Home | Annual Report Home | Investor Relations | News Releases

1998 Annual Report

- --------------------------------------------------------------------------------
      ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
GENERAL
     Market conditions and demand for containerboard and corrugated containers,
the Company's primary products, are generally subject to cyclical changes in the
economy and changes in industry capacity, both of which can significantly impact
selling prices and the Company's profitability.
     Containerboard market conditions have generally been weak since 1996 due
primarily to excess capacity within the industry. During this period, inventory
levels were high and many paper companies, including the Company, took economic
downtime at their mills in order to reduce inventories. Lost production
resulting from economic downtime for the industry overall in the second half of
1998 was approximately 1.5 million tons, or 8% of capacity. Linerboard prices
declined dramatically in 1996 and continued to fall in the first half of 1997,
dropping to $310 per ton in April 1997. Lower inventory levels and strengthening
demand in the second half of 1997 combined to increase prices to approximately
$390 per ton by December 1997. Linerboard prices were stable in the first half
of 1998, but declined during the second half of the year. The price for
linerboard at December 31, 1998 was approximately $340 per ton. Corrugated
container prices followed this same pricing trend during the past three years
with somewhat less fluctuation.
     The outlook for containerboard and corrugated containers in late 1998 and
early 1999 has improved substantially. The strength of December corrugated
container shipments and the amount of economic downtime taken at paper mills in
the second half of 1998 have resulted in a significant reduction in inventory
levels. In addition, several paper companies, including the Company, have
announced mill shutdowns approximating 6% of industry capacity. The shutdowns
will improve the balance between supply and demand. Based on these developments,
the Company implemented a price increase for linerboard and medium of $50 per
ton and $60 per ton, respectively, in the first quarter of 1999.
     Market conditions in the folding carton and boxboard mill industry were
stable in 1997, but weakened somewhat in 1998 as demand declined 3% compared to
last year. Mill productive capacity in the boxboard industry exceeds current
levels of demand. While economic downtime at boxboard mills was avoided, the
lower demand for board resulted in reduced prices. Boxboard prices increased in
1997 and held steady for the first nine months of 1998. Boxboard prices began to
decline in the last quarter of 1998 due to weaker demand. The price for recycled
boxboard declined by approximately $30 per ton during 1998. The combination of
reduced demand and industry-wide excess capacity continued to keep pressure on
folding carton selling prices during 1998.
     Recycled fiber is an important raw material of the Company's recycled
paperboard mills. Supplies of recycled fiber can vary widely at times and are
highly dependent upon the demand of recycled paper mills. Because of the lower
demand created by the extensive economic downtime taken by containerboard mills
in recent years and particularly in 1998, the price of old corrugated containers
("OCC") declined in 1998 to its lowest levels in five years.
RESULTS OF OPERATIONS
SEGMENT DATA
- --------------------------------------------------------------------------------
                                                     1998                    1997                  1996
                                              -------------------     -------------------    ------------------
                                                 Net      Profit/        Net      Profit/       Net     Profit/
(In millions)                                  sales       (loss)      sales       (loss)     sales      (loss)
- ---------------------------------------------------------------------------------------------------------------
Containerboard & corrugated containers ..     $2,014       $ 123      $1,607       $  56     $1,794      $ 197
Boxboard and folding cartons ............        785          67         752          68        756         66
Other operations ........................        670          39         577          39        537         36
                                              -----------------------------------------------------------------
Total operations ........................     $3,469         229      $2,936         163     $3,087        299
                                              ======                  ======                 ======
Other, net(1) ...........................                   (536)                   (186)                 (168)
Income (loss) from continuing operations                    -----                   -----                 -----
  before income taxes, minority interest,
  extraordinary item and cumulative
  effect of accounting change .............                $(307)                  $ (23)                $ 131
===============================================================================================================
(1)  Other, net includes corporate revenues and expenses, net interest expense
     and, for 1998, a restructuring charge in connection with the Merger, which
     covers the cost of shutting down certain mills and termination of employees
     and other Merger-related costs.
