FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2004 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: 1-13923 WAUSAU-MOSINEE PAPER CORPORATION (Exact name of registrant as specified in charter) WISCONSIN 39-0690900 (State of incorporation) (I.R.S. Employer Identification Number) 100 PAPER PLACE MOSINEE, WISCONSIN 54455-9099 (Address of principal executive office) Registrant's telephone number, including area code: 715-693-4470 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 report), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ____ The number of common shares outstanding at October 31, 2004 was 51,685,251. WAUSAU-MOSINEE PAPER CORPORATION AND SUBSIDIARIES INDEX PAGE NO. PART I. FINANCIAL INFORMATION Item 1. Financial Statements 1 Condensed Consolidated Statements of Operations, Three Months and Nine Months Ended September 30, 2004 (unaudited) and September 30, 2003 (unaudited) 1 Condensed Consolidated Balance Sheets, September 30, 2004 (unaudited) and December 31, 2003 (derived from audited financial statements) 2 Condensed Consolidated Statements of Cash Flows, Nine Months Ended September 30, 2004 (unaudited) and September 30, 2003 (unaudited) 3 Notes to Condensed Consolidated Financial Statements (unaudited) 3-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 17 PART II. OTHER INFORMATION Item 6. Exhibits 18 i PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Wausau-Mosinee Paper Corporation and Subsidiaries CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Nine Months Ended September 30, September 30, (Dollars in thousands, except per share data) 2004 2003 2004 2003 NET SALES $ 262,428 $ 249,529 $ 778,352 $ 732,188 Cost of products sold 229,983 221,090 691,073 657,774 GROSS PROFIT 32,445 28,439 87,279 74,414 Selling and administrative expenses 17,158 16,426 55,796 50,089 OPERATING PROFIT 15,287 12,013 31,483 24,325 Interest expense (2,608) (2,537) (7,685) (7,608) Other income (expense), net 191 18 483 19 EARNINGS BEFORE INCOME TAXES 12,870 9,494 24,281 16,736 Provision for income taxes 4,762 3,513 8,984 6,192 NET EARNINGS $ 8,108 $ 5,981 $ 15,297 $ 10,544 NET EARNINGS PER SHARE-BASIC $ 0.16 $ 0.12 $ 0.30 $ 0.20 NET EARNINGS PER SHARE-DILUTED $ 0.16 $ 0.12 $ 0.29 $ 0.20 Weighted average shares outstanding-basic 51,680,686 51,552,250 51,653,843 51,546,462 Weighted average shares outstanding-diluted 51,980,190 51,664,539 51,904,856 51,639,898 Dividends declared per common share $ 0 $ 0 $ 0.17 $ 0.17 See Notes to Condensed Consolidated Financial Statements. 1 Wausau-Mosinee Paper Corporation and Subsidiaries CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands) SEPTEMBER 30, December 31, 2004 2003 ASSETS (UNAUDITED) Current assets: Cash and cash equivalents $ 55,035 $ 36,305 Receivables, net 97,812 81,300 Refundable income taxes 2,400 1,668 Inventories 115,340 115,835 Deferred income taxes 12,312 12,616 Other current assets 2,711 3,694 Total current assets 285,610 251,418 Property, plant and equipment, net 541,528 565,722 Other assets 41,917 40,960 TOTAL ASSETS $869,055 $858,100 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 114 $ 112 Accounts payable 68,744 55,368 Accrued and other liabilities 54,860 59,524 Total current liabilities 123,718 115,004 Long-term debt 161,544 162,174 Deferred income taxes 115,012 115,879 Postretirement benefits 57,062 54,197 Pension 32,578 40,829 Other noncurrent liabilities 20,595 19,701 Total liabilities 510,509 507,784 Stockholders' equity 358,546 350,316 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $869,055 $858,100 See Notes to Condensed Consolidated Financial Statements. 2 Wausau-Mosinee Paper Corporation and Subsidiaries CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, (Dollars in thousands) 2004 2003 Net cash provided by operating activities $47,102 $27,864 Cash provided by (used in) investing activities: Capital expenditures (16,579) (16,794) Acquisition of business 0 (8,511) Proceeds on sale of property, plant and equipment 43 11 (16,536) (25,294) Cash provided by (used in) financing activities: Payments under capital lease obligation (83) (71) Dividends paid (13,166) (13,144) Proceeds from stock option exercise 1,413 167 (11,836) (13,048) Net increase (decrease) in cash and cash equivalents 18,730 (10,478) Cash and cash equivalents, beginning of period 36,305 23,383 Cash and cash equivalents, end of period $55,035 $12,905 Interest-net of amount capitalized $10,568 $10,505 Income taxes paid 7,701 4,129 Noncash investing and financing activities: A capital lease obligation of $336 was recorded in the second quarter of 2003 when the Company entered into a lease for new equipment. See Notes to Condensed Consolidated Financial Statements. