MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

                                                      FORT JAMES CORPORATION 21

Management believes that the following commentary and tables appropriately
discuss and analyze the comparative results of operations and the financial
condition of the company for the periods covered. Certain events occurring in
the last three years represent major unusual or non-recurring items. These
events and their effect on the comparability of data presented herein are
discussed below.

   The components of the non-recurring items and their effect on reported
results for the past three years are summarized as follows:

<TABLE>
<CAPTION>

                                       1997                   1996                    1995
                              ----------------------------------------------------------------------

(in millions)                   Pretax         Net      Pretax        Net      Pretax         Net
----------------------------------------------------------------------------------------------------
<S> <C>
Restructuring and other:
   Merger restructuring charge   $(523.8) $   (377.5)
   Gain on divestitures             69.6        42.5    $   89.2    $  49.1
   Severance costs                                         (40.6)     (25.3)   $  (42.7)   $  (25.3)
   Asset write-downs                                       (59.3)     (36.7)       (4.2)       (2.6)
   Crown Vantage spin-off costs                                                    (5.0)       (4.2)
----------------------------------------------------------------------------------------------------
      Subtotal                    (454.2)     (335.0)      (10.7)     (12.9)      (51.9)      (32.1)
Extraordinary loss on
   debt extinguishment                        (131.5)                  (8.1)                  (18.8)
U.S. Tax Court settlement                                              36.0
French statutory tax rate increase                                                             (6.3)
----------------------------------------------------------------------------------------------------
      Total non-recurring        $(454.2) $   (466.5)   $  (10.7)   $  15.0    $  (51.9)   $  (57.2)
====================================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                1997                   1996                    1995
                                      -----------------------------------------------------------------------
(in millions, except per share data)     Reported   Recurring   Reported   Recurring    Reported   Recurring
-------------------------------------------------------------------------------------------------------------
<S> <C>
Income from operations               $   602.7      $1,056.9    $  909.3    $ 920.0    $  783.4      $835.3
Income before income taxes               272.3         726.5       503.6      514.3       289.1       341.0
Net income (loss)                        (27.0)        439.5       319.9      304.9       141.1       198.3
Diluted earnings (loss) per share    $    (.28)     $   1.97    $   1.43    $  1.35    $    .50      $  .85
-------------------------------------------------------------------------------------------------------------
</TABLE>

1997 Business
Combination, Integration
Plan, Restructure
and Other Unusual Items
and Refinancing Activities

Business Combination

On August 13, 1997, James River Corporation of Virginia ("James River") and Fort
Howard Corporation ("Fort Howard") merged, with Fort Howard shareholders
receiving 1.375 James River common shares for each Fort Howard share, and James
River shareholders retaining their current holdings. A total of 104.8 million
additional shares of common stock were issued in the merger. In connection with
the merger, James River was renamed Fort James Corporation. The merger qualified
as a tax-free reorganization and has been accounted for as a pooling of
interests for financial reporting purposes. Accordingly, the company's
consolidated financial statements have been restated for all years presented to
include the combined results of operations, cash flows and financial positions
of James River and Fort Howard. Similarly, the financial data presented in this
Management's Discussion and Analysis represent the combined James River and Fort
Howard data for all periods presented.

   Net sales and earnings data for James River and its subsidiaries and for Fort
Howard and its subsidiaries for the six months ended June 29, 1997, and for the
prior two years are presented in Note 2 of Notes to Consolidated Financial
Statements.

Integration Plan

Fort James believes the merger will enable it to achieve significant cost
reductions not available to either James River or Fort Howard, individually. By
combining complementary technologies, optimizing product manufacturing and
logistics across the combined system, increasing purchasing efficiencies,
eliminating redundant over-

                                      E-2
<PAGE>

MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


22 FORT JAMES CORPORATION

head costs and consolidating work forces where duplication exists, Fort James
expects to reduce costs and increase productivity. As a result of these
integration efforts, Fort James expects to realize cost savings estimated to be
at a $150 million annual run rate by the end of 1998, increasing to $200 million
per year over time.

Restructure and Other Unusual Items

In conjunction with the merger integration plan, the company recorded a pretax
charge of $523.8 million in 1997. Included in the total is $234.5 million for
facility closures and write-downs of redundant property, plant and equipment;
$103.1 million for employee severance and other employee-related costs; $82.8
million for the cost of terminating contracts and other long-term agreements;
$54.2 million for investment banking, legal, accounting and other transaction
costs; and $49.2 million for other costs. The charge for facility closures
includes amounts related to the company's permanent closure of two tissue mills,
in Ashland, Wisconsin, and Carthage, New York, in the spring of 1998, and
additional rationalization of manufacturing operations planned in North America
and Europe. The integration plan is anticipated to result in a net reduction of
2,500 employees, representing approximately 8 percent of the company's combined
worldwide workforce. Cash costs of the restructure program are estimated to
total approximately $150 million, net of tax benefits. Additional information on
the merger restructure charge is contained in Note 3. Also during 1997, the
company recognized a pretax gain of $69.6 million on the sale of approximately
232,000 acres of timberlands. The merger restructure charge, net of the gain on
the sale of timberlands totaled $454.2 million and was reported as "restructure
and other unusual items" in the statement of operations. The income tax benefit
of the net charge was $119.2 million, or 26 percent of the pretax charge. The
income tax benefit is lower than the statutory income tax rate principally
because certain merger costs and fees are non-deductible. The restructure and
other unusual items reduced 1997 net income by $335.0 million, or $1.62 per
diluted share. An additional estimated $60 million of non-accruable merger
integration costs will be recorded in 1998, as incurred.

Refinancing Activities

In October 1997, the company completed the refinancing of a total of
approximately $2.1 billion principal amount of debt, as further described in
Note 9. An extraordinary charge of $215.0 million ($131.5 million net of taxes,
or $.63 per diluted share) was recorded associated with these refinancings. The
debt refinancings are expected to result in an annual reduction in interest
expense of approximately $50 million.

