SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended: September 29, 1996 Commission File Number: 1-13868 - -------------------------------------------------------------------------------- CROWN VANTAGE INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Virginia 54-1752384 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 Lakeside Drive, Oakland, CA 94612-3592 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (510) 874-3400 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable - -------------------------------------------------------------------------------- (Former name, former address, and former fiscal year, if changed since last report) 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 X No ---- ---- Number of shares of no par value common stock outstanding as of the close of business on November 12, 1996: 9,109,968 Shares ---------------- INDEX CROWN VANTAGE INC. PART I: Financial Information Item 1. Financial Statements - Condensed Consolidated Balance Sheets - September 29, 1996 and December 31, 1995. - Condensed Consolidated Statements of Operations - Third quarter and nine months ended September 29, 1996 and September 24, 1995. - Condensed Consolidated Statements of Cash Flows - Nine months ended September 29, 1996 and September 24, 1995. - Notes to Condensed Consolidated Financial Statements. - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. PART II: Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2 PART I -- FINANCIAL INFORMATION ITEM 1 -- FINANCIAL STATEMENTS CROWN VANTAGE INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS) ASSETS SEPTEMBER 29, 1996 DECEMBER 31, 1995 ------------------ ----------------- (UNAUDITED) ----------- Current Assets: Cash and cash equivalents $ 6,203 $ 5,335 Accounts receivable, net 56,789 106,674 Inventories 96,313 100,422 Prepaid expenses and other current assets 24,666 8,832 Deferred income taxes 14,899 14,899 ------------ ---------- Total current assets 198,870 236,162 Property, plant and equipment, net 669,387 668,340 Other assets 44,468 39,952 Unamortized debt issue costs 16,388 16,448 Intangibles, net 30,383 31,226 ------------ ---------- Total Assets $959,496 $992,128 ------------ ---------- ------------ ---------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 46,087 $ 57,569 Accrued liabilities 77,144 79,959 Current portion of long-term debt 7,308 11,883 ------------ ---------- Total current liabilities 130,539 149,411 Long-term debt 543,628 555,352 Accrued postretirement benefits other than pensions 101,609 100,358 Accrued pension 17,030 14,235 Other long-term liabilities 12,840 15,507 Deferred income taxes 114,222 112,039 ------------ ---------- Total Liabilities 919,868 946,902 ------------ ---------- Shareholder's Equity: Preferred Stock, no par value; Authorized - 500,000 shares; Issued and outstanding - None Common Stock, no par value; Authorized - 50,000,000 shares; Issued and outstanding 9,109,968 and 8,917,661 shares at September 29, 1996 and December 31, 1995, respectively 45,760 44,539 Unearned ESOP shares and other (9,912) (11,152) Cumulative foreign currency translation adjustment 61 (1,348) Retained earnings 3,719 13,187 ------------ ---------- 39,628 45,226 ------------ ---------- Total Liabilities and Shareholders' Equity $959,496 $992,128 ------------ ---------- ------------ ---------- SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 3 CROWN VANTAGE INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS For the Third Quarter (13 weeks) and Nine Months (39 weeks) Ended September 29, 1996 and September 24, 1995 (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE) Third Quarter Nine Months ------------------------ ----------------------- 1996 1995 1996 1995 ----------- ----------- ----------- ---------- (UNAUDITED ) (UNAUDITED) Net sales $221,064 $264,779 $704,481 $798,709 Cost of goods sold 210,319 221,016 638,774 689,207 ----------- ----------- ----------- ---------- Gross margin 10,745 43,763 65,707 109,502 Selling and administrative expenses 13,792 15,398 38,132 43,497 ----------- ----------- ----------- ---------- Operating Income (Loss) (3,047) 28,365 27,575 66,005 Interest expense (15,337) (6,619) (47,167) (7,604) Other income, net 798 16 2,171 268 ----------- ----------- ----------- ---------- Income (loss) before income taxes (17,586) 21,762 (17,421) 58,669 Provision (benefit) for income taxes (8,018) 8,561 (7,953) 23,324 ----------- ----------- ----------- ---------- NET INCOME (LOSS) $ (9,568) $ 13,201 $ (9,468) $ 35,345 ----------- ----------- ----------- ---------- ----------- ----------- ----------- ---------- Loss per share $ (1.11) $ (1.10) --------- --------- --------- --------- SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4 CROWN VANTAGE INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months (39 weeks) Ended September 29, 1996 and September 24, 1995 (IN THOUSANDS OF DOLLARS) Nine Months ------------------------- 1996 1995 ------------ ----------- (UNAUDITED) Cash Provided by (Used for) Operating Activities: Net income (loss) $ (9,468) $ 35,345 Items not affecting cash: Depreciation and cost of timber harvested 57,712 59,244 Amortization of goodwill and other intangibles 844 1,046 Interest on Pay-in-Kind Notes 9,839 1,050 Other, net 5,394 3,472 Changes in current assets and liabilities: Accounts receivable (includes $40,000 sold in 1996) 49,885 (10,917) Inventories 4,109 (5,729) Other current assets (16,296) 423 Accounts payable (11,483) 10,316 Other current liabilities (2,424) 4,195 Other, net 1,565 3,972 ------------ ----------- Cash Provided by Operating Activities 89,677 102,417 ------------ ----------- Cash Used for Investing Activities: Expenditures for property, plant and equipment (58,907) (33,309) Other, net (371) - ------------ ----------- Cash Used for Investing Activities (59,278) (33,309) ------------ ----------- Cash Provided by (Used for) Financing Activities: Proceeds from draw down of Revolving Credit 171,000 59,000 Repayments of Revolving Credit (163,000) (25,000) Proceeds from issuance of Industrial Revenue Bonds less underwriting cost 12,100 - Proceeds from issuance of Term Notes - 190,592 Proceeds from issuance of Subordinated Notes - 242,500 Repayments of Term Loans and other long-term debt (49,631) (720) James River capital withdrawal - (533,126) ------------ ----------- Cash Used for Financing Activities (29,531) (66,754) ------------ ----------- Increase in cash and cash equivalents 868 2,354 Cash and cash equivalents at beginning of period 5,335 12,435 ------------ ----------- Cash and cash equivalents at end of period $6,203 $14,789 ------------ ----------- ------------ ----------- SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 5 CROWN VANTAGE INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 -- ORGANIZATION Crown Vantage Inc. and subsidiaries (the "Company") became an independent company after the Board of Directors of James River Corporation of Virginia ("James River") approved the spin-off of assets, liabilities and operations which comprised a substantial part of James River's Communication Papers Business and the paper-based part of its Food and Consumer Packaging Business ("Predecessor Business"). At the close of business on August 25, 1995, James River distributed to its common shareholders all of the outstanding shares of the Company (the "Distribution"). The Distribution was made in the form of a tax-free dividend on the basis of one share of the Company's common stock for every ten shares of James River common stock. A total of 8,446,362 shares of the Company's common stock were issued and began trading on NASDAQ on August 28, 1995. James River transferred to the Company certain assets of the Predecessor Business and the Company assumed certain related liabilities from James River. In addition, the Company received $250 million in cash through a public offering of Senior Subordinated Notes and $253 million from initial borrowings under credit facilities with certain banks (collectively, the "Financing"). The proceeds from the Financing after payment of expenses and retention of $1.2 million cash ($485 million) were paid to James River together with $100 million Senior Pay-in-Kind Notes issued by the Company, as a return of James River's capital investment. The Distribution, transfer of assets and liabilities, Financing and return of capital are collectively referred to as the "Spin-Off." Also in connection with the Spin-Off, the Company entered into a Contribution Agreement and certain transition agreements with James River. The Company will rely on such agreements for certain services, and the supply of a portion of the products used in the Company's manufacturing business, generally over terms of one to three years, at agreed to prices consistent with market terms. NOTE 2 -- BASIS OF PRESENTATION The accompanying unaudited condensed financial statements include the consolidated operations, assets and liabilities of Crown Vantage Inc. (the "Parent"), Crown Paper Co., and Crown Paper Co.'s consolidated subsidiaries for the three months and nine months ended September 29, 1996 and the combined historical operations, assets and liabilities of the Predecessor Business while a part of James River for the three months and nine months ended September 24, 1995. For simplicity of presentation, these financial statements are referred to as consolidated financial statements herein. The condensed consolidated financial statements for the quarter and nine months ended September 24, 1995 have been prepared as if the Company had operated as an independent stand-alone entity, except the Company generally did not have significant borrowings, and there was no allocation of James River's consolidated borrowings, and related interest expense, except for interest capitalized as a component of properties. During the period ended September 24, 1995, the Company engaged in various transactions with James River and its affiliates that are characteristic of a group of companies under common control. Throughout this period, the Company participated in James River's centralized cash management system and, as such, its cash funding requirements were met by James River. The Company was charged by James River for direct costs and expenses associated with its operations which have been included in cost of goods sold or selling and administrative expenses, as appropriate. James River's administrative costs not directly attributable 6 to the Company, which historically had not been allocated, have been allocated to the Company for the quarter and nine months ended September 24, 1995 based on net sales and are included in selling and administrative expense. The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. The condensed consolidated balance sheet as of December 31, 1995 was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months and nine months ended September 29, 1996 are not necessarily indicative of the results that may be expected for the year ended December 29, 1996. For further information, refer to the consolidated financial statements and footnotes thereto included in Crown Vantage Inc.'s Annual Report to Shareholders and Form 10-K for the year ended December 31, 1995. The Company adopted Statement of Financial Accounting Standards No. 121 ("Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of") in the first quarter of 1996. Adoption of Statement of Financial Accounting Standards No. 121 did not have a material effect on the Company's financial position or results of operations. NOTE 3 --LOSS PER SHARE The computation of loss per share for the quarter and nine months ended September 29, 1996 is