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1. The condensed consolidated financial statements include the results of Wausau-Mosinee Paper Corporation and our consolidated subsidiaries. All significant intercompany transactions have been eliminated. The accompanying condensed financial statements, in the opinion of management, reflect all adjustments, which are normal, and recurring in nature and which are necessary for a fair statement of the results for the periods presented. Results for the interim period are not necessarily indicative of future results. In all regards, the financial statements have been presented in accordance with accounting principles generally accepted in the United States of America. Refer to notes to the financial statements, which appear in the Annual Report on Form 10-K for 3 the year ended December 31, 2003, for the Company's accounting policies, which are pertinent to these statements. Note 2. During the second quarter of 2003, the Company's Towel & Tissue Group, reached a settlement of all claims of the parties in a patent litigation matter. As a result of the settlement, the Company recognized $4.2 million in pre-tax income (reduction of cost of sales) as a fee for licensing certain patented dispenser technologies. Note 3. Effective March 3, 2003, the Company acquired certain assets of a laminated papers producer for approximately $8.5 million in cash. The acquisition was accounted for as a purchase business combination and, accordingly, the purchase price has been allocated using the fair values of the acquired receivables, inventory, machinery and equipment, and identifiable intangible assets. No goodwill was recorded as a result of this acquisition. The pro forma disclosures required under Statement of Financial Accounting Standard (SFAS) No. 141 "Business Combinations" have not been presented, as the impact of this acquisition does not materially impact the results of operations. Note 4. Net earnings include provisions, or credits, for stock incentive plans calculated by using the average price of the Company's stock at the close of each calendar quarter as if all grants under such plans had been exercised on that day. For the three months ended September 30, 2004, the credit for incentive plans on a pretax basis was $175,000. For the three months ended September 30, 2003, the provision for incentive plans on a pretax basis was $577,000. On a pretax basis for the nine months ended September 30, 2004 and 2003, provisions of $1,992,000 and $991,000, respectively, were recognized as stock incentive plan expense. As permitted under SFAS No. 123, "Accounting for Stock-Based Compensation," the Company continues to measure compensation cost for stock-option plans using the "intrinsic value based method" prescribed under APB No. 25, "Accounting for Stock Issued to Employees." 4 Pro forma net earnings and earnings per share had the Company elected to adopt the fair-value based method" of SFAS No. 123 are as follows: (Dollars in thousands, except per share amounts) Three Months Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 Net earnings, as reported $ 8,108 $ 5,981 $ 15,297 $ 10,544 Add: Total stock-based employee compensation expense (credit) under APB No. 25, net of related tax effects (110) 364 1,255 625 Deduct: Total stock-based compensation (expense) credit determined under fair-value based method for all awards, net of related tax effects 27 (417) (1,458) (744) Proforma $ 8,025 $ 5,928 $ 15,094 $ 10,425 Earnings per share - basic: As reported $ 0.16 $ 0.12 $ 0.30 $ 0.20 Pro forma $ 0.16 $ 0.11 $ 0.29 $ 0.20 Earnings per share - diluted: As reported $ 0.16 $ 0.12 $ 0.29 $ 0.20 Pro forma $ 0.15 $ 0.11 $ 0.29 $ 0.20 Note 5. Basic and diluted earnings per share are recognized as follows: (Dollars in thousands, except per share data) Three Months Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 Net earnings $ 8,108 $ 5,981 $ 15,297 $ 10,544 Basic weighted average common shares outstanding 51,680,686 51,552,250 51,653,843 51,546,462 Dilutive securities: Stock options 299,504 112,289 251,013 93,436 Dilutive weighted average common shares outstanding 51,980,190 51,664,539 51,904,856 51,639,898 Net earnings per share-basic $ 0.16 $ 0.12 $ 0.30 $ 0.20 Net earnings per share-diluted $ 0.16 $ 0.12 $ 0.29 $ 0.20 5 For the three months ended September 30, 2004, options for 288,586 shares were excluded from the diluted EPS calculation because the options were antidilutive. For the three months ended September 30, 2003, options for 842,255 shares were excluded from the diluted EPS calculation because the options were antidilutive. For the nine months ended September 30, 2004 and 2003, 395,622 shares and 826,922 shares, respectively, were excluded from the diluted EPS calculation because the options were antidilutive. Note 6. Accounts receivable consisted of the following: (Dollars in thousands) SEPTEMBER 30,December 31, 2004 2003 Trade $ 98,963 $82,142 Other 1,098 1,086 100,061 83,228 Less: Allowances (2,249) (1,928) $ 97,812 $81,300 Note 7. The various components of inventories were as follows: (Dollars in thousands) SEPTEMBER 30,December 31, 2004 2003 Raw Materials $ 32,906 $ 27,282 Finished Goods and Work in Process 80,092 83,757 Supplies 27,961 27,920 Subtotal 140,959 138,959 Less: LIFO Reserve (25,619) (23,124) Net inventories $115,340 $115,835 Note 8. The accumulated depreciation on fixed assets was $682,102,000 as of September 30, 2004, and $652,990,000 as of December 31, 2003. The provision for depreciation, amortization and depletion for the nine months ended September 30, 2004 and September 30, 2003 was $44,852,000 and $45,693,000, respectively. 