1996 and 1995
Dispositions,
Restructuring and
Other Items
and Refinancings

During 1996, the company sold its Flexible Packaging and related Inks divisions,
as well as several small domestic North American Consumer Products Business
mills. In 1995, the company spun off Crown Vantage Inc. ("Crown Vantage") to its
common shareholders. Crown Vantage included a large part of what was formerly in
the company's Communications Papers Business, as well as the specialty
paper-based portion of the Packaging Business. Divestitures are further
described in Note 2. Additionally, the company recorded restructuring and other
unusual charges of $10.7 million ($12.9 million net of taxes, or $.07 per
diluted share) in 1996 and $51.9 million ($32.1 million net of taxes, or $.20
per diluted share) in 1995, as described in Note 3. Extraordinary losses of
$13.4 million ($8.1 million net of taxes, or $.04 per diluted share) were
recorded in 1996 and $30.7 million ($18.8 million net of taxes, or $.11 per
diluted share) were recorded in 1995 in connection with the early extinguishment
of debt. In 1996, the company recorded a $36 million tax benefit ($.19 per
diluted share) as a result of a U.S. Tax Court decision allowing the company to
deduct certain expenses relating to Fort Howard's 1988 leveraged buy-out
("LBO"). In 1995, the company recorded a $6.3 million charge ($.04 per diluted
share) to increase deferred taxes for the effect of a French tax rate increase.
Unusual tax items are described in Note 5.

<PAGE>


                                                      FORT JAMES CORPORATION 23

Results of Operations

<TABLE>
<CAPTION>
(in millions)                                                  1997           1996           1995
----------------------------------------------------------------------------------------------------
<S> <C>
Net sales:
   North American Consumer Products                          $4,360.0       $4,362.0       $4,440.6
   European Consumer Products                                 1,828.1        1,980.2        1,949.9
   Packaging                                                    782.9        1,139.9        1,659.9
   Communications Papers                                        467.7          456.7        1,091.4
   Intersegment elimination                                    (179.7)        (231.7)        (253.9)
----------------------------------------------------------------------------------------------------
      Consolidated                                           $7,259.0       $7,707.1       $8,887.9
====================================================================================================

Income from operations:(a)
   North American Consumer Products                            $845.4       $  753.3       $  583.5
   European Consumer Products                                   202.4          177.1           63.5
   Packaging                                                     81.3           91.9           76.1
   Communications Papers                                         19.8           22.2          191.2
   General corporate expenses                                   (92.0)        (124.5)         (79.0)
----------------------------------------------------------------------------------------------------
      Consolidated                                           $1,056.9       $  920.0       $  835.3
====================================================================================================
Income from operations as a percent of net sales(a)              14.6%          11.9%           9.4%
====================================================================================================
</TABLE>

(a) Represents segment results before restructuring and other unusual items. The
allocation of restructuring and other unusual items by business segment is
presented in Note 16.

Results of
Operations--1997
Compared to 1996

North American Consumer Products Business

Net sales remained level between 1996 and 1997, while operating profits, before
restructuring and other unusual items, increased $92.1 million, or 12 percent.
Segment operating margins increased to 19.4 percent in 1997 versus 17.3 percent
in 1996. Excluding the sales of the divested party goods and foam cup
operations, sales increased by 1 percent. Also impacting the sales comparison
was the loss of three days of Fort Howard shipments in fiscal 1997, resulting
from the conversion to the Fort James fiscal year cutoff. Operating results for
1996 included an $18 million charge for revised estimates of costs of certain
environmental matters.

   Net sales of retail products increased approximately 1 percent in 1997
compared to 1996, on higher volumes and slightly lower average pricing. Retail
towel and tissue product unit volumes increased by approximately 2 percent over
the prior year, while retail tabletop product volumes increased nearly 5 percent
year-over-year. Average pricing in 1997 was fairly comparable to 1996 levels for
retail tabletop products, but pricing for retail towel and tissue products
declined approximately 2 percent, reflecting the effect of list price reductions
put into effect in the spring of 1996. Additionally, promotional spending for
retail towel and tissue products increased moderately in the second half of
1997, in response to competitive activity. In January 1998, the company
announced list price increases for its retail towel and tissue products,
generally ranging from 4 to 6.5 percent.

   Net sales of away-from-home products decreased approximately 1 percent in
1997 compared to 1996, reflecting the combination of improved away-from-home
towel and tissue product volumes, more than offset by reduced away-from-home
foodservice product volumes and slightly lower pricing for tissue products.
Away-from-home towel and tissue product unit volumes increased by approximately
4 percent over the prior year, however, away-from-home foodservice volumes
decreased by approximately 9 percent compared to 1996. Average pricing improved
modestly for away-from-home foodservice products compared to the prior year,
while average away-from-home tissue pricing declined approximately 2 percent.
The company implemented a list price increase for away-from-home towel and
tissue products ranging from 6 to 9 percent late in the year in 1997.

   Net sales of other products (comprised of excess market pulp and the Harmon
Associates wastepaper brokerage business) increased 23 percent in 1997 versus
1996. The company's domestic tissue operations are fully integrated to either
kraft or deinked pulp, with excess capacity of approximately 250,000 metric tons
per

<PAGE>
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


24  FORT JAMES CORPORATION

year sold as market pulp. The increase in sales reflected higher market pulp
volumes in 1997 compared to 1996, partially offset by lower average pulp selling
prices. Tissue-grade wastepaper prices remained relatively level in 1996 and
1997.

U.S tissue industry operating rates were at approximately 94 to 95 percent of
capacity in 1997. The company believes that tissue capacity growth, net of
capacity closures, will not exceed demand growth, which should allow supply and
demand to remain in approximate balance in 1998 and 1999.