based on the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the period (8,623,000 and 8,603,000 for the three and nine months ended September 29, 1996 respectively). The number of shares considered outstanding does not include 255,535 unearned shares held by the Employee Stock Ownership Plan Trust at September 29, 1996. In accordance with Statement of Position 93-6 ("Employers' Accounting for Employee Stock Ownership Plans"), shares held by the Trust are not considered outstanding for purposes of computing earnings per share until the shares are committed for release from the Trust. Earnings (loss) per share information is not presented for the quarter or nine months ended September 24, 1995 since the Company had no separate capital structure until August 25, 1995. See Note 10 for pro forma earnings (loss) per share information for the quarter and nine months ended September 24, 1995. NOTE 4 -- INCOME TAX The income tax benefits for the quarter and nine months ended September 29, 1996 have been provided at the Company's estimated tax rate of 39.75%. A substantial portion of the benefit will be realized by recovery of taxes paid in 1995. In addition, the Company recognized a benefit of approximately $1.0 million in the third quarter for reduction of estimated taxes payable for 1995. Historically the Company has been included in the consolidated federal and combined/unitary state income tax returns of James River. Income taxes in the consolidated financial statements for the quarter and nine months ended September 24, 1995 represent the Company's share of James River's income tax provision which is intended to approximate the amount which would have been recognized had the Company filed separate income tax returns. 7 NOTE 5 -- LONG TERM DEBT Consolidated long-term debt consists of the following: September 29 December 31 1996 1995 --------------- -------------- (IN THOUSANDS OF DOLLARS) CROWN PAPER CO. Bank Credit Facility: Revolving credit, due 2002 $ 18,000 $ 10,000 Term Loan A, due 2002 50,953 97,500 Term Loan B, due 2003 99,250 99,750 ---------------- ------------- 168,203 207,250 11% Senior Subordinated Notes, due 2005 250,000 250,000 Industrial Revenue Bonds, payable to 2026 34,304 24,182 10% Note, payable in 1996 - 352 ---------------- ------------- 452,507 481,784 CROWN VANTAGE INC. 11.45% Senior Pay-in-Kind Notes, due 2007 less unamortized discount 98,429 85,451 ---------------- ------------- 550,936 567,235 Less current portion 7,308 11,883 ---------------- ------------- $543,628 $555,352 ---------------- ------------- ---------------- ------------- In June 1996, the Company prepaid $40 million on Term Loan A using proceeds obtained through the sale of certain accounts receivable (Note 8). In July 1996, the Company completed an $18 million refinancing of certain industrial revenue bonds issued by the Business Finance Authority of the State of New Hampshire (the "Refunding Bonds"). The Refunding Bonds were issued to refinance certain of the Company's pollution control and solid waste disposal facilities located in the State of New Hampshire. The bonds are due January 1, 2022 and bear interest at 7.75%. Also in July 1996, the Company finalized an agreement with the Business Finance Authority of the State of New Hampshire whereby a total of $12.3 million of bonds were sold (the "Project Bonds") to finance certain sewage and solid waste disposal facilities to be used by the Company. The proceeds from the sale of Project Bonds are to be used to finance eligible project costs. An amount equivalent to 50% of proceeds are to be prepaid to the Term Loans. Upon sale, $2.6 million, equivalent to 50% of proceeds, was prepaid on Term Loan A and an additional $4.0 million was deposited in an interest bearing account with a trustee to be drawn as needed to finance additional project costs. The Project Bonds bear interest at 7.875% and are due July 1, 2026. Maturities of long-term debt (after giving effect to the prepayments of Term Loan A) for the next five fiscal year ends are: 1997 - $7.9 million; 1998 - - $9.3 million; 1999 - $9.3 million; 2000 - $9.6 million; and 2001 - $22.2 million. 8 NOTE 6 -- INVENTORIES September 29, 1996 December 31, 1995 ------------------ ----------------- (IN THOUSANDS OF DOLLARS) Raw material $ 25,993 $ 37,238 Work in process 5,709 5,856 Finished goods 42,228 40,745 Stores and supplies 34,722 35,141 ----------- ------------ 108,652 118,980 Reduction to state inventories at last-in, first-out cost (12,339) (18,558) ----------- ------------ $ 96,313 $ 100,422 ----------- ------------ ----------- ------------ NOTE 7 -- LITIGATION AND ENVIRONMENTAL MATTERS The Company is a party to various legal proceedings generally incidental to its business and is subject to a variety of environmental protection statutes and regulations. As is the case with other companies in similar industries, the Company faces exposure from actual or potential claims and legal proceedings involving environmental matters. Although the ultimate disposition of legal proceedings cannot be predicted with certainty, it is the present opinion of the Company's management that the outcome of any claim which is pending or threatened, either individually or on a combined basis, will not have a materially adverse effect on the consolidated financial position of the Company but could materially affect consolidated results of operations in a given period. In addition, the Company has been identified as a potentially responsible party, along with others, under the Comprehensive Environmental Response, Compensation and Liability Act or similar federal and state laws regarding the past disposal of wastes at approximately 20 sites in the United States. It is the Company's policy to accrue remediation costs when it is probable that such costs will be incurred and when