6 Note 9. The components of net periodic benefit costs recognized in the Condensed Consolidated Statements of Operations for the three months Ended September 30, 2004 and 2003, are as follows: (Dollars in thousands) Other Post-retirement Pension Benefits Benefits 2004 2003 2004 2003 Service cost $ 1,730 $ 1,380 $ 466 $ 503 Interest cost 2,491 2,330 1,183 1,392 Expected return on plan assets (2,503) (2,051) 0 0 Amortization of: Prior service cost 549 484 (899) (90) Actuarial loss 419 188 371 224 Transition (asset) (12) (48) 0 0 Settlement 30 0 0 0 Net periodic benefit cost $ 2,704 $ 2,283 $ 1,121 $ 2,029 The components of net periodic benefit costs recognized in the Condensed Consolidated Statements of Operations for the nine months ended September 30, 2004 and 2003, are as follows: (Dollars in thousands) Other Post-retirement Pension Benefits Benefits 2004 2003 2004 2003 Service cost $ 5,170 $ 4,138 $ 1,808 $ 1,511 Interest cost 7,337 6,988 4,229 4,035 Expected return on plan assets (7,508) (6,167) 0 0 Amortization of: Prior service cost 1,524 1,454 (1,073) (268) Actuarial loss 1,258 562 1,265 674 Transition (asset) (38) (142) 0 0 Settlement 30 248 0 0 Net periodic benefit cost $ 7,773 $ 7,081 $ 6,229 $ 5,952 On December 8, 2003, the President signed into law the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act). The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that override a benefit that is at least actuarially equivalent to Medicare. In June 2004, the FASB issued FSP 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The FSP provides guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide prescription drug benefits. The FSP also requires those employers to provide 7 certain disclosures regarding the effect of the federal subsidy provided by the Act. The Company adopted the provisions of the FSP on July 1, 2004. The impact of the adoption of the FSP resulted in a reduction in the accumulated post-retirement benefit obligation of $5.9 million and a reduction in the net periodic benefit cost for the three-months ended September 30, 2004, of $250,000. The company previously disclosed in its consolidated financial statements for the year ended December 31, 2003, that it expected to contribute $21.2 million to its pension plans in 2004. As of September 30, 2004, the Company expects to contribute $20.1 million to its pension plans in 2004. Of this total, $16.8 million of contributions have been made as of September 30, 2004. The Company expects to contribute an additional $3.3 million by December 31, 2004. Note 10. Interim Segment Information FACTORS USED TO IDENTIFY REPORTABLE SEGMENTS The Company's operations are classified into three principal reportable segments: Printing & Writing, Specialty Products, and Towel & Tissue, each providing different products. Separate management of each segment is required because each business unit is subject to different marketing, production, and technology strategies. PRODUCTS FROM WHICH REVENUE IS DERIVED Printing & Writing produces a broad line of premium printing and writing grades at manufacturing facilities in Brokaw, Wisconsin and Groveton, New Hampshire. Printing & Writing also includes converting facilities, which produce wax-laminated roll wrap and related specialty finishing and packaging products, and a converting facility, which converts printing and writing grades. Specialty Products produces specialty papers at its manufacturing facilities in Rhinelander, Wisconsin; Mosinee, Wisconsin; and Jay, Maine. Towel & Tissue produces a complete line of towel and tissue products that are marketed along with soap and dispensing systems for the "away-from-home" market. Towel & Tissue operates a paper mill in Middletown, Ohio, and a converting facility in Harrodsburg, Kentucky. 