<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10Q
FINANCIAL INFORMATION*
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________________ to _________________
Commission file number: 33-88496*
---------
S.D. WARREN COMPANY
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2366983
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
225 Franklin Street, Boston, Massachusetts 02110
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(617) 423-7300
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes___ No___ Not Applicable X*
--
- ------------------------
* This report is being voluntarily filed with the Securities and Exchange
Commission (the "Commission") pursuant to the registrant's contractual
obligations to file with the Commission all financial information that would
be required to be filed on a Form 10-Q. The registrant is not required to
file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934.
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
Form 10-Q, December 31, 1997
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that this Report on Form 10-Q for S.D.
Warren Company and subsidiaries (the "Company") contains certain
"forward-looking statements" as that term is defined under the Private
Securities Litigation Reform Act of 1995. The words "believe," "anticipate,"
"intend," "estimate," "plan," "assume" and other similar expressions which are
predictions of or indicate future events and future trends which do not relate
to historical matters identify forward-looking statements. Reliance should not
be placed on forward-looking statements because they involve known and unknown
risks, uncertainties and other factors which are in some cases beyond the
control of the Company and may cause the actual results, performance or
achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements. Certain factors that may cause such differences
include but are not limited to the following: global economic and market
conditions; production and capacity in the United States and Europe; production
and pricing levels of pulp and paper; any major disruption in production at the
Company's key facilities; alterations in trade conditions in and between the
United States and other countries where the Company does business; and changes
in environmental, tax and other laws and regulations. These and other factors
that might cause differences between actual and anticipated results,
performance, and achievements are discussed in greater detail in this Report on
Form 10-Q. See also "Market Overview" under Part I, Item 2, Management's
Discussion and Analysis of Results of Operations and Financial Condition.
2
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
Form 10-Q, December 31, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Statements of Operations
for the three months ended January 1, 1997 and
December 31, 1997 4
Condensed Consolidated Balance Sheets at
October 1, 1997 and December 31, 1997 5
Condensed Consolidated Statements of Cash Flows
for the three months ended January 1, 1997 and
December 31, 1997 6
Notes to Unaudited Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signature 18
3
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
JANUARY 1, 1997 DECEMBER 31, 1997
------------------- -------------------
<S> <C> <C>
Sales.................................................................. $ 314.5 $ 343.4
Cost of goods sold..................................................... 267.2 262.4
------ ------
Gross profit........................................................... 47.3 81.0
Selling, general and administrative expense............................ 32.6 34.4
Restructuring.......................................................... 10.0 --
------ ------
Income from operations................................................. 4.7 46.6
Other income, net...................................................... 0.9 1.8
Interest expense....................................................... 25.2 21.0
------ ------
Income (loss) before income taxes and extraordinary item............... (19.6) 27.4
Income tax expense (benefit)........................................... (8.0) 11.1
------ ------
Income (loss) before extraordinary item................................ (11.6) 16.3
Extraordinary item, net of tax......................................... -- (1.2)
------ ------
Net income (loss)...................................................... (11.6) 15.1
Dividends and accretions on Warren Series B preferred stock............ 3.6 4.1
------ ------
Net income (loss) applicable to common stockholder..................... $(15.2) $11.0
------ ------
------ ------
Earnings per common share:
Income (loss) before extraordinary item applicable to
common stockholder................................................. $(0.15) $0.12
------ ------
------ ------
Net income (loss) applicable to common stockholder................... $(0.15) $0.11
------ ------
------ ------
Weighted average number of shares outstanding.......................... 100 100
------ ------
------ ------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
4
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31,
OCTOBER 1, 1997
1997 (UNAUDITED)
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $180.7 $ 45.1
Trade accounts receivable, net......................... 40.3 30.7
Other receivables...................................... 14.8 11.2
Inventories............................................ 163.4 195.6
Deferred income taxes.................................. 28.3 28.3
