<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q FINANCIAL INFORMATION*
--------------------------------
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31,1999
-------------
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, MARCH 31, 1999
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: (a) increased competition from
either domestic or foreign paper producers, including increases in competitive
capacity through construction of new mills or conversion of older facilities to
produce competitive products, (b) variations in demand for the Company's
products, (c) changes in the cost or availability of the raw materials used by
the Company, particularly market pulp and wood, (d) costs of compliance with new
environmental laws and regulations, (e) decisions by the Company to make a
significant acquistion or a significant increase in production capacity, (f)
competitive pricing pressures for the Company's products, (g) unanticipated
manufacturing disruptions, (h) unanticipated expenses or delays in resolving
Year 2000 issues by either the Company or its significant business partners, and
(i) 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, MARCH 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
--------
<S> <C>
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations for the three and
six months ended April 1, 1998 and March 31, 1999 4,5
Condensed Consolidated Balance Sheets at September 30, 1998 and
March 31, 1999 6
Condensed Consolidated Statements of Cash Flows for the six months
ended April 1, 1998 and March 31, 1999 7
Notes to Unaudited Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 23
ITEM 2. CHANGES IN SECURITIES 23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 23
ITEM 5. OTHER INFORMATION 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 23
SIGNATURE 24
</TABLE>
3
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
APRIL 1, 1998 MARCH 31, 1999
------------- --------------
<S> <C> <C>
Sales $ 376.1 $ 354.7
Cost of goods sold 291.1 284.2
--------- ---------
Gross profit 85.0 70.5
Selling, general and administrative expense 35.0 38.0
--------- ---------
Income from operations 50.0 32.5
Gain on sale of pressure sensitive business 30.9 --
Other income, net 1.0 3.0
Interest expense 19.2 13.6
--------- ---------
Income before income taxes and extraordinary items 62.7 21.9
Income tax expense 25.8 9.1
--------- ---------
Income before extraordinary items 36.9 12.8
Extraordinary items, net of tax (0.3) (1.4)
--------- ---------
Net income 36.6 11.4
Dividends and accretion on S.D. Warren Series B preferred stock 4.2 4.7
--------- ---------
Net income applicable to common stockholder $ 32.4 $ 6.7
========= =========
Earnings per common share:
Income before extraordinary items applicable to
common stockholder $ 0.33 $ 0.08
========= =========
Net income applicable to common stockholder $ 0.32 $ 0.07
========= =========
Weighted average number of shares outstanding 100 100
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
4
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
APRIL 1, 1998 MARCH 31, 1999
------------- --------------
<S> <C> <C>
Sales $ 719.5 $ 688.1
Cost of goods sold 553.6 544.7
--------- ---------
Gross profit 165.9 143.4
Selling, general and administrative expense 69.5 73.1
Restructuring -- 3.7
--------- ---------
Income from operations 96.4 66.6
Gain on sale of pressure sensitive business 30.9 --
Gain on sale of timberlands -- 75.4
Other income, net 2.8 5.1
Interest expense 40.1 27.9
--------- ---------
Income before income taxes and extraordinary items 90.0 119.2
Income tax expense 36.8 49.6
--------- ---------
Income before extraordinary items 53.2 69.6
Extraordinary items, net of tax (1.5) (3.0)
--------- ---------
Net income 51.7 66.6
Dividends and accretion on S.D. Warren Series B preferred stock 8.3 9.3
--------- ---------
Net income applicable to common stockholder $ 43.4 $ 57.3
========= =========
Earnings per common share:
Income before extraordinary items applicable to
common stockholder $ 0.45 $ 0.60
========= =========
Net income applicable to common stockholder $ 0.43 $ 0.57
========= =========
Weighted average number of shares outstanding 100 100
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
5
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1998 1999
(UNAUDITED)
------------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 34.7 $ 59.0
Trade accounts receivable, net 43.0 54.8
Other receivables 18.1 17.4
Inventories 166.8 198.0
Deferred income taxes 28.5 44.2
Other current assets 10.2 10.9
---------- ----------
Total current assets 301.3 384.3
Plant assets, net 970.5 983.0
Assets held under agreement to sell 98.9 --
Goodwill, net 84.4 80.9
Deferred financing fees, net 28.0 25.6
Other assets, net 24.4 47.4
---------- ----------
Total assets $ 1,507.5 $ 1,521.2
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 6.4 $ 8.4
Accounts payable 129.7 164.9
Accrued and other current liabilities 97.8 82.6
---------- ----------
Total current liabilities 233.9 255.9
---------- ----------
Long-term debt:
Term loans 138.6 86.6
Senior subordinated notes 324.6 274.0
Other 110.6 110.5
---------- ----------
573.8 471.1
---------- ----------
Deferred income taxes 81.7 120.8
---------- ----------
Other liabilities 115.3 119.0
---------- ----------
Total liabilities 1,004.7 966.8
---------- ----------
Commitments and contingencies (Notes 8 and 9)
Warren Series B redeembable exchangeable preferred stock