European Consumer Products Business

Net sales declined $152.1 million, or 8 percent, in 1997 compared to 1996. For
the same period, operating profits, before restructuring and other unusual
items, increased $25.3 million, or 14 percent. Segment operating margins
continued to improve, rising to 11.1 percent in 1997 from 8.9 percent in 1996.
Sales and operating profits were both negatively affected by changes in foreign
currency translation associated with the strengthening of the U.S. dollar.
Absent these changes, the company estimates 1997 sales would have been similar
to the prior year levels and operating profits would have increased by 20
percent.

   Selling prices for European tissue products averaged between 2 and 3 percent
lower in 1997 compared to 1996; however, pricing trends varied significantly by
country. Finished goods pricing trends were weakest in Italy, where aggressive
industry capacity additions have made the market more price competitive, while
pricing in other countries generally ranged from level with the prior year to a
decline of approximately 5 percent. The company expects pricing in European
tissue markets to remain competitive in the near-term future, as additional
industry capacity is anticipated to come on-line at rates greater than expected
demand growth. Italian producers, who also export tissue into Germany, are
adding a disproportionately large percentage of the new capacity. Therefore, it
is expected that the Italian and German markets, where the company has
relatively less exposure, will remain among the most price competitive in
Europe.

   Finished goods unit volumes increased more than 2 percent in 1997 versus
1996, as the company was able to consolidate the strong volume gains achieved in
1996. Unconverted tissue parent roll volumes, which currently account for
approximately 8 percent of the tons sold in Europe, declined by more than 2
percent, reflecting increased sales of converted tissue products.

   Operating profits were favorably affected by a continued gradual decline in
the cost of market pulp during 1997. Similar to most of its European tissue
competitors, Fort James' European business is not backward integrated to kraft
pulp. Approximately two-thirds of the business' fiber requirements are met with
purchased market pulp (some of which is provided by excess pulp within the
company's North American Consumer Products Business), while the remaining
one-third is provided by its deinked pulp facilities. European operating results
also benefited from manufacturing and other cost reductions and increased
productivity.


Packaging Business

Net sales declined $357.0 million, or 31 percent, in 1997 compared to 1996. For
the same period, operating profits, before restructuring and other unusual
items, declined $10.6 million, or 12 percent, while segment operating margins
improved to 10.4 percent in 1997 versus 8.1 percent in 1996. The decline in
sales was principally attributable to the 1996 sale of the Flexible Packaging
and related Inks divisions, while the decline in operating profits was primarily
the result of lower average pricing. On a pro forma basis, excluding the
Flexible Packaging division, sales decreased by $72 million, from $855 million
in 1996 to $783 million in 1997 and operating profits decreased by $9 million,
from $90 million to $81 million, respectively.

   The decline in pro forma sales and profits was primarily the result of lower
average selling prices for the company's folding cartons and coated recycled
board, partially offset by improved volumes. Average carton and recycled board
prices declined approximately 5 percent versus the prior year, as declines in
raw material costs created a more competitive pricing environment. Folding
carton unit volumes improved approximately 5 percent in 1997 compared to 1996,
while recycled board volumes increased by more than 10 percent, reflecting

<PAGE>


                                                     FORT JAMES CORPORATION 25

improvements in productivity and efficiency at the company's Kalamazoo,
Michigan, recycled board mill. Operating profits were also affected by a modest
increase in wastepaper and other raw material costs.

   The Packaging Business experienced a transition in its customer base at the
end of 1997, with the loss of one of the business' major customers. The company
is aggressively seeking new customers and has been successful in replacing a
large portion of the lost business. However, the company expects the transition
in customer base will have a negative affect on this business in the first half
of 1998.

Communications Papers Business

Net sales increased $11 million, or 2 percent, in 1997 compared to 1996. For the
same period, operating profits, before restructuring and other unusual items,
declined $2.4 million, or 11 percent, while segment operating margins declined
slightly to 4.2 percent in 1997 versus 4.9 percent in 1996. The change in sales
and operating profits was principally attributable to a decline in average
selling prices for both uncoated free sheet and uncoated groundwood papers,
offset by increased sales volumes and lower wood costs.

   Selling prices for most uncoated papers declined steadily during 1996,
reaching their lowest levels in the first quarter of 1997, before modestly
improving during the last three quarters of 1997. Lower average prices for
communications papers were the result of a combination of excess industry
capacity and declining market pulp prices creating a more competitive pricing
environment. Selling prices for uncoated free sheet papers averaged
approximately $60 per ton lower in 1997 compared to 1996, while selling prices
for uncoated groundwood papers averaged more than $100 per ton lower. Unit
volumes improved by approximately 15 percent for uncoated free sheet papers and
4 percent for uncoated groundwood papers, reflecting a higher-than-normal level
of market-related downtime taken in 1996. The change in operating profits was
also affected by a 20 percent decline in average wood chip costs in the Pacific
Northwest. Wood costs average higher in this region than in others because of
environmental restrictions on timber harvesting.

   The company believes there is a risk that prices for communications papers
could come under increased pressure in 1998, from weakening pulp markets,
continuing excess industry inventories, new capacity start-ups and risks of
increased imports from Asia.


Other Income and Expense Items

General corporate expenses declined $32.5 million, or 26 percent in 1997
compared to 1996, as a result of reduced spending on new, integrated management
information systems. Corporate costs are expected to increase somewhat in 1998
associated with the establishment of the company's executive offices in Chicago,
Illinois, and merger-related management changes.

   The company has developed and is executing plans to address the impact of
Year 2000 on key financial information and operational systems. The financial
impact of making the required system modifications and software replacements to
comply with Year 2000 issues prior to December 31, 1999, has not been and is not
expected to be material to the company's consolidated financial position or
results of operations.