Other current assets................................... 9.8 7.0
----------- ------------
Total current assets................................. 437.3 317.9
Plant assets, net........................................ 951.1 952.4
Timber resources, net.................................... 95.6 95.7
Goodwill, net............................................ 90.1 89.1
Deferred financing fees, net............................. 35.4 31.5
Other assets, net........................................ 22.5 22.0
----------- ------------
Total assets......................................... $1,632.0 $1,508.6
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt................... $ 27.3 $ 36.1
Accounts payable....................................... 121.0 121.7
Accrued and other current liabilities.................. 109.1 99.8
----------- ------------
Total current liabilities............................ 257.4 257.6
----------- ------------
Long-term debt:
Term loans............................................. 251.5 167.7
Senior subordinated notes.............................. 375.0 375.0
Other.................................................. 113.3 113.1
----------- ------------
739.8 655.8
----------- ------------
Deferred income taxes.................................... 48.7 53.2
----------- ------------
Other liabilities........................................ 113.6 113.3
----------- ------------
Total liabilities.................................... 1,159.5 1,079.9
----------- ------------
Commitments and contingencies (Notes 8 and 9)
Warren Series B redeemable exchangeable preferred stock
(liquidation value, $110.6 and $114.5, respectively)... 103.2 107.3
----------- ------------
Stockholder's equity:
Common stock........................................... -- --
Capital in excess of par value......................... 331.8 321.4
Retained earnings...................................... 37.5 --
----------- ------------
Total stockholder's equity........................... 369.3 321.4
----------- ------------
Total liabilities and stockholder's equity........... $1,632.0 $1508.6
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
6
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions, unaudited)
<TABLE>
<CAPTION>
THREE MONTHSENDED THREE MONTHSENDED
JANUARY 1, 1997 DECEMBER 31, 1997
------------------- -------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net (loss) income...................................................... $(11.6) $ 15.1
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation, cost of timber harvested and amortization.............. 29.5 24.0
Loss on force majeure event.......................................... 4.8 --
Deferred income taxes................................................ (5.5) 4.5
Extraordinary item................................................... -- 2.0
Other................................................................ (0.1) 0.1
Changes in assets and liabilities:
Trade and other accounts receivable, net............................. 26.6 13.3
Inventories, net..................................................... 4.0 (32.2)
Accounts payable, and accrued and other current liabilities.......... 13.3 (8.4)
Other assets and liabilities......................................... (9.4) 2.6
------ ------
Net cash provided by operating activities.......................... 51.6 21.0
------ ------
Cash Flows from Investing Activities:
Investment in plant assets and timber resources........................ (10.8) (22.7)
Proceeds from disposals of plant assets and timber resources........... 0.1 0.1
Refurbishment of fixed assets.......................................... (22.7) --
Insurance proceeds on force majeure events............................. 18.1 --
Other investing activities............................................. -- (0.1)
------ ------
Net cash used in investing activities.............................. (15.3) (22.7)
------ ------
Cash Flows from Financing Activities:
Repayments of long-term debt........................................... (17.9) (75.2)
Dividend paid to Holdings.............................................. -- (58.2)
Other financing activities............................................. (0.5)
------ ------
Net cash used in financing activities.................................... (17.9) (133.9)
------ ------
Net change in cash and cash equivalents.................................. 18.4 (135.6)
Cash and cash equivalents:
Beginning of period:................................................... 49.0 180.7
------ ------
End of period.......................................................... $67.4 $ 45.1
------ ------
------ ------
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest............................................................. $32.4 $ 36.5
------ ------
------ ------
Income taxes......................................................... -- $ 2.5
------ ------
------ ------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of S.D. Warren Company and its subsidiaries ("Warren" or
the "Company"). Intercompany balances and transactions have been eliminated in
the preparation of the accompanying unaudited condensed consolidated financial
statements.
The Company is a direct wholly owned subsidiary of SDW Holdings Corporation
("Holdings"). Holdings is an indirect subsidiary of Sappi Limited ("Sappi").
BUSINESS
The Company 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. The Company also owns approximately 911,000
acres of timberlands in the State of Maine.
UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements include all adjustments, consisting of only
normal recurring adjustments, necessary for the fair presentation of the
Company's financial position and results of operations. The accompanying
unaudited condensed consolidated financial statements should be read in
conjunction with the audited financial statements included in Company's Annual
Report on Form 10-K for the fiscal year ended October 1, 1997. The unaudited
condensed consolidated results of operations for the three months ended December
31, 1997 are not necessarily indicative of results that could be expected for a
full year.
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. Interest costs incurred
in developing the project are also capitalized. The costs will be amortized
over the useful life of the completed software. As of December 31, 1997, $3.8
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.
NOTE 2. RELATED PARTY TRANSACTIONS
The Company sells products to certain subsidiaries of Sappi ("Affiliates"),
at market prices, primarily in U.S. Dollars. These Affiliates then sell the
Company's products to external customers. Proceeds from sales to Affiliates are
remitted to the Company net of sales commissions. The Company sold approximately
$35.5 million and $30.0 million to Affiliates and incurred fees of approximately
$2.4 million and $2.1 million relating to these sales for the three months ended
January 1, 1997 and December 31, 1997,
7
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
respectively. Trade accounts receivable from Affiliates at December 31, 1997
were approximately $23.1 million compared to $24.5 million at October 1, 1997.
Note 3. Inventories (in millions)
OCTOBER 1, 1997 DECEMBER 31, 1997
--------------- -----------------
Finished products........................... $ 76.7 $ 95.5
Work in process............................. 21.4 31.9
Pulp, logs and pulpwood..................... 23.9 25.1
Maintenance parts and other supplies........ 41.4 43.1
------ ------
$ 163.4 $ 195.6
------ ------
------ ------
NOTE 4. LONG-TERM DEBT
The current maturities of long-term debt balance of $36.1 million at
December 31, 1997 primarily represents the principal payments due in June and
December 1998 under Warren's term loan facilities.
In December 1997, the Company made an optional prepayment of $75.0 million
on its term loans. The write-off of deferred financing fees related to the early
extinguishment of this debt resulted in an extraordinary loss of $1.2 million,
net of a tax benefit of $0.8 million, which was recorded during the three months
ended December 31, 1997.
NOTE 5. DIVIDEND TO HOLDINGS
On December 15, 1997, the Company paid a dividend of $58.2 million to its
parent company, Holdings. In turn, Holdings used the proceeds of the dividend to
redeem its 15% Senior Exchangeable Preferred Stock, including accrued and unpaid
dividends. In connection with the dividend, the Company paid $0.5 million in
consent fees to the holders of its 12% Senior Subordinated Notes due 2004 in
exchange for their consent to the dividend transaction. The dividend and the
consent fees together resulted in $48.5 million and $10.2 million charged to
retained earnings and capital in excess of par, respectively.
NOTE 6. RESTRUCTURING
In October 1996, the Company commenced a restructuring plan which resulted
in a pretax charge of $10.0 million taken during the quarter ended January 1,
1997 to cover the costs related to the reduction of approximately 200 salaried
positions, or approximately 14% of the Company's salaried work force.
Substantially all amounts have been expended at December 31, 1997.
NOTE 7. FORCE MAJEURE EVENTS
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 was repaired and normal operating
mill conditions were restored in the quarter ended January 1, 1997. During the
quarter ended January 1, 1997, the Company accrued in cost of sales a flood
damage loss, net of expected insurance recoveries, of $4.8 million based on
management's estimate at the time. By the end of fiscal year 1997, all flood
related claims were submitted and finalized resulting in a final net flood loss
of $0.6 million. In addition, subsequent to the quarter ended January 1, 1997,
the Company received $11.8 million of cash proceeds related to business
interruption claims. Business interruption claim recoveries were recorded as
reductions to cost of sales in the second and fourth quarters of fiscal year
1997.
9
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. 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 EPA would limit dioxin
discharges from the Company's Somerset and Westbrook mills to less than the
level of detectability. The Company is presently meeting the EPA's proposed
dioxin limits but it is not meeting the proposed limits for the other parameters
(e.g., temperature) and is attempting to revise these other wastewater permit
limits for its facilities. While the permit limitation at these two facilities
are being challenged, the Company continues to operate under existing EPA
permits in accordance with accepted administrative practice.