(liquidation value, $126.1 and $135.1, respectively) 119.5 128.8
---------- ----------
Stockholder's equity:
Common stock -- --
Capital in excess of par value 321.4 321.4
Retained earnings 61.9 104.2
---------- ----------
Total stockholder's equity 383.3 425.6
---------- ----------
Total liabilities and stockholder's equity $ 1,507.5 $ 1,521.2
========== ==========
</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>
SIX MONTHS SIX MONTHS
ENDED ENDED
APRIL 1, 1998 MARCH 31, 1999
------------- --------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 51.7 $ 66.6
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, cost of timber harvested and amortization 45.5 44.0
Deferred income taxes 12.0 23.4
Extraordinary items 2.5 5.2
Gain on sale of timberlands -- (75.4)
Gain on sale of pressure sensitive business (30.9) --
Other 0.1 0.2
Changes in assets and liabilities:
Trade and other accounts receivable, net (3.7) (12.1)
Inventories, net (40.2) (31.2)
Accounts payable, and accrued and other current liabilities 10.3 16.8
Other assets and liabilities (2.1) 4.5
-------- --------
Net cash provided by operating activities 45.2 42.0
-------- --------
Cash Flows from Investing Activities:
Investment in plant assets and timber resources (46.4) (51.7)
Proceeds from sale of timberlands -- 3.3
Proceeds from sale of pressure sensitive business 44.8 --
Proceeds from disposals of plant assets and timber resources 0.1 --
Other investing activities (0.4) (4.6)
-------- --------
Net cash used in investing activities (1.9) (53.0)
-------- --------
Cash Flows from Financing Activities:
Monetization of note receivable (Note 6) -- 156.0
Proceeds from short term borrowings -- 54.5
Repayments of debt, including premiums (86.4) (159.5)
Dividends paid to parent (58.2) (15.0)
Other financing activities (1.9) (0.7)
-------- --------
Net cash provided (used) in financing activities (146.5) 35.3
-------- --------
Net change in cash and cash equivalents (103.2) 24.3
-------- --------
Cash and cash equivalents:
Beginning of period 180.7 34.7
-------- --------
End of period $ 77.5 $ 59.0
======== ========
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest $ 42.9 $ 30.8
======== ========
Income taxes $ 15.9 $ 23.4
======== ========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
7
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
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, doing business as
Sappi Fine Paper North America ("SFPNA" 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
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 and
operated approximately 905,000 acres of timberlands in the State of Maine. On
November 12, 1998, the Company sold its timberlands (See Note 6).
SAPPI REORGANIZATION
On April 27, 1998, Sappi announced the business integration of SFPNA 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. S.D. Warren products are now
being marketed under the name of Sappi Fine Paper North America. The legal
entities of Holdings, S.D. Warren and S.D. Warren's subsidiaries continue to
remain in existence.
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 the Company's Annual Report on Form
10-K for the fiscal year ended September 30, 1998. The unaudited condensed
consolidated results of operations for the three months and six months ended
March 31, 1999 are not necessarily indicative of results that could be expected
for a full year.
NOTE 2. ACCOUNTING PRONOUNCEMENTS
Several new accounting pronouncements (Statements of Financial Accounting
Standards ("SFAS") Nos. 130, 131, 132 and 133 and Statement of Position No.
98-5) have been issued over the past year and are pending implementation in
future years on the subjects of reporting comprehensive income, segment
8
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
reporting, pension and other post retirement benefit disclosures, derivative
instruments and hedging activities, and start-up costs, respectively. The
Company does not expect the implementation of SFAS Nos. 130, 131, and 132 or the
statement of position will have a material effect on its consolidated financial
statements. The Company is currently evaluating the impact of SFAS No. 133,
"Derivative Instruments and Hedging Activities" and has not yet determined its
effect on the Company's consolidated financial statements.
NOTE 3. RELATED PARTY TRANSACTIONS
SFPNA ships products to certain Sappi subsidiaries (Sappi Europe, SA, Specialty
Pulp Services and U.S. Paper). These subsidiaries then sell SFPNA's products to
external customers at market prices and remit the proceeds from such sales to
SFPNA, net of a 5% sales commission. Net of commissions, SFPNA shipped $33.5
million and $60.0 million to certain Sappi subsidiaries for the three and six
months ended March 31, 1999, respectively. For the same periods in the prior
fiscal year, SFPNA shipped $32.2 million and $62.2 million, net of commissions,
to these Sappi subsidiaries, respectively. At September 30, 1998 and March 31,
1999, approximately 16% and 22%, respectively, of the Company's trade
receivables (including those receivables which were securitized and sold) were
due from Sappi affiliates.
SFPNA also imports products from certain affiliates (Sappi U.K., Ltd., Hannover
Papier, and beginning in the fourth quarter of fiscal 1998, KNP Leykam) for sale
to SFPNA's North American customers. SFPNA sells these products at market prices
and remits the proceeds, net of a 5% sales commission, to the Sappi affiliates.