they can be reasonably estimated. Estimates of future response costs are necessarily imprecise due to, among other things, the possible identification of presently unknown sites and the allocation of costs among potentially responsible parties with respect to any such sites. However, based upon its previous experience with respect to the cleanup of hazardous substances as well as the regular detailed review of its known hazardous waste sites and estimated costs to remediate certain sites, the Company has accrued $10.9 million and $11.0 million at September 29, 1996 and December 31, 1995 respectively. The liabilities can change substantially due to such factors as the solvency of other potentially responsible parties, additional information on the nature or extent of contamination, methods of remediation required, and other actions by governmental agencies or private parties. Although the Company has accrued cleanup and remediation liabilities currently, expenditures generally are paid over an extended period of time, in some cases as long as 30 years. While it is not feasible to predict the outcome of all environmental liabilities, based on the most recent review by management of these matters, management is of the opinion that its share of the costs of investigation and remediation of the sites of which it is currently aware will not have a material adverse effect upon the consolidated financial position of the Company. 9 However, because of uncertainties associated with remediation activities, regulations, technologies, and the allocation of costs among various other parties, actual costs to be incurred at identified sites may vary from estimates. Therefore, management is unable to determine if the ultimate disposition of all known environmental liabilities will have a material adverse effect on the Company's consolidated results of operations in a given year. The accruals recorded by the Company are periodically reviewed for their adequacy, and the Company will continue to review the status of all significant existing or potential environmental issues and adjust its accruals as necessary. The accruals do not reflect any possible future insurance recoveries. In addition, as is the case with most manufacturing and many other entities, there can be no assurance that the Company will not be named as a potentially responsible party at additional sites in the future or that the costs associated with such additional sites would not be material. In December 1993, the EPA published draft rules which contain proposed regulations affecting pulp and paper industry discharges of wastewater and gaseous emissions ("Cluster Rules"). The final Cluster Rules were scheduled to be issued in late 1995; however, their issuance is now anticipated to occur no earlier than the fourth quarter of 1996 with compliance required three years later. These Cluster Rules may require significant changes in the pulping, bleaching and/or wastewater treatment processes presently used in some U.S. pulp and paper mills, including some of the Company's mills. Although it is reasonably possible that the implementation of the Cluster Rules could materially impact the Company's expenditures between 1997 and 2000, it is not currently possible to estimate such amounts. NOTE 8 -- SALE OF ACCOUNTS RECEIVABLE In June 1996, the Company entered into a five year agreement which provides for the sale of an undivided interest in a $40 million revolving pool of trade accounts receivable. As collections reduce accounts receivable included in the pool, the Company sells undivided interests in new receivables in order to bring the amount sold up to $40 million. The agreement provides for a maximum allowable amount of accounts receivable that can be sold of $60 million. Proceeds from the sale, which are reported as operating cash flows in the condensed consolidated statement of cash flows, were used to prepay $40 million of long-term debt. The proceeds from the initial and subsequent sales are less than the face amount of the undivided interests in accounts receivable sold. The discount from the face amount, which totaled $923,000 through September 1996, is included in selling and administrative expenses in the condensed consolidated statement of operations. NOTE 9 -- NEW ACCOUNTING PRONOUNCEMENT In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 ("Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"). Statement of Financial Accounting Standards No. 125 ("SFAS No. 125") provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. SFAS No. 125 is effective for transactions occurring after December 31, 1996. The Company does not believe that adoption of SFAS No. 125 will have a material adverse effect on its financial position or results of operations. 10 NOTE 10 -- SUPPLEMENTAL UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS The following supplemental unaudited pro forma condensed statements of operations are presented for informational purposes to present the results of operations assuming that the Spin-Off of the Predecessor Business had occurred as of December 26, 1994 and that the issuance of debt discussed in Note 1 had occurred as of December 26, 1994. This information may not necessarily be indicative of the future results of operations of the Company or what the results of operations would have been had the Company operated as a separate independent Company during the entire periods presented. Nine Months Ended September 24, 1995 ----------------------------------------------- Pro forma Historical Adjustments Pro forma ------------ ----------- ---------- (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE) Net sales $ 798,709 $ (750)(a) $ 797,959 Less: Cost of goods sold 689,207 1,393(b) 690,600 ------------ ----------- ---------- Gross margin 109,502 (2,143) 107,359 Selling and