10-Q 1 a2057290z10-q.txt FORM 10-Q 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 JULY 1, 2001 ------------ OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to __________________ Commission file number: 33-88496* S.D. WARREN COMPANY (Exact name of registrant as specified in its charter) Pennsylvania 23-2366983 ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 225 Franklin Street, Boston, Massachusetts 02110 ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (617) 423-7300 ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes / / No / / Not Applicable /X*/ ------------------------------------------------------------------------------- *This report is being voluntarily filed with the Securities and Exchange Commission (the "Commission") pursuant to the registrant's contractual obligations to file with the Commission all financial information that would be required to be filed on a Form 10-Q. The registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 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, and energy, (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, and (h) 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. 1 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 TABLE OF CONTENTS

2 S.D. WARREN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN MILLIONS, UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements. 3 S.D. WARREN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN MILLIONS, UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements 4 S.D. WARREN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT FOR SHARE DATA)

See accompanying notes to unaudited condensed consolidated financial statements 5 S.D. WARREN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS, UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements 6 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 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 wholly owned 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. The Company currently operates four paper mills with total annual production capacity of approximately 1.5 million tons of paper. The Company also owns a sheeting facility in Allentown, Pennsylvania, with annual sheeting capacity of approximately 100,000 tons, and has other sheeting capabilities located at its Muskegon, Michigan mill (205,000 tons annually) and Mobile, Alabama mill (144,000 tons annually). On May 15, 2001, the Company announced that it had finalized its decision to exit the uncoated business and to close the Mobile, Alabama paper mill (see Note 4). The Company also operates several regional distribution facilities. Together these represent the Company's single line of business. CONTROL BY SAPPI The Company is a wholly owned subsidiary of Holdings. On March 30, 2000, Sappi acquired through an indirect wholly-owned subsidiary the 24.93% equity interest in Holdings previously held by Heritage Springer Limited, a British Virgin Islands company. Sappi now indirectly owns 100% of the issued and outstanding common stock of Holdings. 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 27, 2000. The unaudited condensed consolidated results of operations for the three and nine months ended July 1, 2001 are not necessarily indicative of results that could be expected for a full year. COMPREHENSIVE INCOME The Company's only component of comprehensive income is Net Income. 7 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 RECLASSIFICATIONS Certain reclassifications have been made to prior year amounts to conform with the current year presentation. NOTE 2. ACCOUNTING PRONOUNCEMENTS In September 2000, the Financial Accounting Standards Board, ("FASB"), issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities-a replacement of FASB Statement No. 125"("SFAS No. 140"). This statement replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement revises the standard for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of SFAS No. 125's provisions without consideration. The accounting requirements of SFAS No. 140 are effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001, and must be applied prospectively. The disclosures related to securitization transactions are required for fiscal years ending after December 15, 2000, and comparative disclosures for prior periods are not required. The Company has adopted SFAS No. 140 in accounting and reporting for all transfers and servicing of securitized trade receivables occurring after March 31, 2001. The implementation of this statement did not have a material effect on the Company's consolidated financial statements. (see Note 9). In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations"("SFAS No. 141"). SFAS No. 141 addresses financial accounting and reporting for business combinations and amends or supercedes a number of interpretations concerning business combinations. SFAS No. 141 requires companies to use the purchase method of accounting for all business combinations, whereas previous interpretations provided for the use of another method (pooling of interests method) if certain criteria were met. This statement also amends the recognition policies of intangible assets and goodwill and provides for additional disclosure requirements for business combinations. The provisions for this statement apply to all business combinations initiated after June 30, 2001. