<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 JUNE 30, 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
225 Franklin Street, Boston, Massachusetts 02110
- --------------------------------------------------------------------------------
(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, JUNE 30, 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 acquisition 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, JUNE 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations for the three and nine months ended July 1, 1998
and June 30, 1999........................................................................................4
Condensed Consolidated Balance Sheets at September 30, 1998 and June 30, 1999............................6
Condensed Consolidated Statements of Cash Flows for the nine months ended
July 1, 1998 and June 30, 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................................................................................23
Item 1. Legal Proceedings...............................................................................23
Item 2. Changes in Securities..........................................................................23
Item 3. Default 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
JULY 1, 1998 JUNE 30, 1999
------------ -------------
<S> <C> <C>
Sales $ 352.9 $ 335.6
Cost of goods sold 271.6 272.2
------------ -------------
Gross profit 81.3 63.4
Selling, general and administrative expense 35.0 36.3
Restructuring -- 35.9
------------ -------------
Income (loss) from operations 46.3 (8.8)
Other income, net 1.0 1.7
Interest expense 16.2 12.5
------------ -------------
Income (loss) before income taxes and extraordinary items 31.1 (19.6)
Income tax expense (benefit) 13.1 (7.9)
------------ -------------
Income (loss) before extraordinary items 18.0 (11.7)
Extraordinary items, net of tax (1.0) (1.5)
------------ -------------
Net income (loss) 17.0 (13.2)
Dividends and accretion on S.D. Warren Series B preferred stock 3.9 4.1
------------ -------------
Net income (loss) applicable to common stockholder $ 13.1 $ (17.3)
------------ -------------
------------ -------------
Earnings per common share:
Income (loss) before extraordinary items applicable to
common stockholder $ 0.14 $ (0.16)
------------ -------------
------------ -------------
Net income (loss) applicable to common stockholder $ 0.13 $ (0.17)
------------ -------------
------------ -------------
Weighted average number of shares outstanding 100 100
------------ -------------
------------ -------------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
4
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
JULY 1, 1998 JUNE 30, 1999
----------- -----------
<S> <C> <C>
Sales $ 1,072.4 $ 1,023.6
Cost of goods sold 825.2 816.9
----------- -----------
Gross profit 247.2 206.7
Selling, general and administrative expense 104.5 109.4
Restructuring -- 39.6
----------- -----------
Income from operations 142.7 57.7
Gain on sale of pressure sensitive business 30.9 --
Gain on sale of timberlands -- 75.4
Other income, net 3.8 6.8
Interest expense 56.3 40.4
----------- -----------
Income before income taxes and extraordinary items 121.1 99.5
Income tax expense 49.9 41.7
----------- -----------
Income before extraordinary items 71.2 57.8
Extraordinary items, net of tax (2.5) (4.5)
----------- -----------
Net income 68.7 53.3
Dividends and accretion on S.D. Warren Series B preferred stock 12.2 13.4
----------- -----------
Net income applicable to common stockholder $ 56.5 $ 39.9
----------- -----------
----------- -----------
Earnings per common share:
Income before extraordinary items applicable to
common stockholder $ 0.59 $ 0.44
----------- -----------
----------- -----------
Net income applicable to common stockholder $ .57 $ 0.40
----------- -----------
----------- -----------
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>
JUNE 30,
SEPTEMBER 30, 1999
1998 (UNAUDITED)
-------- --------
<S> ASSETS
Current Assets:
<C> <C>
Cash and cash equivalents $ 34.7 $ 22.7
Trade accounts receivable, net 43.0 75.3
Other receivables 18.1 18.9
Inventories 166.8 205.6
Deferred income taxes 28.5 44.2
Other current assets 10.2 12.0
----------- -----------
Total current assets 301.3 378.7
Plant assets, net 970.5 969.7
Assets held under agreement to sell 98.9 --
Goodwill, net 84.4 79.9
Deferred financing fees, net 28.0 23.9
Other assets, net 24.4 47.0
----------- -----------
Total assets $ 1,507.5 $ 1,499.2
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 6.4 $ 8.4
Accounts payable 129.7 166.2
Accrued and other current liabilities 97.8 106.8
----------- -----------
Total current liabilities 233.9 281.4
----------- -----------
Long-term debt:
Term loans 138.6 86.6
Senior subordinated notes 324.6 248.9
Exchange Debentures -- 132.9
Other 110.6 110.5
----------- -----------
573.8 578.9
Deferred income taxes 81.7 111.3
Other liabilities 115.3 119.4
----------- -----------
Total liabilities 1,004.7 1,091.0
----------- -----------
Commitments and contingencies (Notes 8 and 9)