   Interest expense decreased $72.6 million, or 17 percent, from $424.4 million
in 1996 to $351.8 million in 1997. The decline resulted from lower average debt
levels, combined with the benefits from the company's refinancing activities.
Total debt declined by $244.3 million during 1997, from $4,434 million at the
beginning of the year to $4,190 million at the end of the year. Fort James plans
to continue to focus on debt reduction, which is expected to be the primary use
of the company's free cash flow in the near-term future.

   Other income increased marginally, to $21.4 million in 1997 from $18.7
million in 1996, reflecting an increase in gains on the sale of miscellaneous
assets, partially offset by increased foreign currency exchange losses. See Note
4.

   The company's reported effective tax rate increased to 60.2 percent in 1997
versus 33.9 percent in 1996, principally due to non-deductible merger costs.
Excluding restructuring and other unusual items and the 1996 tax deduction of
1988 LBO expenses, the effective tax rate declined to 39 percent in 1997
compared to 39.8 percent in the prior year. This recurring effective tax rate
declined primarily due to the decreased relative size of non-deductible items.

<PAGE>

MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

26  FORT JAMES CORPORATION

Results of
Operations--1996
Compared to 1995

North American Consumer Products Business

Net sales declined $78.6 million, or 2 percent, in 1996 compared to 1995. For
the same periods, operating profits, before restructuring and other unusual
items, improved $169.8 million, or 29 percent. The business' return on sales
improved to 17.3 percent in 1996 compared to 13.1 percent in the prior year. The
decline in sales was principally attributable to the divestitures of the
company's foam cup and party goods operations, combined with the decline in
average selling prices for the company's excess North American pulp and
wastepaper.

   Net sales of retail products were comparable in 1996 and 1995, as unit volume
increases for retail tissue products were offset by lower retail tabletop
volumes. Average pricing was comparable to the prior year for retail tissue
products, but slightly higher for retail tabletop products. List prices for
retail tissue and towel products were increased twice in 1995, but were reduced
in the spring of 1996 by between 5 and 8 percent, following competitive pricing
actions tied to the falling cost of market pulp. Net sales into warehouse club
and private label channels increased over 1995 sales, driven by both stronger
volumes and higher average selling prices.

   Net sales of away-from-home products declined from the prior year, reflecting
a combination of unit volume increases for tissue products, more than offset by
unit volume and price decreases for foodservice products. Average pricing for
commercial tissue products improved slightly compared to 1995 levels. High
industry utilization rates contributed to relatively stable commercial tissue
pricing throughout 1996, despite significantly lower average wastepaper costs.
Commercial foodservice products experienced lower average pricing in 1996
compared to the prior year, as competitive price reductions were taken following
raw material cost reductions.

   The improvement in operating results was driven by a combination of cost
reduction initiatives, lower raw material costs and lower levels of trade
spending, partially offset by increased advertising and marketing costs and
reduced market pulp profitability.

European Consumer Products Business

Net sales increased by $30.3 million, or 2 percent in 1996 compared to 1995. For
the same periods, operating profits, before restructuring and other unusual
items, increased by $113.6 million, or more than 175 percent. Operating margins
increased to 8.9 percent in 1996 from 3.3 percent in 1995.

   Increased sales in 1996 were attributable to market share gains, partially
offset by a small decline in average net selling prices. Converted product unit
volumes increased in 1996, despite a two-month strike at the company's Spanish
tissue facility. Volume gains occurred in all geographic regions and were
attributable, in part, to successful new product innovations, as well as a
recovery of lower than normal volumes experienced in 1995. Average finished
goods pricing declined somewhat compared to 1995, in response to dramatically
lower raw material costs.

   In Europe, where the company is not backward integrated to kraft pulp, a
sharp reduction in fiber costs, without a commensurate reduction in average
selling prices, contributed to the higher operating margins reported in 1996. In
addition to higher volumes and lower fiber costs, operating profit improvements
were generated by manufacturing cost reductions, partially offset by the lower
average selling prices and increased expenses for advertising, consumer
promotion and trade spending.

Packaging Business

Net sales decreased by $520.0 million, or 31 percent, in 1996 compared to 1995.
For the same periods, operating profits, before restructuring and other unusual
items, increased $15.8 million, or 21 percent. The majority of the decline in
sales was due to divestitures. On a pro forma basis, excluding the Flexible
Packaging division and the packaging facilities spun off to Crown Vantage, sales
decreased by $120 million, from $975 million in 1995 to $855 million in 1996,
while operating profits decreased $1 million, from $91 million to $90 million,
respectively. The business' pro forma return on sales improved to 10.5 percent
in 1996 from 9.3 percent in 1995.

<PAGE>

                                                    FORT JAMES CORPORATION 27

   The decline in pro forma sales was principally attributable to lower volumes
for folding cartons, partially offset by increased volumes for coated recycled
board. Selling prices for coated recycled board averaged approximately 10
percent lower in 1996 compared to 1995. Average folding carton prices were
similar in 1996 and 1995, as prices trended higher throughout 1995, before
trending lower during 1996. The improvement in operating profits was
attributable to a combination of lower raw material costs, particularly for
purchased wastepaper, and manufacturing cost reductions, partially offset by the
lower volumes and pricing for certain packaging grades. Operating profits also
improved following the Flexible Packaging sale and the Crown Vantage spin-off,
as these divisions reported operating losses in 1995.

Communications Papers Business

Net sales decreased by $634.7 million, or 58 percent, in 1996 compared to 1995.
For the same periods, operating profits, before restructuring and other unusual
items, declined $169.0 million, or 88 percent. The majority of the decline in
sales was due to the August 1995 spin-off of Crown Vantage. On a pro forma
basis, excluding the communications papers facilities spun off to Crown Vantage,
sales decreased by $189 million, from $646 million in 1995 to $457 million in
1996, and operating profits declined by $105 million, from $127 million to $22
million, respectively. The business' pro forma return on sales declined from
19.7 percent in 1995 to 4.9 percent in 1996.