1998 COMPARED TO 1997
     As previously discussed, a wholly-owned subsidiary of the Company merged
with Stone on November 18, 1998. SSCC's results for 1998 include Stone after
November 18, 1998. SSCC's net sales of $3,469 million and operating profits of
$229 million were higher than 1997 by 18% and 40%, respectively, due primarily
to the Merger and higher sales prices for containerboard and corrugated
containers. The increase or decrease in net sales for each of the Company's
segments is shown in the chart below.
                                                     1998 Compared to 1997
                                       ----------------------------------------------------
                                       Containerboard   Boxboard
                                        & Corrugated   & Folding       Other
(In millions)                            Containers     Cartons      Operations      Total
- -------------------------------------------------------------------------------------------
Increase (decrease) due to:
  Sales prices and product mix ....        $ 146         $ (13)        $ (48)        $  85
  Sales volume ....................          (63)           45            22             4
  Stone merger ....................          318             1           128           447
  Acquisitions and new facilities..            9                                         9
  Sold or closed facilities .......           (3)                         (9)          (12)
                                           ------------------------------------------------
Total increase ....................        $ 407         $  33         $  93         $ 533
===========================================================================================
CONTAINERBOARD AND CORRUGATED CONTAINERS SEGMENT
     Net sales of the Containerboard and Corrugated Containers segment increased
25% compared to 1997 to $2,014 million and segment profits increased $67 million
over 1997 to $123 million. The increase in net sales was due primarily to the
Merger and improved sales prices. The profit increase was due primarily to the
improvements in sales price. Net sales and profits for the Stone operations
included in this segment for the period after November 18, 1998 were $318
million and $10 million, respectively.
     Containerboard and corrugated container prices were higher in 1998 by 16%
and 11%, respectively, compared to 1997. SBS prices declined 2% during the
period. Containerboard sales volume for the Company's mills in 1998 declined 2%
compared to 1997 due to the closure of three containerboard mills, effective
December 1, 1998 (See "Restructuring, Merger Related Costs and Litigation
Costs") and higher levels of economic downtime. The cost of the mill closures is
included in other, net in the Segment Data table. The Company also had 28 days
of downtime in 1997 at its Brewton, AL mill associated with a rebuild and
upgrade of its mottled white paper machine. Sales volume for the Company's
corrugated container facilities declined 5% compared to 1997 due to the
Company's strategy to reduce volume associated with low-margin accounts. Cost of
goods sold as a percent of net sales decreased from 88% in 1997 to 86% in 1998
due primarily to the higher sales prices in 1998.
BOXBOARD AND FOLDING CARTONS SEGMENT
     Net sales of the Boxboard and Folding Cartons segment increased 4% compared
to 1997 to $785 million and segment profits declined $1 million compared to 1997
to $67 million. The increase in net sales was due primarily to increased sales
volume of folding cartons. Folding carton sales volume increased 10% compared to
1997, reflecting growth in new business acquired near the end of 1997. Sales
volume for the boxboard mills declined 1% compared to 1997. Boxboard prices were
higher in 1998 on average, increasing 3% compared to 1997. Folding carton prices
declined 3%, reflecting the change in product mix related to the new business
acquired. Cost of goods sold as a percent of net sales for 1998 was comparable
to 1997.
DISCONTINUED OPERATIONS
     During February 1999, the Company announced its intention to divest the
operating assets of SNC. The SNC results are reflected as discontinued
operations for all periods presented in the Company's statements of operations.
Net sales for discontinued operations amounted to $324 million, $302 million,
and $323 million for 1998, 1997 and 1996 respectively.
RESTRUCTURING, MERGER RELATED COSTS AND LITIGATION COSTS
     During the fourth quarter of 1998, the Company recorded pre-tax charges of
$310 million ($187 million after tax), including $257 million for restructuring
costs in connection with the Merger, $23 million of other Merger related costs
and $30 million for settlement of certain litigation.