administrative expenses 43,497 43,497 ------------ ----------- ---------- Operating Income 66,005 (2,143) 63,862 Interest expense (7,604) (41,109)(c) (48,713) Other income 268 268 ------------ ----------- ---------- Income before income taxes 58,669 (43,252) 15,417 Provision for income taxes 23,324 16,825(d) 6,499 ------------ ----------- ---------- NET INCOME $ 35,345 $(26,427) $ 8,918 ------------ ----------- ---------- ------------ ----------- ---------- Pro forma earnings per share $ 1.04(e) ---------- ---------- Three Months Ended September 24, 1995 --------------------------------------------- Pro forma Historical Adjustments Pro forma ----------- ------------- ---------- (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE) Net sales $ 264,779 $ (250)(a) $ 264,529 Less: Cost of goods sold 221,016 464(b) 221,480 ----------- ------------- ---------- Gross margin 43,763 (714) 43,049 Selling and administrative expenses 15,398 15,398 ----------- ------------- ---------- Operating Income 28,365 (714) 27,651 Interest expense (6,619) (10,154)(c) (16,773) Other income 16 16 ----------- ------------- ---------- Income before income taxes 21,762 (10,868) 10,894 Provision for income taxes 8,561 4,228(d) 4,333 ----------- ------------- ---------- NET INCOME $ 13,201 $ (6,640) $ 6,561 ----------- ------------- ---------- ----------- ------------- ---------- Pro forma earnings per share $ .76(e) ---------- ---------- 11 a) Historically, the Company has produced approximately 38,000 tons of creped paper for converting to toweling for sale to James River's Consumer Products Business at the Company's cost to produce. In connection with the Spin-Off, the Company has entered into a product supply agreement whereby the Company will supply to James River creped paper for converting to toweling amounting to up to 20,000 tons annually at an agreed upon price. The financial effect of this agreement would have decreased each of net sales and income before income taxes by approximately $750,000 for the nine months of 1995 and $250,000 for the three months of 1995. The Company will utilize the remaining 18,000 tons of capacity as it deems appropriate. No adjustment has been made in the pro forma statements with respect to the Company's utilization of this remaining capacity. b) Historically, when the Company has purchased pulp from facilities within James River, the purchase price of the pulp was reflected at existing published prices less a discount ranging from 0% to 9% based upon a combination of prevailing market prices and volumes purchased. Beginning August 28, 1995, based upon a three year Pulp Purchase Agreement entered into by the Company and James River, the price of such pulp purchases will be at existing published prices less a discount ranging from 0% to 6% based upon a combination of prevailing market prices and volumes purchased. The effect of this agreement, if it was consummated at the beginning of the periods presented, would have increased cost of goods sold by approximately $1,393,000 for the nine months of 1995 and $464,000 for the three months of 1995. c) Reflects pro forma increases in the Company's interest expense assuming that amounts outstanding in 1996 with respect to the Senior Subordinated Notes, Senior Pay-in-Kind Notes, and borrowings under the Bank Credit Facility were outstanding during the corresponding period in 1995. Pro forma interest expense also includes line of credit fees, guaranty fees for IRB's and commitment fees on the unused portion of the Revolver for the periods presented. Included in pro forma interest expense is the amortization of the pro rata portion of debt issue costs related to the Financings which will be amortized over the lives of the related indebtedness. Variable rate debt of the Company is subject to ongoing interest rate fluctuations. The effect of a 1% increase in the interest rate on these borrowings would have the impact of increasing interest expense by approximately $1.3 million for the nine months of 1995 and $.7 million for the three months of 1995. d) Reflects the effects of the pro forma adjustments on income tax expense using an estimated marginal tax rate of 38.9% for the periods presented. e) Pro forma earnings per share is computed based upon 8,623,000 and 8,603,000 assumed weighted average shares outstanding for the three month and nine month periods, respectively. The number of shares considered outstanding does not include 255,535 shares held be the Employee Stock Ownership Plan Trust. In accordance with generally accepted accounting principles, shares held by the Trust are not considered outstanding for earnings per share calculations until the shares are committed for release from the Trust. 12 ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Crown Vantage Inc. and subsidiaries (the "Company") became an independent company after the Board of Directors of James River Corporation of Virginia ("James River") approved the spin-off of assets, liabilities and operations which comprised a substantial part of James River's Communication Papers Business and the paper-based part of its Food and Consumer Packaging Business ("Predecessor Business"). At the close of business on August 25, 1995, James River distributed to its common shareholders all of the outstanding shares of the Company (the "Distribution"). The Distribution was made in the form of a tax-free dividend on the basis of one share of the Company's common stock for every ten shares of James River common stock. A total of 8,446,362 shares of the Company's common stock were issued and began trading on NASDAQ on August 28, 1995. The following management's discussion and analysis of certain significant factors affecting the Company's results of operations during the periods included in the accompanying condensed consolidated statements