscal 1998. Although domestic demand grew during fiscal year 1998, a
large portion of this growth was absorbed by a high level of imported product.
The Company managed, however, to grow its coated volume during this period
indicating a growth in its market share. The increase in coated freesheet
imports, together with enhanced domestic production output levels, played a key
role in placing pressure on coated freesheet pricing for certain grade
categories in the United States during fiscal year 1998.
4
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The uncoated and technical paper side of the business experienced strong
demand in the latter part of fiscal year 1998 with sales volume for the fiscal
year at 105% of fiscal year 1997. The Company continues to target higher margin
opportunities in order to optimize sales mix. The net effect of an improvement
in sales mix and aggressive market pricing contributed to relatively flat
average net selling prices for this area of business compared to last year.
Excluding the effect of the pressure sensitive business which was sold in
March 1998, the specialty business, which now consists of casting and panel
release papers, experienced a 6% decline in volume from fiscal year 1997 to
1998. Although sales of the Company's high-end products increased due to added
capacity during the year, the low-end commodity products were depressed by the
worsening economic conditions worldwide. Excess capacity in the industry has
kept pricing flat in individual product lines, however improved product mix
resulted in a 10% increase in the average selling price.
Any failure of the industry to maintain its current levels of shipments and
pricing or any prolonged or severe weakness 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 following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto.
FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997
SALES
Sales for fiscal year 1998 were $1,458.9 million compared to $1,405.6
million for fiscal year 1997, an increase of $53.3 million or 3.8%. The increase
was achieved primarily by a 32,000 ton or 4.1% increase in paper shipment volume
during the period. Average net revenue per paper ton for the fiscal year 1998
was 0.3% lower compared to the prior fiscal year.
COST OF GOODS SOLD
Cost of goods sold for fiscal year 1998 was $1,118.4 million and relatively
flat compared to $1,115.4 for fiscal year 1997. Cost of goods sold on a per
paper ton basis decreased to $792 per ton from $820 per ton for the prior fiscal
year. This $28 per ton decrease was accomplished through improvements in
productivity, lower utilization per ton of raw materials and specific efficiency
and cost reduction initiatives.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense totaled $142.6 million for
fiscal year 1998 compared to $137.6 million for fiscal year 1997, an increase of
$5.0 million. The increase is primarily attributable to $6.7 million of costs
associated with becoming Year 2000 compliant offset by decreases in other
administrative costs.
EXTRAORDINARY ITEMS
The premium paid of $5.3 million in connection with the purchase of $50.4
million face value of the Company's Senior Subordinated Notes (the "Notes"),
together with the accelerated amortization of deferred financing fees relating
to the purchased Notes and the repayments of term loans during fiscal year 1998,
resulted in extraordinary losses aggregating $4.9 million (net of $3.4 million
of tax benefits).
OTHER INCOME (EXPENSE), NET
Other income (expense), net includes interest income of $4.0 million and
$4.4 million for fiscal years 1998 and 1997, respectively.
5
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INTEREST EXPENSE AND TAXES
Interest expense for fiscal year 1998 was $71.3 million compared to $99.0
million for fiscal year 1997. The $27.7 million reduction in interest expense
was primarily due to lower levels of outstanding debt and improved bank margins.
Interest expense includes the normal amortization of deferred financing fees,
but excludes write-offs due to accelerated reductions in related financing.
For fiscal year 1998, income tax expense, excluding the aggregate $3.4
million of tax benefits attributable to the extraordinary losses, was $66.5
million compared to $19.3 million for fiscal year 1997. This reflects the change
in the Company's earnings level including the impact of the $30.9 million gain
on the sale of the Company's pressure sensitive business.
FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996
The following discussion compares the results of operations for fiscal year
1997 with fiscal year 1996 (which included 53 weeks). The additional week in
fiscal year 1996 did not have a significant impact on sales or other operating
results.
SALES
Sales for fiscal year 1997 were $1,405.6 million compared to $1,441.6
million for fiscal year 1996, a decrease of $36.0 million or 2.5%. This decrease
was primarily due to a 7% decrease in average net sales per paper ton which was
partially offset by a 61,000 ton increase in paper shipment volume over the
previous year. Paper sales volume for fiscal year 1997 totaling 1.336 million
tons was achieved despite a flood-related closure of the Westbrook mill during
the first fiscal quarter of 1997. The volume improvement was driven by strong
marketing efforts, including certain successful new product launches, and
supported by improved levels of productivity.
COST OF GOODS SOLD
Cost of goods sold for fiscal year 1997 was $1,115.4 million compared to
$1,186.6 million for fiscal year 1996, a decrease of $71.2 million or 6.0%. Cost
of goods sold on a per paper ton basis decreased to $820 per ton from $917 per
ton for the prior year. The decrease is primarily due to aggressive cost
reduction initiatives including more efficient maintenance and staffing levels,
decreased chemical and other material procurement costs and lower fiber input
costs. Productivity improvements were achieved in both the pulp and paper
operations which also contributed to the improved cost structure.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense totaled $137.6 million for
fiscal year 1997 compared to $134.1 million for fiscal year 1996, an increase of
$3.5 million. The increase was due primarily to the opening of additional
regional distribution centers, professional services supporting the Company's
profit improvement initiatives, and other administrative expenses.
RESTRUCTURING
In October 1996, the Company commenced a restructuring plan which resulted
in a pretax charge of $10.0 million taken during fiscal year 1997 to cover the
costs related to the reduction of approximately 200 salaried positions or
approximately 14% of the Company's salaried work force.
OTHER INCOME (EXPENSE), NET
Other income (expense), net for fiscal year 1997 was $4.1 million income
compared to $0.1 million expense for fiscal year 1996. This change was largely
due to higher interest income resulting from higher average cash balances on
hand during fiscal year 1997.
6
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INTEREST EXPENSE AND TAXES
Interest expense for fiscal year 1997 was $99.0 million compared to $108.9
million for fiscal year 1996. The $9.9 million reduction in interest expense was
primarily due to lower levels of outstanding debt. Interest expense includes the
amortization of deferred financing fees.
Income tax expense was $19.3 million for fiscal year 1997 compared to $5.1
million for the prior fiscal year, primarily reflecting the change in the
Company's earnings level.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $166.2 million for fiscal year
1998 as compared to $222.6 million for fiscal year 1997. The lower amount in
1998 resulted from higher investments in inventory and accounts receivable
(exclusive of the effects of the sale of the pressure sensitive business) at
September 30, 1998 compared to October 1, 1997 as well as lower current
liabilities, with the fiscal year 1997 reflecting corresponding reductions in
working capital investment. The higher income from operations in fiscal year
1998 partially offset this difference.
The Company's operating working capital was $0.4 million at September 30,
1998 compared to a deficit at October 1, 1997 of $11.6 million. Operating
working capital is defined as trade accounts receivable, other receivables and
inventories less accounts payable and accrued and other current liabilities. The
increase primarily resulted from increases in inventory and trade and other
receivables and a net decrease in accounts payable and accrued and other current
liabilities.
Capital expenditures for fiscal year 1998 were $111.0 million, up from $61.0
million for fiscal year 1997. Of the $111.0 million, $19.8 million was related
to construction in progress on the Company's new sheeting and warehouse facility
at the Muskegon, Michigan mill. Expenditures for fiscal year 1998 also include
$15.7 million for the company-wide integrated application system implementation
in progress. Expenditures for this implementation are expected to aggregate
$48.8 million through calendar year 1999. In addition, the Company believes that
environmental compliance expenditures, the bulk of which are for cluster rules
compliance, will aggregate approximately $70.0 million to $112.0 million through
2001, of which $20.0 million has already been incurred. The Company believes
that cash generated by operations and net proceeds from the sale of certain
noncore assets will be sufficient to meet its ongoing operating and capital
expenditure requirements.
Net cash used in financing activities was $251.3 million for fiscal year
1998 compared to $177.3 million for the previous year. The Company made term
loan prepayments aggregating $115.0 million during fiscal year 1998 compared
with prepayments of $182.5 million made in the prior fiscal year. In addition,
as part of the modification of its credit arrangement, Warren repaid $11.3
million of its term loans in March 1998. In June 1998, the Company purchased
$50.4 million face value of the Notes for cash of $55.7 million. The current
maturities of long-term debt balance of $6.4 million at September 30, 1998
consists primarily of the amounts payable in September 1999 under the Company's
term loan facility under the Credit Agreement (as defined below). The Company
may continue to purchase the Notes subject to opportune pricing.
During December 1997, the Company paid a dividend (the "Dividend") of $58.2
million to its parent company, Holdings. In turn, Holdings used the proceeds of
the Dividend to redeem the Holdings 15% Senior Exchangeable Preferred Stock,
including accrued and unpaid dividends. In connection with the Dividend
transaction, the Company paid $0.5 million of fees to the holders of the Notes
in exchange for their consent to the Dividend transaction.
LONG-TERM DEBT AND PREFERRED STOCK
On March 6, 1998, Holdings and Warren modified Warren's credit arrangement
with a group of domestic and international lenders by refinancing the $196.3
million aggregate balance outstanding under Warren's Tranche A and Tranche B
term loans, and entering into the Second Amended and Restated
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Credit Agreement (the "Credit Agreement"). The Credit Agreement consists of (1)
a seven-year amortizing Term Loan, originally in an aggregate amount of $185.0
million, (2) a $250.0 million Revolving Credit Facility and (3) a $136.3 million
Letter of Credit Facility. See Note 11--Long-Term Debt in the Notes to
Consolidated Financial Statements included in this Form 10-K for further
discussion of the Credit Agreement.
At September 30, 1998, long-term debt was $573.8 compared to $739.8 million
at October 1, 1997, a decrease of $166.0 million. At September 30, 1998, Warren
did not have any borrowings outstanding under the Revolving Credit Facility,
resulting in an unused borrowing capacity of approximately $233.4 million, after
giving effect to outstanding letters of credit, which may be used to finance
working capital needs. In addition, Warren had approximately $136.3 and $150.8
million of letters of credit outstanding under its Letter of Credit Facility at
September 30, 1998 and October 1, 1997, respectively.
The Credit Agreement contains restrictive covenants which limit the Company
with respect to certain matters including, among other things, the ability to
incur debt, pay dividends, make acquisitions, sell assets, merge, grant or incur
liens, guarantee obligations, make investments or loans, make capital
expenditures, create subsidiaries or change its line of business. The Credit
Agreement also restricts the Company from prepaying certain of its indebtedness.