     The restructuring included the shutdown of approximately 1.1 million tons,
or 15%, of the Company's North American containerboard mill capacity and
approximately 400,000 tons of the Company's market pulp capacity. The
restructuring charge of $257 million included provisions for costs for JSC
(U.S.) associated with (i) adjustment of property, plant and equipment of closed
facilities to fair value less costs to sell of $179 million, (ii) facility
closure costs of $42 million, (iii) severance related costs of $27 million, and
(iv) other Merger related costs of $9 million. The cash and non-cash elements of
the restructuring charge are $78 million and $179 million, respectively.
     The restructuring included the closure of a Stone containerboard mill and
other pulp mill facilities, as well as the termination costs for certain Stone
employees. The adjustment to fair value of property, plant and equipment
associated with the permanent shutdown of Stone's facilities, liabilities for
the termination of certain Stone employees and the liabilities for long-term
commitments were included in the preliminary allocation of the cost to acquire
Stone.
     The Company closed the mill facilities on December 1 and, as of December
31, 1998, the Company had terminated approximately 1,500 employees. The Company
intends to either abandon or sell these facilities in the near future. Future
cash outlays for the restructuring are anticipated to be $80 million in 1999,
$21 million in 2000, $19 million in 2001 and $57 million thereafter. The Company
is continuing to evaluate all areas of its business in connection with the
Merger integration, including the identification of corrugated container
facilities that might be closed. Additional restructuring charges are expected
in 1999 as management finalizes its plans.
     Merger synergies of at least $350 million per year are targeted by the end
of 2000. The most significant portion, more than $180 million, is projected to
come from optimizing the combined manufacturing systems of JSC (U.S.) and Stone.
Synergies in 1999, less costs to implement these savings, are expected to exceed
$200 million.
     During January 1999, SSCC and SNC entered into a Settlement Agreement to
implement a nationwide class action settlement of claims involving Cladwood'r',
a composite wood siding product manufactured by SNC that has been used primarily in
the construction of manufactured or mobile homes. The Company recorded a $30
million pre-tax charge in its results from discontinued operations for amounts
SNC has agreed to pay into a settlement fund, administrative costs, plaintiffs'
attorneys' fees, class representative payments and other costs. The Company
believes its reserve is adequate to pay eligible claims. However, the number of
claims, and the number of potential claimants who choose not to participate in
the settlement, could cause the Company to re-evaluate whether the liabilities
in connection with the Cladwood'r' cases could exceed established reserves. See
Item 3. Legal Proceedings.
INTEREST
     Interest expense for 1998 was $247 million, an increase of $51 million
compared to 1997. The increase was due to higher levels of debt as a result of
the Merger.
INCOME TAXES
     For information concerning the benefit from (provision for) income taxes as
well as information regarding differences between effective tax rates and
statutory rates, see Note 7 of the Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
1997 COMPARED TO 1996
     Net sales of $2,936 million and profits of $163 million for the Company's
operations were lower than 1996 by 5% and 45%, respectively due primarily to
lower sales prices. Other net costs shown in the Segment Data table above
include corporate revenues and expenses and net interest expense. The increase
or decrease in net sales for each of the Company's segments is shown in the
chart below.
- --------------------------------------------------------------------------------
                                                      1997 Compared to 1996
                                     -----------------------------------------------------
                                     Containerboard   Boxboard
                                      & Corrugated   & Folding       Other
(In millions)                          Containers      Cartons     Operations      Total
- ------------------------------------------------------------------------------------------
Increase (decrease) due to:
  Sales prices and product mix .....     $(220)        $ (38)        $  25         $(233)
  Sales volume .....................        15            34            35            84
  Acquisitions and new facilities...        22                           6            28
  Sold or closed facilities ........        (4)                        (26)          (30)
                                        --------------------------------------------------
Total increase (decrease) ..........     $(187)        $  (4)        $  40         $(151)
==========================================================================================
CONTAINERBOARD AND CORRUGATED CONTAINERS SEGMENT
     Net sales of the Containerboard and Corrugated Containers segment decreased
10% compared to 1996 to $1,607 million and segment profit decreased $141 million
compared to 1996 to $56 million. The decrease in net sales and profits were
primarily a result of significant reductions in sales prices for containerboard
and corrugated containers. An increase in sales volume slightly offset the
decline due to price. On average, corrugated container prices and containerboard
prices each decreased 13% compared to 1996. SBS prices decreased 2% compared to
1996. Demand for corrugated containers was strong throughout 1997 and shipments
of corrugated containers increased 6% compared to 1996. As market conditions
improved, the Company successfully implemented two price increases in 1997 for
linerboard, the first in August for $40 per ton and the second in October for
$50 per ton. Containerboard sales volume in 1997 decreased 2% compared to 1996
due to economic downtime taken to reduce inventories in 1997 and a shutdown at
the Company's Brewton, AL mill associated with a rebuild and upgrade of its
mottled while paper machine. Shipments of SBS increased 2% compared to 1996.