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, but the County
has appealed the court's decision. If the Company and the other plaintiffs do
not prevail in that appeal or are not successful in ongoing negotiations with
the County, the Company may not be able to obtain additional treatment
capacity for future expansions, and the County could impose stricter permit
limits. In June 1997, the EPA sued the County for failure to 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.
Recently the group of industrial users and municipalities filed motions to
intervene 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 that 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 signed on
November 14, 1997, 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
9
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 financial
position, results of operations or cash flows.
NOTE 9. COMMITMENTS AND CONTINGENCIES
In connection with the acquisition in December 1994 of the Company from
Scott Paper Company ("Scott"), now Kimberly-Clark, Warren entered into a
long-term (25 years initially, subject to mill closures and certain force
majeure events) agreement with Scott for the supply of pulp at the Mobile mill.
Under this agreement, pulp prices are discounted from market price which
incorporates the elimination of freight costs associated with delivering pulp to
Warren's Mobile paper mill, and pulp quantities are subject to minimum (170,000
to 182,400 tons per year) and maximum (220,000 to 233,400 tons per year) limits.
Warren has entered into a long-term agreement to purchase electric power and
steam for the Mobile mill at rates generally comparable to market tariffs,
including fuel cost and capital recovery components.
The Company's power requirements at its Somerset mill are currently
satisfied through a power purchase 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 that the mill
purchase electricity from CMP at the standard industrial tariff rate. The
Somerset Agreement expires in the year 2012. Warren's long-term agreement with
CMP relating to its Westbrook mill expired on October 31, 1997, and has been
replaced by a short-term agreement with CMP in which the mill cogenerates
electricity and sells the excess output not used by the mill to CMP at market
rates. The short-term agreement for the Westbrook mill expires on April 30, 1998
and may be renewed monthly through October 1998.
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 financial position, results of operations
or cash flows.
NOTE 10. PROPOSED SALE OF BUSINESS UNIT
Consistent with Warren's strategy to divest of noncore assets, the Company
entered into an Asset Purchase Agreement (the "Asset Purchase Agreement") on
November 18, 1997 to sell its pressure sensitive business unit located at the
Westbrook 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. The sale is anticipated to close in the first calendar
quarter of 1998, and is subject to the satisfaction of various conditions. The
Company expects to realize a net gain from the sale. The Company has obtained
consent from its lenders under its bank credit agreement to the consummation of
the proposed sale. Such lenders have waived the requirement that the Company use
the proceeds from the sale to pay down outstanding obligations under the credit
agreement.
In connection with the sale, the Company and Spinnaker intend to execute a
Site Lease and a Site Separation and Service Agreement. Under the Site Lease,
the Company will lease to Spinnaker the
10
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
portion of the Westbrook mill in which the pressure sensitive business is
located for a term of 99 years for nominal rent. Under the Site Separation
and Service Agreement, the Company will provide Spinnaker, for a limited time
at predetermined costs, shipping, transportation and storage, maintenance and
support, and information and administrative services. In addition, such an
agreement will require the Company to supply certain raw materials, primarily
bodystock, for up to one year at predetermined amounts on a per-unit basis.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
The following discussion is a summary of the key factors management
considers necessary in reviewing the Company's results of operations, liquidity
and capital resources. The Company wishes to caution readers that this
discussion and analysis contains certain " forward looking statements" as that
term is defined under the Private Securities Litigation Reform Act of 1995.
Reliance should not be placed on forward-looking statements because they involve
known and unknown risks, uncertainties and other factors which are in some cases
beyond the control of the Company and may cause the actual results, performance
or achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements. This discussion should be read in conjunction with
the financial statements and related notes of the Company included in this Form
10-Q, as well as the Consolidated Financial Statements and related notes
included in the Company's Annual Report on Form 10-K for the fiscal year ended
October 1, 1997. See "Note Regarding Forward--Looking Statements" on Page 2 of
this report.