Under the Credit Agreement, the Company is required to satisfy certain financial
covenants which will require the Company to maintain specified financial ratios,
including a minimum interest coverage ratio, a maximum leverage ratio and a net
worth test.
The Company has elected to enter into fixed rate interest protection
agreements on a portion of its outstanding debt. Debt covered by such interest
rate protection agreements was $25.0 million at September 30, 1998 and $205.0
million at October 1, 1997. The one agreement for $25.0 million remaining at
September 30, 1998 expires in January 2000.
The Company does not currently anticipate paying any cash dividends on the
Warren Series B Redeemable Exchangeable Preferred Stock (the "Warren Series B
Preferred Stock") for any period ending on or prior to December 15, 1999. In
addition, the terms of the Credit Agreement and the Indenture relating to the
Notes limit the amount of cash dividends the Company may pay with respect to
preferred stock and other equity securities both before and after that date. See
the Notes to Consolidated Financial Statements. The Company has the right to
exchange the Warren Series B Preferred Stock for subordinated exchange
debentures. If the Company exercises this right prior to December 15, 1999, it
will be the intention of the Company thereafter to settle the quarterly interest
accruals in cash.
FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable and debt. The Company has
used interest rate swaps to the degree indicated above as a means of protection
against a portion of interest rate risk associated with the current debt
balances.
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The Company does not hold derivative financial instruments for trading
purposes.
OTHER ITEMS
EVALUATION AND SALE OF NONCORE ASSETS
In May 1997, the chairman of Sappi announced that Sappi was evaluating the
sale of noncore assets throughout the Sappi group. Consequently, Warren
investigated the sale or monetization of businesses not within its main area of
focus. Consistent with this strategy, on March 18, 1998, the Company sold its
pressure sensitive business located at the Westbrook, Maine mill to Spinnaker
Industries, Inc. ("Spinnaker"). Proceeds of the sale consisted of $44.8 million
of cash and a subordinated note (the "Spinnaker Note") for $7.0 million. On
March 31, 1998, the Company sold the Spinnaker Note to a third party for $6.7
million which was received in cash on May 1, 1998. See Note 4--Evaluation and
Sale of Noncore Assets in the Notes to Consolidated Financial Statements
included in this Form 10-K for further discussion.
On November 12, 1998 the Company sold its interests in approximately 905,000
acres of timberlands located in Maine and certain machinery and equipment to
Plum Creek in exchange for a note receivable with a fair market value of $177.1
million and cash of approximately $3.0 million. To consummate the sale, the
Company transferred all of its timberlands and related machinery and equipment
to a wholly-owned limited liability company, all of the membership interest of
which was then sold to Plum Creek. The timberlands and machinery and equipment
sold are shown in the Company's balance sheet at September 30, 1998 as assets
under agreement to sell. The respective carrying amounts of the timberlands and
machinery and equipment are $96.0 million and $2.9 million. These assets have
been classified as long-term consistent with the long-term nature of the note
received from Plum Creek.
The Company and Plum Creek executed a fiber supply agreement (the "supply
agreement"), with an initial term of 25 years and with three five-year renewal
options. Under the supply agreement, the Company will purchase hardwood pulpwood
at an annual minimum of 300,000 to 375,000 tons, or approximately 13% of the
Company's annual requirements, at market prices.
The Company has determined to not, at this stage, pursue the sale of the
energy assets at its Muskegon, Somerset and Westbrook mills.
FORCE MAJEURE EVENT
See Note 5--Force Majeure Event in the Notes to Consolidated Financial
Statements included in this Form 10-K for a discussion of damages and insurance
recoveries resulting from the flooding of the Westbrook mill in October 1996.
ENVIRONMENTAL AND SAFETY MATTERS
The Company is subject to a wide variety of environmental laws and
regulations relating to, among other matters, air emissions, wastewater
discharges, past and present landfill operations and hazardous waste management.
See Note 14--Environmental and Safety Matters in the Notes to Consolidated
Financial Statements included in this Form 10-K for a discussion of these
matters.
LABOR RELATIONS
With ratification of a new six year contract with the major union at its
Muskegon, Michigan mill effective July 3, 1998, the Company has successfully
negotiated new long-term labor contracts which reflect more flexible work rule
provisions at each of its production sites. The current labor contracts for
Somerset Muskegon, Mobile and Westbrook expire in 2002, 2004, 2003 and 2002,
respectively. The Company has experienced no work stoppage in the U.S. in the
past eight years and believes that its relationship with its employees is
satisfactory.
LONG-TERM CONTRACTS
See Note 15--Commitments and Contingencies in the Notes to Consolidated
Financial Statements included in this Form 10-K for a discussion of certain
long-term contracts.
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YEAR 2000
The statements in this section are "Year 2000 readiness disclosure" within
the meaning of the "Year 2000 Information and Disclosure Act."
The millennium computer date ("Year 2000") issue is the result of computer
programs using a two digit format, as opposed to four digits, to indicate the
year. Such computer systems will be unable to correctly interpret dates beyond
the year 1999, which could cause systems failure or other computer errors,
leading to a significant disruption in operations and the potential for
short-term business failure. All of these issues are collectively referred to as
the Year 2000 issue.
The Company commenced its Year 2000 remediation project during the fourth
quarter of fiscal year 1996. The enterprise-wide project is intended to
remediate the cross-century date processing problem within the Company's
computer systems including embedded production control systems and data
communications infrastructure. The Company has contracted with a national
consulting firm specializing in Year 2000 initiatives. The consulting firm is
employing its compliance methodology and staff to advise and assist in the
management of the Company's Year 2000 remediation project.
The Company completed the compilation of the enterprise systems inventory
and the assignment of compliance strategies was substantially completed in the
third quarter of fiscal year 1997. The enterprise systems inventory includes the
Company's business applications, manufacturing execution systems, production
control systems and computing environments. The embedded systems inventory was
substantially completed in July 1998.
Compliance strategies employed by the Year 2000 project team include: system
remediation (compliance modifications), system retirement and system replacement
(which includes certain systems being replaced by the implementation of a
company-wide integrated application system ("the integrated system")). Detailed
project plans and established project milestones are used to monitor the
progress of the Company's compliance strategies. The target completion date for
compliance of all material systems is June 30, 1999. Project progress is
reported monthly to the Company's Year 2000 project Executive Steering
Committee. Currently, the project is progressing as planned, although there can
be no assurance that the Company will not encounter unexpected delays.
The Company's Year 2000 contingency plans include the establishment of
milestones or "trigger" dates to test the progress and confirm the validity of
the Company's various compliance strategies. If the expected measure of progress
is not attained by a "trigger date", alternative strategies are evaluated and
the appropriate strategy initiated. The Company also has system component-based
impact definition and failure resolution plans which describe the potential for
failure within a system, alternatives for system remediation, and prescribe
failure recovery solutions. Technology and business failure resolution teams
will be maintained into the first calendar quarter of 2000.
With respect to the Year 2000 assessment of the Company's critical business
partners, the Year 2000 project team is working with Company representatives to
identify material vendors and customers whose Year 2000 failure could have a
material adverse effect on Warren's manufacturing or distribution processes.
These vendors and customers are being contacted and asked to complete and return
a Year 2000 compliance questionnaire for Warren's assessment. Both returned
questionnaires and the absence of responses are being reviewed to assess
exposure to risky vendors. This business partner assessment will continue and
intensify through 1999, particularly in relation to the Company's significant
vendors and customers.
For those systems not being replaced by the implementation of the integrated
system, the Year 2000 initiative is estimated to cost a total of $14.0 million,
which includes $13.1 million for remediation services by third party consultants
and $0.3 million for new hardware and software. Through fiscal year 1998, $6.7
million of primarily consulting costs have been expensed, all of which are
included in the results of operations for fiscal year 1998. Costs to implement
the integrated system are estimated to aggregate $48.8 million which includes
$24.1 million, $9.2 million and $5.5 million for consulting, software and
hardware, respectively. Through fiscal year 1998, $15.7 million of costs, which
include $6.0 million of
10
<PAGE>
consulting costs and $5.2 million of software costs, have been capitalized. All
of the $15.7 million in costs were expended in fiscal year 1998. There can be no
assurance that these costs will not increase as the Company continues to
implement its integrated systems and Year 2000 project.
CONTROL BY SAPPI
The Company is a wholly owned subsidiary of Holdings. Sappi owns 100% of the
issued and outstanding voting common stock and 75.07% of the common equity of
Holdings in the form of Holdings Class A Common Stock. Heritage Springer
Limited, a British Virgin Islands company, owns the remaining 24.93% of the
common equity of Holdings in the form of Holdings non-voting, convertible Class
B Common Stock.
CONSIDERATIONS RELATING TO HOLDINGS' CASH OBLIGATIONS
The Company expects that it may make certain cash payments to Holdings or
other affiliates during fiscal 1999 to the extent cash is available and to the
extent it is permitted to do so under the terms of the Credit Agreement, the
Indenture relating to the Notes and the terms of the Warren Series B Preferred
Stock. Such payments may include, among other things, (i) amounts under a tax
sharing agreement between the Company and Holdings necessary to enable Holdings
to pay the Company's taxes, (ii) administrative fees to Holdings and amounts to
cover specified costs and expenses of Holdings, (iii) an annual advisory fee for
management advisory services to Sappi and/or its affiliates, the payment of
which is limited to $1.0 million in any one year and (iv) any dividends that
might be paid to Sappi.
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). 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 relating to the Notes 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
See Note 2--Summary of Significant Accounting Policies in the Notes to
Consolidated Financial Statements in this Form 10-K for a discussion of the
Company's plans for the implementation of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income", SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information", SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits",
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and
the Accounting Standards Executive Committee's Statement of Position 98-5,
"Reporting on the Costs of Start-up Activities."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 by Section 13 or
15(d) of the Securities Exchange Act of 1934. The registrant is not required
to file reports pursuant to Section 13 and 15(d) of the Securities Exchange
Act of 1934.