Warren Series B redeemable exchangeable preferred stock
(liquidation value, $126.1 and $0, respectively) 119.5 --
----------- -----------
Stockholder's equity:
Common stock -- --
Capital in excess of par value 321.4 321.4
Retained earnings 61.9 86.8
----------- -----------
Total stockholder's equity 383.3 408.2
----------- -----------
Total liabilities and stockholder's equity $ 1,507.5 $ 1,499.2
----------- -----------
----------- -----------
</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>
NINE MONTHS NINE MONTHS
ENDED ENDED
JULY 1, 1998 JUNE 30, 1999
------------ -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 68.7 $ 53.3
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, cost of timber harvested and amortization 68.0 86.8
Deferred income taxes 18.9 13.9
Extraordinary items 4.2 7.7
Gain on sale of timberlands -- (75.4)
Gain on sale of pressure sensitive business (30.9) --
Other 0.3 0.2
Changes in assets and liabilities:
Trade and other accounts receivable, net 6.8 (34.1)
Inventories, net (43.1) (38.8)
Accounts payable and other current liabilities (16.4) 42.3
Other assets and liabilities 2.1 5.7
------------ -------------
Net cash provided by operating activities 78.6 61.6
------------ -------------
Cash Flows from Investing Activities:
Monetization of note receivable -- 156.0
Investment in plant assets and timber resources (73.4) (80.5)
Proceeds from sale of timberlands -- 3.3
Proceeds from sale of pressure sensitive business 51.5 --
Other investing activities (1.5) (4.8)
------------ -------------
Net (cash used) provided by in investing activities (23.4) 74.0
------------ -------------
Cash Flows from Financing Activities:
Proceeds from short term borrowings -- 54.5
Repayments of debt, including premiums (145.3) (186.5)
Dividends paid to parent (58.2) (15.0)
Other financing activities (3.1) (0.6)
------------ -------------
Net cash (used in) financing activities (206.6) (147.6)
------------ -------------
Net change in cash and cash equivalents (151.4) (12.0)
------------ -------------
Cash and cash equivalents:
Beginning of period 180.7 34.7
------------ -------------
End of period $ 29.3 $ 22.7
------------ -------------
------------ -------------
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest $ 75.1 $ 51.4
------------ -------------
------------ -------------
Income taxes $ 27.9 $ 23.4
------------ -------------
------------ -------------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
7
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 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 UK's Blackburn mill and Sappi Fine Paper in South Africa) to create Sappi
Fine Paper plc. The Sappi Fine Paper Division has established 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.
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.
8
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements include all adjustments, consisting of 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 nine months ended June 30, 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
("SOP") No. 98-5 have been issued over the past year on the subjects of
reporting comprehensive income, segment reporting, pension and other post
retirement benefit disclosures, derivative instruments and hedging
activities, and start-up costs, respectively. SFAS Nos. 130, 131, 132 and SOP
No. 98-5 will be adopted in the fourth quarter of fiscal 1999. The Company
does not expect the implementation of these statements to have a material
effect on its consolidated financial statements. SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" will be effective in the
first quarter of fiscal 2001. The Company is currently evaluating the impact
of SFAS No. 133 and has not yet determined its effect on the Company's
consolidated financial statements.
NOTE 3. RELATED PARTY TRANSACTIONS
SFPNA sells products to certain Sappi subsidiaries (Sappi Europe, Sappi UK,
Sappi South Africa, Specialty Pulp Services and U.S. Paper). These subsidiaries
then resell 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 $29.5 million and $89.5 million to certain Sappi
subsidiaries for the three and nine months ended June 30, 1999, respectively.
For the same periods in the prior fiscal year, SFPNA shipped $30.0 million and
$92.2 million, net of commissions, to these Sappi subsidiaries, respectively. At
September 30, 1998 and June 30, 1999, approximately 16% and 21% respectively, of
the Company's gross trade receivables (including those receivables which were
securitized and sold) were due from Sappi affiliates.
SFPNA also purchases products from certain affiliates (Sappi UK, Hannover
Papier, and beginning in the fourth quarter of fiscal 1998, KNP Leykam) for sale
to SFPNA's North American customers. SFPNA resells 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
$56.2 million of products from these Sappi affiliates for the three and nine
months ended June 30, 1999, and $5.9 million and $19.7 million for the three and
nine months ended July 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.