Cost of goods sold as a percent of net sales increased from 81% in 1996 to 88%
in 1997 due primarily to the lower sales prices in 1998.
BOXBOARD AND FOLDING CARTONS SEGMENT
     Net sales of the Boxboard and Folding Cartons segment decreased 1% compared
to 1996 to $752 million, and segment profit increased $2 million when compared
to 1996 to $68 million. The decrease in net sales was primarily a result of
lower average sales prices largely offset by an increase in volume. Sales prices
for boxboard and folding cartons each decreased 5% compared to 1996. Demand
strengthened in the second half of 1997, enabling the Company to implement a $40
per ton price increase in the fourth quarter of 1997. Demand for folding cartons
and boxboard remained steady throughout 1997. Shipments of folding cartons and
boxboard increased 3% and 6%, respectively, compared to 1996. Cost of goods sold
as a percent of net sales decreased from 84% in 1996 to 83% in 1997 due
primarily to product mix.
INTEREST
     Interest expense of $196 million for 1997 was $2 million lower than for
1996. The decline was due primarily to lower average debt levels outstanding and
lower effective interest rates.
INCOME TAXES
     For information concerning the benefit from (provision for) income taxes as
well as information regarding differences between effective tax rates and
statutory rates, see Note 7 of the Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
     Operating activities have historically been the major source of cash to
fund the Company's capital expenditures and debt payments. Net cash provided by
operating activities for 1998 of $129 million, cash acquired with the
acquisition of Stone of $222 million and borrowings under the Company's bank
credit facilities of $1,502 million were used primarily to fund capital
investments totaling $287 million, net debt payments of $1,384 million and $44
million of deferred debt issuance costs. Capital investments of $287 million
include the purchase of a containerboard machine located at the Company's mill
in Fernandina Beach, FL for $175 million from a subsidiary of Jefferson Smurfit
Group plc (the "Fernandina No. 2 Machine").
     The Company completed the Merger on November 18, 1998. A total of 104
million shares of SSCC common stock were issued in the Merger, resulting in an
aggregate purchase price (including the fair value of stock options and related
fees) of approximately $2,245 million. The Merger was accounted for as a
purchase business combination and, accordingly, Stone has been included in the
consolidated statements of the Company after November 18, 1998. See Note 2 of
the Notes to Consolidated Financial Statements.
FINANCING ACTIVITIES
     In March 1998, JSC (U.S.) entered into a new credit facility (the "JSC
(U.S.) Credit Agreement") consisting of a $550 million revolving credit
facility, a $400 million seven-year Tranche A Term Loan, and a $350 million
eight-year Tranche B Term Loan. Net proceeds from the JSC (U.S.) Credit
Agreement were used to fully repay outstanding principal and accrued interest
under the Company's previous credit facility. The JSC (U.S.) Credit Agreement
reduced interest expense, extended debt maturities, and improved the financial
flexibility of the Company. JSC (U.S.) recorded an extraordinary loss of $13
million (net of income tax benefits of $9 million) related to the early
extinguishment of the Company's bank debt.