11
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
S.D. WARREN COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report..................................... 13
Consolidated Financial Statements:
Consolidated Statements of Operations for the years ended October
2, 1996, October 1, 1997 and September 30, 1998................ 14
Consolidated Balance Sheets as of October 1, 1997 and September
30, 1998....................................................... 15
Consolidated Statements of Cash Flows for the years ended October
2, 1996, October 1, 1997 and September 30, 1998................ 16
Consolidated Statements of Changes in Stockholder's Equity for
the years ended October 2, 1996, October 1, 1997 and September
30, 1998....................................................... 17
Notes to Consolidated Financial Statements....................... 18
Financial Statement Schedule:
II--Valuation and Qualifying Accounts.......................... 40
</TABLE>
12
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of S.D. Warren Company and subsidiaries:
We have audited the consolidated balance sheets of S.D. Warren Company and
subsidiaries (the "Company") as of September 30, 1998 and October 1, 1997 and
the related consolidated statements of operations, changes in stockholder's
equity, and cash flows for each of the three years in the period ended September
30, 1998. Our audits also included the financial statement schedule listed in
the Index. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule 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, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of September 30,
1998 and October 1, 1997 and the results of its operations and its cash flows
for each of the three years in the period ended September 30, 1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
October 22, 1998 (November 12, 1998 as to the second and third paragraphs of
Note 4)
13
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Sales........................................ $1,441.6 $1,405.6 $1,458.9
Cost of goods sold........................... 1,186.6 1,115.4 1,118.4
---------- ---------- -------------
Gross profit................................. 255.0 290.2 340.5
Selling, general and administrative
expense.................................... 134.1 137.6 142.6
Restructuring................................ -- 10.0 --
---------- ---------- -------------
Income from operations....................... 120.9 142.6 197.9
Gain on sale of pressure sensitive business -- -- 30.9
Other income (expense), net.................. (0.1) 4.1 3.0
Interest expense............................. 108.9 99.0 71.3
---------- ---------- -------------
Income before income taxes and extraordinary
items...................................... 11.9 47.7 160.5
Income tax expense........................... 5.1 19.3 66.5
---------- ---------- -------------
Income before extraordinary items............ 6.8 28.4 94.0
Extraordinary items, net of tax.............. (2.0) -- (4.9)
---------- ---------- -------------
Net income................................... 4.8 28.4 89.1
Dividends and accretion on Warren Series B
redeemable exchangeable preferred stock.... 13.5 15.2 16.3
---------- ---------- -------------
Net income (loss) applicable to common
stockholder................................ $ (8.7) $ 13.2 $ 72.8
---------- ---------- -------------
---------- ---------- -------------
Earnings (loss) per common share:
Income (loss) before extraordinary items
applicable to common stockholder....... $ (0.07) $ 0.13 $ 0.78
---------- ---------- -------------
---------- ---------- -------------
Net income (loss) applicable to common
stockholder............................ $ (0.09) $ 0.13 $ 0.73
---------- ---------- -------------
---------- ---------- -------------
Weighted average number of shares
outstanding................................ 100 100 100
---------- ---------- -------------
---------- ---------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
14
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 180.7 $ 34.7
Trade accounts receivable, net............................... 40.3 43.0
Other receivables............................................ 14.8 18.1
Inventories, net............................................. 163.4 166.8
Deferred income taxes........................................ 28.3 28.5
Other current assets......................................... 9.8 10.2
---------- -------------
Total current assets..................................... 437.3 301.3
Plant assets, net................................................ 951.1 970.5
Timber resources, net............................................ 95.6 --
Assets under agreement to sell................................... -- 98.9
Goodwill, net.................................................... 90.1 84.4
Deferred financing fees, net..................................... 35.4 28.0
Other assets, net................................................ 22.5 24.4
---------- -------------
Total assets............................................. $1,632.0 $1,507.5
---------- -------------
---------- -------------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt......................... $ 27.3 $ 6.4
Accounts payable............................................. 121.0 129.7
Accrued and other current liabilities........................ 109.1 97.8
---------- -------------
Total current liabilities................................ 257.4 233.9
---------- -------------
Long-term debt:
Term loans................................................... 251.5 138.6
Senior subordinated notes.................................... 375.0 324.6
Other........................................................ 113.3 110.6
---------- -------------
Total long-term debt..................................... 739.8 573.8
---------- -------------
Deferred income taxes............................................ 48.7 81.7
---------- -------------
Other liabilities................................................ 113.6 115.3
---------- -------------
Total liabilities........................................ 1,159.5 1,004.7
---------- -------------
Commitments and contingencies (Notes 11, 13, 14 and 15)
Warren Series B redeemable exchangeable preferred stock
(liquidation value, $110.6 and $126.1, respectively)........... 103.2 119.5
---------- -------------
Stockholder's equity:
Common stock ($.01 par value; 1,000 shares authorized; 100
shares issued and outstanding at October 1, 1997 and
September 30, 1998)........................................ -- --
Capital in excess of par value............................... 331.8 321.4
Retained earnings............................................ 37.5 61.9
---------- -------------
Total stockholder's equity............................... 369.3 383.3
---------- -------------
Total liabilities and stockholder's equity............... $1,632.0 $1,507.5
---------- -------------
---------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
15
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income................................. $ 4.8 $ 28.4 $ 89.1
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation............................. 86.8 86.6 80.9
Cost of timber harvested and amortization
of logging roads....................... 0.9 2.1 1.8
Amortization of intangibles.............. 27.5 26.6 8.1
Loss on force majeure event.............. -- 0.6 --
Deferred income taxes.................... 4.3 3.8 32.8
Extraordinary items...................... 3.3 -- 8.3
Gain on sale of pressure sensitive
business............................... -- -- (30.9)
Other.................................... -- (3.6) 1.4
Changes in assets and liabilities:
Trade and other accounts receivable,
net.................................... 80.3 28.2 (10.9)
Inventories, net......................... 30.8 32.3 (13.0)
Accounts payable, accrued and other
current liabilities.................... (6.8) 28.2 (2.0)
Other assets and liabilities............. (15.3) (10.6) 0.6
---------- ---------- -------------
Net cash provided by operating
activities........................... 216.6 222.6 166.2
---------- ---------- -------------
Cash Flows from Investing Activities:
Investments in plant assets and timber
resources................................ (51.3) (61.0) (111.0)
Proceeds from disposals of plant assets and
timber resources......................... -- 151.0 0.4
Proceeds from sale of pressure sensitive
business................................. -- -- 51.5
Refurbishment of plant assets.............. -- (40.1) --
Insurance proceeds to refurbish plant
assets................................... -- 40.9 --
Other investing activities................. 2.7 (4.4) (1.8)
---------- ---------- -------------
Net cash provided by (used in)
investing activities................. (48.6) 86.4 (60.9)
---------- ---------- -------------
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt... -- 38.1 --
Repayments of long-term debt, including
premiums paid............................ (178.2) (214.0) (191.0)
Dividend paid to parent.................... -- -- (58.2)
Other financing activities................. (3.0) (1.4) (2.1)
---------- ---------- -------------
Net cash used in financing
activities........................... (181.2) (177.3) (251.3)
---------- ---------- -------------
Net change in cash and cash equivalents...... (13.2) 131.7 (146.0)
Cash and cash equivalents:
Beginning of period........................ 62.2 49.0 180.7
---------- ---------- -------------
End of period.............................. $ 49.0 $ 180.7 $ 34.7
---------- ---------- -------------
---------- ---------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CAPITAL
IN
EXCESS
OF
COMMON COMMON PAR RETAINED
SHARES STOCK VALUE EARNINGS TOTAL
------ ------ ------- -------- ------
<S> <C> <C> <C> <C> <C>
Balance, September 28, 1995.................. 100 $-- $331.8 $ 33.0 $364.8
Net income................................. -- -- -- 4.8 4.8
Dividends accrued and accretion on Warren
Series B redeemable exchangeable
preferred stock.......................... -- -- -- (13.5) (13.5)
------ ------ ------- -------- ------
Balance, October 2, 1996..................... 100 -- 331.8 24.3 356.1
Net income................................. -- -- -- 28.4 28.4
Dividends accrued and accretion on Warren
Series B redeemable exchangeable
preferred stock.......................... -- -- -- (15.2) (15.2)
------ ------ ------- -------- ------
Balance, October 1, 1997..................... 100 -- 331.8 37.5 369.3
Net income................................. -- -- -- 89.1 89.1
Dividends accrued and accretion on Warren
Series B redeemable exchangeable
preferred stock.......................... -- -- -- (16.3) (16.3)
Dividend paid to parent.................... -- -- (10.4) (47.8) (58.2)
Consent fees and other charges............. -- -- -- (0.6) (0.6)
------ ------ ------- -------- ------
Balance, September 30, 1998.................. 100 $-- $321.4 $ 61.9 $383.3
------ ------ ------- -------- ------
------ ------ ------- -------- ------
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS
S.D. Warren Company and subsidiaries (the "Company" or "Warren")
manufactures printing, publishing and specialty papers and has pulp and
timberland operations vertically integrated with certain of its manufacturing
facilities. Together these represent the Company's single line of business. The
Company currently operates four paper mills, a sheeting facility and several
distribution facilities. Prior to November 12, 1998, the Company also owned
approximately 905,000 acres of timberlands in the State of Maine. On November
12, 1998, the Company sold its timberlands (See Note 4).
FORMATION AND ACQUISITION
On December 20, 1994, SDW Acquisition Corporation ("SDW Acquisition"), a
direct wholly-owned subsidiary of SDW Holdings Corporation ("Holdings"), the
Company's parent, acquired (the "Acquisition") from Scott Paper Company
("Scott") all of the outstanding capital stock of Warren, and certain related
affiliates of Scott. Immediately following the Acquisition, SDW Acquisition
merged with and into Warren, with Warren surviving. Scott has since been
acquired by Kimberly-Clark Corporation ("Kimberly-Clark"). Holdings is an
indirect subsidiary of Sappi Limited ("Sappi")
SAPPI REORGANIZATION
On April 27, 1998, Sappi announced the integration of Warren with Sappi's
four international fine paper operations (KNP Leykam, Hannover Papier, Sappi
U.K.'s Blackburn mill and Sappi Fine Paper in South Africa) to create Sappi Fine
Paper plc. The Sappi Fine Paper Division has a corporate head office in London.
The purpose of the reorganization is to focus on Sappi's main business
sectors--fine paper and forest products. Warren products are being marketed
under the name of Sappi Fine Paper North America. The legal entities of
Holdings, Warren and Warren's subsidiaries continue to remain in existence.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company have been
prepared on the accrual basis of accounting and include the accounts of the
Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates used by management include realization
of certain assets such as trade and other accounts receivable, inventory,
goodwill and deferred tax assets, as well as estimates of exposure and certain
liabilities of the Company. Actual results could differ from those estimates.
FISCAL YEAR
The Company and its subsidiaries' fiscal year ends on the Wednesday closest
to the last day of September. The year ended October 2, 1996 ("fiscal year
1996") included 53 weeks.
18
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist primarily of highly liquid investments
with insignificant interest rate risk and original maturities of three months or
less at the date of acquisition. Similar investments with original maturities
beyond three months are considered short-term marketable securities. At October
1, 1997 and September 30, 1998, the Company had no short-term marketable
securities.