of operations and changes in the Company's financial condition since December 31, 1995 is made on a historical basis. Historical results of Crown Vantage Inc. include the actual operations of the Company for the three months and nine months ended September 29, 1996, and the combined historical operations of the Predecessor Business while a part of James River for the three months and nine months ended September 24, 1995. James River provided certain corporate general and administrative services to the Company prior to the Spin-Off. These overhead costs for the quarter and nine months ended September 24, 1995 have been allocated to the Company based upon net sales and are included in selling and administrative expenses. The Company is a major producer of value-added paper products for a diverse array of end-uses. The Company's two business sectors and corresponding principal product categories are (i) printing and publishing papers, for applications such as special interest magazines, books, custom business forms and corporate communications and promotions (e.g., annual reports and stationery); and (ii) specialty papers, principally for food and retail packaging applications and conversion into such items as coffee filters, cups and plates. The Company operates 11 facilities using 33 diverse paper machines. The Company's two largest facilities are integrated operations located in St. Francisville, Louisiana and Berlin and Gorham, New Hampshire. St. Francisville produces coated groundwood papers for magazines and catalogs and uncoated specialty converting papers. Berlin-Gorham primarily produces uncoated printing and publishing papers as well as market pulp. The Company also produces uncoated printing and publishing papers at its non-integrated facilities in Adams, Massachusetts; Newark, Delaware; Ypsilanti, Michigan; and Dalmore and Guardbridge, Scotland. The Company's food and retail packaging papers are produced primarily at non-integrated facilities in Port Huron and Parchment, Michigan and Milford, New Jersey. In addition to its primary paper-making operations, the Company operates a cast-coating facility in Richmond, Virginia. 13 RESULTS OF OPERATIONS The Company's net sales for each business sector as well as pulp and miscellaneous, are as follows: Net Sales and Tonnage by Sector for the Nine Months Ended September 29, 1996 September 24, 1995 ----------------------------- ---------------------------- Tons Sales Tons Sales ------------- ------------ ------------- ------------ (thousands) (millions) (thousands) (millions) Printing and Publishing Papers Coated groundwood 193.4 $ 170.6 208.7 $ 185.6 Uncoated 181.9 181.1 180.1 202.0 Specialty Papers Food and retail packaging 176.9 229.7 189.2 264.6 Converting 125.3 112.5 122.4 116.7 Pulp and Miscellaneous 28.7 10.6 34.9 29.8 ------------- ------------ ------------- ------------ 706.2 $ 704.5 735.3 $ 798.7 ------------- ------------ ------------- ------------ ------------- ------------ ------------- ------------ Net Sales and Tonnage by Sector for the Quarter Ended September 29, 1996 September 24, 1995 --------------------------- --------------------------- Tons Sales Tons Sales ------------ ----------- ------------- ---------- (thousands) (millions) (thousands) (millions) Printing and Publishing Papers Coated groundwood 69.4 $ 53.2 69.7 $ 68.1 Uncoated 60.1 56.6 57.7 65.7 Specialty Papers Food and retail packaging 57.7 69.7 57.9 84.1 Converting 44.6 37.4 36.3 37.3 Pulp and Miscellaneous 11.6 4.2 12.2 9.6 ------------ ----------- ------------- ---------- 243.4 $221.1 233.8 $264.8 ------------ ----------- ------------- ---------- ------------ ----------- ------------- ---------- 14 NET SALES The Company's net sales decreased 11.8% to $704.5 million for the nine months ended September 29, 1996 as compared to $798.7 million for the same period in 1995. Net sales decreased 16.5% to $221.1 million for the three months ended September 29, 1996 as compared to $ 264.8 million for the same period in 1995. The decrease for the nine month period of 1996 resulted primarily from a 8.2% decline in average selling price per ton for the nine months in 1996 as compared to 1995. The decrease in sales for the quarter ended September 29, 1996 as compared to the quarter ended September 24, 1995 was also attributable to a decline in average selling price per ton which totalled 19.8%, partially offset by a 4.1% increase in sales volume. Net sales of coated groundwood paper (which is used principally in the production of magazines and catalogs) for the nine month period ended September 29, 1996 were $170.6 million, a 8.1% decline as compared to the same period in 1995. Sales volume decreased 15,300 tons for the first nine months of 1996 compared to 1995, while the average price per ton decreased only slightly from $889 in 1995 to $882 in 1996. Net sales of coated groundwood papers decreased $15.0 million in the third quarter of 1996 as compared to the third quarter of 1995, a 21.9% decline. While demand remained strong in the third quarter of 1996, the average price per ton decreased by 21.5% to $767 as compared to the third quarter of 1995 average price per ton of $977. A continued overhang of coated groundwood paper inventory at the customer level suppressed prices in the third quarter of 1996 despite improvements in demand from earlier in the year. Net sales of uncoated printing and publishing papers decreased from $202.0 million for the first nine months of 1995 to $181.1 million for the first nine months of 1996, a 10.4% decline. Average selling price per ton for the first nine months of 1996 declined by $126 or 11.2% as compared to the same period in 1995, while 1996 sales volume was slightly improved over 1995. Net sales of uncoated printing and publishing papers in the third quarter of 1996 were $56.6 