     In November 1998, in connection with the Merger, the Company and its bank
group amended and restated the JSC (U.S.) Credit Agreement to, among other
things (i) allow an additional $550 million borrowing on the Tranche B Term
Loan, (ii) allow the purchase of the Fernandina No. 2 Machine, (iii) make a $300
million inter-company loan to the Company, which was contributed to Stone as
additional paid-in capital, (iv) permit the Merger, and (v) ease certain
financial covenants.
     Also in connection with the Merger, Stone amended and restated the Stone
Credit Agreement (the "Stone Credit Agreement") to (i) extend the maturity date
on the Stone Tranche B $190 million Term Loan from October 1, 1999 to April 1,
2000, (ii) extend the maturity date of the revolving credit facility from May
15, 1999 to April 1, 2000 or, in the event the Tranche B Term Loan is repaid on
or before April 1, 2000, December 31, 2000, (iii) permit the use of the net
proceeds from the sale of the newsprint and related assets at the Stone Snowflake,
AZ facility to repay a portion of Stone's 11.875% Senior Notes due December 1,
1998, (iv) permit the Merger; and (v) ease certain financial covenants.
     The JSC (U.S.) Credit Agreement and the Stone Credit Agreement
(collectively, the "Credit Agreements") contain various business and financial
covenants including, among other things, (i) limitations on dividends,
redemptions and repurchases of capital stock, (ii) limitations on the incurrence
of indebtedness, (iii) limitations on capital expenditures and (iv) maintenance
of certain financial covenants. The Credit Agreements also require prepayments
if JSC (U.S.) or Stone have excess cash flows, as defined, or receive proceeds
from certain asset sales, insurance, issuance of equity securities or incurrence
of certain indebtedness. The obligations under the JSC (U.S.) Credit Agreement
are unconditionally guaranteed by the Company and certain of its subsidiaries.
The obligations under the Credit Agreements are secured by a security interest
in substantially all of the assets of JSC (U.S.) and Stone, respectively. Such
restrictions, together with the highly leveraged position of the Company, could
restrict corporate activities, including the Company's ability to respond to
market conditions, to provide for unanticipated capital expenditures or to take
advantage of business opportunities.
     On January 22, 1999, Stone obtained a waiver from its bank group for
non-compliance with certain financial covenant requirements under the Stone
Credit Agreement as of December 31, 1998. Subsequently, on March 23, 1999, Stone
and its bank group amended the Stone Credit Agreement to further modify certain
quarterly financial covenant requirements for 1999.
     As mentioned above, the declaration of dividends by the Board of Directors
is subject to, among other things, certain restrictive provisions contained in
the Credit Agreements and certain note indentures. At December 31, 1998, Stone
had accumulated dividend arrearages of $14 million related to its preferred
stock.
     Stone's senior notes, aggregating $1,723 million (the "Stone Senior Notes")
are redeemable in whole or in part at the option of Stone at various dates
beginning in February 1999, at par plus a weighted average premium of 2.68%. The
Stone senior subordinated debentures (the "Stone Senior Subordinated
Debentures"), aggregating $627 million, are redeemable as of December 31, 1998,
in whole or in part, at the option of Stone at par plus a weighted average
premium of 2.56%. The indentures governing the Stone Senior Notes and the Stone
Senior Subordinated Debentures (the "Stone Indentures") generally provide that
in the event of a change in control (as defined), Stone must, subject to certain
exemptions, offer to repurchase the Stone Senior Notes and the Stone Senior
Subordinated Debentures at a price equal to 101% of the principal amount
thereof. The Merger constituted such a change in control. Stone's obligation to
offer to repurchase the Stone Senior Subordinated Debentures is subject to the
condition precedent that Stone has first either repaid its outstanding bank debt
or obtained the consent of its bank lenders to make such repurchase. In the case
of the Stone Senior Notes, Stone is required to make an offer to repurchase
unless such a repurchase would constitute an event of default under Stone's
outstanding bank debt and Stone has neither repaid its bank debt nor obtained
the consent of its bank lenders to such repurchase. A repurchase of the Stone
Senior Notes or the Stone Senior Subordinated Debentures is prohibited by the
terms of the Stone Credit Agreement. Although the terms of the Stone Senior
Notes refer to an obligation to repay the bank debt or obtain the consent of the
bank lenders to such repurchase, the terms do not specify a deadline, if any,
following the Merger for repayment of bank debt or obtaining such consent. The
Company intends to actively seek commercially acceptable sources of financing to
repay the Stone Credit Agreement or alternative financing arrangements which
would cause the bank lenders to consent to the repurchase of the Stone Senior
Notes or the Stone Senior Subordinated Debentures. There can be no assurance
that the Company will be successful in obtaining such financing or consents or
as to the terms of any such financing or consents.