8 RECONCILIATIONS The following are reconciliations to corresponding totals in the accompanying consolidated financial statements: Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Net sales external customers Printing & Writing $102,590 $104,105 $303,872 $301,940 Specialty Products 101,351 90,191 308,053 272,350 Towel & Tissue 58,487 55,233 166,427 157,898 $262,428 $249,529 $778,352 $732,188 Operating profit Printing & Writing $ 5,124 $ 5,265 $ 9,646 $ 9,455 Specialty Products 5,204 2,444 12,030 4,020 Towel & Tissue 7,855 7,619 21,287 20,022 Total reportable segment operating profit 18,183 15,328 42,963 33,497 Corporate & eliminations (2,896) (3,315) (11,480) (9,172) Interest expense (2,608) (2,537) (7,685) (7,608) Other income (expense), net 191 18 483 19 Earnings before income taxes $ 12,870 $ 9,494 $ 24,281 $ 16,736 (Dollars in thousands) SEPTEMBER 30, December 31, 2004 2003 Segment Assets Printing & Writing $281,032 $283,711 Specialty Products 328,160 334,079 Towel & Tissue 165,639 165,199 Corporate & Unallocated* 94,224 75,111 $869,055 $858,100* Segment assets do not include intersegment accounts receivable, cash, deferred tax assets and certain other assets, which are not identifiable with segments. Note 11. Subsequent Event On October 21, 2004, the Company purchased the assets of a specialty manufacturer of high-quality uncoated freesheet paper for $9.6 million in cash. The mill has production capacity of 170,000 tons and will complement the existing Printing & Writing business segment. The acquisition will be accounted for as a purchase business combination and, accordingly, the purchase price will be allocated using the fair values of the acquired land, buildings, and machinery and equipment. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The gradual improvement in market conditions experienced in each of the Company's business segments during the first half of 2004 continued in the third quarter for the Specialty Products and Towel & Tissue segments, while the uncoated freesheet market that impacts the Printing & Writing business slowed with volumes declining from prior year levels. As a result, the Company's Specialty Products and Towel & Tissue business segments experienced both increased sales and shipments in the third quarter of 2004 compared to the third quarter of 2003, while the Printing & Writing business experienced declines in both net sales and shipments for the same quarter-over-quarter comparison. Increased fiber-related and natural gas costs unfavorably impacted the current quarter in comparison to the same quarter last year. Through the first nine months of 2004, sales from new products developed within the previous three years accounted for nearly 40% of the Company's consolidated net sales, exceeding the Company's internal target of 25%; operating efficiencies increased more than the Company's target of 1% as compared to last year; and continued progress was made toward achieving the Company's cost reduction goal of 2% of prior year cost of sales. In addition, during the third quarter of 2004 the Company announced an agreement to purchase the assets of an uncoated freesheet mill for $9.6 million. The mill has production capacity of 170,000 tons and will complement the existing Printing & Writing business segment. The transaction was completed on October 21, 2004. The Company is targeting a mid- November start-up of the mill's largest paper machine, capable of producing up to 90,000 tons per year of premium printing and writing paper. No timetable has been established for the start-up of the mill's second paper machine. OPERATIONS REVIEW Net Sales Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Net sales $262,428 $249,529 $778,352 $732,188 Percent increase/(decrease) 5% (1%) 6% 2% For the three months ended September 30, 2004, consolidated net sales for the Company were $262.4 million compared to $249.5 million for the same three-month period in 2003, an increase of 5%. Company-wide shipments in the third quarter of 2004 were 213,293 tons, a 1% decline from the 215,430 tons shipped in the third quarter of 2003. Third quarter 2004 average selling price increased nearly 6%, or approximately $15 million, as compared to the same period in 2003 with product mix enhancements accounting for nearly half of the average selling price increase. For the nine months ended September 30, 2004 and 2003, consolidated net sales were $778.4 million and $732.2 million, respectively, representing a 6% improvement year-over-year. Year- 10 to-date shipments through September 30, 2004, improved to 649,858 tons, an increase of 2% over the 637,600 tons reported for the same year-to-date period of 2003. During the first nine months of 2004, average selling price improved approximately 4%, with product mix enhancements accounting for most of the increase. Together, product pricing and product mix changes accounted for approximately $29 million of the consolidated net sales improvement. Third quarter net sales and shipments for Printing & Writing decreased 1% and 5%, respectively, as compared to the third quarter of 2003. Net sales declined to $102.6 million in 2004 from $104.1 million reported for the same three-month period in 2003 while shipments declined quarter-over-quarter from the 95,164 tons in 2003 to 90,030 tons in 2004. Average net selling price improved approximately 4% over the third quarter of 2003, with sales mix accounting for the majority of the increase as the volume of higher-margin premium printing and writing papers and consumer products