Net of commissions, SFPNA imported approximately $20.6 million and $35.6 million
of products from these Sappi affiliates for the three and six months ended March
31, 1999, and $7.7 million and $11.8 million for the three and six months ended
April 1, 1998, respectively.
On March 29, 1999, the Company paid a $15.0 million cash dividend to its parent,
Holdings. In turn, Holdings advanced $15.0 million to an affiliate of Sappi in
the form of a promissory note due April 2002.
NOTE 4. INVENTORIES, NET (IN MILLIONS)
<TABLE>
<CAPTION>
April 1, 1998 September 30, 1998 March 31, 1999
------------- ------------------ --------------
<S> <C> <C> <C>
Finished products $ 96.6 $ 81.6 $ 103.1
Work in process 31.6 26.3 25.7
Pulp, logs and pulpwood 26.1 24.5 33.8
Maintenance parts and other supplies 39.7 34.4 35.4
-------- -------- --------
$ 194.0 $ 166.8 $ 198.0
======== ======== ========
</TABLE>
NOTE 5. LONG-TERM DEBT
The current maturities of long-term debt balance of $8.4 million consists
primarily of bank term loan principal payments scheduled for September 1999 and
March 2000.
During the six months ended March 31, 1999, the Company purchased $50.6 million
face value of its 12% Senior Subordinated Notes (the "Notes"). The Note purchase
transactions were settled for $55.0 million of cash. The premium paid of $4.4
million to purchase the Notes, together with the related accelerated
amortization of $0.7 million of deferred financing fees, resulted in an
extraordinary loss of $3.0 million (net of a $2.1 million tax benefit). This
extraordinary loss was recorded in the six months
9
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
ended March 31, 1999. The Company may continue to purchase additional amounts of
the Notes subject to opportune pricing.
During February 1999, the Company used a portion of the cash proceeds received
in connection with the issuance of the SDW Timber III notes payable (the "SDW
III Notes Payable") (see Note 6 below) to repay $50.0 million of its bank term
loan. The related accelerated amortization of deferred financing fees was not
material.
During April 1999, the Company repurchased $9.5 million face value of its Notes
for a cash settlement of $10.3 million. The premium paid of $0.8 million, along
with $0.3 million of accelerated amortization of deferred financing fees, will
result in an extraordinary loss, net of tax, of approximately $0.6 million which
will be recorded in the third quarter of fiscal year 1999.
NOTE 6. SALE OF TIMBERLANDS
On November 12, 1998, the Company sold its interest 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 notes receivable
(the "Notes Receivable") with a fair market value of $177.1 million and cash of
$3.3 million. The Notes Receivable have an aggregate face amount of $171.4
million and original maturities ranging from 8.25 years to 12.25 years. Interest
rates on the notes (originally ranging from 7.17% to 7.23% per annum) were reset
on February 12, 1999 and now range from 7.62% to 7.83% per annum. 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 Company recognized a pre-tax
gain from the sale of the timberlands of $75.4 million. The timberlands and
related machinery and equipment sold are shown in the Company's balance sheet at
September 30, 1998 as assets under agreement to sell.
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.
On January 21, 1999, the Notes Receivable were contributed to a wholly-owned
bankruptcy remote subsidiary, SDW Timber III ("SDW III"). On February 12, 1999,
SDW III issued an aggregate of $156.0 million of SDW III Notes Payable using the
Notes Receivable as a pledge of security. The SDW III Notes Payable mature in
three installments ranging from 8 to 12 years and bear interest payable
semi-annually at rates ranging from 7.16% to 7.36% per annum. The earnings of
SDW III, which consist of interest income earned on the Notes Receivable, net of
interest expense incurred on the SDW III Notes Payable, is included in other
income in the accompanying statements of operations for the three and six months
ended March 31, 1999. The Company's investment in the undivided interest in SDW
III of approximately $24.2 million is included in other noncurrent assets in the
accompanying balance sheet as of March 31, 1999.
NOTE 7. RESTRUCTURING
In October 1998, the Company announced a restructuring plan which included
production and maintenance job consolidations and eliminations, as well as the
decision to shut down one of its paper machines located at the Westbrook, Maine
mill. This paper machine produced release liner paper and
10
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
face sheets used for pressure sensitive papers. The Company has recorded a
charge of $3.7 million to cover costs relating to the restructuring which
include $2.8 million of costs associated with the termination of 105 employees,
or approximately 14% of the Westbrook mill workforce in force at that date, and
an estimated loss to dispose of the paper machine of $0.9 million. Of the $3.7
million charged, $0.8 million has been paid with the remaining $2.9 million
included in current liabilities in the accompanying balance sheet as of March
31, 1999.