9
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
NOTE 4. INVENTORIES, NET (IN MILLIONS)
<TABLE>
<CAPTION>
JULY 1, 1998 SEPTEMBER 30, 1998 JUNE 30, 1999
------------ ------------------ -------------
<S> <C> <C> <C>
Finished products $102.8 $81.6 $115.8
Work in process 34.1 26.3 28.6
Pulp, logs and pulpwood 22.2 24.5 26.3
Maintenance parts and other supplies 37.8 34.4 34.9
------- ------- -------
$196.9 $166.8 $205.6
------- ------- -------
------- ------- -------
</TABLE>
NOTE 5. LONG-TERM DEBT
The current portion of long-term debt of $8.4 million consists primarily of bank
term loan principal payments scheduled for September 1999 and March 2000.
During the nine months ended June 30, 1999, the Company purchased an aggregate
of $75.8 million face value of its 12% Senior Subordinated Notes (the "Notes").
The Notes purchase transactions were settled for $82.1 million of cash. The
premium paid of $6.3 million to purchase the Notes, together with the related
accelerated amortization of $1.4 million of deferred financing fees, resulted in
an extraordinary loss of $4.5 million (net of a $3.2 million tax benefit). This
extraordinary loss was recorded in the nine months ended June 30, 1999. The
Company may continue to purchase additional amounts of the Notes subject to
opportune pricing.
On June 15, 1999 (the "Exchange Date"), the Company exchanged its 14% Series B
Senior Exchangeable Preferred Stock due 2006 (the "Preferred Stock") into 14%
Subordinated Exchange Debentures due 2006 (the "Exchange Debentures"). The
Company exchanged all of the Preferred Stock for Exchange Debentures having a
principal amount of $132.9 million, representing $25.00 per share of Preferred
Stock, plus accrued and unpaid dividends on the Preferred Stock. On the Exchange
Date, all rights with respect to the Preferred Stock were terminated, and
dividends on the Preferred Stock ceased to accrue on and after the Exchange
Date. It is the intention of the Company to settle in cash, on a quarterly
basis the interest due on the Exchange Debentures.
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.
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 Receivable (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
10
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
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, are included in other
income in the accompanying statements of operations for the three and nine
months ended June 30, 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 June 30, 1999.
NOTE 7. RESTRUCTURING
In October 1998, the Company announced a restructuring plan at the Westbrook,
Maine mill which included production and maintenance job consolidations and
eliminations, as well as the decision to shut down one of its paper machines.
This paper machine produced release liner paper and face sheets used for
pressure sensitive papers. The Company recorded a charge of $3.7 million to
cover costs relating to the restructuring which included $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 of $0.9
million to dispose of the paper machine. Of the $2.8 million of cash charges,
$0.9 million has been paid, with the remaining $1.9 million included in current
liabilities in the accompanying balance sheet as of June 30, 1999.
On April 13, 1999, the Company announced the closures at its facility in
Westbrook, Maine of both the pulp mill and a production line which made coated
base paper. Approximately 315 employees, both salaried and hourly, have been
affected by the closures, or approximately 48% of the then remaining Westbrook
mill workforce. The Company has recorded a pre-tax charge of approximately $35.9
million during the third quarter of fiscal year 1999. The restructuring costs
associated with the closures include $20.3 million of non-cash expenses relating
to fixed asset write-offs and $15.6 million of accruals of one-time cash costs,
primarily associated with the termination of employees. The closures are
expected to improve future operating income. Of the $15.6 million charged, $0.2
million has been paid with the remaining amounts included in current liabilities
in the accompanying balance sheet as of June 30, 1999.
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
11
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
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 late June 1999, the Company closed the Westbrook pulp mill
(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 regarding the consent decree 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,
including the Company 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 noncompliance. In December 1997, the County notified the Company
and other industrial users of its intentions to terminate their wastewater
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 wastewater 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.
12
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
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. Commencing on or after September 1, 1999 the Company will be
purchasing pulp from a number of suppliers at market rates. 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. 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
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 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 expires on
February 29, 2000.