MARKET OVERVIEW
The market for coated paper has historically experienced price fluctuations,
which are driven by North American supply/demand imbalances, inventory shifts
and, to a lesser degree, the availability and relative pricing of imported
paper. The exceptional increase in shipments that the industry experienced
during the last half of fiscal year 1997 slowed during the first quarter of
fiscal year 1998, coinciding with the lower seasonal demand. Industry shipments
for the first quarter of fiscal 1998, were however, 4.1% higher than
the previous year. During these three months, industry inventory of coated
woodfree paper increased by 17,000 tons to 430,000 tons.
During the first quarter of fiscal year 1998, Warren's shipments of coated
woodfree paper grew by 11% over the first quarter of fiscal year 1997 indicating
an increase in Warren's market share. Coated groundwood continued to ship at
near capacity rates during the first two months of the quarter and this could
continue to provide a price floor for coated woodfree. If this continues, the
Company should be able to maintain the improved pricing achieved in the last
half of fiscal year 1997.
The uncoated and technical paper side of the business experienced a normal
seasonally lower level of activity in the first quarter of fiscal year 1998
compared to the fourth quarter of fiscal year 1997. The Company continues to
push higher value opportunities in order to optimize sales mix. The specialty
business, consisting of pressure sensitive and release casting papers,
experienced strengthened demand over the same prior year period, with a 10%
increase in sales volume.
Any failure of the industry to maintain its recovery in the future, 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. In addition, new coated paper capacity scheduled in
Europe and the Far East, as well as certain machine conversions during 1997 to
coated free sheet manufacture in the United States, will impact supply/demand
balance and may constrain upward movement of coated prices.
12
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
RESULTS OF OPERATIONS
Three Months Ended December 31, 1997 Compared to Three Months Ended January
1, 1997
SALES
Sales for the three months ended December 31, 1997 were $343.4 million
compared to $314.5 million for the three months ended January 1, 1997, an
increase of $28.9 million or 9.2%. The increase was primarily due to a 9.1%
increase in paper shipment volume during the period. Average net revenue per
paper ton for the quarter ended December 31, 1997 was virtually flat compared to
the same period in the prior fiscal year.
COST OF GOODS SOLD
Cost of goods sold for the three months ended December 31, 1997 decreased
$4.8 million, or 1.8% to $262.4 million compared to $267.2 million for the three
months ended January 1, 1997. Cost of goods sold on a per paper ton basis,
adjusted for flood related accruals of $4.8 million in the quarter ended January
1, 1997, decreased to $811 per ton for the three months ended December 31, 1997
from $882 per ton for the corresponding prior year quarter. The decrease was
primarily due to the impact of higher productivity, lower pulp costs per ton,
and other cost reduction initiatives.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense increased marginally from $32.6
million for the three months ended January 1, 1997 to $34.4 million for the
three months ended December 31, 1997.
EXTRAORDINARY ITEM
In December 1997, the Company made an optional prepayment of $75.0 million
on its term loans. The write-off of deferred financing fees related to the early
extinguishment of this debt resulted in an extraordinary loss of $1.2 million,
net of a tax benefit of $0.8 million.
INTEREST EXPENSE AND TAXES
Interest expense for the three months ended December 31, 1997 was $21.0
million compared to $25.2 million for the three months ended January 1, 1997.
The $4.2 million decrease was primarily due to the impact of lower levels of
outstanding debt and lower interest rates. Interest expense includes the
amortization of deferred financing fees.
Income tax expense, excluding the $0.8 million tax benefit attributable to
the extraordinary term resulting from the write-off of deferred financing fees,
was $11.1 million for the three months ended December 31, 1997 compared to a
benefit of $8.0 million for the corresponding period in the prior year,
primarily reflecting the change in the Company's earnings level.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $21.0 million for the three
months ended December 31, 1997 as compared to $51.6 million for the three months
ended January 1, 1997. This decrease was largely influenced by the low level of
finished goods and work-in-process inventory achieved at the end of the prior
13
<PAGE>
quarter which reversed during the seasonally lower demand quarter ended December
31, 1997. The higher net earnings for the quarter partially offset this cash
drain.
