<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 DECEMBER 30,1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to __________________
Commission file number: 33-88496*
S.D. WARREN COMPANY
-------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2366983
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 Franklin Street, Boston, Massachusetts 02110
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(Address of principal executive offices) (Zip Code)
(617) 423-7300
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(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 30, 1998
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, Europe and the Far
East; production and pricing levels of pulp and paper; any major disruption in
production at the Company's key facilities; alterations in trade conditions in
and between the United States and other countries where the Company does
business; unanticipated expenses or delays in resolving Year 2000 issues by
either the Company or its significant business partners; and changes in
environmental, tax and other laws and regulations. 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 30, 1998
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 months ended
December 31, 1997 and December 30, 1998 4
Condensed Consolidated Balance Sheets at September 30, 1998 and
December 30, 1998 5
Condensed Consolidated Statements of Cash Flows for the three months ended
December 31, 1997 and December 30, 1998 6
Notes to Unaudited Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 19
ITEM 2. CHANGES IN SECURITIES 19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 19
ITEM 5. OTHER INFORMATION 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 19
SIGNATURE 20
</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
DECEMBER 31, 1997 DECEMBER 30, 1998
----------------- -----------------
<S> <C> <C>
Sales $ 343.4 $ 333.4
Cost of goods sold 262.4 260.5
------- -------
Gross profit 81.0 72.9
Selling, general and administrative expense 34.4 35.1
Restructuring -- 3.7
------- -------
Income from operations 46.6 34.1
Gain on sale of timberlands -- 75.4
Other income, net 1.8 2.1
Interest expense 21.0 14.3
------- -------
Income before income taxes and extraordinary items 27.4 97.3
Income tax expense 11.1 40.5
------- -------
Income before extraordinary items 16.3 56.8
Extraordinary items, net of tax (1.2) (1.6)
------- -------
Net income 15.1 55.2
Dividends and accretions on S.D. Warren Series B preferred stock 4.1 4.6
------- -------
Net income applicable to common stockholder $ 11.0 $ 50.6
------- -------
------- -------
Earnings per common share:
Income before extraordinary items applicable to
common stockholder $ 0.12 $ 0.52
------- -------
------- -------
Net income applicable to common stockholder $ 0.11 $ 0.51
------- -------
------- -------
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>
SEPTEMBER 30, DECEMBER 30,
1998 1998
(UNAUDITED)
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 34.7 $ 4.0
Trade accounts receivable, net 43.0 35.7
Other receivables 18.1 18.0
Inventories 166.8 189.8
Deferred income taxes 28.5 46.4
Other current assets 10.2 4.7
-------- --------
Total current assets 301.3 298.6
Plant assets, net 970.5 975.7
Assets held under agreement to sell 98.9 --
Goodwill, net 84.4 81.8
Deferred financing fees, net 28.0 26.6
Other assets, net 24.4 199.1
-------- --------
Total assets $1,507.5 $1,581.8
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 6.4 $ 54.2
Accounts payable 129.7 138.3
Accrued and other current liabilities 97.8 89.1
-------- --------
Total current liabilities 233.9 281.6
-------- --------
Long-term debt:
Term loans 138.6 90.8
Senior subordinated notes 324.6 298.0
Other 110.6 110.5
-------- --------
573.8 499.3
-------- --------
Deferred income taxes 81.7 126.7
-------- --------
Other liabilities 115.3 116.2
-------- --------
Total liabilities 1,004.7 1,023.8
-------- --------
Commitments and contingencies (Notes 8 and 9 )
Warren Series B redeembable exchangeable preferred stock
(liquidation value, $126.1 and $130.5, respectively) 119.5 124.1
-------- --------
Stockholder's equity:
Common stock -- --
Capital in excess of par value 321.4 321.4
Retained earnings 61.9 112.5
-------- --------
Total stockholder's equity 383.3 433.9
-------- --------
Total liabilities and stockholder's equity $1,507.5 $1,581.8
-------- --------
-------- --------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
5
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS, UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
DECEMBER 31, 1997 DECEMBER 30, 1998
----------------- -----------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 15.1 $ 55.2