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, JUNE 30, 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 UK's Blackburn mill and Sappi Fine Paper in South
Africa) to create Sappi Fine Paper plc. The Sappi Fine Paper Division has
established 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 nine
months of fiscal year 1999 versus the same period in the prior year. The
Company's coated volume in the nine months ended June 1999 was up slightly
compared to the prior year. Increased coated freesheet imports, together with
enhanced domestic production output levels, has over the past one to two
years, played a key role in placing downward pressure on coated freesheet
industry pricing. Overall Company pricing has generally followed industry
pricing. Given recent improvements in pulp price increases, the Company and
other coated free producers announced price increases in most coated grades
during the fiscal quarter ended June 1999. The Company traditionally has
experienced its strongest sales volume during the fourth fiscal quarter and
trends indicate that this should recur.
Increased uncoated sales volume was achieved through production efficiencies and
inventory management. Sales volume for the nine months ended June 30, 1999
increased 5% versus sales volume for the same period in the prior fiscal year.
Net sales price per ton for the nine months ended June 30, 1999 decreased 10%
over the same period in the prior fiscal year, due to market conditions.
Uncoated market prices, however, appear to be stabilizing and price increases in
white offset web have been announced.
During the nine months ended June 30, 1999, the Company's specialties business
increased shipments of high-end products by 11% as compared to the prior year
period. 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 following discussion and analysis should be read in conjunction with the
accompanying Unaudited Condensed Consolidated Financial Statements and the Notes
thereto.
14
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JULY 1, 1998
SALES
Sales for the three months ended June 30, 1999 were $335.6 million compared to
$352.9 million for the three months ended July 1, 1998, a decrease of $17.3
million or 4.9%. The decrease was primarily due to a 6.2% decrease in average
net selling price per paper ton (consistent with the industry-wide downward
pressure noted above) for the quarter ended June 30, 1999 compared to the same
period in the prior fiscal year, partially offset by the impact of a 1.1%
increase in paper volume.
COST OF GOODS SOLD
Cost of goods sold for the three months ended June 30, 1999 was $272.2 million
compared to $271.6 million for the three months ended July 1, 1998. Cost of
goods sold on a per paper ton basis decreased to $789 per ton for the three
months ended June 30, 1999 from $795 per ton for the corresponding prior year
quarter. The decrease was primarily due to the impact of lower pulp costs and
specific efficiency and cost reduction initiatives.
RESTRUCTURING
On April 13, 1999, the Company announced the closures at its facility in
Westbrook, Maine of both the pulp mill and a production line which made coated
base paper. Approximately 315 employees, both salaried and hourly, have been
affected by the closures, or approximately 48% of the then remaining Westbrook
mill workforce. The Company has recorded a pre-tax charge of approximately $35.9
million during the third quarter of fiscal year 1999. The restructuring costs
associated with the closures include $20.3 million of non-cash expenses relating
to fixed asset write-offs and $15.6 million of accruals of one-time cash costs,
primarily associated with the termination of employees. The closures are
expected to improve future operating income. Of the $15.6 million charged, $0.2
million has been paid with the remaining amounts included in current liabilities
in the accompanying balance sheet as of June 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense totaled $36.3 million for the three
months ended June 30, 1999 compared to $35.0 million for the three months ended
July 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 June 30, 1999, other income includes $1.2 million
of interest income, of which $0.4 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.
15
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
EXTRAORDINARY ITEM
The premium paid of $1.9 million in connection with the purchase of $25.1
million face value of the Company's Senior Subordinated Notes (the "Notes"),
together with the related $0.6 million of accelerated amortization of deferred
financing fees resulted in an extraordinary loss of $1.5 million (net of $1.0
million of tax benefits) in the three months ended June 30, 1999.
INTEREST EXPENSE AND TAXES
Interest expense for the three months ended June 30, 1999 was $12.5 million
compared to $16.2 million for the three months ended July 1, 1998. The $3.7
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.
For the three months ended June 30, 1999, income tax benefit, excluding the
$1.0 million tax benefit attributable to the extraordinary loss, was $7.9
million compared to income tax expense of $13.1 million for the corresponding
period in the prior year. The income tax benefit in 1999 was a function of
lower operating earnings together with the restructuring charge of
approximately $35.9 million during the third quarter of fiscal 1999.
NINE MONTHS ENDED JUNE 30, 1999 COMPARED TO THE NINE MONTHS ENDED JULY 1, 1998
SALES
Sales for the nine months ended June 30, 1999 were $1,023.6 million compared to
$1,072.4 million for the nine months ended July 1, 1998, a decrease of $48.8
million or 4.5%. The decrease, despite higher overall volume, was primarily due
to lower pricing in the nine months ended June 30, 1999.