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"("SFAS No. 142"). This statement supercedes APB Opinion No. 17, "Intangible Assets"("APB No. 17") and addresses financial accounting and reporting for intangible assets, but not those acquired in a business combination at acquisition. SFAS No. 142 addresses financial accounting and reporting of goodwill and other intangible assets subsequent to their acquisition, assigning a definite or indefinite useful life to these assets. Goodwill and other intangible assets having an indefinite useful life will not be amortized, but rather tested at least annually for impairment. It also provides guidance on how to define, measure and record impairment losses on goodwill and other intangible assets and provides for additional disclosures regarding these assets in years subsequent to their acquisition. The provisions for this statement are required to be applied for fiscal years beginning after December 15, 2001, although earlier adoption is permitted. The Company has not completed its evaluation of SFAS No. 142 and has not yet determined its effect on its consolidated financial statements. Amortization of goodwill for the nine months ended July 1, 2001 was $2.9 million. 8 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 NOTE 3. RELATED PARTY TRANSACTIONS The Company sells products to certain Sappi subsidiaries (Sappi Europe, Sappi UK, Sappi South Africa, Specialty Pulp Services, and U.S. Paper). These subsidiaries then resell the Company's products to external customers at market prices and remit the proceeds from such sales to the Company, net of a 5% sales commission. Net of commissions, the Company shipped $30.8 million and $92.1 million to certain Sappi subsidiaries for the three and nine months ended July 1, 2001, respectively. For the same periods in the prior fiscal year, the Company shipped $37.6 million and $105.6 million net of commissions, to these Sappi subsidiaries, respectively. At July 1, 2001 and September 27, 2000, interaffiliate trade and non-trade receivables totaled $26.6 million and $35.6 million, respectively. The Company also imports products from certain affiliates (Sappi UK, Hannover Papier and KNP Leykam) for sale to the Company's North American customers. The Company resells these products at market prices and remits the proceeds, net of a 5% sales commission, to the Sappi affiliates. Net of commissions, the Company imported approximately $24.8 million and $78.9 million of products from these Sappi affiliates for the three and nine months ended July 1, 2001 and $25.1 million and $74.0 million for the three and nine months ended June 28, 2000, respectively. Accounts payable at July 1, 2001 and September 27, 2000, included $38.4 million and $28.3 million, respectively, due to subsidiaries of Sappi. In addition to the above, the Company has contracted through a management services agreement with Sappi Fine Paper Plc ("SFP") to provide management advisory services. The aggregate fee paid by the Company is limited to an annual amount of $1.0 million. The aggregate fees charged to the Company by SFP were $2.5 million and $7.6 million for the three and nine months ended July 1, 2001, respectively, and $2.3 million and $6.8 million for the three and nine months ended June 28, 2000, respectively. The accompanying condensed consolidated balance sheets at July 1, 2001 and September 27, 2000 include accrued management advisory service fees of $21.0 million and $14.4 million, respectively. NOTE 4. RESTRUCTURING AND OTHER CHARGES On May 15, 2001, the Company announced that it had finalized its decision to exit the uncoated paper business in the United States and close the Mobile, Alabama paper mill. As of July 1, 2001, the Company has permanently shut one paper machine and will permanently shut the other two paper machines at the mill over the next several months and cease all operations at the Mobile site. The Company has recorded a charge to earnings of $186.3 million for the impairment losses and write-downs of certain operating assets and severance and other costs to exit the uncoated business. Of this amount, approximately $17.7 million represented lower of cost or market inventory provisions and $4.1 million of reserves for trade accounts receivable as a result of the decision to close the Mobile mill. These amounts have been included in the condensed consolidated statement of operations as components of Cost of goods sold and Selling, general and administrative expense, respectively, and components of Inventories, net and Trade accounts receivable, net, respectively, in the accompanying condensed consolidated balance sheets at July 1, 2001. 9 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 The remaining charge to earnings of $164.5 million has been included under the caption "Restructuring and other charges" in the condensed consolidated statement of operations. This charge is comprised of the following; (1) $101.1 million primarily to write assets down to their estimated salvage value, including $7.6 million of unamortized goodwill attributable to the Mobile mill, (2) $30.5 million of severance and benefits costs covering the termination of 583 employees, and (3) other exit costs of $32.9 million, primarily related to lease and contract terminations. The accompanying condensed consolidated balance sheets at July 1, 2001 include $47.2 million and $15.9 million, respectively, of severance and benefits costs and other exit costs recorded as "Accrued and other current liabilities" and "Other liabilities". As of July 1, 2001, the Company has paid $0.3 million of severance costs and 126 employees have been terminated. Excluding restructuring charges, the Mobile mill had operating revenues of $59.6 million and $191.8 million for the three and nine month periods ending July 1, 2001, respectively and pre-tax operating losses of $4.9 million and $29.2 million for the three and nine month periods ending July 1, 2001, respectively. NOTE 5. INVENTORIES, NET (IN MILLIONS)