     Based upon covenants in the Stone Indentures, Stone is required to maintain
certain levels of equity. If the minimum equity levels are not maintained for
two consecutive quarters, the applicable interest rates on the Indentures are
increased by 50 basis points per semiannual interest period (up to a maximum of
200 basis points) until the minimum equity level is attained. Stone's equity
level was below the minimum equity level during most of 1998. As a result, the
interest rates increased; however, the additional interest charges for the period
after the Merger were nominal. The interest rates on the Indentures will return to
the original interest rates on April 1, 1999 due to Stone's minimum equity levels
exceeding the minimum on December 31, 1998.
     On December 1, 1998, Stone repaid its $240 million 11.875% Senior Unsecured
Notes with borrowings under the Stone Credit Agreement and proceeds from the
sale of the Snowflake Mill. Stone sold the Snowflake Mill to Abitibi in October
1998, prior to the Merger.
     The Company intends to sell or liquidate certain of its assets, including
its woodlands operations, its remaining newsprint operations, its interest in
Abitibi and other non-core businesses. On January 21, 1999, the Company sold 7.8
million shares of Abitibi to a third party for approximately $80 million. The
Company intends to sell its remaining interest in Abitibi later in 1999 subject
to market conditions. Proceeds from asset sales are required to be used to pay
down borrowings under the Credit Agreements.
     It is expected that the Company will continue to incur operating losses
unless prices for the Company's products substantially improve. The Company
expects that internally generated cash flows, proceeds from asset divestitures
and existing financing resources will be sufficient for the next several years
to meet its obligations, including debt service, restructuring payments,
settlement of the Cladwood'r' litigation and capital expenditures. Scheduled
debt payments in 1999 and 2000 are $204 million and $844 million, respectively,
with increasing amounts thereafter. Capital expenditures for 1999 are expected
to be approximately $225 million. The Company expects to use any excess cash
provided by operations to make further debt reductions. As of December 31, 1998,
JSC (U.S.) had $422 million of unused borrowing capacity under its credit
agreement and Stone had $363 million of unused borrowing capacity under its
credit agreement.
YEAR 2000
     The Year 2000 problem concerns the inability of computer systems and
devices to properly recognize and process date-sensitive information when the
year changes to 2000. The Company depends upon its information technology ("IT")
and non-IT systems (used to run manufacturing equipment that contain embedded
hardware or software that must handle dates) to conduct and manage the Company's
business. The Company believes that, by replacing, repairing or upgrading the
systems, the Year 2000 issue can be resolved without material operational
difficulties. While it is difficult, at present, to fully quantify the overall
cost of this work, the Company expects to spend approximately $68 million
through 1999 to correct the Year 2000 problem, of which approximately $22
million has been incurred through December 31, 1998. A large portion of these
costs relate to enhancements that will enable the Company to reduce or avoid
costs and operate many of its production facilities more efficiently. Some of
these projects have been accelerated in order to replace existing systems that
cannot be brought into compliance by the year 2000. The Company is utilizing
both internal and external resources to evaluate the potential impact of the
Year 2000 problem. The Company plans to fund its Year 2000 effort with cash from
operations and borrowings under the Credit Agreements.