COST OF GOODS SOLD
Cost of goods sold for the nine months ended June 30, 1999 was $816.9 million
compared to $825.2 million for the nine months ended July 1, 1998, a decrease
of $8.3 million. Cost of goods sold on a per paper ton basis decreased to
$785 per ton from $812 per ton for the corresponding prior year period. The
decrease was primarily due to the impact of lower pulp costs and specific
efficiency and cost reduction initiatives.
RESTRUCTURING
In October 1998, the Company announced a restructuring plan at the Westbrook,
Maine mill which included production and maintenance job consolidations and
eliminations, as well as the decision to shut down one of its paper machines.
This paper machine produced release liner paper and face sheets used for
pressure sensitive papers. The Company recorded a charge of $3.7 million to
cover costs relating to the restructuring which included $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 of $0.9
million to dispose of the paper machine. Of the $2.8 million of cash charges,
$0.9 million has been paid, with the remaining $1.9 million included in current
liabilities in the accompanying balance sheet as of June 30, 1999.
On April 13, 1999, the Company announced the closures at its facility in
Westbrook, Maine of both the pulp mill and a production line which made coated
base paper. Approximately 315 employees, both salaried and hourly, have been
affected by the closures, or approximately 48% of the then remaining Westbrook
mill workforce. The Company has recorded a pre-tax charge of approximately $35.9
million during the third quarter of fiscal year 1999. The restructuring costs
associated with the closures include $20.3 million of non-cash expenses relating
to fixed asset write-offs and $15.6 million of accruals of one-time cash costs,
primarily associated with the termination of employees. The closures are
expected to improve future operating income. Of the $15.6 million charged, $0.2
million has been paid with the remaining amounts included in current liabilities
in the accompanying balance sheet as of June 30, 1999.
16
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense was $109.4 million for the nine
months ended June 30, 1999 compared to $104.5 million for the nine months ended
July 1, 1998, an increase of $4.9 million. The increase is largely due to higher
corporate administration and management charges as well as expenses associated
with Year 2000 initiatives.
OTHER INCOME, NET
For the nine months ended June 30, 1999, other income includes $5.5 million of
interest income, of which $3.5 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.
EXTRAORDINARY ITEMS
The premium paid of $6.3 million to purchase the $75.8 million face value of the
Notes, together with the related $1.4 million of accelerated amortization of
deferred financing fees, resulted in an extraordinary loss of $4.5 million (net
of a $3.2 million of tax benefits) in the nine months ended June 30, 1999.
INTEREST EXPENSE AND TAXES
Interest expense for the nine months ended June 30, 1999 was $40.4 million
compared to $56.3 million for the nine months ended July 1, 1998. The $15.9
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 $3.2 million of tax benefits
attributable to the extraordinary items, was $41.7 million for the nine months
ended June 30, 1999 compared to $49.9 million for the corresponding period in
the prior year. This is due to the change in the Company's earnings level,
17
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
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, offset by the $39.6 million restructuring charge in 1999.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $61.6 million for the nine months
ended June 30, 1999 compared to $78.6 million for the nine months ended July 1,
1998. This decrease of $17.0 million is primarily due to lower operating income
offset by the favorable impact of a lower investment in working capital, and
lower interest expense during the nine months ended June 30, 1999, compared to
the same period in the prior year.
The Company's operating working capital was $26.8 million at June 30, 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
during the nine months ended June 30, 1999, offset by an increase in accounts
payable and accrued and other current liabilities.
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 Note 6 - SALE OF TIMBERLANDS). Capital
expenditures for the nine months ended June 30, 1999 were $80.5 million, up from
$73.4 million for the nine months ended July 1, 1998. Of the $80.5 million, $7.6
million related to the construction of the Company's new sheeting and warehouse
facility at the Muskegon Michigan mill and $31.4 million related to the
company-wide integrated application system implementation in progress. The
Company completed the implementation of phase one of this information and
business system replacement during the period May through July 1999. Capital
expenditures are projected to be approximately $120.0 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 used in financing activities was $147.6 million for the nine months
ended June 30, 1999 compared to $206.6 million for the corresponding period
of the previous year. The Company purchased $75.8 million of face value of
Notes for $82.1 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.
18
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
LONG-TERM DEBT
At June 30, 1999, long-term debt, excluding current maturities, was $578.9
million compared to $573.8 million at September 30, 1998, a decrease of $5.1
million which was primarily due to the aforementioned repayments, significantly
offset by the exchange of Preferred Stock for the Exchange Debentures. See Note
5 - Long Term Debt for a discussion of these matters. At June 30, 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 June 30,
1999.