NOTE 6. 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 1995, the Company, as one of several industrial plaintiffs, initiated litigation in state court against the County of Muskegon (the "County") challenging an Ordinance governing the County's industrial wastewater pretreatment program. The lawsuit challenged, among other things, the treatment capacity availability and local effluent limit provisions of the Ordinance. In 1996, the state trial court ruled substantially in favor of the Company. In 1998, a state appeals court affirmed the lower court's ruling. 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 10 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 be able to obtain additional treatment capacity for future expansions and the County could impose stricter permit limits. In June 1997, the United States and Environmental Protection Agency ("EPA") sued the County in federal court for failure (a) to meet its discharge permit limits for the wastewater facility and (b) to 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 to protect the earlier state court ruling. In December 1998, however, 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 court also authorized the County to readopt the Ordinance previously invalidated by the state courts. The Company has appealed the federal ruling, and the appeal is pending. The Company also 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 and may pursue litigation on these issues. If the Company and other plaintiffs do not prevail on their appeal, or in any future litigation regarding the Ordinance, 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. This, in turn, could result in substantial expenditures to add pretreatment at the Muskegon facility or potential fines being levied by the County. In April 1998, the EPA issued final regulations that 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"). Compliance with the cluster rules was required beginning in April 2001 for the Somerset, Maine and Muskegon, Michigan mills. Approximately $70.0 million has already been incurred, primarily for required improvements at the Somerset and Muskegon mills. The Company believes that future capital expenditures for environmental compliance, the bulk of which are for cluster rules compliance at Muskegon, will aggregate approximately $5.0 million to $15.0 million through fiscal year 2002. NOTE 7. COMMITMENTS AND CONTINGENCIES 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 that provide for MESC to recover fuel and capital costs. Kimberly-Clark has closed 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. In January 1999, MESC filed for bankruptcy. The Company has given notice of termination of the Energy Agreement effective in December 2001 in connection with the closure of the Mobile paper mill (see Note 4). A substantial majority of the Company's electricity requirements are satisfied through its own generation or cogeneration agreements. The Company's power requirements at its Somerset mill are currently satisfied through a cogeneration agreement whereby the mill cogenerates electricity and sells the output to Central Maine Power ("CMP") at a "wash rate" which matches the average rate the mill pays for the power it consumes. The CMP agreement relating to the Somerset mill historically also provided, but did not require, that the mill purchase electricity from CMP at the same rate. The Somerset agreement expires in the year 2012. Commencing March 1, 2000, as a result of deregulation of the Maine power 11 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 industry, CMP was no longer permitted to sell power to its customers. Accordingly, the Company has entered into a new one-year agreement with a third party to purchase all of Somerset's power needs through February 28, 2002. The Company continues to evaluate the impact of deregulation on its energy rates at Somerset. The Company also has recently entered into a one-year agreement expiring March 21, 2002 with a third party pursuant to which the Westbrook mill cogenerates electricity and sells any excess output not used by the mill to the third party. Power sales revenue is recognized by the Company at the time that power is provided to or used by CMP based on fixed rates per kilowatt-hour in the case of the Westbrook agreement and variable rates per kilowatt-hour in the case of the Somerset agreement. In November 1998, the Company signed a supply agreement with Plum Creek Timber Company, L.P., which has an initial term of 25 years and 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. In April 2000, the Lemelson Medical, Educational and Research Foundation, Limited Partnership ("Lemelson") filed a lawsuit against Sappi and over 70 other companies in the United States Court for the District of Arizona. The lawsuit