   The decline in pro forma sales and profits was principally due to
significantly lower average selling prices and unit volumes for both uncoated
free sheet and uncoated groundwood papers. After increasing sharply during the
first nine months of 1995, selling prices fell steadily throughout 1996 due to
major customer inventory corrections combined with weaker demand growth and
excess industry capacity. Selling prices for uncoated free sheet papers averaged
approximately $250 per ton lower in 1996 compared to 1995, while selling prices
for uncoated groundwood papers averaged approximately $50 per ton lower. Unit
volumes declined from 1995 levels by 6 to 7 percent. The majority of the volume
declines occurred in the first half of 1996, as substantial market-related
downtime was taken to prevent a build-up of inventory. The decline in pro forma
profits was partially offset by reduced wood chip costs, which decreased between
20 and 25 percent in 1996 compared to 1995.

Other Income and Expense Items

General corporate expenses, before restructuring and other unusual items,
increased 58 percent, to $124.5 million in 1996 from $79.0 million in 1995. The
increase principally resulted from consulting and other costs incurred during
1996 in installing new integrated management information systems to support the
company's cost reduction initiatives.

   Interest expense decreased by $111.9 million, or 21 percent, from $536.3
million in 1995 to $424.4 million in 1996 principally due to significant
reductions in outstanding debt. The application of divestiture proceeds (net of
acquisitions), common stock issuance proceeds and free cash flows to pay down
debt resulted in a $1,761 million reduction in debt, from $6,195 million at the
beginning of 1996 to $4,434 million as of the end of 1996.

   Other income declined by $23.3 million, from $42.0 million in 1995 to $18.7
million in 1996, largely due to an $18 million reduction in equity earnings of
unconsolidated affiliates and a $3 million reduction in interest income. The
company's share of earnings of Aracruz Celulose S.A., the world's largest
producer of eucalyptus market pulp, was lower in 1996 following the downturn in
worldwide market pulp prices during 1996.

   Fort James' reported effective tax rate was 33.9 percent in 1996, compared to
44.2 percent in 1995. Excluding restructuring and other unusual items, the 1996
tax deduction of 1988 LBO expenses and the 1995 French tax rate increase, the
effective tax rate declined to 39.8 percent in 1996 compared to 41.4 percent
1995. This recurring effective tax rate declined primarily due to the decreased
relative size of non-deductible items.

<PAGE>

MANAGEMENT'S DISCUSSION
and analysis of financial condition
and results of operations

28  FORT JAMES CORPORATION

Liquidity and
Capital Resources

Operating Activities

Cash provided by operating activities totaled $764.2 million in 1997 compared to
$1,084.6 million in 1996. Working capital reductions generated $230.3 million of
cash in 1996, while working capital increases used cash of $163.4 million in
1997. A portion of the working capital increase in 1997 related to the
termination of a $60 million Fort Howard accounts receivable securitization
facility and a planned increase in inventories in anticipation of mill closures.

Investing Activities

Net cash used for investing activities totaled $297.7 million in 1997 and
included $505.9 million of capital expenditures, net of $190.1 million of cash
proceeds from asset sales and $18.1 million of other miscellaneous cash
proceeds. During 1996, net cash used for investing activities totaled $192.5
million and included $499.5 million of capital expenditures and $199.9 million
of cash paid for the remaining 14 percent minority interest in the company's
European Consumer Products Business, net of $496.6 million of cash proceeds from
asset sales and $10.3 million of other miscellaneous cash proceeds.

   Cash proceeds from assets sales in 1997 totaled $190.1 million, primarily
from the sale of its remaining 232,000 acres of timberlands in the southeastern
U.S. and in Maine, pursuant to an ongoing timberlands divestiture program.
Divestitures are detailed in Note 2.

   Capital spending of $505.9 million in 1997 was only slightly higher than the
$499.5 million spent in 1996. Approximately three-quarters of the total 1997
expenditures were within the Consumer Products Businesses, including
approximately $68 million of spending on tissue converting modernizations and
$45 million of spending on a new tissue machine under construction at the
company's Rincon, Georgia mill. The company currently expects 1998 capital
spending to be in the range of $550 million, reflecting the spending to complete
the new Rincon tissue machine in the fall. Contractual capital commitments as of
December 28, 1997, were not material.

Financing Activities

Total indebtedness decreased by $244.3 million in 1997, principally from the use
of free cash flows and divestiture proceeds. During 1997, new borrowings totaled
$2,200.9 million and debt payments totaled $2,378.4 million, principally
associated with the company's refinancings. Additionally, changes in currency
translation rates reduced debt denominated in foreign currencies by $66.8
million.

   As of December 28, 1997, Fort James and its subsidiaries had domestic and
foreign revolving credit facilities providing for unsecured borrowings of up to
$2,790 million, of which $2,500 million expire in 2002 and the balance expire
between 1998 and 2000. The company also had domestic and foreign commercial
paper programs, supported by the revolving credit facilities, providing for
issuances of up to $583.5 million. In addition, Fort James had agreements with
several banks under which it may borrow funds on an uncommitted basis at
below-prime rates. On December 28, 1997, the company had outstanding borrowings
of $1,731.5 million that were supported by the revolving credit facilities.

   As of the end of 1997, Fort James' weighted-average interest rate was 7.19
percent (including the impact of the interest rate swaps), compared to 8.24
percent as of the end of 1996. The company's total debt portfolio is sensitive
to changes in interest rates. Interest rate changes would result in gains or
losses in the market value of the company's debt portfolio due to differences
between market interest rates and rates at the inception of the debt agreements.
Based on the company's debt portfolio outstanding at December 28, 1997, and
current market perception, a 10 basis point change in interest rates as of
December 28, 1997 would have changed the fair value of the debt portfolio by
approximately $12.3 million, and made an immaterial change to the fair value of
the interest rate swap portfolio discussed below. See Note 9 for additional
information.