increased 9% and 15%, respectively, quarter-over-quarter. Lower overall shipments were principally due to inconsistent demand and competitive market conditions for paper mill packaging products, while reduced shipments to paper merchants and converters also contributed to the year-over-year decline. Market demand remained similar to prior year with pricing competitive as the fourth quarter began. Printing & Writing net sales for the first nine months of 2004 improved 1% to $303.9 million compared to $301.9 million in the first nine months of 2003, while shipments declined slightly to 273,151 tons from 274,567 tons shipped in the first nine months of 2003. Average selling price improved approximately 1% year-over-year with sales mix enhancement driving the improvement as real selling prices declined in the first nine months of 2004. Specialty Products' net sales improved 12% in the three months ended September 30, 2004 over the three months ended September 30, 2003. Net sales were $101.4 million compared to $90.2 million for the third quarters of 2004 and 2003, respectively. Shipments improved to 83,804 tons in the third quarter of 2004 compared to 80,988 tons in 2003. Average net selling price increased more than 8% in the third quarter of 2004 compared to the third quarter of 2003, with product selling price increases resulting, in part, from the pass-through of increased fiber costs accounting for nearly three-quarters of the improvement. For the first nine months of 2004, Specialty Products' net sales were $308.1 million compared to $272.4 million in the same period of 2003, an increase of 13%. Shipment volume increased 5% year-over year with 263,115 tons shipped in 2004 and 251,314 tons shipped in 2003. Average selling price improvement of 7% year-over-year was driven by actual product pricing improvements of 5% and product mix enhancements of 2%. Towel & Tissue net sales increased to $58.5 million in the third quarter of 2004, compared with $55.2 million in the same period last year. Shipment volume increased slightly with 39,459 tons shipped in the third quarter of 2004 compared to 39,278 tons shipped in the third quarter of 2003. Average selling price improved by nearly 5% with actual product selling prices increasing 3% and product mix improving approximately 2%. Year-to-date net sales for Towel & Tissue were $166.4 million in 2004 compared to $157.9 million in 2003. Year-to-date shipments increased 2% to 113,592 tons in 2004 versus 111,719 11 tons shipped in 2003. The "away-from-home" segment of the towel and tissue market grew approximately 2% during the nine months of 2004 compared with the same period in 2003. Average net selling price increased 4%, with an improvement in product mix driving the majority of the increase. Gross Profit Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Gross profit on sales $32,445 $28,439 $87,279 $74,414 Gross profit margin 12% 11% 11% 10% Gross profit for the three months ended September 30, 2004, was $32.4 million compared to $28.4 million for the three months ended September 30, 2003. Gross profit margins increased slightly compared to those reported in the same period last year as increases in energy and fiber-related prices were offset by improvement in average selling price, operational efficiency gains and cost- reduction efforts. In total, natural gas prices increased 14% resulting in additional cost of $1.1 million in the third quarter of 2004 compared to the third quarter of 2003. Compared to the third quarter of 2003, market pulp prices were higher by $56 per air-dried metric ton, or approximately $5.5 million, wastepaper prices increased $1.5 million, or 44%, and linerboard increased $1.1 million, or approximately 20%, quarter-over-quarter. Year-to-date, gross profit margins improved to $87.3 million, or 11% of net sales in 2004 compared to $74.4 million, or 10% of net sales in 2003. As in the quarterly comparison, improvements in average selling price, operational efficiency gains and cost-reduction efforts more than offset unfavorable fiber- related and energy costs that negatively impacted the gross profit margin year- over-year. Year-over-year, market pulp prices increased nearly 10% or $13.2 million and natural gas costs increased approximately 2% or $0.5 million. In the nine months ended September 30, 2003, the Company recognized $4.2 million of income as a fee for licensing certain patented dispenser technologies, favorably impacting gross profit margin in that period. The list price of northern bleached softwood kraft decreased $30 per air-dried metric ton during the third quarter with another $30 per air-dried metric decline occurring early in the fourth quarter. During this period, the list price of most other market pulps has moved lower by lesser amounts. Some market pulp producers have announced a $30 per air-dried metric ton price increase targeted for late in the fourth quarter. Printing & Writing's gross profit for the third quarter of 2004 and 2003 was 10% of net sales, and on a year-to-date basis, gross profit was 9% for both nine-month periods of 2004 and 2003. As discussed in the consolidated gross margin comparisons, in both the quarter-over-quarter and year-over-year periods, increases in average net selling price combined with cost-reduction efforts offset unfavorable pricing in both natural gas and market pulp. The Specialty Products' average selling price increase, improved operations and cost-reduction efforts offset the unfavorable impacts of energy and market pulp to report improved year-over- 12 year gross profit margins of 10% in the third quarter of 2004 compared to 8% in the third quarter of 2003. Similarly, year-to-date margins improved to 9% in 2004 from 6% in 2003. The gross profit margin for Towel & Tissue improved to 21% in the third quarter of 2004 from 20% in the third quarter of 2003. Increased average selling price and improved operations drove the improvement in gross margin on a quarter- over-quarter basis. Year-to-date gross margins remained constant at 20% of net sales in both 2004 and 2003. 2003 results include a favorable $4.2 million settlement of a patent litigation matter. Consolidated order backlogs increased to approximately 46,300 tons at September 30, 2004, from approximately 33,400 tons at September 30, 2003. Backlog tons at September 30, 2004 represent $57.3 million in sales compared to $37.8 million in sales at September 30, 2003. Improvements in customer backlog were evident in Specialty Products and Towel & Tissue, while Printing & Writing declined slightly. Printing & Writing's backlog tons declined from 10,800 tons as of September 30, 2003, to 10,400 tons at September 30, 2004. Specialty Products' backlog tons improved to 31,000 tons at the end of the third quarter of 2004 compared to 20,100 tons at the end of the third quarter of 2003. Towel & Tissue experienced an increase in backlogs with 4,900 tons and 2,500 tons reported at the end of the third quarter of 2004 and 2003, respectively. The change in customer order backlogs does not necessarily indicate business conditions as a large portion of orders are shipped directly from inventory upon receipt and do not impact backlog numbers. Selling and Administrative Expenses Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Selling and administrative expense $17,158 $16,426 $55,796 $50,089 Percent increase 4% 22% 11% 6% As a percent of net sales 7% 7% 7% 7% Selling and administrative expenses in the third quarter of 2004 were $17.2 million compared to $16.4 million in the same period of 2003. Incentive compensation programs based on the market price of the Company's stock resulted in a credit of $0.2 million for the three months ended September 30, 2004 compared to a provision of $0.6 million for the three months ended September 30, 2003. Costs increasing quarter-over quarter included fringe benefit expenses, particularly health-care costs, relocation and recruiting expenses, and consulting expenses related to the Companies compliance work associated with Section 404 of the Sarbanes-Oxley Act. For the nine months ended September 30, 2004, selling and administrative expenses were $55.8 million compared to $50.1 million in the first nine months of 2003. Expense recognized for stock-incentive based programs for the nine months ended September 30, 2004 and 2003, was $2.0 million and $1.0 million, respectively. As in the quarter-over-quarter comparison, other costs increasing include fringe benefit expenses, particularly health-care costs, relocation and recruiting expenses, and consulting expenses related to the Company's compliance work associated with Section 404 of the Sarbanes-Oxley Act. 13 Other Income and Expense Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Interest expense $2,608 $2,537 $7,685 $7,608 Other income (expense), net 191 18 483 19 Interest expense was similar between comparable periods of 2004 and 2003. Quarter-over-quarter, interest expense of $2.6 million was recorded in the third quarter of 2004 compared to $2.5 million in the third quarter of 2003. Interest expense was $7.7 million and $7.6 million for the nine months ended September 30, 2004 and 2003, respectively. Long-term debt was $161.5 million and $162.4 million at September 30, 2004 and 2003, respectively. Long-term debt at December 31, 2003, was $162.2 million. Interest expense is expected to remain similar between 2004 and 2003 for the balance of the year. Other income is higher in 2004 and 2003 in both the quarterly and year-to-date comparisons due to interest income as a result of higher cash and cash equivalent balances year-over-year. Income Taxes Three Months Nine Months Ended September 30, Ended September 30, (Dollars in thousands) 2004 2003 2004 2003 Provision for income taxes $4,762 $3,513 $8,984 $6,192 Effective tax rate 37% 37% 37% 37% The effective