alleges that the defendants have infringed upon various machine vision and automatic identification patents held by Lemelson. Lemelson seeks to enjoin the defendants from further alleged acts of infringement and to collect unspecified damages. Sappi was formally served with a summons with respect to this lawsuit in September 2000. Lemelson has offered to license the patents alleged to be infringed to the defendants, and based on the Company's understanding of the terms that Lemelson has made available to other licensees, the Company believes that obtaining the same or similar terms would not have a material adverse effect upon the Company's operating results or financial position. However, there can be no assurance either that, if sought, Sappi would be offered similar terms to those made available to other licensees, or that, if defended, this matter will not have a material adverse effect on the Company's operating results or financial position. In April 2000, 18 individuals filed a lawsuit against the Company, Kimberly-Clark and several other defendants in Somerset County Court, Maine. The plaintiffs allege that they suffered personal injury as a result of hazardous waste from various sources, which was allegedly transported to and stored at a local landfill during the period from 1976 through 1986. Plaintiffs have recently amended their complaint to bring several new theories of liability, which relate to the air and water discharges from the Somerset and Winslow mills and land spreading. In addition the plaintiffs allege that the defendants fraudulently concealed the character of their waste. In terms of Sappi's purchase of the Company from Scott Paper Company in 1994, the Company is indemnified for monitoring, clean up and any other costs relating to or arising out of the affected landfill. While the Company does not believe that the lawsuit will have a material adverse effect on its operating results or financial position, including due to the possibility that the Company is indemnified for this matter, there can be no assurance that this will be the case. The Company is also involved in various other lawsuits and administrative proceedings. The relief sought in such lawsuits and proceedings includes injunctions, damages and penalties. Although the final results in these suits and proceedings cannot be predicted with certainty, it is the present opinion of the Company, after consulting with legal counsel, that they will not have a material effect on the Company's consolidated financial position, results of operations or cash flows. 12 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 NOTE 8. SEGMENTS AND OTHER RELATED INFORMATION The Company's segments have been aggregated into a single reportable segment since they have similar economic characteristics, products, production processes, types of customers and distribution methods. Business segment revenue for the three and nine months ended June 28, 2000 and July 1, 2001 follow:

NOTE 9. TRADE ACCOUNTS RECEIVABLE On April 4, 2001, the Company, through a bankruptcy remote subsidiary, S.D. Warren Finance Co. ("SDWF"), entered into a receivable sales agreement that provides the Company with a five-year $100 million revolving accounts receivable securitization facility (the "A/R Facility"), replacing a five year $90 million revolving accounts receivable securitization facility. Under this facility and pursuant to a purchase and contribution agreement between the Company and SDWF, the Company sells to SDWF, on a non-recourse basis, all rights and interests in its accounts receivables. Pursuant to this receivables purchase agreement, SDWF, in turn securitizes certain interests in the accounts receivable pool owned by SDWF under similar terms to a third-party purchaser. The Company has adopted SFAS No. 140 in accounting and reporting for all transfers and servicing of securitized trade receivables occurring after March 31, 2001. The Company records no gain or loss on the sale of these receivables. The Company's continuing involvement is limited to the servicing of the transferred receivables for which the Company receives an annual fee of 1% of the average outstanding balance. Proceeds from collections reinvested in revolving-period securitizations with SDWF amounted to $225.8 million for the three month period ended July1, 2001. 13 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION MARKET OVERVIEW The market for coated paper has historically experienced price fluctuations driven by global supply and demand imbalances, inventory shifts, and the availability and relative pricing of imported paper products. Coated free sheet industry shipments from U.S. producers declined during the quarter ended April 1, 2001 and again in the quarter ended July 1, 2001 (as compared on a year over year basis). This was due in large part to an increase in coated imports, a shift in demand from coated woodfree to lightweight coated groundwood due to postal rate increases, cost reduction moves by publishers and a general slowing of the U.S. economy. Increasing coated free sheet imports, together with enhanced domestic production, have over the past few years played a key role in placing downward pressure on coated free sheet industry pricing. Similar to the quarter ended April 1, 2001, supply exceeded demand during the quarter ended July 1, 2001, which continued to put downward pressure