million, down $9.1 million from the third quarter of 1995. The decrease in net sales is primarily due to a 17.2% decline in average selling price per ton in the third quarter of 1996 as compared to the third quarter of 1995, partially offset by a 4.1% increase in tons sold. Food and retail packaging paper net sales totaled $229.7 million during the first nine months of 1996, a $34.9 million decline from the same period in 1995. The 13.2% decrease in net sales is the result of a l2,300 ton decrease in sales volume, coupled with a $99 per ton (7.1%) decline in average selling price per ton during the nine month period ended September 29, 1996 compared to the same period in 1995. For the third quarter of 1996, net sales were $69.7 million, down $14.4 million from third quarter 1995. Average selling price per ton in the third quarter of 1996 was $1,207, down 16.9% from the average selling price per ton of $1,453 in the third quarter of 1995. Demand for food and retail packaging papers was virtually unchanged quarter to quarter with sales volume of 57,700 tons in the third quarter of 1996 as compared to 57,900 tons in the third quarter of 1995. Net sales of specialty converting papers during the first nine months of 1996 were $112.5 million, a 3.6% decrease compared to the first nine months of 1995. The decrease is the result of a 5.8% decrease in average selling price per ton, partially offset by a 2.4% increase in tons sold . Net sales of specialty converting papers in the third quarter of 1996 totaled $37.4 million, as compared to net sales of $37.3 million in the third quarter of 1995. Tons sold in the third quarter of 1996 were 44,600, a 22.9% increase over the same period in 1995. However, average selling price per ton in the third quarter of 1996 declined $189 to $838 as compared to $1,027 in the third quarter of 1995. 15 Net sales of pulp and miscellaneous products decreased to $10.6 million for the nine months ended September 29, 1996 as compared to $29.8 million in the same period in 1995. Tons sold in the nine month period of 1996 decreased to 28,700 tons compared to 34,900 tons in the same period of 1995. This decrease was due primarily to the increased internal use of pulp produced by the Company. The average sales price per ton in the first nine months of 1996 was $368, a 57.0% decrease from the same period in 1995. In the third quarter, net sales of pulp and miscellaneous products decreased from $9.6 million in 1995 to $4.2 million in 1996. Tons sold decreased to 11,600 in the third quarter of 1996 from 12,200 in the third quarter of 1995. During the third quarter of 1996, the average sales price per ton decreased 54.5% to $357 as compared to $783 in the third quarter of 1995. OPERATING INCOME Operating Income by Sector Operating Income by Sector for the Quarter Ended for the Nine Months Ended ------------------------------ --------------------------------- Sept. 29, 1996 Sept. 24, 1995 Sept. 29, 1996 Sept. 24, 1995 -------------- -------------- -------------- --------------- (Millions) (Millions) Printing and Publishing Papers $ (1.5) $ 22.5 $ 20.6 $ 48.6 Food and retail packaging (1.3) (5.9) 3.9 (8.7) Converting 1.2 6.6 10.7 15.3 Pulp and Miscellaneous (1.4) 5.2 (7.6) 10.8 -------- -------- -------- -------- $ (3.0) $ 28.4 $ 27.6 $ 66.0 -------- -------- -------- -------- -------- -------- -------- -------- The Company had operating income of $27.6 million for the nine month period in 1996 compared to operating income of $66.0 million for the same period in 1995. In the third quarter of 1996, the Company had an operating loss of $3.0 million, as compared to operating income of $28.4 million in the third quarter of 1995. Operating income for printing and publishing papers decreased to $20.6 million in the nine months of 1996 compared to $48.6 million for 1995. The decrease in operating income resulted primarily from the 11.2% decrease in uncoated paper prices discussed above as well as the 15,300 ton decrease in coated groundwood sales during the first nine months of 1996 as compared to 1995. The operating loss for printing and publishing papers was $1.5 million in the third quarter of 1996 as compared to $22.5 million of operating income in the third quarter of 1995. The decrease in operating income was primarily because of the 21.5% decline in average selling price per ton for coated groundwood papers discussed above. Food and retail packaging operating income increased from a loss of $8.7 million for the first nine months of 1995 to a profit of $ 3.9 million in the first nine months of 1996. The increase in operating profits is attributable to a 30% decrease in pulp costs and cost reduction initiatives implemented in 1996. The Company's packaging mills are non-integrated and, as a result, operating results generally improve during periods of declining pulp costs. Operating results improved from a loss of $ 5.9 million in the third quarter of 1995 to a loss of $1.3 million in the third quarter of 1996. Third quarter 1996 operating results improved as a result of the lower pulp costs and cost reduction initiatives. 