   Total outstanding debt of $4,190 million on December 28, 1997, included
approximately $2,224 million of fixed rate and $1,966 million of floating rate
obligations. The company manages its ratio of fixed to floating rate debt with
the objective of achieving a mix that management believes is appropriate. To
manage this mix in a cost-effective manner, the company enters into interest
rate swap agreements, in which it agrees to exchange

<PAGE>

                                                      FORT JAMES CORPORATION 29

various combinations of fixed and/or variable interest rates based on agreed
upon notional amounts. The company had $1,138 million and $1,286 million in
notional amounts of interest rate swap agreements in effect as of December 28,
1997, and December 29, 1996, respectively. The strategy employed by the company
to manage its exposure to interest rate fluctuations is consistent with that of
prior years. Management does not foresee or expect any significant changes in
its exposure to interest rate fluctuations or in how such exposure is managed in
the near future. Additional information on interest rate management activities
is provided in Note 10.

   The company's most restrictive debt covenants contain limitations on
borrowings and require maintenance of a minimum ratio of net tangible assets. As
of December 28, 1997, under the most restrictive provision of the company's debt
agreements, Fort James had additional borrowing capacity of $1.9 billion.

   As of December 28, 1997, the company's debt ratings were investment grade and
were as follows:

<TABLE>
<CAPTION>
                                                                  Preferred     Commercial
                                    Outlook       Senior Debt       Stock          Paper
-------------------------------------------------------------------------------------------
<S> <C>
Moody's Investor Services            Stable          Baa3            ba2        Prime-3
Standard & Poor's                    Stable          BBB-            BB+            A-3
</TABLE>

   As of December 28, 1997, Fort James had $352.7 million face value of
outstanding preferred stocks. All of the company's preferred stocks are
redeemable at its option, at any time, at face value. The preferred stocks are
also convertible, at the option of the holder, into common stock at conversion
prices ranging between $36.69 and $37.38 per common share. When the common stock
price is at a sufficient premium to the conversion prices, the company may
consider calling these preferred stocks for redemption. During 1997, the company
converted its Series P 9% preferred stock, having a face value of $287.5
million, into 15.3 million shares of common stock, and redeemed its Series O
8.25% preferred stock, having a face value of $98.1 million, for cash.

   Dividends paid increased to $121.6 million in 1997, compared to $97.2 million
in 1996. The increase was due to a combination of increased common dividend
payments, partially offset by reduced preferred dividends. Common dividends
increased due to both timing (four common dividend payment dates occurred in
fiscal 1997 while only three quarterly dividend payments dates occurred in
fiscal 1996) and the payment of common dividends to former Fort Howard
shareholders. Prior to the merger, Fort Howard did not pay a common dividend.
The conversion and redemption of the Series P and Series O preferred stocks will
reduce annual net dividend payments by approximately $25 million.

   The company's international operations create exposure to foreign currency
exchange rate risks. To manage these risks, the company utilizes foreign
exchange contracts. As of December 28, 1997, and December 29, 1996, the company
had outstanding foreign exchange contracts of $304 million and $47 million in
notional amount, respectively, to hedge firm and anticipated purchase
commitments and firm sales commitments denominated in foreign currencies. The
use of these derivative financial instruments allows the company to reduce its
overall exposure to exchange rate movements, since the gains and losses on these
contracts substantially offset losses and gains on the assets, liabilities and
transactions being hedged. As of December 28, 1997 and December 29, 1996, Fort
James had unrealized gains (losses) on foreign currency exposures of $.5 million
and $(.1) million, respectively, primarily related to French francs, British
pounds, Spanish pesatas and Dutch guilders. A 10% change from the prevailing
market rates of these foreign currencies would not have a material effect on the
results of operations. Management does not foresee or expect any significant
changes in foreign currency exposure or in the strategies it employs to manage
such exposures in the near future. In the first quarter of 1997, the company
unwound $470 million in notional amount of foreign exchange contracts at a cost
of $31.5 million, net of taxes. These contracts had been designated as hedges of
a portion of the company's net investment in its European Consumer Products
Business, which is no longer hedged.

Environmental Matters

Like its competitors, Fort James is subject to extensive regulation by various
federal, state, provincial, and local agencies concerning compliance with
environmental control statutes and regulations. These regulations

<PAGE>

MANAGEMENT'S DISCUSSION
and analysis of financial condition
and results of operations


30 FORT JAMES CORPORATION

impose limitations on the discharge of materials into the environment, as well
as require the company to obtain and operate in compliance with the conditions
of permits and other governmental authorities.

   Fort James has made and will continue to make substantial capital investments
and operating expenditures, as well as production adjustments, to comply with
increasingly stringent standards for air, water, and solid and hazardous waste
regulations. Capital expenditures totaling approximately $15 million in 1997 and
$30 million in 1996 were made by Fort James for pollution control facilities and
equipment.

   In 1997, the U.S. Environmental Protection Agency ("EPA") published
regulations, generally referred to as the "Cluster Rules", affecting pulp and
paper industry discharges of wastewater and gaseous emissions. These rules
require changes in the pulping and bleaching processes presently used in some
U.S. pulp mills, including several of Fort James' mills. Based on its evaluation
of the rules, the company believes that capital expenditures totaling
approximately $100 million may be required, the majority of which will be spent
in the next three to four years.

   As of December 28, 1997, Fort James had been identified as a "potentially
responsible party," along with others, under federal or state laws with respect
to various sites where hazardous substances or other contaminants are located.
Note 15 provides information on the company's accrued remediation liabilities.

Contingent Liabilities

During 1994, James River was sued in Alabama and in Connecticut by former
holders of James River's 10 3/4% Debentures due October 1, 2018, all of which
were either retired in a tender offer or redeemed in the fall of 1992. In
general, the complaints alleged violations of certain covenants and disclosure
obligations, and sought damages in excess of $50 million plus punitive damages
in excess of $500 million. In June 1997, the Alabama court granted the company's
motion for summary judgement and dismissed the action. The Alabama plaintiffs
have appealed. Fort James believes that these claims are without merit and
intends to defend them vigorously. In 1996 and 1997, the company settled the
claims of all non-Alabama suit holders, representing approximately 55 percent of
the debentures, for a total of $1.4 million plus reimbursement of attorney fees.