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, cost of timber harvested and amortization 24.0 22.5
Deferred income taxes 4.5 27.1
Extraordinary item 2.0 2.8
Gain on sale of timberlands -- (75.4)
Other 0.1 --
Changes in assets and liabilities:
Trade and other accounts receivable, net 13.3 6.4
Inventories, net (32.2) (23.0)
Accounts payable, and accrued and other current liabilities (8.4) (3.4)
Other assets and liabilities 2.6 7.1
------ ------
Net cash provided by operating activities 21.0 19.3
------ ------
Cash Flows from Investing Activities:
Investment in plant assets and timber resources (22.7) (25.2)
Proceeds from disposals of plant assets and timber resources 0.1 --
Proceeds from sale of timberlands -- 3.3
Other investing activities (0.1) 1.0
------ ------
Net cash used in investing activities (22.7) (20.9)
------ ------
Cash Flows from Financing Activities:
Repayments of long-term debt, including premiums (75.2) (29.0)
Dividend paid to Holdings (58.2) --
Other financing activities (0.5) (0.1)
------ ------
Net cash used in financing activities (133.9) (29.1)
------ ------
Net change in cash and cash equivalents (135.6) (30.7)
------ ------
Cash and cash equivalents:
Beginning of period 180.7 34.7
------ ------
End of period $ 45.1 $ 4.0
------ ------
------ ------
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest $ 35.1 $ 24.9
------ ------
------ ------
Income taxes $ 2.5 $ 0.3
------ ------
------ ------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
6
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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 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 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 ended December 30, 1998
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
reporting, pension and other post retirement benefit disclosures, derivatives
instruments and hedging activities, and start-up costs. The Company does not
expect the implementation of SFAS Nos. 130, 131,
7
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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 been 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 $29.9
million and $27.9 million to certain Sappi subsidiaries for the three months
ended December 30, 1998 and December 31, 1997, respectively. Trade accounts
receivable at September 30, 1998 and December 30, 1998 included approximately
$18.1 million and $22.6 million, respectively, due from subsidiaries of Sappi.
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 $15.1 million of products from
these Sappi affiliates for the three months ended December 30, 1998. Imports for
the same period in the prior year were immaterial.
NOTE 4. INVENTORIES, NET (IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 30, 1998
------------------ -----------------
<S> <C> <C>
Finished products $ 81.6 $ 93.8
Work in process 26.3 29.3
Pulp, logs and pulpwood 24.5 31.9
Maintenance parts and other supplies 34.4 34.8
-------- --------
$ 166.8 $ 189.8
-------- --------
-------- --------
</TABLE>
NOTE 5. LONG-TERM DEBT
The current maturities of long-term debt balance of $54.2 million consists
primarily of a term loan principal payment of $50.0 million scheduled for
February 1999.
During the three months ended December 30, 1998, the Company purchased $26.6
million face value of its 12% Senior Subordinated Notes (the "Notes"). The Note
purchase transactions were settled for $29.0 million of cash. The premium paid
of $2.4 million to purchase the Notes, together with the related accelerated
amortization of $0.4 million of deferred financing fees resulted in an
extraordinary loss of $1.6 million (net of a $1.2 million tax benefit) recorded
in the three months ended December 30, 1998. The Company may continue to
purchase additional amounts of the Notes subject to opportune pricing.
NOTE 6. 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
with a fair market value of $177.1 million and cash of $3.3 million. The notes
receivable, which have an aggregate face amount of $171.4 million, mature in
three installments ranging from 8.25 years to 12.25 years and bear interest at
rates ranging from 7.17% to
8
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
7.23% per annum, are included in other assets, net in the accompanying balance
sheet as of December 30, 1998. 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.
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 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 and an estimated loss to dispose of the paper machine
of $0.9 million. Of the $3.7 million charged, $0.4 million has been paid with
the remaining $3.3 million included in accrued and other current liabilities in
the accompanying balance sheet as of December 30, 1998.