The Company's operating working capital was $16.0 million at December 31,
1997 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.
This increase primarily resulted from the increase in inventories, described in
the previous paragraph, and net decreases in accounts payable and accrued and
other current liabilities, offset by the impact of reductions in trade and other
accounts receivables. The net decrease in accounts payable and accrued and other
liabilities largely resulted from a decrease in accrued interest.
Capital expenditures for the three months ended December 31, 1997 were $22.7
million, up from $10.8 million for the three months ended January 1, 1997.
Capital expenditures are estimated to be approximately $100.0 million during
fiscal year 1998. 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 amounts available under its revolving credit
facility will be sufficient to meet its ongoing operating and capital
expenditure requirements.
Net cash used in financing activities was $133.9 million for the three
months ended December 31, 1997 as compared to $17.9 million for the
corresponding period of the previous year, primarily due to the optional
prepayment of $75.0 million of the Company's term loans in December 1997 and
the payment of a dividend of $58.2 million to the Company's parent, Holdings,
on December 15, 1997. In turn, Holdings used the proceeds of the dividend to
redeem its 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 its 12% Senior Subordinated Notes
due 2004 the ("Notes") in exchange for their consent to the dividend
transaction.
DEBT AND PREFERRED STOCK
At December 31, 1997, long-term debt was $655.8 million compared to $739.8
million at October 1, 1997, a decrease of $84.0 million. The current maturities
of long-term debt balance of $36.1 million at December 31, 1997 primarily
represents the amounts payable in June and December 1998 under the Company's
term loan facilities.
Warren has a $250.0 million revolving credit facility to finance working
capital needs. At December 31, 1997, Warren did not have any borrowings
outstanding under this facility, resulting in an unused borrowing capacity of
approximately $239.0 million, after giving effect to outstanding letters of
credit, which may be used to finance working capital needs. Warren is required
to pay a commitment fee, which is based on the achievement of a certain
financial ratio, of between 0.375% and 0.5% per annum on the average daily
unused commitment available under the revolving credit facility.
In addition, Warren had approximately $150.8 million of letters of credit
outstanding under its letter of credit facility at December 31, 1997 and October
1, 1997. Warren pays a commission, which is based on the achievement of a
certain financial ratio, of between 1.00% and 2.50% on outstanding letters of
credit and an issuance fee of between 0.125% and 0.25% per annum on letters of
credit issued.
14
<PAGE>
FORCE MAJEURE EVENTS
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 was repaired and normal operating
mill conditions were restored in the quarter ending January 1, 1997. During the
quarter ended January 1, 1997, the Company accrued a flood damage loss, net of
expected insurance recoveries, of $4.8 million based on management's estimate at
the time. As of January 1, 1997, the Company had accrued an estimate of $44.7
million for costs to refurbish plant assets at the Westbrook facility, of which
$18.1 million had been received as insurance proceeds at January 1, 1997 with
the remainder, net of a deductible of $3.5 million, included in other
receivables in the condensed consolidated balance sheet at January 1, 1997. By
the end of fiscal year 1997, all flood related claims were submitted and
finalized resulting in a final net flood loss of $0.6 million. In addition,
subsequent to the quarter ended January 1, 1997, the Company received $11.8
million in cash proceeds related to business interruption claims. Business
interruption claim recoveries were recorded as reductions to cost of sales in
the second and fourth quarters of fiscal year 1997.
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 8 -Environmental and Safety Matters to the Condensed Consolidated
Financial Statements included in this Form 10-Q for a discussion of these
matters.
LABOR RELATIONS
By early February 1997, the Company had reached a settlement on a new
six-year labor agreement with its three major Somerset, Maine mill unions. The
ratified contract reflects more flexible work rule provisions and a 3.0% annual
wage increase for the term of the agreement. By October 1, 1997 and by November
20, 1997, the Company had reached settlements with both of its unions at
Westbrook and both of its unions at the Mobile mill, respectively, with the
unions in each case ratifying new five and six year agreements with more
flexible work rule provisions. The Company's contracts with the two unions at
the Muskegon mill expire in June 1998. 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 9--Commitments and Contingencies to the Condensed Consolidated
Financial Statements included in this Form 10-Q for a discussion of certain
long-term contracts.