   During 1997, civil actions were filed in several jurisdictions against Fort
James and various other manufacturers of sanitary paper products alleging
violations of federal and state antitrust and unfair competition laws. This
litigation is in its early stages. The Company believes these cases are without
merit and intends to defend the litigation vigorously. Further information on
Fort James' legal matters is included in Note 15.

Effect of New Accounting Standards

During 1997 and 1998, the Financial Accounting Standards Board issued several
new disclosure-related accounting standards, effective for 1998. These new
standards are described in Note 1.

Information Concerning
Forward-Looking
Statements

Certain sections of this annual report contain forward-looking statements, which
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are made based upon
management's expectations and beliefs concerning future events impacting the
company. Such forward-looking statements are not guarantees of future
performance and are subject to risks and uncertainties that could cause actual
results and company plans and objectives to differ materially from those
projected. Such risks and uncertainties include, but are not limited to, general
business and economic conditions; competitive pricing pressures for the
company's products; changes in raw material, energy and other costs;
opportunities that may be presented to and pursued by the company;
determinations by regulatory and governmental authorities; the ability to
successfully integrate the James River and Fort Howard businesses; and the
ability to achieve synergistic and other cost reductions and efficiencies.

<PAGE>

CONSOLIDATED
statements of operations

                                                       FORT JAMES CORPORATION 31

<TABLE>
<CAPTION>
                                           52 Weeks      52 Weeks       53 Weeks
                                            Ended          Ended          Ended
                                          December 28,  December 29,   December 31,
(in millions, except per share amounts)      1997           1996           1995
------------------------------------------------------------------------------------
<S> <C>

Net sales                                 $ 7,259.0      $ 7,707.1      $ 8,887.9
Cost of goods sold                          5,077.7        5,564.2        6,835.2
Selling and administrative expenses         1,124.4        1,222.9        1,217.4
Restructure and other unusual items           454.2           10.7           51.9
------------------------------------------------------------------------------------
         Income from operations               602.7          909.3          783.4
Interest expense                              351.8          424.4          536.3
Other income, net                              21.4           18.7           42.0
------------------------------------------------------------------------------------
         Income before income taxes,
            minority interests and
            extraordinary item                272.3          503.6          289.1
Income tax expense                            164.0          171.0          127.8
------------------------------------------------------------------------------------
         Income before minority
            interests and
            extraordinary item                108.3          332.6          161.3
Minority interests                             (3.8)          (4.6)          (1.4)
------------------------------------------------------------------------------------
         Income before extraordinary
            item                              104.5          328.0          159.9
Extraordinary loss on early
   extinguishment of debt, net of
   taxes of $83.5 million in 1997,
   $5.3 million in 1996 and $11.9
   million in 1995                           (131.5)          (8.1)         (18.8)
------------------------------------------------------------------------------------
                  Net income (loss)       $   (27.0)     $   319.9      $   141.1
====================================================================================
Preferred dividend requirements               (43.4)         (58.5)         (58.5)
------------------------------------------------------------------------------------
                  Net income (loss)
                    applicable to
                    common shares         $   (70.4)     $   261.4      $    82.6
====================================================================================
Net income (loss) per share:
         Before extraordinary item        $     .31      $    1.49      $     .62
         Extraordinary loss on
            early extinguishment
            of debt                            (.67)          (.05)          (.11)
------------------------------------------------------------------------------------
                  Net income (loss)
                     per share            $    (.36)     $    1.44      $     .51
====================================================================================
Weighted-average number of
   common shares                              195.5          181.4          163.4
====================================================================================
Net income (loss) per share --
   assuming dilution:
         Before extraordinary item        $     .35      $    1.47      $     .62
         Extraordinary loss on
            early extinguishment
            of debt                            (.63)          (.04)          (.12)
------------------------------------------------------------------------------------
                  Net income (loss)
                    per share             $    (.28)     $    1.43      $     .50
====================================================================================
Weighted-average number of common
   shares and common share
   equivalents                                207.6          183.1          164.1
====================================================================================
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

<PAGE>

CONSOLIDATED
balance sheets

32 FORT JAMES CORPORATION

<TABLE>
<CAPTION>

                                                      December 28,   December 29,
(in millions)                                             1997          1996
------------------------------------------------------------------------------------
<S> <C>
Assets
Current assets:
         Cash and cash equivalents                          $   33.6      $   34.6
         Accounts receivable                                   787.8         781.3
         Inventories                                           854.3         801.6
         Deferred income taxes                                 214.4         138.5
         Prepaid expenses and other current assets              26.4          52.6
------------------------------------------------------------------------------------
                  Total current assets                       1,916.5       1,808.6
------------------------------------------------------------------------------------
Property, plant and equipment                                4,565.3       4,999.3
Goodwill                                                       636.9         730.0
Other assets                                                   614.5         619.0
------------------------------------------------------------------------------------
                     Total assets                           $7,733.2      $8,156.9
====================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
         Accounts payable                                   $  636.5      $  607.3
         Accrued liabilities                                   913.0         805.8
         Current portion of long-term debt                      34.4         128.9
------------------------------------------------------------------------------------
                  Total current liabilities                  1,583.9       1,542.0
------------------------------------------------------------------------------------
Long-term debt                                               4,155.5       4,305.3
Deferred income taxes                                          650.8         690.5
Accrued postretirement benefits other than pensions            474.8         475.9
Other long-term liabilities                                    283.9         291.7
------------------------------------------------------------------------------------
                  Total liabilities                          7,148.9       7,305.4
------------------------------------------------------------------------------------
Shareholders' equity:
         Preferred stock                                       352.7         738.4
         Common stock, $.10 par value; shares outstanding
            1997--209.3 million and 1996--188.5 million         20.9          18.9
         Additional paid-in capital                          2,807.9       2,407.0
         Retained deficit                                   (2,597.2)     (2,312.8)
------------------------------------------------------------------------------------
                  Total shareholders' equity                   584.3         851.5
------------------------------------------------------------------------------------
                     Total liabilities and shareholders'
                         equity                             $7,733.2      $8,156.9
====================================================================================
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