OTHER ITEMS
SALE OF TIMBERLANDS
See Note 6 - Sale of Timberlands.
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,
19
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
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 (catastrophic) 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.
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 information 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. This 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.
Year 2000 remediation activities for all material systems other than specific
manufacturing execution systems for a specific mill and embedded systems, were
substantially completed as planned on June 30, 1999. The target completion dates
for the compliance of all remaining embedded systems is August 31, 1999 and
September 30, 1999 for completion of the remaining manufacturing execution
systems at the final mill. Project progress is reported monthly to the Company's
Year 2000 Project Executive Steering Committee. Overall, the program to date has
continued 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
20
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 1999
phase are failure recovery, business continuity, and contingency plan
execution management. The target date for completion of all contingency plans
is October 31, 1999.
For those information technology systems not being replaced by the
aforementioned phase one implementation of the company-wide integrated
application system, the Year 2000 initiative is estimated to cost a total of
$14.5 million, which includes $13.1 million for remediation services by third
party consultants and $0.5 million for new hardware and software. Cumulative
through June 30, 1999, $12.2 million of primarily consulting costs have been
expensed, $5.1 million of which are included in the results of operations for
the nine months ended June 30, 1999. There can be no assurance that these costs
will not increase as the Company continues to implement its Year 2000 project.
As stated above, the Company is currently implementing a company-wide integrated
application system which has replaced a number of systems which are not Year
2000 compliant. The phase of this project which related to non-Year 2000-ready
systems was completed during July 1999.
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 Indentures
relating to the Notes and Exchange Debentures. 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. The Company
had an accrual as of June 30, 1999, in relation to its annual advisory and
services fee, of $5.5 million, the payment of which is subject to the
abovementioned limitations under the terms of its current financial
instruments.
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 Exchange Debentures 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, JUNE 30, 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 Credit Facility bears interest at rates which fluctuate with
changes in the Eurodollar rate. The majority of the Company's long-term debt,
approximately $587.3 million at June 30, 1999, is at fixed interest rates.
Accordingly, the Company's interest expense on its Credit Facility and the fair
value of its fixed long-term debt is sensitive to changes in market interest
rates. The effect of an adverse change in market interest rates on the Company's
interest expense and the fair value of its long-term debt would not be
materially different than that disclosed in the Company's quarterly report on
Form 10-Q for the six months ended March 31, 1999. The fair value of the
Company's interest rate swap would not be materially affected by a change in
interest rates.
During the nine months ended June 30, 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, JUNE 30, 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 ON FORM 8-K
Intentionally omitted.*
- --------------------------------------------------------------------------------
* This report is being voluntarily filed with the Commission pursuant to the
registrant's contractual obligations to file with the Commission all
financial information that would be required to be filed on a Form 10-Q. The
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.
23
<PAGE>
S.D. WARREN COMPANY AND SUBSIDIARIES
FORM 10-Q, JUNE 30, 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: August 6, 1999 By: /s/ Trevor Larkan
-------------------------------
Trevor Larkan
Vice President and Chief Financial Officer
(Principal Financial Officer)
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM S.D. WARREN
COMPANY'S (THE "COMPANY") CONDENSED STATEMENTS OF OPERATIONS FOR THE QUARTER
ENDED JUNE 30, 1999 AND BALANCE SHEET AS OF JUNE 30, 1999 FOUND ON PAGE 5 AND 6,
RESPECTIVELY, OF THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-29-1999
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 22,700
<SECURITIES> 0
<RECEIVABLES> 80,600
<ALLOWANCES> 5,300
<INVENTORY> 205,600
<CURRENT-ASSETS> 378,700
<PP&E> 1,341,000
<DEPRECIATION> 371,300
<TOTAL-ASSETS> 1,499,200
<CURRENT-LIABILITIES> 281,400
<BONDS> 578,900
0
0
<COMMON> 0
<OTHER-SE> 321,400
<TOTAL-LIABILITY-AND-EQUITY> 1,499,200
<SALES> 1,023,600
<TOTAL-REVENUES> 1,023,600
<CGS> 816,900
<TOTAL-COSTS> 965,900
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 40,400
<INCOME-PRETAX> 99,500
<INCOME-TAX> 41,700
<INCOME-CONTINUING> 57,800
<DISCONTINUED> 0
<EXTRAORDINARY> (4,500)
<CHANGES> 0
<NET-INCOME> 53,300
<EPS-BASIC> 0.40
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