on prices over the first nine months of the fiscal year. The uncoated paper market continues to suffer from a slowdown in demand and high inventories. Average pricing is down versus last year. The technical papers market is beginning to reflect the seasonal slowdown. Market softness, increased pulp and energy costs and downward pricing pressures contributed negatively to the Company's results of operations in the uncoated paper business. On May 15, 2001, the Company announced that it had finalized its decision to exit the uncoated paper business in the United States and close the Mobile, Alabama paper mill. The closure of this mill would result in the phase-out of the production of uncoated products, permanent shutting of 3 paper machines and a move of its technical papers business to alternate mill sites. As of July 1, 2001, the Company has recorded a charge to earnings of $186.3 million for the impairment losses and write-downs of certain operating assets and severance and other costs to exit the uncoated business. Of this amount, approximately $17.7 million represented lower of cost or market inventory provisions and $4.1 million of reserves for trade accounts receivable as a result of the decision to close the Mobile mill. These amounts have been included in the condensed consolidated statement of operations as components of cost of goods sold and selling, general and administrative expense, respectively. The remaining charge to earnings of $164.5 million has been included under the caption "Restructuring and other charges" in the condensed consolidated statement of operations. This charge is comprised of the following; (1) $101.1 million primarily to write assets down to their estimated salvage value, including $7.6 million of unamortized goodwill attributable to the Mobile mill, (2) $30.5 million of severance and benefits costs covering the termination of 583 employees, and (3) other exit costs of $32.9 million, primarily related to lease and contract terminations. As a result of the decision to exit the uncoated business, the Company expects to generate on an annualized and pretax basis net cash savings of approximately $15.0 million and anticipates that the benefit to expected future earnings will approximate $25.0 million. The Company believes that cash 14 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 generated by operations and amounts available under its revolving credit facility will be sufficient to meet its ongoing obligations resulting from its decision to exit the uncoated business. The Company's release papers business was impacted by deteriorating global economic conditions and a weak exchange rate in European markets. These downward pressures have been partially offset by an improved product mix. Any failure of the industry to maintain its current levels of shipments and pricing or any prolonged or severe weakness in the market for any of the Company's products in the future may adversely affect the Company's consolidated financial position, results of operations and cash flow. The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and the Notes thereto. THREE MONTHS ENDED JULY 1, 2001 COMPARED TO THREE MONTHS ENDED JUNE 28, 2000 NET SALES Net Sales for the three months ended July 1, 2001 was $331.4 million compared to $379.6 million for the three months ended June 28, 2000, a decrease of $48.2 million or 12.7%. Paper shipment (sales) volume for the three months ended July 1, 2001 decreased approximately 14,571 tons or 4.1% from the prior year's quarter ended June 28, 2000. The decrease in net sales from the same prior year quarter reflects both decreased market demand and downward pricing pressures in the paper industry. COST OF GOODS SOLD Cost of goods sold for the three months ended July 1, 2001 was $302.2 million compared to $296.8 million for the three months ended June 28, 2000. As of July 1, 2001, the Company recorded a $17.7 million lower of cost or market inventory provision in conjunction with the decision to close the Mobile mill and included this amount in cost of goods sold. Excluding this provision for inventories, cost of goods sold on a per paper ton basis, increased to $830 per ton for the three months ended July 1, 2001 from $825 per ton for the prior year quarter ended June 28, 2000. The increase was primarily due to higher energy costs, offset by favorable pulp pricing. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense totaled $43.8 million for the three months ended July 1, 2001 compared to $39.4 million for the three months ended June 28, 2000. As of July 1, 2001, the Company recorded a $4.1 million provision for trade accounts receivable in conjunction with the decision to close the Mobile mill. RESTRUCTURING AND OTHER CHARGES The Company recorded non-inventory and trade accounts receivable valuation charges to earnings of $164.5 million for the impairment losses and write-downs of certain operating assets and severance and benefits costs and other costs to exit the uncoated business and to close the Mobile mill. 15 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 OTHER INCOME, NET Other income, net, of $1.2 million and $2.4 million for the three months ended July 1, 2001 and June 28, 2000, respectively, includes interest income of $0.4 million and $0.8 million. INTEREST EXPENSE AND TAXES Interest expense for the three months ended July 1, 2001 was $10.6 