OTHER RECEIVABLES
Other receivables primarily represent amounts due from the sale of energy
produced by the Company's cogeneration facilities, certain outstanding insurance
claims, income taxes receivable and sundry other receivables.
INVENTORIES
Inventories are valued at the lower of cost or market, using the first-in,
first-out ("FIFO") cost method. Inventories of maintenance parts and other
supplies are recorded at purchase cost.
PLANT ASSETS
Plant assets are recorded at cost. For financial accounting purposes,
depreciation is principally calculated by the straight-line method over the
estimated useful lives of the assets, which range from three to twenty years.
Expenditures for renewals and improvements which increase the useful life or
capacity of plant assets are capitalized. For retirements or sales of assets
which have not been fully depreciated, the cost of plant assets and the related
accumulated depreciation are removed from the asset account. The Company records
gains and losses on the retirement or sale of plant assets when realized.
Interest expense is capitalized on major construction projects, including
timber resources, discussed below, to the extent that such timber has not yet
matured. For fiscal years 1996, 1997 and 1998, the Company capitalized interest
of approximately $1.9 million, $3.7 million and $4.1 million, respectively.
TIMBER RESOURCES
Timber resources are recorded at cost less timber harvested and amortization
of logging roads. Cost of timber resources includes original costs, road
construction costs and reforestation costs such as site preparation and planting
costs. Timber harvested is computed on the units-of-production method. Property
taxes, surveying, fire control and other forest management expenses are charged
to expense as incurred.
COSTS OF COMPUTER SOFTWARE DEVELOPED FOR INTERNAL USE
The Company capitalizes direct costs of developing internal-use computer
software, including costs of external materials and services, and payroll and
related costs for employees directly associated with the project to the extent
their time is spent directly on the project. The costs will be amortized over
the estimated useful life of the completed software. As of September 30, 1998,
$15.7 million of costs have been incurred which are directly related to the
Company's implementation of a company-wide integrated application system. These
costs have been included in plant assets.
19
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
GOODWILL
Goodwill, which resulted from Sappi's 1994 acquisition of the Company, is
being amortized for financial statement purposes on a straight-line basis over
25 years. On an ongoing basis, the carrying value of goodwill is evaluated on
the basis of whether anticipated operating cash flows generated by the acquired
businesses are adequate to recover the recorded asset balance over its estimated
useful life. The goodwill balance at October 1, 1997 and September 30, 1998 was
approximately $90.1 million and $84.4 million, respectively, net of accumulated
amortization of approximately $11.1 million and $15.1 million, respectively.
DEFERRED FINANCING FEES
Deferred financing fees are being amortized over the life of the related
debt and are recorded net of accumulated amortization of approximately $25.5
million and $34.5 million at October 1, 1997 and September 30, 1998,
respectively. As a result of the partial early extinguishment of debt during
fiscal years 1996 and 1998, the Company recorded pre-tax extraordinary losses of
$3.3 million and $3.0 million, respectively, related to the write-off of
deferred financing fees which were partially offset by a deferred tax benefit of
$1.3 million in each year. The Company also extinguished certain debt during
fiscal year 1997. The net gain (loss) on such extinguishments was not
significant. (See Note 11.)
OTHER ASSETS
Other assets include intangible assets, primarily patents, aggregating $17.7
million and $14.3 million at October 1, 1997 and September 30, 1998,
respectively. These intangible assets are being amortized over their average
estimated useful lives of approximately 11 years. Intangibles are stated net of
accumulated amortization of approximately $5.3 million and $6.8 million at
October 1, 1997 and September 30, 1998, respectively.
FINANCIAL INSTRUMENTS
The Company uses interest rate swap agreements ("Swaps") and interest rate
cap agreements ("Caps") as a means of managing interest-rate risk associated
with debt balances. These instruments are matched with either fixed or variable
rate debt and are recorded on a settlement basis as an adjustment to interest
expense. Premiums paid to purchase Caps are amortized as an adjustment to
interest expense over the life of the contract. Cash flows from Swaps and Caps
are classified in the consolidated statements of cash flows in the same category
as the items being hedged or on a basis consistent with the nature of the
investment.
The Company does not hold derivative financial instruments for trading
purposes.
INCOME TAXES
The Company uses an asset and liability approach to computing deferred
income taxes, which requires recognition of deferred tax liabilities and assets
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this approach, deferred income
taxes are determined based on the difference between the financial statement and
income tax bases of assets and liabilities using enacted tax rates in effect for
the year in which the differences are expected to reverse. Valuation allowances
are established when necessary to reduce deferred tax assets to the amounts
expected to be realized.
20
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
WORKERS' COMPENSATION INSURANCE
The Company has a combination of self-insured and insured workers'
compensation programs. The self-insurance claim liability for workers'
compensation is based on claims reported and actuarial estimates of adverse
developments and claims incurred but not reported. The Company's workers'
compensation liability is discounted to reflect the passage of several years
before the claims related to a particular year are paid in full. The liability
has been determined based on an actuarial valuation as the timing of payments
associated therewith are reasonably estimable. The present value of such claims
was determined using a discount rate of 5.5% for fiscal years 1997 and 1998. The
gross liability was $39.9 million and $31.3 million at October 1, 1997 and
September 30, 1998, respectively.
RESEARCH AND DEVELOPMENT EXPENDITURES
Expenditures for research and development are charged to expense as
incurred. Research and development costs were $15.6 million, $13.6 million and
$13.5 million for fiscal years 1996, 1997 and 1998, respectively. These
expenditures are included in selling, general and administrative expense in the
accompanying consolidated statements of operations.
ENVIRONMENTAL EXPENDITURES
Environmental expenditures that pertain to current operations or relate to
future revenues are expensed or capitalized consistent with the Company's
capitalization policy. Expenditures that result from the remediation of an
existing condition caused by past operations, and do not contribute to current
or future revenues, are expensed. Environmental accruals are recorded based on
current interpretations of environmental laws and regulations when it is
probable that a liability has been incurred and the amount of such liability can
be reasonably estimated. Amounts accrued are not discounted and do not include
third-party recoveries. Liabilities are recognized for remedial activities when
the clean-up is probable and the cost can be reasonably estimated. All available
information is considered including the results of remedial
investigation/feasibility studies ("RI/FS"). In evaluating any disposal site
environmental exposure, an assessment is made of the Company's potential share
of the remediation costs by reference to the known or estimated volume of the
Company's waste that was sent to the site and the range of costs to treat
similar waste at other sites if a RI/FS is not available.
OTHER INCOME (EXPENSE), NET
Other income (expense), net, represents interest income on cash and cash
equivalents and other non-operating income and expense items.
EARNINGS PER COMMON SHARE
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings per Share", effective October 2, 1997. SFAS 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. The adoption of SFAS No. 128 had no effect on the Company's
earnings per share due to the absence of dilutive instruments in all periods
presented.
Earnings per common share is computed using the weighted average number of
common shares outstanding during the period. For purposes of computing income
(loss) per share applicable to common stockholder, the Company's income before
extraordinary items and net income (loss) have been reduced by Warren Series B
Preferred Stock dividends and accretion (See Note 19).
21
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
CASH PAID FOR INCOME TAXES
Cash paid for income taxes for fiscal years 1996, 1997 and 1998 was $4.7
million, $10.6 million and $35.5 million, respectively. Cash received for income
tax refunds in fiscal years 1997 and 1998 was $4.9 million and $0.8 million,
respectively.
CASH PAID FOR INTEREST
Cash paid for interest during fiscal years 1996, 1997 and 1998 was $112.3
million, $86.7 million and $75.8 million, respectively.
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income", and SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information", both of which will be
effective for the Company in fiscal year 1999. SFAS 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. SFAS No. 131 establishes standards for the way
that public business enterprises report selected information about operating
segments. SFAS No. 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The implementation
of SFAS Nos. 130 and 131 is not expected to have a material effect on the
Company's consolidated financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits", which the Company is required
to implement no later than fiscal year 1999. SFAS No. 132 is an amendment to
SFAS Nos. 87, 88 and 106. The statement standardizes disclosure requirements for
pension and postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis and eliminates certain other
disclosures. The implementation of SFAS No. 132 is not expected to have a
material effect on the Company's consolidated financial statements.
In April 1998, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities", which
the Company is required to implement no later than fiscal year 2000. SOP 98-5
establishes standards that require start-up and organization costs to be
expensed as incurred. The implementation of SOP 98-5 is not expected to have a
material effect on the Company's consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", and is effective for the Company in the
first quarter of fiscal year 2000. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. The Company believes
the adoption of SFAS No. 133 will not have a material effect on its consolidated
financial statements.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform
with the current year presentation.
22
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
NOTE 3--RESTRUCTURING
In October 1996, the Company commenced a restructuring plan which resulted
in a charge of $10.0 million to cover the costs related to the reduction of
approximately 200 salaried positions, or approximately 14% of the Company's
salaried work force. Substantially all amounts had been expended at September
30, 1998.
NOTE 4--EVALUATION AND SALE OF NONCORE ASSETS
In May 1997, the chairman of Sappi announced that Sappi was evaluating the
sale of noncore assets throughout the Sappi group. Consequently, Warren
investigated the sale or monetization of businesses not within its main area of
focus. Consistent with this strategy, on March 18, 1998, the Company sold its
pressure sensitive business located at the Westbrook, Maine mill to Spinnaker
Industries, Inc. ("Spinnaker"). This business unit manufactures pressure
sensitive paper products in roll form which are sold to label printers that
produce products used primarily for informational labels and product
identification. Proceeds of the sale consisted of $44.8 million of cash and a
subordinated note (the "Spinnaker Note") for $7.0 million. On March 31, 1998,
the Company sold the Spinnaker Note to a third party for $6.7 million which was
received in cash on May 1, 1998. The Company recognized a pretax gain from the
sale of the business unit (net of the loss on the sale of the Spinnaker Note) of
$30.9 million. Sales of the pressure sensitive business unit included in the
accompanying consolidated statements of operations for fiscal 1997 and 1998 were
approximately $62.1 million and $27.7 million, respectively.
On November 12, 1998 the Company sold its interests in approximately 905,000
acres of timberlands located in Maine and certain machinery and equipment to
Plum Creek Timber Company, L.P. ("Plum Creek") in exchange for a note receivable
with a fair market value of $177.1 million and cash of approximately $3.0
million. To consummate the sale, the Company transferred all of its timberlands
and related machinery and equipment to a wholly-owned limited liability company,
all of the membership interest of which was then sold to Plum Creek. The
timberlands and machinery and equipment sold are shown in the accompanying
consolidated balance sheet at September 30, 1998 as assets under agreement to
sell. The respective carrying amounts of the timberlands and machinery and
equipment are $96.0 million and $2.9 million. These assets have been classified
as long-term consistent with the long-term nature of the note received from Plum
Creek.