On April 13, 1999, the Company announced the closures of both the pulp mill and
a production line which makes coated base paper at its facility in Westbrook,
Maine. Approximately 315 employees, both salaried and hourly, will be affected
by the closures. Accordingly, the Company will record a pre-tax charge of
approximately $39.0 million during the third quarter of fiscal year 1999. The
restructuring costs associated with the closures, include $22.0 million of
non-cash expenses relating to fixed asset write-offs and $17.0 million of
accruals of one-time cash costs. The closures are expected to improve future
operating income.
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. In February 1999, the U.S. EPA issued a National Pollutant
Discharge Elimination System ("NPDES") wastewater permit and administrative
order for the Westbrook mill, requiring compliance with new effluent permit
limits by 2001. In April 1999, the Company announced its plan to close the
Westbrook pulp mill by late June 1999 ( See Note 7 ).
The Company's Muskegon mill is involved, as one of various industrial
plaintiffs, in litigation with the County of Muskegon (the "County") regarding
an ordinance governing the treatment capacity availability and local effluent
limit provisions of the ordinance. In July 1998, the appeals court affirmed the
lower court's decision substantially in favor of the industrial plaintiffs.
However, in February 1999, the County passed a similar ordinance in connection
with a federal consent decree. If the Company and other plaintiffs do not
prevail in any future appeal or are not successful in ongoing negotiations with
government authorities, 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 among other things,
failure to (a) meet its discharge permit limits for the wastewater facility and
(b) develop and enforce an industrial pretreatment program. A group of
industrial users and a group of municipalities filed motions to intervene in the
EPA lawsuit. In December 1998, the federal court approved a motion filed by the
County to terminate the industrial users' rights to discharge certain pollutant
loadings, but not the right to discharge certain volumes of wastewater to the
system. The industrial users believe they have a meritorious basis for further
legal action and are evaluating their alternatives. A final adverse decision in
either of these lawsuits could require substantial additional expenditures,
including short-term expenditures, and may lead to substantial fines for any
11
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
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 commitments, 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 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 $55.0 million to $75.0 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 9. COMMITMENTS AND CONTINGENCIES
In connection with the acquisition of SFPNA from Scott Paper ("Scott") in
December of 1994, SFPNA 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. 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 Company's pulp contract with
Kimberly-Clark is expected to benefit the Company's paper making operations by
providing for increased flexibility in procuring fiber from competitive global
market sources and allowing for improved paper machine scheduling efficiencies
and product mix. The Company is currently negotiating agreements with a number
of suppliers providing for pulp deliveries at market rates commencing on or
about September 1, 1999. Kimberly-Clark has announced its intention to close its
pulp mill at the Mobile site effective September 1999. While Kimberly-Clark will
continue to provide to SFPNA water and effluent services generally at current
cost after the pulp mill closes, closure could adversely impact the Company's
energy rates as described below.
The Company has a long-term agreement (the "Energy Agreement") with Mobile
Energy Services Corporation ("MESC") to buy its requirements for electric
power and steam for the Mobile paper mill at current rates (subject to change
as described below) generally comparable to market tariffs. The Company is
currently evaluating the impact on continued MESC operations of the announced
closure of the Kimberly-Clark pulp mill. The closure of the Kimberly-Clark
pulp mill may result in a MESC default under certain bond indentures, and has
recently led to the filing by MESC under a Chapter 11 provision of the
bankruptcy laws. If MESC continues operations, as the Company expects, the
loss of lower cost biomass and black liquor fuels currently provided to MESC
by the pulp mill could have an adverse impact on the Company's energy rates.
Although, at this time, there can be no assurance as to the outcome, the
Company is currently working with MESC to develop ways to mitigate this
impact.
A substantial portion 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
12
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
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 has a short-term agreement
relating to the Westbrook mill pursuant to which the Westbrook mill cogenerates
electricity and sells any excess output not used by the mill to CMP at market
rates. The current short-term agreement for the Westbrook mill will expire on
May 31, 1999. The Company and CMP are negotiating an extension of the short-term
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 are not likely to
have a material effect on the Company's consolidated financial position, results
of operations or cash flows.
13
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
SAPPI REORGANIZATION
On April 27, 1998, Sappi Limited ("Sappi") announced the business integration of
S.D. Warren and its subsidiaries, doing business as Sappi Fine Paper North
America ("SFPNA") and 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. S.D. Warren
products are now being marketed under the name Sappi Fine Paper North America.
The legal entities of Holdings, S.D. Warren and S.D. Warren's subsidiaries
continue to remain in existence.
MARKET OVERVIEW
The market for coated paper has historically experienced price fluctuations
driven by global supply/demand imbalances, inventory shifts and the availability
and relative pricing of imported products. Coated freesheet industry volume in
the United States was up slightly during the first six months of fiscal year
1999 versus the same period in the prior year. The Company's coated volume in
the first half of fiscal year 1999 was down slightly, compared to the prior
year. Increased coated freesheet imports, together with enhanced domestic
production output levels, has played a key role in placing downward pressure on
coated freesheet industry pricing. Overall Company pricing has generally
followed industry pricing during this period.