million compared to $13.8 million for the three months ended June 28, 2000. The decrease was primarily due to lower rates obtained on the debt incurred in connection with the refinancing of the Notes. Interest expense includes the amortization of deferred financing fees. For the three months ended July 1, 2001, the Company has recorded an income tax benefit of $74.5 million compared to income tax expense of $12.7 million for the three months ended June 28, 2000, primarily reflecting the change in the Company's earnings level and the tax impact of impairment losses and write-downs of certain operating assets and severance and benefits costs and other costs to exit the uncoated business and to close the Mobile mill. NINE MONTHS ENDED JULY 1, 2001 COMPARED TO THE NINE MONTHS ENDED JUNE 28, 2000 The Company changed its financial closing calendar for fiscal year 2001 which results in an additional five days being included in the first quarter ended December 31, 2000. NET SALES Net Sales for the nine months ended July 1, 2001 was $1,086.0 million compared to $1,128.3 million for the nine months ended June 28, 2000, a decrease of $42.3 million or 3.7%. Paper shipment volume for the nine months ended July 1, 2001 increased slightly by 8,180 tons or 0.8% from the prior year's nine months ended June 28, 2000. The positive impact of increased volume shipments continues to be offset by downward pricing pressures evident in the paper industry. COST OF GOODS SOLD Cost of goods sold for the nine months ended July 1, 2001 was $949.2 million compared to $886.8 million for the nine months ended June 28, 2000. As of July 1, 2001, the Company recorded a $17.7 million lower of cost or market inventory provision in conjunction with the decision to close the Mobile mill and included this amount in cost of goods sold. Excluding this provision for inventories, cost of goods sold on a per paper ton basis increased to $849 per ton for the nine months ended July 1, 2001. Cost of goods sold for the nine months ended June 28, 2000 is net of a $4.0 million business interruption insurance claim recovery received in conjunction with a fire at the Company's Muskegon mill. Including this insurance recovery, cost of goods sold on a per paper ton basis was $806 per ton for the corresponding prior year period. The increase was primarily due to higher pulp and energy costs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense totaled $121.9 million for the nine months ended July 1, 2001 compared to $116.1 million for the nine months ended June 28, 2000. As of July 1, 2001, the Company recorded a $4.1 million provision for trade accounts receivable in conjunction with the decision to close the Mobile mill. Excluding this adjustment, the increase of $1.7 million over the prior 16 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 year's corresponding nine months is primarily attributable to the additional five days being included in the quarter ended December 31, 2000. RESTRUCTURING AND OTHER CHARGES The Company recorded non-inventory and trade accounts receivable valuation charges to earnings of $164.5 million for the impairment losses and write-downs of certain operating assets and severance and benefits costs and other costs to exit the uncoated business and to close the Mobile mill. OTHER INCOME, NET Other income, net, of $5.9 million and $5.7 million for the nine months ended July 1, 2001 and June 28, 2000, respectively, includes interest income of $1.5 million and $3.9 million. EXTRAORDINARY ITEM The premium paid of $10.5 million in connection with the purchase of $232.4 million face value of the Company's Senior 12% Subordinated Notes (the "Notes"), together with the related $7.0 million of accelerated amortization of deferred financing fees and other costs, resulted in an extraordinary loss of $10.6 million (net of $6.9 million of tax benefits) in the nine months ended June 28, 2000. There were no extraordinary items for the nine months ended July 1, 2001. INTEREST EXPENSE AND TAXES Interest expense for the nine months ended July 1, 2001 was $33.7 million compared to $46.0 million for the nine months ended June 28, 2000. The decrease was primarily due to lower rates obtained on the debt incurred in connection with the refinancing of the Notes. Interest expense includes the amortization of deferred financing fees. For the nine months ended July 1, 2001, the Company has recorded an income tax benefit of $70.1 million compared to income tax expense of $33.8 million for the nine months ended June 28, 2000, primarily reflecting the change in the Company's earnings level and the tax impact of impairment losses and write-downs of certain operating assets and severance and benefits costs and other costs to exit the uncoated business and to close the Mobile mill. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $71.5 million for the nine months ended July 1, 2001 compared to $104.9 million for the nine months ended June 28, 2000. This decrease of $33.4 million primarily reflects the change in the Company's earnings level. The Company's operating working capital, excluding restructuring amounts for the third quarter, was $55.6 million at July 1, 2001 compared to $24.2 million at September 27, 2000. Operating working capital is defined as trade accounts receivable, other receivables and inventories less accounts payable and accrued and other current liabilities. This increase resulted primarily from increased inventory levels and higher accrued and other current liabilities offset by lower receivables and payables. Capital expenditures for the nine months ended July 1, 2001 were $87.6 million, up from $48.1 million for the nine months ended June 28, 2000. The increase of $39.5 million for the nine months ended July 1, 2001 over the nine months ended June 28, 2000 is primarily due to environmental compliance work at the 17 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 Company's Muskegon, Michigan location. Capital expenditures forecasts are updated periodically and currently project approximately $109.0 million of expenditures for the fiscal year ended September 30, 2001. In addition, the Company believes that future capital expenditures for environmental compliance, the bulk of which will be for cluster rules compliance at Muskegon, will aggregate approximately $5.0 million to $15.0 million through fiscal year 2002. 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 the fiscal year. Cash provided by financing activities for the nine months ended July 1, 2001 was $7.2 million compared to $107.1 million used in financing activities for the corresponding period of the previous year. During the nine months ended July 1, 2001, the Company received net long-term advances of $15.0 million on its long-term revolving credit facility (the "Credit Facility"), thereby increasing the total principal outstanding on the Facility to $155.0 million at July 1, 2001. Pursuant to the credit agreement, relating to the Credit Facility (the "Credit Agreement"), the Company made payments of $4.2 million on the term loan during the first six months, thereby decreasing the total principal outstanding on the term loan to $78.2 million at July 1, 2001. In addition, the Company made payments totaling $3.6 million on its Skowhegan Series C and D and Westbrook Series A 1973 Revenue Bonds, thereby reducing the total principal outstanding on the Revenue bonds to $106.9 million at July 1, 2001. LONG-TERM DEBT At July 1, 2001, long-term debt, excluding current maturities, was $460.1 million compared to $452.1 million at September 27, 2000. OTHER ITEMS 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 6 - 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 to the Unaudited Condensed Consolidated Financial Statements - New Accounting Pronouncements LONG-TERM CONTRACTS See Note 7 to the Unaudited Condensed Consolidated Financial Statements - Commitments and Contingencies. 18 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 CONSIDERATIONS RELATING TO HOLDINGS' CASH OBLIGATIONS The Company expects that it may make certain cash payments to Holdings or other affiliates during fiscal 2001 to the extent cash is available and to the extent it is permitted to do so under the terms of the Credit Agreement, and the Indenture relating to the Company's 14% Subordinated Exchange Debentures due 2006, (the " 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 cash payment of which is limited to $1.0 million in any one year and (iv) any dividends that might be paid to Sappi. The accompanying condensed consolidated balance sheets at July 1, 2001 and September 27, 2000, respectively, include accrued management advisory fees of $21.0 million and $14.4 million, respectively, the payment of which is subject to the above mentioned limitations under the terms of its current financial instruments. Because Holdings has no material assets other than the outstanding common stock of the Company (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 the Company) are currently conducted through the Company and its subsidiaries, Holdings' ability to meet its cash obligations is dependent upon the earnings of the Company and its subsidiaries and the distribution or other provision of those earnings to Holdings. Holdings has no material indebtedness outstanding (other than advances that may be owed from time to time to the Company and guarantees in respect of indebtedness of the Company 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 and the Indenture relating to the Exchange Debentures permit the Company 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 the Company meets certain conditions. Among such conditions are that the Company maintain specified financial ratios and comply with certain financial tests. 19 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 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. 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 $241.4 million at July 1, 2001, is at fixed interest rates. 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 a 10% 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 Annual Report on Form 10-K for the year ended September 27, 2000. During the three and nine months ended July 1, 2001, the Company did not engage in foreign currency hedging activities. The currency exchange impact from the Company's transactions with its affiliates was immaterial. 20 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 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. 21 S.D. WARREN COMPANY AND SUBSIDIARIES FORM 10-Q, JULY 1, 2001 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 15, 2001 By: /s/ Mark T. Becker ------------------------------------ Mark T. Becker Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) 22

WARREN S D CO /PA/ 10-Q