tax rates for the periods presented are indicative of the Company's normalized tax rate. The effective rate for 2004 is expected to remain at 37%. On October 22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into law. The Act contains $137 billion in tax cuts over a ten year period beginning in 2005, which are mainly U.S. manufacturing businesses and multinational companies. The Company has not yet completed its assessment of how the Act might impact its future results of operations or cash flows. LIQUIDITY AND CAPITAL RESOURCES Cash Flows and Capital Expenditures Nine Months Ended September 30, (Dollars in thousands) 2004 2003 Cash provided by operating activities $47,102 $27,864 Capital expenditures 16,579 16,794 For the nine months ended September 30, 2004, cash provided by operating activities was $47.1 million compared to cash provided by operations for the nine months ended September 30, 2003, of $27.9 million. The improvement in cash flows provided by operating activities year-over-year 14 is primarily attributable to increased accounts payable levels and current year earnings, offset by increased customer receivables and higher income tax payments. In 2004, the Company has continued to limit capital spending to necessary maintenance-related and high-return capital projects. Capital spending for the first nine months of 2004 was $16.6 million compared to $16.8 million during the first nine months of 2003. Total capital spending in 2004 is expected to be comparable to 2003 capital spending of $24 million, or less than one-half the Company's rate of depreciation, depletion and amortization. For the first nine months of 2004, capital expenditures for projects with total spending expected to exceed $1.0 million were $1.2 million in Printing & Writing as part of a capital project to expand premium papers production capabilities at the Brokaw mill and $1.3 million for a digester replacement at the Brokaw mill. In Towel & Tissue, project spending included $0.2 million on a screw press project, $0.3 million on production equipment, and $3.2 million for various converting lines. The balance of spending during the first nine months of 2004 was related to projects that individually are expected to cost less than $1.0 million. These expenditures included approximately $5.1 million for essential non or low- return projects, and approximately $5.3 million on projects expected to provide a return on investment that exceeds the Company's cost of capital. For 2003, capital expenditures for projects with total spending expected to exceed $1.0 million were $2.9 million in Printing & Writing as part of a capital project to expand premium papers production capabilities and $0.3 million for a digester replacement at the Brokaw mill. In addition, $0.4 million was spent on a process control system computer replacement at the Groveton mill. At Towel & Tissue, $2.0 million was spent on a screw press project and $1.8 million was spent for various converting lines. The balance of spending for the first nine months of 2003 was related to projects that individually are expected to cost less than $1.0 million. These expenditures included approximately $6.3 million for essential non-or low- return projects, and approximately $3.1 million on projects expected to provide a return on investment that exceeds the Company's cost of capital. On October 21, 2004, the Company purchased the assets of a specialty manufacturer of high-quality uncoated freesheet paper for $9.6 million in cash. The acquisition will be accounted for as a purchase business combination and, accordingly, the purchase price will be allocated using the fair values of the acquired land, buildings, and machinery and equipment. Effective March 3, 2003, the Company acquired certain assets of a laminated papers producer for approximately $8.5 million in cash. The acquisition is being accounted for as a purchase business combination and, accordingly, the purchase price has been allocated using the fair values of the acquired receivables, inventory, machinery and equipment, and identifiable intangible assets. 15 Debt and Equity SEPTEMBER 30, December 31, (Dollars in thousands) 2004 2003 Short-term debt $ 114 $ 112 Long-term debt 161,544 162,174 Total debt 161,658 162,286 Stockholders' equity 358,546 350,316 Total capitalization 520,204 512,602 Long-term debt/capitalization ratio 31% 32% As of September 30, 2004, there was no significant change in total debt as compared to December 31, 2003. On August 31, 2004, the Company replaced its $150 million unsecured revolving credit agreement that was scheduled to expire on December 10, 2004 with a four- year, $100 million unsecured revolving credit agreement with four participating banks. Under the new facility, the Company may elect the base for interest from either domestic or offshore rates. In addition, the facility provides for sublimits of $50 million for the issuance