     The Company's Year 2000 Program Management Office is responsible for
guiding and coordinating operating units in developing and executing their Year
2000 plans, enabling the Company to share knowledge and work across operating
units, developing standard planning and formats for internal and external
reporting, consistent customer and vendor communications and where appropriate,
the development of contingency plans. The Company's Year 2000 program consists
of the following seven phases:
     Phase 1: Planning/Awareness: The planning and awareness phase includes the
          identification of critical business processes and components.
     Phase 2: Inventory: During the inventory phase, Company personnel will
          identify systems that could potentially have a Year 2000 problem and
          categorize the system as compliant, non-compliant, obsolete or
          unknown.
     Phase 3: Triage: In the triage phase, every system is assigned a business
          risk as high, medium, or low.
     Phase 4: Detailed Assessment: The detailed assessment provides for a
          planned schedule of remediation and estimated cost.
     Phase 5: Remediation: Remediation involves what corrective action to take
          if there is a Year 2000 problem, such as replacing, repairing or
          upgrading the system, and concludes with the execution of system test.
     Phase 6: Fallout: In the Fallout phase, the inventory will be kept up to
          date and no new Year 2000 problems will be introduced.
     Phase 7: Contingency Planning: The Company is developing contingency plans
          for the most reasonable worst case scenarios.
     The Company has completed the planning, inventory, triage, and detailed
assessment of its IT systems and is taking corrective action and testing the
new, upgraded or repaired systems. The Company identified nine high-risk IT
systems, of which two have been remediated and the remaining seven are scheduled
to be substantially completed by the end of the second quarter of 1999.
     The Company's operating facilities rely on control systems, which control
and monitor production, power, emissions and safety. The inventory, triage and
detailed assessment phases for all operating facilities are expected to be
substantially completed by the first quarter of 1999. The Company retained a
third party to assist with the verification and validation of these three
phases. The Company expects to have substantially completed all phases of its
Year 2000 program by the end of the second quarter of 1999.
     The Year 2000 Project Management Office is in the process of surveying each
vendor to insure that they are Year 2000 compliant or have a plan in place.
Vendor responses are due to be received by the end of the first quarter of 1999.
The Company also has compiled a list of mission critical vendors. A mission
critical vendor is a provider of goods or services without which a facility
could not function. Where appropriate, Company representatives will conduct an
in-depth investigation of a mission critical vendor's ability to be Year 2000
compliant.
     The Company currently believes that it will be able to replace, repair or
upgrade all of its IT and non-IT systems affected by the Year 2000 problem on a
timely basis. In the event the Company does not complete its plan to bring
systems into compliance before the year 2000, there could be severe disruption
in the operation of its process control and other manufacturing systems,
financial systems and administrative systems. Production problems and delayed
product deliveries could result in a loss of customers. The production impact of
a Year 2000 related failure varies significantly among the facilities and any
such failure could cause manufacturing delays, possible environmental
contamination or safety hazards. The most reasonably likely worst case scenario
is the occurrence of a Year 2000 related failure on one or more of the Company's
paper machines. The Company has the capability to produce and ship products from
multiple geographic locations should disruptions occur. Delays in invoicing
customer shipments could cause a slowdown in cash receipts, which could affect
the Company's ability to meet its financial obligations. To the extent customers
experience Year 2000 problems that are not remediated on a timely basis, the
Company may experience material fluctuations in the demand for its products. The
amount of any potential liability and/or lost revenue cannot be reasonably
estimated at this time; however, such amounts could be material.
     While the Company currently expects no material adverse consequences on its
financial condition or results of operations due to Year 2000 issues, the
Company's beliefs and expectations are based on certain assumptions that
ultimately may prove to be inaccurate. Each of the Company's operating
facilities is developing a specific contingency plan for their most reasonably
likely worst case scenarios. These plans are expected to be complete for both IT
systems and non-IT systems by the end of the second quarter of 1999. The Company
will also seek to take appropriate actions to mitigate the effects of the
Company's or significant vendors' failure to remediate the Year 2000 problem in
a timely manner, including increasing the inventory of critical raw materials
and supplies, increasing finished goods inventories, switching to alternative
energy sources, and making arrangements for alternate vendors.