Increased uncoated sales volume was achieved through additional production
output and aggressive sales to achieve inventory reductions, each accounting for
approximately half of that gain. Net sales price per ton for the three months
ended March 31, 1999 was lower due to market transaction pricing. Sales volume
for the six months ended March 31, 1999 increased 8% versus sales volume for the
same period in the prior fiscal year. Uncoated market prices appear to be
stabilizing and price increases in the white offset web segment have been
announced.
The Company's specialties business increased shipments of high-end products by
16% during the six months ended March 31, 1999. This was facilitated by the
addition of capacity with the installation of a new coater during 1998 together
with product improvements. Sales of commodity products have, however, declined
due to worldwide economic conditions as well as customers' shifting to higher
end products. The Company has maintained its prices in each segment of the
specialty business while overall net sales price per ton increased as a result
of improved sales mix.
The following discussion and analysis should be read in conjunction with the
accompanying Unaudited Condensed Consolidated Financial
Statements and the Notes thereto.
14
<PAGE>
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED APRIL 1, 1998
SALES
Sales for the three months ended March 31, 1999 were $354.7 million compared to
$376.1 million for the three months ended April 1, 1998, a decrease of $21.4
million or 5.7%. The decrease was primarily due to a 8.6% decrease in average
net selling price per paper ton (consistent with the industry-wide downward
pressure noted above) for the quarter ended March 31, 1999 compared to the same
period in the prior fiscal year, partially offset by the impact of a 2.9%
increase in paper volume.
COST OF GOODS SOLD
Cost of goods sold for the three months ended March 31, 1999 decreased $6.9
million or 2.4% to $284.2 million compared to $291.1 million for the three
months ended April 1, 1998. Cost of goods sold on a per paper ton basis
decreased to $791 per ton for the three months ended March 31, 1999 from $830
per ton for the corresponding prior year quarter. The decrease was primarily due
to the impact of lower pulp and energy costs per ton, higher productivity, and
other specific efficiency and cost reduction initiatives.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense totaled $38.0 million for the three
months ended March 31, 1999 compared to $35.0 million for the three months ended
April 1, 1998. The increase in 1999 was due primarily to higher corporate
administration and management charges as well as expenses associated with the
Year 2000 initiatives.
OTHER INCOME, NET
For the three months ended March 31, 1999, other income-net includes $2.2
million of interest income, of which $1.7 million (net of interest expense
accrued on the SDW Timber III notes payable (the "SDW III Notes Payable") was
accrued on the notes receivable received in exchange for the sale of the
Company's timberlands (See Other Items below).
EXTRAORDINARY ITEM
The premium paid of $1.9 million in connection with the purchase of $24.0
million face value of the Company's Senior Subordinated Notes (the "Notes"),
together with the related $0.3 million of accelerated amortization of deferred
financing fees resulted in an extraordinary loss of $1.3 million (net of $0.9
million of tax benefits) in the three months ended March 31, 1999. The
accelerated amortization of deferred financing fees resulting from the $50.0
million payment of the Company's term loan was not material.
INTEREST EXPENSE AND TAXES
Interest expense for the three months ended March 31, 1999 was $13.6 million
compared to $19.2 million for the three months ended April 1, 1998. The $5.6
million decrease was primarily due to lower levels of outstanding debt and lower
achieved interest rates and margins. Interest expense includes the amortization
of deferred financing fees, but excludes write-offs due to accelerated
reductions in related financing.
15
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
For the three months ended March 31, 1999, income tax expense, excluding the
$1.4 million tax benefit attributable to the extraordinary loss, was $9.1
million compared to $25.8 million for the corresponding period in the prior
year, primarily reflecting the change in the Company's earnings level, including
the effect of the gain on the sale of the pressure sensitive business in the
three months ended April 1, 1998.
SIX MONTHS ENDED MARCH 31, 1999 COMPARED TO THE SIX MONTHS ENDED APRIL 1, 1998
SALES
Sales for the six months ended March 31, 1999 were $688.1 million compared to
$719.5 million for the six months ended April 1, 1998, a decrease of $31.4
million or 4.4%. The decrease, despite higher overall volume, was primarily due
to lower pricing in the six months ended March 31, 1999.
COST OF GOODS SOLD
Cost of goods sold for the six months ended March 31, 1999 was $544.7 million
compared to $553.6 million for the six months ended April 1, 1998, an increase
of $8.9 million or 1.6 %. Cost of goods sold on a per paper ton basis decreased
to $787 per ton from $821 per ton for the corresponding prior year period. The
decrease was primarily due to the impact of lower pulp costs and energy costs
per ton, higher productivity and other specific efficiency and cost reduction
initiatives.