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 Environmental
Protection Agency ("EPA") would limit dioxin discharges from the Company's
Somerset and Westbrook mills. While the permit limitations at these two
facilities are being challenged, the Company continues to operate under existing
EPA permits in accordance with accepted administrative practice.
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 substantially
in favor of the Company and other plaintiffs. In July 1998, the appeals court
affirmed the lower court's decision. In June 1997, the EPA sued the County for
failure to implement and enforce its industrial pre-treatment operations
associated with its operation of the wastewater facility. The Company is
uncertain as to the effects, if any, of this action on its current dispute with
the County which has raised the industrial users' contractual
9
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
rights as an issue in the EPA lawsuit. The group of industrial users and
municipalities intervened in the lawsuit. In December 1998, the federal court
approved a motion filed by the County and the municipalities authorizing 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. The imposition of currently
proposed permit limits or the failure of the Muskegon lawsuit could require
substantial additional expenditures, including short-term expenditures, and may
lead to substantial fines for any noncompliance. In December 1997, the County
notified the Company and other industrial users of its intentions to terminate
their service agreements on January 1, 2000. The Company believes that under
Michigan contract law, related contracts and county bond resolutions, the County
does not have the authority to unilaterally terminate the service agreements.
In November 1993, the EPA announced proposed regulations that would impose new
air and water quality standards aimed at further reductions of pollutants from
pulp and paper mills, particularly those conducting bleaching operations
(generally referred to as the "cluster rules"). The cluster rules were published
on April 15, 1998, with compliance with the rules generally required beginning
in 2001. The Company believes that environmental compliance expenditures, the
bulk of which are for the cluster rules compliance, will require aggregate
capital expenditures of approximately $70.0 million to $112.0 million through
2001, of which $20.0 million has already been incurred. The ultimate financial
impact to the Company of compliance with the cluster rules will depend upon the
cost and availability of new technology.
The Company believes that none of these matters, individually or in the
aggregate, is expected to have a material adverse effect on its consolidated
financial position, results of operations or cash flows.
NOTE 9. COMMITMENTS AND CONTINGENCIES
In connection with the acquisition of SFPNA from Scott Paper ("Scott"), 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. Wood pulp is
supplied generally at market prices. Pulp prices are discounted due to the
elimination of freight costs associated with delivering pulp to SFPNA's Mobile
mill and pulp quantities arc subject to minimum (162,000 tons per year) and
maximum (208,000 tons per year) limits. Prices for other services to be provided
by Kimberly-Clark are generally based upon cost. On May 4, 1998, the Company
announced an agreement with Kimberly-Clark to terminate the long-term pulp
supply contract effective September 1, 1999. The cancellation of the pulp
contract is expected potentially to benefit the Company's paper making
operations by providing for increased flexibility in procuring fiber from
competitive global market sources. In addition, the Company believes the
contract cancellation will allow for improved paper machine scheduling
efficiencies and product mix. The Company has a long-term agreement (the "Energy
Agreement") with Mobile Energy Services Corporation ("MESC") to buy electric
power and steam for the Mobile paper mill at rates generally comparable to
market tariffs, including fuel cost and capital recovery components.
Kimberly-Clark has announced their intention to close their pulp mill at the
Mobile site effective September 1999. The closure of the Kimberly-Clark pulp
mill may result in a MESC default under certain bond indentures, and has
recently led to the filing by MESC under a Chapter 11 provision of the
bankruptcy laws. The Company is currently evaluating the impact on continued
MESC operations of the closure of the Kimberly-Clark pulp mill. In isolation,
loss of biomass and black liquor fuels currently provided to MESC by the pulp
mill could have an adverse impact on the Company's energy rates.
10
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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 to
Central Maine Power ("CMP") at market rates. The CMP agreement relating to the
Somerset mill also provides, but does not require, that the mill purchase
electricity from CMP at the standard industrial tariff rate. The Somerset
agreement expires in the year 2012. The Company previously had a long-term
agreement with CMP relating to the Westbrook mill, which expired on October 31,
1997. This long-term agreement with CMP has been replaced with a short-term
agreement pursuant to which the Westbrook mill cogenerates electricity and sells
any excess output not used by the mill to CMP at market rates. The short-term
agreement for the Westbrook mill will expire on February 28, 1999.