of standby letters of credit and $10 million for certain short-term bid loans among the bank group. The Company pays the banks a facility fee under this agreement based on quarterly debt/capitalization ratios. On September 30, 2004, the Company had approximately $100 million available borrowing capacity under the bank facility. The Company's cash position and borrowing capacity is expected to provide sufficient liquidity to support operations, meet capital spending requirements and fund dividend payments to shareholders. Dividends On June 14, 2004, the Board of Directors declared a quarterly cash dividend of $0.085 per common share. The dividend was paid on August 16, 2004, to shareholders of record on August 1, 2004. On October 22, 2004, the Board of Director's declared a cash dividend in the amount of $0.085 per share. The dividend is payable on November 15, 2004, to shareholders of record on November 1, 2004. 16 INFORMATION CONCERNING FORWARD LOOKING STATEMENTS This report contains certain of management's expectations and other forward- looking information regarding the Company pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. While the Company believes that these forward-looking statements are based on reasonable assumptions, such statements are not guarantees of future performance, and all such statements involve risk and uncertainties that could cause actual results to differ materially from those contemplated in this report. The assumptions, risks, and uncertainties relating to the forward-looking statements in this report include general economic and business conditions, changes in the prices of raw materials or energy, competitive pricing in the markets served by the Company as a result of economic conditions, overcapacity in the industry and the demand for paper products, manufacturing problems at Company facilities and various other risks and assumptions. These and other assumptions, risks, and uncertainties are described under the caption "Cautionary Statement Regarding Forward-Looking Information" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and from time to time, in the Company's other filings with the Securities and Exchange Commission. The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change in the information provided in response to Item 7A of the Company's Form 10-K for the year ended December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, management, under the supervision, and with the participation, of the Company's President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934. Based upon, and as of the date of such evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective in all material respects. There have been no significant changes in the Company's internal controls or in other factors during the period covered by this report which could significantly affect internal controls, nor were there any significant deficiencies or material weaknesses identified which required any corrective action to be taken. 17 PART II. OTHER INFORMATION ITEM 6. EXHIBITS Exhibits required by Item 601 of Regulation S-K 4.1 Credit Agreement dated August 31, 2004 among the Company and Bank of America, N.A., M&I Marshall & Ilsley Bank, Harris Trust and Savings Bank, and Wells Fargo Bank, National Association 10.1 Standard Form of Performance Unit Grant Agreement 10.2 Standard Form of Non-Qualified Performance Stock Option Agreement 10.3 Standard Form of Non-Qualified Stock Option Agreement 10.4 Standard Form of Non-Qualified Stock Option Agreement for Directors 31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act of 2002 31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002 32.1 Certification of CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of 2002 18 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. WAUSAU-MOSINEE PAPER CORPORATION November 9, 2004 SCOTT P. DOESCHER Scott P. Doescher Senior Vice President-Finance, Secretary and Treasurer (On behalf of the Registrant and as Principal Financial Officer) 19 EXHIBIT INDEX TO FORM 10-Q OF WAUSAU-MOSINEE PAPER CORPORATION FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 Pursuant to Section 102(d) of Regulation S-T (17 C.F.R. Section 232.102(d)) The following exhibits are filed as part of this report: 4.1 Credit Agreement dated August 31, 2004 among the Company and Bank of America, N.A., M&I Marshall & Ilsley Bank, Harris Trust and Savings Bank, and Wells Fargo Bank, National Association 10.1 Standard Form of Performance Unit Grant Agreement 10.2 Standard Form of Non-Qualified Performance Stock Option Agreement 10.3 Standard Form of Non-Qualified Stock Option Agreement 10.4 Standard Form of Non-Qualified Stock Option Agreement for Directors 31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act of 2002 31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002 32.1 Certification of CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of 2002 20