RESTRUCTURING
In October 1998, the Company announced a restructuring plan which included
production and maintenance job consolidations and eliminations, as well as the
decision to shut down one of its paper machines located at the Westbrook, Maine
mill. This paper machine produced release liner paper and face sheets used for
pressure sensitive papers. The Company has recorded a charge of $3.7 million to
cover costs relating to the restructuring which include $2.8 million of costs
associated with the termination of 105 employees, or approximately 14% of the
Westbrook mill workforce in force at that date, and an estimated loss to dispose
of the paper machine of $0.9 million. Of the $3.7 million charged, $0.8 million
has been paid with the remaining $2.9 million included in current liabilities in
the accompanying balance sheet as of March 31, 1999. (see also SUBSEQUENT EVENTS
below)
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense was $73.1 million for the six months
ended March 31, 1999 compared to $69.5 million for the six months ended April 1,
1998, an increase of $3.6 million. The increase of 5.2% is largely due to higher
corporate administration and management charges as well as expenses associated
with Year 2000 initiatives.
OTHER INCOME, NET
For the six months ended March 31, 1999, other income-net includes $4.3 million
of interest income, of which $3.2 million (net of interest expense accrued on
the SDW III Notes Payable) was accrued on the notes receivable received in
exchange for the sale of the Company's Timberlands.
16
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
EXTRAORDINARY ITEMS
The premium paid of $4.4 million to purchase the $50.6 million face of the
Notes, together with the related $0.7 million of accelerated amortization of
deferred financing fees, resulted in an extraordinary loss of $3.0 milllion (net
of $2.1 million of tax benefits) in the six months ended March 31, 1999.
INTEREST EXPENSE AND TAXES
Interest expense for the six months ended March 31, 1999 was $27.9 million
compared to $40.1 million for the six months ended April 1, 1998. The $12.2
million reduction in interest expense was primarily due to lower levels of
outstanding debt. Interest expense includes the normal amortization of deferred
financing fees, but excludes write-offs due to accelerated reductions in related
financing.
Income tax expense, excluding the aggregate $2.1 million of tax benefits
attributable to the extraordinary items, was $49.6 million for the six months
ended March 31, 1999 compared to $36.8 million for the corresponding period in
the prior year, primarily reflecting the change in the Company's earnings level,
including the $75.4 million gain from the timberlands sale and the $30.9 million
gain from the pressure sensitive sale in the first half of fiscal 1999 and 1998,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $42.0 million for the six months
ended March 31, 1999 compared to $45.2 million for the six months ended April 1,
1998. This decrease of $3.2 million is primarily due to lower operating income
offset by the impact of a lower investment in working capital and lower interest
expense during the first half of fiscal 1999 compared to the same period in the
prior year.
The Company's operating working capital was $22.7 million at March 31, 1999
compared to $0.4 million at September 30, 1998. 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 an increase in trade accounts receivable and inventories
and a decrease in accrued and other current liabilities during the six months
ended March 31, 1999, offset by the impact of an increase in accounts payable.
Capital expenditures for the six months ended March 31, 1999 were $51.7 million,
up from $46.4 million for the six months ended April 1, 1998. Of the $ 51.7
million, $5.5 million was related to construction of the Company's new sheeting
and warehouse facility at the Muskegon Michigan mill and $21.4 million was
related to the company-wide integrated application system implementation in
progress. Capital expenditures are projected to be approximately $130.0 million
during fiscal year 1999. In addition, the Company believes that environmental
compliance expenditures, the bulk of which are for cluster rules compliance,
will approximate $55.0 million to $75.0 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 for the remainder of 1999.
Net cash provided by financing activities was $35.3 million for the six months
ended March 31, 1999 compared to $146.5 million cash used in financing
activities for the corresponding period of the previous
17
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
year. In February 1999, cash of $156.0 million was received in connection with
the monetization of a portion of the notes receivable received in exchange for
the sale of the timberlands (see Other Items SALE OF TIMBERLANDS). The Company
also purchased $50.6 million of face value of Notes for $55.0 million of cash
and prepaid $50.0 million of its bank term loan. On March 29, 1999 the Company
paid a $15.0 million cash dividend to its parent, Holdings. In turn, Holdings
has advanced $15.0 million to an affiliate of Sappi in the form of a promissory
note due April 2002. During December 1997, the Company made an optional
prepayment of $75.0 million of the Company's term loans and paid a dividend of
$58.2 million to the Company's parent, Holdings.
LONG-TERM DEBT
At March 31, 1999, long-term debt was $471.1 million compared to $573.8 million
at September 30, 1998, a decrease of $102.7 million which was primarily due to
the aforementioned repayments. At March 31, 1999, SFPNA did not have any
borrowings outstanding under its 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, SFPNA had approximately $120.2 million of letters of credit
outstanding under its letter of credit facility at March 31, 1999.
SUBSEQUENT EVENTS
On April 13, 1999, the Company announced the closures of both the pulp mill and
a machine which makes coated base paper, at its facility in Westbrook, Maine.