PROPOSED SALE OF BUSINESS UNIT
Consistent with Warren's strategy to divest of noncore assets, the
Company entered into an Asset Purchase Agreement (the "Asset Purchase
Agreement") on November 18, 1997 to sell its pressure sensitive business unit
located at the Westbrook 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. The sale is anticipated
to close in the first calendar quarter of 1998, and is subject to the
satisfaction of various conditions. The Company expects to realize a net gain
from the sale. The Company has obtained consent from its lenders under its
bank credit agreement to the consummation of the proposed sale. Such
15
<PAGE>
lenders have waived the requirement that the Company use the proceeds from
the sale to pay down outstanding obligations under the credit agreement.
In connection with the sale, the Company and Spinnaker intend to execute a
Site Lease and a Site Separation and Service Agreement. Under the Site Lease,
the Company will lease to Spinnaker the portion of the Westbrook mill in which
the pressure sensitive business is located for a term of 99 years for nominal
rent. Under the Site Separation and Service Agreement, the Company will provide
Spinnaker, for a limited time at predetermined costs, shipping, transportation
and storage, maintenance and support, and information and administrative
services. In addition, such an agreement will require the Company to supply
certain raw materials, primarily bodystock, for up to one year at predetermined
amounts on a per-unit basis.
CONTROL BY SAPPI
The Company is a wholly owned subsidiary of Holdings. Sappi Limited owns 100%
of the issued and outstanding voting common stock and 75.07% of the common
equity of Holdings in 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
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 governing 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.
16
<PAGE>
PART II--OTHER INFORMATION
Item 1. Legal Proceedings
Intentionally omitted. *
Item 2. Changes in Securities
Intentionally omitted. *
Item 3. Defaults Upon Senior Securities
Intentionally omitted. *
Item 4. Submission of Matters to a Vote of Security
Holders
Intentionally omitted. *
Item 5. Other Information
Intentionally omitted. *
Item 6. Exhibits and Reports on Form 8-K
Intentionally omitted. *
- ------------------------
* This report is being voluntarily filed with the Commission pursuant to the
registrant's contractual obligations to file with the Commission all
financial information that would be required to be filed on a Form 10-Q. The
registrant is not required to file reports pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934.
17
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
S.D. Warren Company
Date: February 9, 1998 By: /s/ TREVOR LARKAN
--------------------------------------------
Trevor Larkan
Vice President (Principal Financial Officer)
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
S.D. WARREN COMPANY'S (THE "COMPANY") CONDENSED STATEMENTS OF OPERATIONS FOR THE
QUARTER ENDED DECEMBER 31, 1997 AND BALANCE SHEET AS OF DECEMBER 31, 1997 FOUND
IN PAGE 4 AND 5, RESPECTIVELY, OF THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q
FINANCIAL INFORMATION FOR THE QUARTER ENDED DECEMBER 31, 1997.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-02-1997
<PERIOD-END> DEC-31-1997
<CASH> 45,100
<SECURITIES> 0
<RECEIVABLES> 36,300
<ALLOWANCES> 5,600
<INVENTORY> 195,600
<CURRENT-ASSETS> 317,900
<PP&E> 1,187,300
<DEPRECIATION> 234,900
<TOTAL-ASSETS> 1,508,600
<CURRENT-LIABILITIES> 257,600
<BONDS> 655,800
107,300
0
<COMMON> 0
<OTHER-SE> 321,400
<TOTAL-LIABILITY-AND-EQUITY> 1,508,600
<SALES> 343,400
<TOTAL-REVENUES> 343,400
<CGS> 262,400
<TOTAL-COSTS> 296,800
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,000
<INCOME-PRETAX> 27,400
<INCOME-TAX> 11,100
<INCOME-CONTINUING> 15,100
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,100
<EPS-PRIMARY> .11
<EPS-DILUTED> .11
</TABLE>