16 Operating income for converting papers decreased to $10.7 million in the nine months of 1996 as compared to $15.3 million in the first nine months of 1995. The decrease in operating profits is attributable to a 1l.7% decrease in average selling price per ton at the Company's specialty converting facility. This decrease was partially offset by a 6,400 ton increase in tons sold at the Company's cast coating facility which generally produces higher margin products. Operating profits for the third quarter of 1996 were $1.2 million, as compared to operating profits of $6.6 million in the third quarter of 1995. The decrease in average selling price per ton discussed above resulted in the $5.4 million decrease in operating profits. Selling and administrative expenses decreased $5.4 million for the nine month period of 1996 compared to the same period in 1995 as a result of certain cost reduction initiatives underway. For the third quarter, selling and administrative expenses were down $1.6 million in 1996 compared to 1995 for the same reasons. INTEREST EXPENSE Interest expense increased $39.6 million and $8.7 million for the nine month and three month periods of 1996 compared to the same periods in 1995 as a result of the borrowings incurred in connection with the Spin-Off (see Liquidity and Sources of Capital). LIQUIDITY AND SOURCES OF CAPITAL Prior to the Spin-Off, the assets of the Company comprised a substantial part of the Communications Paper Business and the paper-based part of the Food and Consumer Packaging Business of James River. For the periods presented for 1995, the Company participated in James River's centralized cash management system and, as such, its cash funding requirements, if any, were met by James River. Since consummation of the Spin-Off, the Company no longer has any such financial arrangements with James River and now relies on internally generated funds and its ability to access funds from the equity and debt markets. In connection with the Spin-Off, the Company obtained $250 million in financing through a public offering of Senior Subordinated Notes and $253 million initial borrowing under a $350 million credit facility from a group of banks (collectively, the "Financing"). The net proceeds from the Financing were paid to James River together with $100 million Senior Pay-in-Kind Notes as a return of James River's capital investment. Under the bank credit facility the revolving credit available is in the aggregate amount of $150 million with a $75 million sublimit for letters of credit (of which $42 million has been used at September 29, 1996) and can be used for general corporate purposes, working capital needs, letters of credit and permitted investments. At September 29, 1996, $18.0 million of the revolving credit was outstanding and $90 million of the aggregate line was available if needed. 17 Principal amounts on the Term Loan A and Term Loan B are due in quarterly installments together with accrued interest. In addition to scheduled repayments, the Company is obligated to make prepayments upon the occurrence of certain events. During June 1996, the Company prepaid $40 million on Term Loan A using proceeds from the sale of certain trade accounts receivable. Term Loan A was further prepaid by $2.6 million, an amount equivalent to 50% of proceeds from the issuance of bonds (see below). The Company anticipates that cash flows provided by operating activities will be sufficient to pay its operating expenses and satisfy its debt repayments for the remainder of 1996. Cash flows provided by operating activities were $89.7 million for the nine months ended September 29, 1996 compared to $102.4 million in the first nine months of 1995. Operating cash flows increased by $40 million as a result of the sale of certain trade accounts receivable in June 1996 (see Note 8). Earnings before interest, taxes, depreciation and amortization (EBITDA) were $88.3 million for the first nine months of 1996, as compared to $126.6 million in 1995. The Company's capital expenditures for the nine months ended September 29, 1996 were $58.9 million compared to $33.3 million in the same period in 1995. A fully-integrated pulp and paper mill generally consists of an extensive network of buildings, machines and equipment, which require continual upgrade, replacement, modernization and improvement to remain competitive and meet changing customer preferences and regulatory requirements. The Company's strategic capital plans involve aggregate capital expenditure for the remainder of 1996 of approximately $24 million. These capital expenditures will be financed primarily by cash flows from operations. In July 1996, the Company completed an $18 million refinancing of certain industrial revenue bonds issued by the Business Finance Authority of the State of New Hampshire (the "Refunding Bonds"). The Refunding Bonds were issued to refinance certain of the Company's pollution control and solid waste disposal facilities located in the State of New Hampshire. The bonds are due January 1, 2022 and bear interest at 7.75%. Also in July 1996, the Company finalized an agreement with the Business Finance Authority of the State of New Hampshire whereby a total of $12.3 million of bonds were sold (the "Project Bonds") to finance certain sewage and solid waste disposal facilities to be used by the Company. The proceeds from the sale of Project Bonds are to be used to finance eligible project costs. An amount equivalent to 50% of proceeds are to be prepaid to the Term Loans. Upon sale, $2.6 million, equivalent to 50% of proceeds, was prepaid on Term Loan A and an additional $4.0 million was deposited in an interest bearing account with a trustee to be drawn as needed to finance additional project costs. The Project Bonds bear interest at 7.875% and are due July 1, 2026. 18 PART II -- OTHER INFORMATION ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Ex. 3(ii) Restated Bylaws of Crown Vantage Inc. (as amended July 31, 1996) (Electronic Filing Only) Ex. 11 Statement re: Computation of Per Share Earnings Ex. 27 Financial Data Schedule (Electronic Filing Only) Ex. 99(i) Crown Vantage Inc. 1995 Incentive Stock Plan (as amended March 21, 1996 and May 7, 1996)(Electronic Filing Only) (b) Reports on Form 8-K -- None 19 SIGNATURES 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. CROWN VANTAGE INC. (Registrant) /s/ Charles H. Shreve - --------------------- Charles H. Shreve Senior Vice President, Chief Accounting Officer (Duly Authorized Officer and Chief Accounting Officer) November 12, 1996 21