Approximately 315 employees, both salaried and hourly, will be affected by the
closures. Accordingly, the Company will record a pre-tax charge of approximately
$39.0 million during the third quarter of fiscal year 1999. The restructuring
costs associated with the closures include $22.0 million of non-cash expenses
relating to fixed asset write-offs and $17.0 million of accruals of one-time
cash costs. The closures are expected to improve future operating income.
During April 1999, the Company repurchased $9.5 million face value of its Notes
for a cash settlement of $10.3 million. The premium paid of $0.8 million, along
with approximately $0.3 million of accelerated amortization of deferred
financing fees will result in an extraordinary loss, net of tax, of
approximately $0.6 million which will be recorded in the third quarter of fiscal
year 1999.
OTHER ITEMS
SALE OF TIMBERLANDS
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 notes receivable
(the "Notes Receivable") with a fair market value of $177.1 million and cash of
$3.3 million. The Notes Receivable have an aggregate face amount of $171.4
million and original maturities ranging from 8.25 years to 12.25 years. Interest
rates on the notes (originally ranging from 7.17% to 7.23% per annum) were reset
on February 12, 1999 and now range from 7.62% to 7.83% per annum. 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 Company recognized a pre-tax
gain
18
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
from the sale of the timberlands of $75.4 million. The timberlands and related
machinery and equipment sold are shown in the Company's balance sheet at
September 30, 1998 as assets under agreement to sell.
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.
On January 21, 1999, the Notes Receivable were contributed to a wholly-owned
bankruptcy remote subsidiary, SDW Timber III ("SDW III"). On February 12, 1999,
SDW III issued an aggregate of $156.0 million of the SDW III Notes Payable using
the Notes Receivable as a pledge of security. The SDW III Notes Payable mature
in three installments ranging from 8 to 12 years and bear interest payable
semi-annually at rates ranging from 7.16% to 7.36% per annum. The earnings of
SDW III, which consist of interest income earned on the Notes Receivable net of
interest expense incurred on the SDW III Notes Payable is included in other
income in the accompanying statements of operations for the three and six months
ended March 31, 1999. The Company's investment in the undivided interest of SDW
III of approximately $24.2 million is included in other noncurrent assets in the
accompanying balance sheet as of March 31, 1999.
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 in the Notes to Unaudited Condensed
Consolidated Financial Statements included in this Form 10-Q for a discussion of
these matters.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 2 - New Accounting Pronouncements in the Notes to Unaudited
Condensed Consolidated Financial Statements included in this Form 10-Q
for a discussion of these matters.
LONG-TERM CONTRACTS
See Note 9 - Commitments and Contingencies in the Notes to Unaudited
Condensed Consolidated Financial Statements included in this Form 10-Q
for a discussion of certain long-term contracts.
YEAR 2000
The statements in this section constitute a "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 two digits (as opposed to four digits) to store, manipulate or
display calendar year information. Computer applications and hardware configured
in this manner may be unable to correctly interpret dates beyond December 31,
1999. In addition, programming logic for date handling often does not account
for leap day, February 29, 2000. These conditions could result in computer
application errors or systems failure, and ultimately could lead to 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.
19
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
The Company commenced its Year 2000 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 business applications systems, manufacturing execution systems,
production control systems, and data communications infrastructure. The Company
has contracted with a national consulting firm specializing in Year 2000
initiatives. This consulting firm has employed its Year 2000 compliance
methodology as well as specialized project management and technical staff to
advise and assist in the conduct of the Company's Year 2000 project.
An enterprise systems inventory was completed by the Company in the third
quarter of fiscal year 1997. The enterprise systems inventory includes the
Company's business applications, manufacturing execution systems, end-user
computing systems, and computing environments. Similarly, a production
control/embedded systems inventory was also undertaken in fiscal 1998.
Compliance strategies employed by the Year 2000 project team include: system
remediation (Year 2000 readiness modifications), system retirement, and system
replacement. This includes the replacement of a significant number of legacy
business systems with 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 the compliance of all material systems, other
than specific manufacturing excution systems and the embedded systems, is June
30, 1999. The embedded system compliance completion date is August 1999, with
the final manufacturing execution system being completed by September 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 or expenses during the final stages of the project.
Following the remediation phase of the Year 2000 project and continuing through
the remainder of calendar 1999, verification testing of technologies is planned,
particularly in the area of production control/embedded systems.
With respect to the Year 2000 assessment and assurance of the Company's critical
business partners, the Year 2000 project team is working in cooperation with
Company business representatives to assess the Year 2000 readiness of critical
vendors and customers whose failure would have a material adverse affect on
SFPNA's manufacturing and distribution processes. These vendors and customers
are being contacted and asked to complete and return a Year 2000 readiness
questionnaire for SFPNA's assessment. Both returned questionnaires and the
absence of responses are being reviewed for implicit risk. Contingency plans
will be developed for those vendors and customers who may expose the Company to
adverse business risks.