The Company and Plum Creek executed a fiber supply agreement (the "supply
agreement"), with an initial term of 25 years and with three five-year renewal
options. Under the supply agreement, the Company will purchase hardwood pulpwood
at an annual minimum of 300,000 to 375,000 tons, or approximately 13% of the
Company's annual requirements, at market prices.
NOTE 5--FORCE MAJEURE EVENT
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. In connection with the flood, the
Company incurred $45.9 million of costs to refurbish the mill, of which $4.0
million was capitalized representing improvements to existing plant assets. The
Company received, net of deductibles of $3.5 million, insurance proceeds
totaling $52.7 million of which $40.9 million related to the refurbishment and
$11.8 million related to business interruption claims. All claims were submitted
and finalized as of October 1, 1997.
23
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
NOTE 6--TRADE ACCOUNTS RECEIVABLE AND MAJOR CUSTOMER INFORMATION
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
------------- -------------
(IN MILLIONS)
<S> <C> <C>
Trade accounts receivable.................... $45.3 $48.4
Allowance for doubtful accounts.............. (5.0) (5.4)
----- -----
$40.3 $43.0
----- -----
----- -----
</TABLE>
In April 1996, the Company, through a bankruptcy remote subsidiary, S.D.
Warren Finance Co. ("SDWF"), entered into a receivables sales agreement that
provides the Company with a five-year $110 million revolving accounts receivable
securitization facility (the "A/R Facility"). Under this facility and pursuant
to a purchase and contribution agreement between the Company and SDWF, the
Company sells to SDWF, on a non-recourse basis, all rights and interests in its
accounts receivable. Pursuant to the receivables purchase agreement, SDWF, in
turn, securitizes certain interests in the accounts receivable pool owned by
SDWF under similar terms to a third party purchaser.
The A/R Facility also contains restrictive covenants which limit SDWF with
respect to certain matters including, among other things, the maintenance of a
certain net worth and the ability to incur liens, extend credit terms beyond
their stated maturity, change its credit policy, create subsidiaries or change
its line of business. The A/R Facility also limits SDWF's ability to pay
dividends, incur indebtedness or amend other agreements related to the A/R
Facility without the consent of the third-party purchaser. In addition, the A/R
Facility requires that SDWF maintain certain ratios related to the performance
of the underlying accounts receivable, including a delinquency ratio, a default
ratio and a loss-to-liquidation ratio.
The Company's trade accounts receivable, shown in the table above, are net
of $93.2 million and $72.0 million at October 1, 1997 and September 30, 1998,
respectively, which represent accounts receivable that were securitized and sold
under the A/R Facility.
The Company had sales to customers outside of the United States ("export
sales") of $179.1 million, $186.2 million and $185.0 million, for fiscal years
1996, 1997 and 1998, respectively. Export sales are primarily to Canada, Europe,
Australia, Latin America and the Far East. Export sales do not exceed 10% of
total sales for any geographic region. Sales outside North America are primarily
handled by the Company's affiliates under the common control of Sappi.
Sales to unaffiliated customers which individually exceed 10% of total sales
amounted to approximately 52.5%, 51.9% and 53.8% of sales for fiscal years 1996,
1997 and 1998, respectively. Each of these customers is a merchant that resells
the Company's paper products to a wide range of end users. The loss of any of
these customers could have a material effect on the Company's business and
consolidated results of operations. Sales to each such customer are indicated
below (in millions):
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
1............................................ $355.0 $360.3 $353.0
2............................................ 201.9 169.9 202.9
3............................................ 199.8 199.6 228.6
</TABLE>
24
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
At October 1, 1997 and September 30, 1998, approximately 41.5% and 45.2%,
respectively, of the Company's net trade receivables, including those
receivables which are securitized and sold, were concentrated in these three
customers.
NOTE 7--INVENTORIES, NET (IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Finished products............................ $ 76.7 $ 81.6
Work in process.............................. 21.4 26.3
Pulp, logs and pulpwood...................... 23.9 24.5
Maintenance parts and other supplies......... 41.4 34.4
---------- ------
$163.4 $166.8
---------- ------
---------- ------
</TABLE>
NOTE 8--PLANT ASSETS (IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Plant assets, at cost:
Land and buildings....................... $ 174.4 $ 175.5
Plant and equipment...................... 991.3 1,085.3
---------- -------------
1,165.7 1,260.8
Accumulated depreciation................. (214.6) (290.3)
---------- -------------
$ 951.1 $ 970.5
---------- -------------
---------- -------------
</TABLE>
25
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
NOTE 9--INCOME TAXES
Income before income taxes and extraordinary items for fiscal years 1996,
1997 and 1998 was from domestic sources.
The components of the tax provisions before extraordinary items are as
follows (in millions):
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Current:
Federal.................................. $(1.1) $13.5 $27.1
Foreign.................................. (1.2) -- --
State and local.......................... 1.8 2.0 4.8
----- ----- -----
Total current........................ (0.5) 15.5 31.9
----- ----- -----
Deferred:
Federal.................................. 5.3 1.9 24.9
Foreign.................................. 1.2 -- --
State and local.......................... (0.9) 1.9 9.7
----- ----- -----
Total deferred....................... 5.6 3.8 34.6
----- ----- -----
$ 5.1 $19.3 $66.5
----- ----- -----
----- ----- -----
</TABLE>
The components of the deferred tax provisions before extraordinary items are
as follows (in millions):
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Inventory.................................... $ (0.1) $ 1.2 $ (0.8)
Plant assets................................. 93.0 28.3 0.5
Accrued and other liabilities................ (35.5) (15.6) 28.6
AMT credit carryforwards..................... (3.7) (14.9) (28.1)
Tax loss carryforwards....................... (41.7) 4.8 34.4
Other credits................................ (6.4) -- --
---------- ---------- ------
Deferred tax provision....................... $ 5.6 $ 3.8 $ 34.6
---------- ---------- ------
---------- ---------- ------
</TABLE>
26
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The components of the deferred tax assets and (liabilities) are as follows
(in millions):
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
----------- -------------
<S> <C> <C>
Current:
Deferred tax assets:
Restructuring reserves................... $ 1.3 $ 0.3
Accrued and other liabilities............ 24.4 24.9
Inventory................................ 6.3 7.1
----------- -------------
Total current deferred tax assets.... 32.0 32.3
Deferred tax liabilities:
Accrued and other liabilities and
prepaids............................... (3.7) (3.8)
----------- -------------
Net current deferred tax asset............... 28.3 28.5
----------- -------------
Noncurrent:
Deferred tax assets:
Alternative minimum tax credit
carryforwards.......................... 27.9 56.0
Tax loss carryforwards................... 36.9 2.5
Accrued and other liabilities............ 73.7 40.7
----------- -------------
Total noncurrent deferred tax
assets............................. 138.5 99.2
----------- -------------
Deferred tax liabilities:
Plant assets............................. (134.3) (134.8)
Other.................................... (52.9) (46.1)
----------- -------------
Total noncurrent deferred tax
liability.......................... (187.2) (180.9)
----------- -------------
Net noncurrent deferred tax liability........ (48.7) (81.7)
----------- -------------
Net deferred tax liability............... $ (20.4) $ (53.2)
----------- -------------
----------- -------------
</TABLE>
The differences between the U.S. statutory income tax rate and the Company's
effective income tax rate before extraordinary items are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
U.S. statutory income tax rate............... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit... 5.2 5.3 5.9
Other factors................................ 2.7 0.2 0.5
----- ----- -----
Effective tax rate........................... 42.9% 40.5% 41.4%
----- ----- -----
----- ----- -----
</TABLE>
27
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
As of September 30, 1998, the Company had available federal and state tax
net operating loss carryforwards of approximately $7.3 million. For federal tax
purposes, the loss carryforwards will begin to expire in the year 2011. For
state tax purposes, the loss carryforwards will expire between the years 2001
and 2011. The Company also has available federal and state alternative minimum
tax credit carryforwards for tax return purposes of $56.0 million which will
carry forward to future taxable years indefinitely.
NOTE 10--ACCRUED AND OTHER CURRENT LIABILITIES (IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Accrued salaries, wages and employee
benefits................................... $ 48.0 $ 44.4
Accrued interest............................. 23.5 18.8
Accrued workers' compensation................ 3.6 5.0
Other accrued expenses....................... 34.0 29.6
---------- ------
$109.1 $ 97.8
---------- ------
---------- ------
</TABLE>
NOTE 11--LONG-TERM DEBT
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
(IN MILLIONS)
<S> <C> <C>
Bank term loans under Credit Agreement....... $271.3 $145.0
Warren Series B Senior Subordinated Notes.... 375.0 324.6
Revenue bonds................................ 119.5 110.6
Other........................................ 1.3 --
---------- ------
767.1 580.2
Current maturities of long-term debt......... 27.3 6.4
---------- ------
Long-term debt............................... $739.8 $573.8
---------- ------
---------- ------
</TABLE>
CREDIT AGREEMENT
On March 6, 1998 Holdings and Warren entered into the Second Amended and
Restated Credit Agreement (the "Credit Agreement"), with a group of domestic and
international lenders. The Credit Agreement consists of (1) a seven-year
amortizing Term Loan, originally in an aggregate amount of $185.0 million, (2) a
$250.0 million Revolving Credit Facility and (3) a $136.3 million Letter of
Credit Facility (together collectively referred to herein as the "Credit
Facilities").
Loans under the Credit Agreement bear interest at a rate equal to, at the
Company's option, (1) the ABR Rate plus the Applicable Margin ("ABR Loans") or
(2) the Eurodollar Rate (adjusted for reserves) for the respective interest
period plus the Applicable Margin ("Eurodollar Loans"). Applicable Margin means
a percentage annum rate ranging (a) in the case of ABR Loans, from 0% to 1.00%
and (b) in the case of Eurodollar loans, from 0.75% to 2.00%, in each case
determined by the Company's achievement of a certain financial ratio determined
from the most recent financial statements of the Company calculated as of the
last day of each fiscal quarter on a rolling four quarters basis. ABR Rate means
the highest of (1) the prime rate, (2) the secondary market rate for three-month
certificates of deposit (adjusted for reserves) plus 1.00% and (3) the federal
funds rate in effect from time to time plus 0.5%.