     There is a risk that the Company's plans for achieving Year 2000 compliance
may not be completed on time. However, failure to meet critical milestones being
identified in the Company's plans would provide advance notice, and steps would
be taken to prevent injuries to employees and others, and to prevent
environmental contamination. Customers and suppliers would also receive advance
notice allowing them to implement alternate plans.
ENVIRONMENTAL MATTERS
     The Company's operations are subject to extensive environmental regulation
by federal, state and local authorities in the United States and regulatory
authorities with jurisdiction over its foreign operations. The Company has made,
and expects to continue to make, significant capital expenditures to comply with
water, air and solid and hazardous waste regulations. Capital expenditures for
environmental control equipment and facilities were approximately $48 million in
1997 and approximately $18 million in 1998. The Company anticipates that
environmental capital expenditures will approximate $132 million in 1999. The
majority of the 1999 expenditures relate to amounts that the Company currently
anticipates will be required to comply with the Cluster Rule. Although capital
expenditures for environmental control equipment and facilities and compliance
costs in future years will depend on legislative and technological developments
which cannot be predicted at this time, such costs could increase as
environmental regulations become more stringent. Environmental control
expenditures include projects which, in addition to meeting environmental
concerns, may yield certain benefits to the Company in the form of increased
capacity and production cost savings. In addition to capital expenditures for
environmental control equipment and facilities, other expenditures incurred to
maintain environmental regulatory compliance (including any remediation)
represent ongoing costs to the Company.
     In November 1997, the EPA issued the Cluster Rule, which made existing
requirements for discharge of wastewaters under the Clean Water Act more
stringent and imposed new requirements on air emissions under the Clean Air Act
for the pulp and paper industry. Though the final rule is still not fully
promulgated, the Company currently believes it will be required to make capital
expenditures of up to $310 million from 1999 through 2002 in order to meet the
requirements of the new regulations. Also, additional operating expenses will be
incurred as capital installations required by the Cluster Rule are put into
service.
     In addition, the Company is from time to time subject to litigation and
governmental proceedings regarding environmental matters in which injunctive
and/or monetary relief is sought. The Company has been named as a PRP at a
number of sites which are the subject of remedial activity under CERCLA or
comparable state laws. Although the Company is subject to joint and several
liability imposed under CERCLA, at most of the multi-PRP sites there are
organized groups of PRPs and costs are being shared among PRPs. Payments related
to clean-up at existing and former operating sites and CERCLA sites were not
material to the Company's liquidity during 1998. Future environmental
regulations may have an unpredictable adverse effect on the Company's operations
and earnings, but they are not expected to adversely affect the Company's
competitive position.
EFFECTS OF INFLATION
     Although inflation has slowed in recent years, it is still a factor in the
economy and the Company continues to seek ways to mitigate its impact to the
extent permitted by competition. Inflationary increases in operating costs have
been moderate since 1996, and have not had a material impact on the Company's
financial position or operating results during the past three years. The Company
uses the last-in, first-out method of accounting for approximately 82% of its
inventories. Under this method, the cost of products sold reported in the
financial statements approximates current costs and thus provides a closer
matching of revenue and expenses in periods of increasing costs. With the
exception of Stone's property, plant and equipment, depreciation charges
represent the allocation of historical costs incurred over past years and are
significantly less than if they were based on the current cost of productive
capacity being consumed.
PROSPECTIVE ACCOUNTING STANDARDS
     In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for Computer Software
Developed or Obtained for Internal Use," which requires that certain costs
incurred in connection with developing or obtaining software for internal-use
must be capitalized. Cost for such work performed internally by Company
employees is currently expensed as incurred. SOP 98-1 is effective beginning on
January 1, 1999. The Company does not expect that the adoption of SOP 98-1 will
have a material impact on its future earnings or financial position.
     In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Investments and Hedging Activities." SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. The Company has not
assessed what the impact of SFAS No. 133 will be on the Company's future
earnings or financial position.
< Prev     Next > 

Smurfit-Stone Home Annual Report Contents 10-K Contents