The contingency planning phase has begun and will continue through the remainder
of calendar 1999. This phase of the Year 2000 project will seek to address the
potential for impact to the Company's internal business processes and
technologies. Key aspects which will be addressed by the contingency planning
phase are failure recovery, business continuity, and contingency plan execution
management. The target date for identification of all contingency plans is June
30, 1999. The target date for completion of all contingency plans is October
1999.
20
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
For those information technology systems not being replaced by the
implementation of the integrated system, the Year 2000 initiative is estimated
to cost a total of $14.2 million, which includes $13.1 million for remediation
services by third party consultants and $0.3 million for new hardware and
software. Cumulative through March 31, 1999, $10.8 million of primarily
consulting costs have been expensed, $3.3 million of which are included in the
results of operations for the six months ended March 31, 1999. There can be no
assurance that these costs will not increase as the Company continues to
implement its integrated systems and Year 2000 project. As stated above, the
Company is currently implementing a company-wide integrated application system
which will replace a number of systems which are not Year 2000 compliant. The
completion of the phase of this project which relates to non-Year 2000-ready
systems is July 1999.
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 terms of the S.D. 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) an administrative fee 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 S.D. 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 SFPNA) are currently conducted through SFPNA and
its subsidiaries, Holdings' ability to meet its cash obligations is dependent
upon the earnings of SFPNA and it 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 SFPNA and
guarantees in respect of indebtedness of SFPNA 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 S.D. Warren B Series Preferred Stock permit SFPNA 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 SFPNA meets
certain conditions. Among such conditions are that SFPNA maintain specified
financial ratios and comply with certain financial tests.
21
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with changes in interest rates.
The Company's objective in managing its exposure to interest rate change is to
limit the impact of interest rate changes in earnings and cash flow and to lower
its overall borrowings costs. Short-term borrowings, if required, are used to
meet working capital requirements and long-term borrowings are generally used to
finance long-term investments. 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 relevant outstanding debt receivables. The
carrying amounts of cash, cash equivalents, accounts receivable and accounts
payable approximate fair value due to the short-term nature of these
instruments.
The Company's interest rate exposure is limited primarily to interest rate
changes on its variable rate Credit Facility. The Credit Facility bears interest
at rates which fluctuate with changes in the Eurodollar rate. For the six months
ended March 31, 1999, a hypothetical 10% immediate increase in interest rates
would increase the Company's interest expense by approximately $0.4 million. The
fair value of the Company's interest rate swap would not be materially effected
by a change in interest rates.
The majority of the Company's long-term debt, approximately $480.0 million at
March 31, 1999, is at fixed interest rates. Accordingly, there would be no
immediate impact on the Company's interest expense associated with its long-term
debt due to fluctuations in market interest rates. However, based on a
hypothetical 10% immediate decrease in market interest rates, the fair value of
the Company's long-term debt, which would be sensitive to such interest rate
changes, would be increased by approximately $3.7 million as of March 31, 1999.
Such fair value changes may affect the Company's determination as to whether to
retain, replace or retire its long-term debt.
During the six months ended March 31, 1999, the Company did not engage in
foreign currency hedging activities. The currency exchange impact from the
Company's transactions with its affiliates was immaterial.
22
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Intentionally omitted.*
ITEM 2. CHANGES IN SECURITIES
Intentionally omitted.*
ITEM 3. DEFAULT 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 FROM 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.
23
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, MARCH 31, 1999
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: May 12, 1999 By: /s/ TREVOR LARKAN
----------------------
Trevor Larkan
Vice President and Chief Financial Officer
(Principal Financial Officer)
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
S.D. Warren Company's (The "Company") Consolidated Statements of Operations For
the Quarter Ended March 31, 1999 and Balance Sheet as of March 31, 1999 found on
page 5 and 6, respectively, of the Company's Quarterly Report on Form 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-29-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 59,000
<SECURITIES> 0
<RECEIVABLES> 59,800
<ALLOWANCES> 5,000
<INVENTORY> 198,000
<CURRENT-ASSETS> 384,300
<PP&E> 1,313,800
<DEPRECIATION> 330,800
<TOTAL-ASSETS> 1,521,200
<CURRENT-LIABILITIES> 255,900
<BONDS> 471,100
128,800
0
<COMMON> 0
<OTHER-SE> 321,400
<TOTAL-LIABILITY-AND-EQUITY> 1,521,200
<SALES> 688,100
<TOTAL-REVENUES> 688,100
<CGS> 544,700
<TOTAL-COSTS> 621,500
<OTHER-EXPENSES> 3,700
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 27,900
<INCOME-PRETAX> 119,200
<INCOME-TAX> 49,600
<INCOME-CONTINUING> 69,600
<DISCONTINUED> 0
<EXTRAORDINARY> 3,000
<CHANGES> 0
<NET-INCOME> 66,600
<EPS-PRIMARY> 0.57
<EPS-DILUTED> 0.57
</TABLE>