28
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The Credit Facilities are guaranteed by Holdings and each of its U.S.
subsidiaries. The Credit Facilities and such guarantees are secured by security
interests (subject to other liens permitted by the terms of the Credit
Facilities), to the extent permissible under the applicable laws and
regulations, in (a) all of the capital stock of Warren and each of its U.S.
subsidiaries and 65% of the common stock and 100% of the preferred stock of each
foreign subsidiary and (b) all assets (subject to certain limitations), except
certain trade accounts receivable, owned by Warren and its subsidiaries.
The Credit Agreement contains restrictive covenants which limit Holdings,
Warren and their subsidiaries with respect to certain matters including, among
other things, the ability to incur debt, pay dividends, make acquisitions, sell
assets, merge, grant or incur liens, guarantee obligations, make investments or
loans, make capital expenditures, create subsidiaries or change its line of
business. The Credit Agreement also restricts Warren from prepaying certain of
its indebtedness. Under the Credit Agreement, Warren is required to satisfy
certain financial covenants which require Warren to maintain specified financial
ratios and comply with certain financial tests, including a minimum interest
coverage ratio, a maximum leverage ratio, and a net worth test. Such covenants
are not considered by the Company to be of a restrictive nature in conducting
its business activities. As of September 30, 1998, management believes the
Company is in compliance with all covenants.
TERM LOAN
Pursuant to the Credit Agreement as originally written, the Term Loan was
payable in semi-annual installments beginning in September 1998 with a final
maturity in March 2005. Subsequent to the $40.0 million prepayment (as discussed
below), the payment schedule was revised to commence semi-annual installments in
September 1999. At September 30, 1998, the Term Loan was a Eurodollar loan with
a weighted-average interest rate of 6.50%. Warren is required to prepay the Term
Loan with (1) 50% of the net cash proceeds of certain aggregate asset sales in
excess of $50.0 million and (2) 100% of the net proceeds of incurrences of
indebtedness, to the extent that the aggregate exceeds $20.0 million. Unless the
Company achieves a certain financial ratio, as defined, Warren will be required
to prepay the Term Loan annually in an amount equal to 50% of the Excess Cash
Flow (as defined) of Warren and its subsidiaries for the prior fiscal year.
Excess Cash Flow prepayments relating to fiscal years 1996, 1997 and 1998 were
not required.
The Company may also make optional prepayments without premium or penalty at
any time (subject to payments of certain termination costs if other than on the
last day of an interest period under certain circumstances).
REVOLVING CREDIT FACILITY
Under the Revolving Credit Facility, which expires in March 2005, Warren can
borrow up to $250.0 million. In addition, $75.0 million of the Revolving Credit
Facility is available to Warren for letters of credit. At October 1, 1997 and
September 30, 1998, $11.0 million and $16.6 million, respectively, of the
Revolving Credit facility was utilized to guarantee the issuance of letters of
credit. At October 1, 1997 and September 30, 1998, availability under the
Revolving Credit Facility was $239.0 million and $233.4 million, respectively.
In addition, Warren pays a quarterly commitment fee between 0.20% and 0.50% per
annum on the unused portion of the Revolving Credit facility based on the
achievement of a certain financial ratio. At October 1, 1997 and September 30,
1998, the Company had no loans outstanding under the Revolving Credit Facility.
29
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
LETTER OF CREDIT FACILITY
Warren had approximately $150.8 million and $136.3 million of letters of
credit outstanding under the Letter of Credit Facility at October 1, 1997 and
September 30, 1998, respectively, in support of its ongoing obligations under
tax-exempt bond financings and certain leases. Warren pays a commission, which
is based on the achievement of a certain financial ratio, of between 0.75% and
2.00% on outstanding letters of credit and an issuance fee of 0.125% per annum
on letters of credit issued.
WARREN SERIES B SENIOR SUBORDINATED NOTES
The Warren 12% Series B Senior Subordinated Notes due 2004 (the "Notes") are
unsecured, subordinated obligations of Warren and rank (i) junior in right of
payment to all existing and future Senior Debt (as defined for purposes of the
Notes), including obligations of Warren under the Credit Agreement and (ii)
senior in right of payment to or PARI PASSU in right of payment with all
existing and future subordinated indebtedness.
REVENUE BONDS
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, refunding or defeasing
revenue bonds aggregating $28.1 million, and issuing new bonds aggregating $38.1
million. The extraordinary gain resulting from the extinguishment of the
original bonds was not significant.
At September 30, 1998 the Company is obligated under revenue bonds
aggregating $110.6 million which are due from 2002 to 2022 and bear interest
from 5.90% to 7.375%.
LONG-TERM DEBT REPAYMENTS
During fiscal year 1998, Warren made prepayments on its term loans under the
Credit Agreement for aggregate amounts of $86.3 million (including amounts
repaid pursuant to the modification of the credit arrangement) and $40.0
million. Also in fiscal year 1998, the Company purchased $50.4 million face
value of the Notes for $55.7 million of cash. The premium paid of $5.3 million
to purchase the Notes, together with the accelerated amortization of deferred
financing fees relating to the purchased Notes and the repayments of term loans,
resulted in an aggregate extraordinary loss of $4.9 million (net of a $3.4
million tax benefit).
FUTURE MATURITIES OF LONG-TERM DEBT
Scheduled maturities of long-term debt, including sinking fund payments, at
September 30, 1998 are as follows (in millions):
<TABLE>
<S> <C>
1999.................................................................. $ 6.4
2000.................................................................. 12.8
2001.................................................................. 17.1
2002.................................................................. 23.0
2003.................................................................. 27.7
Thereafter............................................................ 493.2
------
$580.2
------
------
</TABLE>
30
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
NOTE 12--FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company's financial instruments consist mainly of cash and cash
equivalents, accounts receivable, accounts payable and debt. In addition, the
Company uses interest rate swaps as a means of managing interest rate risk
associated with outstanding debt. Summarized below are the carrying values and
fair values of the Company's financial instruments. The carrying amounts for
cash, cash equivalents, accounts receivable and accounts payable approximate
fair value due to the short-term nature of these instruments. Accordingly, these
items have been excluded from the table below:
<TABLE>
<CAPTION>
SEPTEMBER 30,
OCTOBER 1, 1997 1998
----------------- -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------ -------- ------
<S> <C> <C> <C> <C>
BALANCE SHEET FINANCIAL INSTRUMENTS (IN MILLIONS):
Term loans.................................................. $271.3 $271.3 $145.0 $145.0
Notes....................................................... 375.0 422.1 324.6 353.8
Revenue bonds and other..................................... 120.8 126.6 110.6 120.8
Interest rate caps and swaps................................ 0.0 (1.1) 0.0 (0.9)
</TABLE>
The fair values of the Notes and revenue bonds were estimated by the Company
based upon quotations provided by a nationally recognized pricing service. The
principal amounts of the Term Loans approximate market value since they are
variable rate instruments which reprice as often as monthly.
The Company's off-balance sheet financial instruments include the letters of
credit under both the Revolving Credit Facility and the Letter of Credit
Facility, interest rate caps and swaps, and the A/R Facility. At October 1,
1997, the carrying amount of the premium associated with the interest rate caps
and swaps had been fully amortized. Unrealized losses related to the interest
rate caps and swaps approximated $1.1 million and $0.9 million at October 1,
1997 and September 30, 1998, respectively. At these two dates, respectively, the
total carrying amounts of accounts receivable reflect $93.2 million and $72.0
million of reductions related to the A/R Facility. There are no unrealized
losses on the A/R Facility at October 1, 1997 or September 30, 1998.
The fair value of interest rate swaps and caps is the estimated amount that
the Company would pay to terminate the swap agreement at the balance sheet date,
taking into account current interest rates and the current credit worthiness of
the swap counterparties.
A significant portion of the Company's sales and accounts receivable are
from major customers (See Note 6). None of the Company's other financial
instruments represent a concentration of credit risk because the Company has
dealings with a variety of major banks and customers worldwide. None of the
Company's off-balance sheet financial instruments would result in a significant
loss to the Company if the other party failed to perform according to the terms
of its agreement, as any such loss would generally be limited to the unrealized
gain in any contract.
NOTE 13--LEASES
On July 29, 1997, the Company entered into a sale/leaseback arrangement
involving the sale of one of the paper machines at its Somerset, Maine mill for
$150.4 million. In connection with the transaction, the Company entered into a
15 year agreement to lease back the paper machine. Rental payments of
approximately $7.6 million are made semi-annually in arrears in January and
July. The sale/leaseback arrangement is being accounted for as an operating
lease. The gain on the transaction of approximately $17.4 million was deferred
and is being 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
31
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Term Loans in July 1997. Rental expense relating to this lease, net of
amortization of deferred gain, was $2.3 million and $14.0 million for fiscal
years 1997 and 1998, respectively.
The Company also leases office and warehouse space and various office and
other manufacturing equipment under operating leases. Unexpired lease terms for
operating leases range from one to six years. Most leases contain renewal
options and options to purchase such equipment at fair market value. Rental
expense relating to these leases was $3.5 million, $4.2 million and $3.2 million
for fiscal years 1996, 1997 and 1998, respectively.
Additionally, the Company has other commitments, which expire in 2008, to
operate a biomass cogeneration facility adjacent to its Westbrook mill and to
purchase its steam and electricity output on a take-or-pay basis (the
"Cogeneration Obligation"). Under the Cogeneration Obligation, the Company paid
approximately $7.0 million, $7.5 million and $7.7 million for fiscal years 1996,
1997 and 1998, respectively.
The future minimum obligations under leases (including the Somerset paper
machine lease) and other commitments as of September 30, 1998 are as follows (in
millions):
<TABLE>
<CAPTION>
OPERATING OTHER
YEAR ENDING SEPTEMBER LEASES COMMITMENTS
- ------------------------------------------------------------ --------- -----------
<S> <C> <C>
1999........................................................ $ 21.7 $7.3
2000........................................................ 19.4 7.4
2001........................................................ 18.2 8.8
2002........................................................ 17.0 12.1
2003........................................................ 16.8 8.9
Thereafter.................................................. 151.5 41.4
--------- -----
$244.6 $85.9
--------- -----
--------- -----
</TABLE>
Certain lease obligations and the Cogeneration Obligation contain scheduled
payment increases. The Company is recognizing expenses associated with these
contracts on a straight-line basis over the related contract's terms.