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.
11
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
Form 10-Q, DECEMBER 30, 1998
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 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 being marketed under the name Sappi Fine Paper North America. The
legal entities of SDW 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. The coated freesheet sector in the
United States reported lower volume for the first quarter of fiscal 1999 versus
the same period in the prior year. The Company managed to improve its coated
volume in the first fiscal quarter of 1999 compared to the prior year quarter.
Increased coated freesheet imports, together with enhanced domestic production
output levels, played a key role in placing downward pressure on coated
freesheet pricing. Overall Company pricing generally followed industry pricing.
The uncoated freesheet market reported a slight improvement in demand for the
first quarter of fiscal 1999 versus the first quarter of fiscal 1998. Despite
increased demand, the market has experienced a decline in prices in part due to
weaker U.S. exports and increased imports. The Company reduced export shipments
in the uncoated business due to lower export pricing, resulting in a slight
decline in uncoated shipments.
The Company's specialties business increased sales of high-end products with the
added capacity of a new coater installed during the second quarter of fiscal
1998. However, sales of our commodity products have slowed due to economic
conditions worldwide. The net result was a slight decline in sales volume
compared to the first quarter of fiscal 1998. Excess capacity in the industry
has kept pricing flat in individual product lines, however improved product mix
resulted in a 12% improvement in the Company's average specialties selling
prices.
The following discussion and analysis should be read in conjunction with the
accompanying Unaudited Condensed Consolidated Financial Statements and the
Notes thereto.
THREE MONTHS ENDED DECEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
DECEMBER 31, 1997
SALES
Sales for the three months ended December 30, 1998 were $333.4 million compared
to $343.4 million for the three months ended December 31, 1997, a decrease of
$10.0 million or 2.9%. The decrease was primarily due to a 5.7% decrease in
average net revenue per paper ton (consistent with the industry-wide downward
pressure noted above) for the quarter ended December 30, 1998 compared to the
same period in the prior fiscal year, offset by the impact of a 8,800 ton or
2.8% increase in paper volume.
12
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
COST OF GOODS SOLD
Cost of goods sold for the three months ended December 30, 1998 decreased $1.9
million or 0.7% to $260.5 million compared to $262.4 million for the three
months ended December 31, 1997. Cost of goods sold on a per paper ton basis
decreased to $782 per ton for three months ended December 30, 1998 from $811 per
ton for the corresponding prior year quarter. This decrease was primarily due to
the impact of lower pulp and other raw materials costs per ton, higher
productivity, and other specific efficiency and cost reduction initiatives.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense totaled $35.1 million for the three
months ended December 30, 1998 compared to $34.4 million for the three months
ended December 31, 1997.
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 and an estimated loss to
dispose of the paper machine of $0.9 million. Of the $3.7 million charged,
$0.4 million has been paid with the remaining $3.3 million included in
accrued and other current liabilities in the accompanying balance sheet as of
December 30, 1998.
OTHER INCOME, NET
Other income, net includes $2.0 million of interest income, of which $1.5
million was accrued on the notes receivable received in exchange for the sale of
the Company's timberlands.
INTEREST EXPENSE AND TAXES
Interest expense for the three months ended December 30, 1998 was $14.3 million
compared to $21.0 million for the three months ended December 31, 1997. The $6.7
million decrease was primarily due to lower levels of outstanding debt. Interest
expense includes the amortization of deferred financing fees, but excludes
write-offs due to accelerated reductions in related financing.
For the three months ended December 30, 1998, income tax expense, excluding the
$1.6 million tax benefit attributable to the extraordinary loss, was $40.5
million compared to $11.1 million for the corresponding period in the prior
year, primarily reflecting the change in the Company's earnings level including
the impact of the sale of the timberlands in November 1998.