NOTE 14--ENVIRONMENTAL AND SAFETY MATTERS
The Company is subject to a wide variety of 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 Environmental
Protection Agency ("EPA") would limit dioxin discharges from the Company's
Somerset and Westbrook mills. While the permit limitations at these two
facilities are being challenged, the Company continues to operate under existing
EPA permits in accordance with accepted administrative practice.
32
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The Company's 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 pre-treatment
program. The lawsuit challenges, among other things, the treatment capacity
availability and local effluent limit provisions of the ordinance. In July 1996,
the court hearing the lawsuit rendered a decision substantially in favor of the
Company and other plaintiffs. The County appealed the court's decision. In July
1998, the appeals court affirmed the lower court's decision. In June 1997, the
EPA sued the County for failure to implement and enforce its industrial
pre-treatment operations 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 which has raised the industrial users'
contractual rights as an issue in the EPA lawsuit. The group of industrial users
and municipalities intervened in the lawsuit. 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 December 1997, the County
notified the Company and other industrial users of its intentions to terminate
their service agreements on January 1, 2000. The Company believes that under
Michigan contract law, related contracts and county bond resolutions, the County
does not have the authority to unilaterally terminate the service agreements.
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"). The cluster rules were published
on April 15, 1998, with compliance with the rules generally required beginning
in 2001. The Company believes that environmental compliance expenditures, the
bulk of which are for the cluster rules compliance, will require aggregate
capital expenditures of approximately $70.0 million to $112.0 million through
2001, of which $20.0 million has already been incurred. The ultimate financial
impact to the Company of compliance with the cluster rules will depend upon the
cost and availability of new technology.
The Company believes that none of these matters, individually or in the
aggregate, is expected to have a material adverse effect on its consolidated
financial position, results of operations or cash flows.
NOTE 15--COMMITMENTS AND CONTINGENCIES
In connection with the Acquisition, Warren entered into long-term (25 years
initially, subject to mill closures and certain FORCE MAJEURE events) agreements
with Scott (now Kimberly-Clark) 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 mill and pulp
quantities are subject to minimum (162,000 tons per year) and maximum (208,000
tons per year) limits. Prices for other services to be provided by
Kimberly-Clark are generally based upon cost. During fiscal years 1996, 1997 and
1998, the Company purchased pulp and utilities under these agreements
aggregating $148.0 million, $108.0 million and $109.3 million, respectively. On
May 4, 1998, the Company announced an agreement with Kimberly-Clark to terminate
the long-term pulp supply contract effective September 1, 1999. The cancellation
of the pulp contract is expected potentially to benefit the Company's paper
making operations by providing for increased flexibility in procuring fiber from
competitive global market sources. In addition, the Company believes the
contract cancellation will allow for improved paper machine scheduling
efficiencies and product mix. The cancellation of the pulp contract did not
materially impact the Company's earnings for the year ended September 30, 1998.
The Company has a long-term agreement (the "Energy Agreement") with Mobile
Energy Services Corporation ("MESC") to buy electric power and steam for the
Mobile paper mill at rates generally comparable to market tariffs, including
fuel cost and capital recovery components. Kimberly-Clark has announced their
33
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
intention to close their pulp mill at the Mobile site effective September 1999.
The closure of the Kimberly-Clark pulp mill may result in a MESC default under
certain bond indentures. The Company is currently evaluating the impact on
continued MESC operations of the closure of the Kimberly-Clark pulp mill. Loss
of biomass and black liquor fuels currently provided to MESC by the pulp mill
could have an adverse impact on the Company's energy rates.
A substantial majority of the Company's electricity requirements are
satisfied through its own generation or cogeneration agreements. The Company's
power requirements at its Somerset mill are currently satisfied through a
cogeneration agreement whereby the mill cogenerates electricity and sells the
output to Central Maine Power ("CMP") at market rates. The CMP agreement
relating to the Somerset mill also provides, but does not require, that the mill
purchase electricity from CMP at the standard industrial tariff rate. The
Somerset agreement expires in the year 2012. The Company previously had a
long-term agreement with CMP relating to the Westbrook mill, which expired on
October 31, 1997. This long-term agreement with CMP has been replaced with a
short-term agreement pursuant to which the Westbrook mill cogenerates
electricity and sells any excess output not used by the mill to CMP at market
rates. The short-term agreement for the Westbrook mill will expire on December
31, 1998. As of the date of the Acquisition, the Company established a deferred
asset and deferred liability of approximately $32.3 million and $15.0 million,
respectively, to reflect the fair value of the Somerset and now expired
Westbrook agreements. For fiscal years 1996 and 1997, amortization expense
related to the deferred asset approximated $12.0 million and $9.5 million,
respectively. As of October 1, 1997, the asset was fully amortized. Amortization
of the deferred liability commenced in fiscal year 1998 with $2.9 million
amortized in fiscal year 1998. Power sales revenue is recognized by the Company
at the time that power is provided to or used by CMP based on fixed rates per
kilowatt hour in the case of the Westbrook agreement and variable rates per
kilowatt hour in the case of the Somerset agreement.
The Company is also involved in various other lawsuits and administrative
proceedings. The relief sought in such lawsuits and proceedings includes
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 consolidated financial position, results of
operations or cash flows.
NOTE 16--RETIREMENT BENEFITS
PENSION PLANS
The Company has four defined-benefit, trusteed pension plans that provide
retirement benefits for substantially all employees. Benefits provided are
primarily based on employees' years of service and compensation. The Company's
funding policy complies with the requirements of Federal law and regulations.
Plan assets consist of equity securities, bonds and short-term investments. The
current portion of the net pension liability, detailed below, was $9.8 million
and $12.9 million at October 1, 1997 and September 30, 1998, respectively.
34
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
The funded status of the pension plans is shown below (in millions):
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Actuarial present value of benefit
obligation:
Vested.............................. $102.9 $130.7
Nonvested........................... 20.1 27.1
---------- ------
Accumulated benefit obligation...... 123.0 157.8
Additional obligation for future salary
increases.............................. 34.6 39.9
---------- ------
Projected benefit obligation............ 157.6 197.7
Plan assets at fair value............... 147.5 174.1
---------- ------
Projected benefit obligation in excess
of plan assets......................... (10.1) (23.6)
Unrecognized components................. (19.3) (8.3)
---------- ------
Accrued pension cost.................... (29.4) (31.9)
Contributions........................... 3.5 5.6
Additional minimum liability............ -- (3.4)
---------- ------
Net pension liability................... $(25.9) $(29.7)
---------- ------
---------- ------
</TABLE>
The net pension cost for the plans includes the following components (in
millions):
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Service cost-benefits earned during the period.... $ 6.3 $ 6.0 $ 7.1
Interest cost on projected benefit obligation..... 9.8 10.5 12.3
Actual return on plan assets...................... (14.1) (13.4) (26.2)
Net deferral...................................... 4.9 2.0 12.6
---------- ---------- ------
Net pension cost.................................. $ 6.9 $ 5.1 $ 5.8
---------- ---------- ------
---------- ---------- ------
</TABLE>
The projected benefit obligation at October 1, 1997 and September 30, 1998
was determined using assumed discount rates of 7.75% and 7.0%, respectively, and
assumed long-term rates of compensation increases of 4.5% and 3.75%,
respectively. The assumed rate of return on plan assets (on an annualized basis)
was 9.0% and 9.25% for fiscal years 1997 and 1998, respectively.
SAVINGS PLANS
Warren currently sponsors two 401(k) defined contribution plans covering
substantially all Warren employees pursuant to which Warren is obligated to
match employee contributions, up to specified amounts. Warren contributions to
these plans totaled $5.3 million, $5.5 million and $5.3 million for fiscal years
1996, 1997 and 1998, respectively.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
Effective in fiscal year 1996, Warren approved a Supplemental Executive
Retirement Plan ("SERP"). Key executives are eligible to participate in the SERP
provided such individuals meet specified criteria upon retirement. Payments
pursuant to the plan are made at the time key executives retire. The related
35
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
expense is recorded in each fiscal year based on actuarially determined amounts.
To date, payments made and expenses incurred pursuant to the plan have not been
material to Warren's consolidated results of operations or cash flows.
NOTE 17--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Warren sponsors a defined benefit postretirement plan that provides health
care and life insurance benefits to eligible retired employees. Employees are
generally eligible for benefits upon retirement and completion of a specified
number of years of service. The current portion of Warren's net postretirement
liability, detailed below, was $0.2 million and $0.7 million at October 1, 1997
and September 30, 1998, respectively.
The following schedule provides the plan's funded status and obligations (in
millions):
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Accumulated postretirement benefit obligation
(APBO):
Retirees...................................... $ 3.4 $ 6.8
Active participants........................... 30.8 33.1
---------- ------
Total APBO.................................... 34.2 39.9
Plan assets at fair value......................... -- --
---------- ------
APBO in excess of plan assets..................... (34.2) (39.9)
Unrecognized prior service cost................... (0.9) (0.8)
Unrecognized net actuarial gain................... (1.8) (0.7)
---------- ------
Net postretirement liability...................... $(36.9) $(41.4)
---------- ------
---------- ------
</TABLE>
Components of the net periodic postretirement benefit expense are as follows
(in millions):
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30,
1996 1997 1998
---------- ---------- -------------
<S> <C> <C> <C>
Service cost...................................... $2.6 $2.5 $2.5
Interest cost on APBO............................. 2.3 2.4 2.6
--- --- ---
Net postretirement benefit cost................... $4.9 $4.9 $5.1
--- --- ---
--- --- ---
</TABLE>
The discount rates used to estimate the accumulated benefit obligations as
of October 1, 1997 and September 30, 1998 were 7.75% and 7.0%, respectively. The
initial health care cost trend rates used to value the APBO were 9.0%, 6.75% and
6.0% at October 2, 1996, October 1, 1997 and September 30, 1998, respectively,
decreasing gradually to an ultimate rate of 5.25%, 4.75% and 4.0% in the year
2007. A one-percentage point increase in the assumed health care trend rate for
each future year would increase the APBO by approximately 7.4% at September 30,
1998 and would increase the sum of the benefits earned and interest cost
components of net postretirement benefit cost for 1998 by approximately 9.9%.
36
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
NOTE 18--OTHER LIABILITIES (IN MILLIONS)
<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1997 1998
---------- -------------
<S> <C> <C>
Accrued workers' compensation..................... $ 29.6 $ 20.2
Accrued pension and other postretirement
benefits........................................ 52.8 57.5
Deferred gain on sale/leaseback................... 15.9 14.8
Other accrued liabilities......................... 15.3 22.8
---------- ------
$113.6 $115.3
---------- ------
---------- ------
</TABLE>
NOTE 19--WARREN SERIES B REDEEMABLE EXCHANGEABLE PREFERRED STOCK
Warren has authorized 10.0 million shares of Series B redeemable
exchangeable preferred stock (the "Warren Series B Preferred Stock"), of which
3.0 million shares were previously issued and exchanged for currently
outstanding shares. The Warren Series B Preferred Stock has a liquidation
preference of $25.00 per share (aggregate liquidation preference is $75.0
million, plus accumulated dividends). The Warren Series B Preferred Stock is
recorded net of issuance costs and excludes approximately $6.9 million related
to Class A warrants of Holdings issued in connection with such preferred stock.
The excess of the liquidation preference over the carrying value is being
accreted by periodic charges to retained earnings over the life of the issue.
The Company may elect not to pay dividends in cash on or prior to December
15, 1999, in which case such unpaid dividends shall accrue and become part of
the Specified Amount, as defined, of the Warren Series B Preferred Stock upon
which dividends must be paid. Dividends are cumulative and accrue quarterly at a
rate of 14% per annum of (a) the liquidation preference amount and (b) the
amount of accrued but unpaid dividends from prior dividend accrual periods
ending on or prior to December 15, 1999 ("Accumulated Dividends"). In addition,
the terms of the Credit Agreement and the Indenture relating to the Notes limit
the amount of cash dividends the Company may pay with respect to the Warren
Series B Preferred Stock both before and after that date. Cumulative dividends
on Warren Series B Preferred Stock that have not been paid at October 1, 1997
and September 30, 1998 are $35.6 million and $51.2 million, respectively, and
are included in the carrying amount of the Warren Series B Preferred Stock as
indicated below (in millions):
<TABLE>
<S> <C>
Balance, September 28, 1995........................................... $ 74.5
Dividends and accretion on Warren Series B Preferred Stock........ 13.5
------
Balance, October 2, 1996.............................................. 88.0
Dividends and accretion on Warren Series B Preferred Stock........ 15.2
------
Balance, October 1, 1997.............................................. 103.2
Dividends and accretion on Warren Series B Preferred Stock........ 16.3
------
Balance, September 30, 1998........................................... $119.5
------
------
</TABLE>
REDEMPTION
The Warren Series B Preferred Stock is redeemable at the option of Warren,
in whole or in part, at any time on or after December 15, 2001 at redemption
prices (expressed as a percentage of the Specified Amount) set forth below plus
all accrued and unpaid liquidated damages and dividends (excluding any
37
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Accumulated Dividends), if any, if redeemed during the year ended beginning on
December 15 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- ------------------------------------------------------------ -----------
<S> <C>
2001........................................................ 104.2%
2002........................................................ 102.8%
2003........................................................ 101.4%
2004........................................................ 100.0%
</TABLE>
"Specified Amount" on any specific date with respect to any share of Warren
Series B Preferred Stock means the sum of (i) the liquidation preference with
respect to such share and (ii) the Accumulated Dividends with respect to such
share.
Warren is required to redeem the Warren Series B Preferred Stock on December
15, 2006 at the Specified Amount plus all accrued and unpaid damages and
dividends (excluding any Accumulated Dividends).
At any scheduled dividend payment date, Warren may, at its option exchange
all of the shares of the Warren Series B Preferred Stock then outstanding for
Warren 14% Series B Subordinated Exchange Debentures due 2006.
In the event of a Change of Control, as defined, the holders of Warren
Series B Preferred Stock will have the right to require Warren to repurchase
such Warren Series B Preferred Stock, in whole or in part, at a price equal to
101% of the Specified Amount thereof, plus accrued and unpaid liquidated damages
and dividends (excluding any Accumulated Dividends).
Holders of the Warren Series B Preferred Stock have limited voting rights,
customary for preferred stock, including the right to elect two additional
directors upon certain events such as Warren failing to pay dividends in cash
for more than six consecutive dividend accrual periods ending after December 15,
1999.
NOTE 20--RELATED PARTY TRANSACTIONS
Pursuant to the limitations on restricted payments outlined in the Credit
Agreement, the indenture relating to the Notes and the Warren Series B Preferred
Stock, the Company may make cash payments to Holdings, including, among other
things, (i) amounts under a tax sharing agreement to be entered into between the
Company and Holdings necessary to enable Holdings to pay the Company's taxes and
(ii) administrative fees to Holdings and amounts to cover various specified
costs and expenses of Holdings. The associated administrative fee expensed was
$1.0 million for each of fiscal years 1996, 1997 and 1998.
Warren has contracted through a management services agreement (the
"Management Services Agreement") and central cost allocation agreement (the
"Central Cost Allocation Agreement") with two subsidiaries of Sappi, Sappi
International Management AG ("SIM") and Sappi Management Services Limited
("SMS"), to provide management advisory services. The aggregate fee paid by
Warren to SIM and SMS is limited to an annual amount of $1.0 million. The
aggregate fees charged to Warren by SIM and SMS were $1.0 milion in each of
fiscal years 1996, 1997 and 1998. These agreements, which may be terminated by
either party with six months written notice, are based upon cost reimbursement
plus a profit markup of 10%.
Warren has also entered into a cross licensing agreement with Sappi
Deutschland, the worldwide holding company for all European and U.S. business
operations of the Sappi group, and Hannover Papier AG ("Hannover"), a subsidiary
of Sappi. Pursuant to this agreement, Warren and Hannover have agreed
38
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
to enter into specific written agreements to share paper processing techniques
and have also agreed to enter into specific distribution agreements whereby
Warren has agreed to use its distribution network in the United States to
facilitate and increase Hannover's exports. Sappi Deutschland will facilitate
the licensing process. No specific agreements have been entered into in
connection with this cross licensing agreement as of September 30, 1998.
Warren ships products to certain Sappi subsidiaries (Sappi Europe, SA,
Specialty Pulp Services and U.S. Paper). These subsidiaries then sell Warren's
products to external customers at market prices and remit the proceeds from such
sales to Warren, net of a 5% sales commission. Net of commissions, Warren
shipped $102.8 million, $126.2 million and $114.9 million of products to Sappi
subsidiaries for fiscal years 1996, 1997 and 1998, respectively. Trade accounts
receivable at October 1, 1997 and September 30, 1998 included approximately
$24.5 million and $18.1 million, respectively, due from subsidiaries of Sappi.
Amounts as of October 1, 1997 and September 30, 1998 are included in the pool of
receivables securitized under the A/R Facility (See Note 6).
Warren also imports products from certain Sappi affiliates (Sappi UK, Ltd.,
Hannover Papier, and beginning in the fourth quarter of fiscal 1998, KNP Leykam)
for sale to Warren's North American customers. Warren sells these products at
market prices and remits the proceeds, net of a 5% sales commission, to the
Sappi affiliates. Net of commissions, Warren imported approximately $10.6
million, $21.9 million and $26.8 million of products from certain Sappi
affiliates for fiscal years 1996, 1997 and 1998, respectively.
39
<PAGE>
SCHEDULE II
S.D. WARREN COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN MILLIONS)
<TABLE>
<CAPTION>
BALANCE AT DEDUCTIONS BALANCE AT
BEGINNING COSTS AND (PRINCIPALLY END OF
OF PERIOD EXPENSES WRITE-OFFS) PERIOD
---------- --------- ------------ ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Year ended September 30, 1998.................................... $5.0 $2.7 $2.3 $5.4
Year ended October 1, 1997....................................... 5.3 1.3 1.6 5.0
Year ended October 2, 1996....................................... 5.6 -- 0.3 5.3
</TABLE>
40
<PAGE>
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Intentionally Omitted.*
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Intentionally Omitted.*
ITEM 11. EXECUTIVE COMPENSATION
Intentionally Omitted.*
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Intentionally Omitted.*
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Intentionally Omitted.*
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 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 by Section 13 or
15(d) of the Securities Exchange Act of 1934. The registrant is not required
to file reports pursuant to Section 13 and 15(d) of the Securities Exchange
Act of 1934.
41
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
S.D. WARREN COMPANY
By: /s/ MONTE R. HAYMON
-----------------------------------------
Monte R. Haymon
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Date: December 1, 1998
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
President, Chief Executive
/s/ MONTE R. HAYMON Officer and Director
- ------------------------------ (Principal Executive December 1, 1998
Monte R. Haymon Officer)
Chief Financial Officer,
Vice President,
/s/ TREVOR L. LARKAN Treasurer, Assistant
- ------------------------------ Secretary and Director December 1, 1998
Trevor L. Larkan (Principal Financial and
Accounting Officer)
/s/ O. HARLEY WOOD
- ------------------------------ Vice President and December 1, 1998
O. Harley Wood Director
/s/ JAMES FRICK
- ------------------------------ Director December 1, 1998
James Frick
/s/ EUGENE VAN AS
- ------------------------------ Director December 1, 1998
Eugene Van As
/s/ WILLIAM E. HEWITT
- ------------------------------ Director December 1, 1998
William E. Hewitt
/s/ ANDRIES J.G. VLOK
- ------------------------------ Director December 1, 1998
Andries J.G. Vlok
/s/ D'OEKO BOSSCHER
- ------------------------------ Director December 1, 1998
D'oeko Bosscher
</TABLE>
42
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM S.D. WARREN
COMPANY CONSOLIDATED FINANCIAL STATEMENTS FOUND ON PG. 14 AND 15 OF THE
COMPANY'S REPORT ON FORM 10-K FINANCIAL INFO FOR THE YEAR ENDED SEPTEMBER 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-02-1997
<PERIOD-END> SEP-30-1998
<CASH> 34,700
<SECURITIES> 0
<RECEIVABLES> 48,400
<ALLOWANCES> 5,400
<INVENTORY> 166,800
<CURRENT-ASSETS> 301,300
<PP&E> 1,260,800
<DEPRECIATION> 290,300
<TOTAL-ASSETS> 1,507,500
<CURRENT-LIABILITIES> 233,900
<BONDS> 573,800
119,500
0
<COMMON> 0
<OTHER-SE> 321,400
<TOTAL-LIABILITY-AND-EQUITY> 1,507,500
<SALES> 1,458,900
<TOTAL-REVENUES> 1,458,900
<CGS> 1,118,400
<TOTAL-COSTS> 1,261,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 71,300
<INCOME-PRETAX> 160,500
<INCOME-TAX> 66,500
<INCOME-CONTINUING> 94,000
<DISCONTINUED> 0
<EXTRAORDINARY> (4,900)
<CHANGES> 0
<NET-INCOME> 89,100
<EPS-PRIMARY> 0.73
<EPS-DILUTED> 0.73
</TABLE>