EXTRAORDINARY ITEM
The premium paid of $2.4 million in connection with the purchase of $26.6
million face value of the Company's Senior Subordinated Notes (the "Notes"),
together with the related $0.4 million of accelerated amortization of deferred
financing fees resulted in an extraordinary loss of $1.6 million (net of $1.2
million of tax benefits) in the three months ended December 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $19.3 million for the three months
ended December 30, 1998 compared to $21.0 million for the three months ended
December 31, 1997. This decrease of $1.7 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 quarter of fiscal 1999 compared to
the same period in the prior year.
The Company's operating working capital was $16.1 million at December 30, 1998
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 finished goods and work-in-process
inventories during the three
13
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
months ended December 30, 1998, offset by the impact of reductions in trade and
other accounts receivables.
Capital expenditures for the three months ended December 30, 1998 were $25.2
million, up from $22.7 million for the three months ended December 31, 1997. Of
the $25.2 million, $5.3 million was related to construction in progress on the
Company's new sheeting and warehouse facility at the Muskegon Michigan mill.
Expenditures for the three months ended December 30, 1998 also include $9.2
million for 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 $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 $29.1 million for the three months
ended December 30, 1998 compared to $133.9 million for the corresponding period
of the previous year. During the current fiscal year period, the Company
purchased $26.6 million of face value of Notes for $29.0 million of cash. During
December 1997, the Company made an optional prepayment of $75.0 million of the
Company's term loans and paid payment of a dividend of $58.2 million to the
Company's parent, Holdings. In turn, Holdings used the proceeds of the dividend
to redeem its 15% Senior Exchangeable Preferred Stock, including accrued and
unpaid dividends.
LONG-TERM DEBT
At December 30, 1998, long-term debt was $499.3 compared to $573.8 million at
September 30, 1998, a decrease of $74.5 million. Of the $74.5 million decrease,
$50.0 million was a reclassification from long-term debt to the current
maturities of long-term debt to reflect a term loan principal payment scheduled
for February 1999. At December 30, 1998, 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 $136.3 million of letters of credit
outstanding under its letter of credit facility at December 30, 1998.
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
with a fair market value of $177.1 million and cash of approximately $3.3
million. The notes receivable, which have an aggregate face amount of $171.4
million, mature in three installments ranging from 8.25 years to 12.25 years and
bear interest at rates ranging from 7.17% to 7.23% per annum, are included in
other assets, net in the accompanying balance sheet as of December 30, 1998. 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.
14
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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.
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 are "Year 2000 readiness disclosure" within the
meaning of the "Year 2000 Information and Disclosure Act."
The millennium computer date ("Year 2000") issue is the result of computer
programs using a two digit format, as opposed to four digits, to indicate the
year. Such computer systems will be unable to correctly interpret dates beyond
the year 1999, which could cause systems failure or other computer errors,
leading to a significant disruption in operations and the potential for
short-term business failure. All of these issues are collectively referred to as
the Year 2000 issue.
The Company commenced its Year 2000 remediation project during the fourth
quarter of fiscal year 1996. The enterprise-wide project is intended to
remediate the cross-century date processing problem within the Company's
computer systems including embedded production control systems and data
communications infrastructure. The Company has contracted with a national
consulting firm specializing in Year 2000 initiatives. The consulting firm is
employing its compliance methodology and staff to advise and assist in the
management of the Company's Year 2000 remediation project.
The Company completed the compilation of the enterprise systems inventory and
the assignment of compliance strategies was substantially completed in the third
quarter of fiscal year 1997. The enterprise systems inventory includes the
Company's business applications, manufacturing execution systems, production
control systems and computing environments. The embedded systems inventory was
substantially completed in July 1998.
Compliance strategies employed by the Year 2000 project team include: system
remediation (compliance modifications), system retirement and system replacement
(which includes certain systems being replaced by the implementation of a
company-wide integrated application system ("the integrated
15
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
system")). Detailed project plans and established project milestones are used to
monitor the progress of the Company's compliance strategies. The target
completion date for compliance of all material systems, other than manufacturing
execution systems and the embedded systems, is June 30, 1999. The embedded
system compliance completion date is August 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.
The Company's Year 2000 contingency plans include the establishment of
milestones or "trigger" dates to test the progress and confirm the validity of
the Company's various compliance strategies. If the expected measure of progress
is not attained by a "trigger date", alternative strategies are evaluated and
the appropriate strategy initiated. The Company also has system component-based
impact definition and failure resolution plans which describe the potential for
failure within a system, alternatives for the system remediation, and prescribes
failure recovery solutions. Technology and business failure resolution teams
will be maintained into the first calendar quarter of 2000.
With respect to the Year 2000 assessment of the Company's critical business
partners, the Year 2000 project team is working with Company representatives to
identify material vendors and customers whose Year 2000 failure could have a
material adverse affect on SFPNA's manufacturing and distribution process. These
vendors and customers are being contacted and asked to complete and return a
Year 2000 compliance questionnaire for SFPNA's assessment. Both returned
questionnaires and the absence of responses are bring reviewed to assess vendors
and customers who may expose the Company to adverse business risks. The business
partners assessment will continue to intensify through 1999, particularly in
relation to the Company's significant vendors and customers.
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 $14.0 million, which includes $13.1 million for remediation
services by third party consultants and $0.3 million for new hardware and
software. Cumulative through December 30, 1998, $8.7 million of primarily
consulting costs have been expensed, $1.7 million of which are included in the
results of operations for the three months ended December 30, 1998. There can be
no assurance that these costs will not increase as the Company continues to
implement its integrated systems and Year 2000 project. 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 noncompliant 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
16
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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 ratio's and comply with certain financial tests.
17
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Currently, the Company does not enter into financial instrument transactions for
trading or other speculative purposes. The Company is exposed to interest rate
risk primarily through its financing activities. The Company's financial
instruments include the letters of credit under both its revolving credit
facility and the letter of credit facility, interest rate caps and swaps, and
its revolving accounts receivable securitization facility. In addition, the
Company's Credit Agreement provides for borrowings which bear interest at a rate
equal to, at the Company's option, (1) the ABR Rate plus the Applicable Margin
("ABR Loans") or (2) the Eurodollar Rate (adjusted for reserves) for the
respective interest period plus the Applicable Margin ("Eurodollar Loans"). The
ABR Rate means the highest of (1) the prime rate, (2) the secondary market rate
for three-month certificates of deposit (adjusted for reserves) plus 1.00% and
(3) the federal funds rate in effect from time to time plus 0.5%. The Company
believes the effect, if any, of reasonable possible near-term changes in
interest rates on the Company's financial position, results of operations, and
cash flows would not be material.
The Company's objective in managing its exposure to interest rate change is to
limit the impact of interest rate changes on 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 or receivables. The
carrying amounts for cash, cash equivalents, accounts receivable and accounts
payable approximate fair value due to the short-term nature of these
instruments. With respect to other instruments, which include the Company's
obligations under its term loans, Notes and revenue bonds, there has been no
significant change in fair value during the three months ended December 30,
1998.
During the three months ended December 30, 1998, the Company did not engage in
foreign currency hedging activities. The currency exchange impact from the
Company's transactions with its affiliates was immaterial.
18
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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.
19
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, DECEMBER 30, 1998
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 4, 1999 BY: /S/ TREVOR LARKAN
--------------------------
Trevor Larkan
Vice President and Chief Financial Officer
(Principal Financial Officer)
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
S.D. Warren Company's (The "Company") Consolidated Statements of Operations For
the Quarter Ended December 30, 1998 and Balance Sheet as of December 30, 1998
found on page 4 and 5, respectively, of the Company's Quarterly Report on Form
10-Q
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-29-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-30-1998
<CASH> 4,000
<SECURITIES> 0
<RECEIVABLES> 41,000
<ALLOWANCES> 5,300
<INVENTORY> 189,800
<CURRENT-ASSETS> 298,600
<PP&E> 1,286,500
<DEPRECIATION> 310,800
<TOTAL-ASSETS> 1,581,800
<CURRENT-LIABILITIES> 281,600
<BONDS> 499,300
124,100
0
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<TOTAL-LIABILITY-AND-EQUITY> 1,581,800
<SALES> 333,400
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