<PAGE>

CONSOLIDATED
statements of cash flows

                                                 FORT JAMES CORPORATION 33
<TABLE>
<CAPTION>
                                                                 52 Weeks        52 Weeks        53 Weeks
                                                                   Ended          Ended           Ended
                                                                December 28,   December 29,    December 31,
(in millions)                                                      1997            1996            1995
-----------------------------------------------------------------------------------------------------------
<S> <C>
Cash provided by (used for) operating activities:
         Net income (loss)                                         $(27.0)      $  319.9       $  141.1
         Depreciation expense and cost of timber harvested          474.7          502.5          560.3
         Amortization of goodwill                                    20.1           21.4           24.4
         Deferred income tax provision (benefit)                    (41.4)          53.7           49.4
         Restructure and other unusual items                        454.2           10.7           51.9
         Loss on early extinguishment of debt, net of tax           131.5            8.1           18.8
Change   in current assets and  liabilities,  net of effects
         of acquisitions and dispositions:
         Accounts receivable                                        (88.8)          96.1           18.8
         Inventories                                                (79.7)          82.5          (80.5)
         Other current assets                                        23.5           (2.1)           3.7
         Accounts payable and accrued liabilities                   (18.4)          53.8          (28.2)
         Foreign currency hedge                                     (31.5)
         Other, net                                                 (53.0)         (62.0)           6.5
-----------------------------------------------------------------------------------------------------------
                  Cash provided by operating activities             764.2        1,084.6          766.2
-----------------------------------------------------------------------------------------------------------
Cash provided by (used for) investing activities:
         Expenditures for property, plant and equipment            (505.9)        (499.5)        (488.5)
         Cash paid for acquisitions, net                                          (199.9)         (52.5)
         Cash received from sale of assets                          190.1          496.6           10.9
         Other, net                                                  18.1           10.3           50.9
-----------------------------------------------------------------------------------------------------------
                  Cash used for investing activities               (297.7)        (192.5)        (479.2)
-----------------------------------------------------------------------------------------------------------
Cash provided by (used for) financing activities:
         Additions to long-term debt                              2,200.9            4.2        1,476.9
         Payments of long-term debt                              (2,378.4)      (1,049.2)      (2,419.4)
         Debt premiums and issuance costs                          (152.3)          (1.5)         (50.1)
         Proceeds from spin-off of Crown Vantage Inc.                                             480.4
         Common stock issued, net of offering costs                                203.8          284.1
         Preferred stock redeemed                                   (98.1)          (1.9)
         Common and preferred stock cash dividends paid            (121.6)         (97.2)        (120.4)
         Common stock issued on exercise of stock options            82.0           16.1           68.8
         Other, net                                                                  1.2
-----------------------------------------------------------------------------------------------------------
                  Cash used for financing activities               (467.5)        (924.5)        (279.7)
-----------------------------------------------------------------------------------------------------------
         Increase (decrease) in cash and cash equivalents            (1.0)         (32.4)           7.3
         Cash and cash equivalents, beginning of year                34.6           67.0           59.7
-----------------------------------------------------------------------------------------------------------
                  Cash and cash equivalents, end of year         $   33.6       $   34.6       $   67.0
===========================================================================================================
</TABLE>


The accompanying notes are an integral part of the consolidated financial
statements.

<PAGE>

CONSOLIDATED
statements of changes
in capital accounts

34  FORT JAMES CORPORATION

<TABLE>
<CAPTION>
                                                  52 Weeks          52 Weeks             53 Weeks
                                                    Ended             Ended                Ended
                                                 December 28,      December 29,         December 31,
(in millions)                                        1997               1996               1995
------------------------------------------------------------------------------------------------------
<S> <C>
Preferred stock
         Balance, beginning of year                $  738.4          $  740.3             $  740.3
         Conversion of preferred stock               (287.6)
         Redemption of preferred stock                (98.1)             (1.9)
------------------------------------------------------------------------------------------------------
                  Balance, end of year             $  352.7          $  738.4             $  740.3
======================================================================================================
Common shareholders' equity (deficit)
Common stock:
         Balance, beginning of year                $   18.9          $   17.2             $   13.4
         Common stock offerings                                           1.5                  3.5
         Conversion of preferred stock                  1.5
         Exercise of stock options and awards            .4                .1                   .3
         Other                                           .1                .1
------------------------------------------------------------------------------------------------------
                  Balance, end of year                 20.9              18.9                 17.2
------------------------------------------------------------------------------------------------------
Additional paid-in capital:
         Balance, beginning of year                 2,407.0           2,181.7              1,807.2
         Common stock offerings                                         202.3                280.6
         Conversion of preferred stock                286.1
         Exercise of stock options and
            awards, net of tax effect                 103.7              18.8                 82.2
         Restricted stock compensation earned          13.1               3.0
         Other                                         (2.0)              1.2                 11.7
------------------------------------------------------------------------------------------------------
                  Balance, end of year              2,807.9           2,407.0              2,181.7
------------------------------------------------------------------------------------------------------
Retained deficit:
         Balance, beginning of year                (2,312.8)         (2,523.4)            (2,547.7)
         Net income (loss)                            (27.0)            319.9                141.1
         Common stock cash dividends declared         (88.5)            (51.2)               (50.0)
         Preferred stock cash dividends declared      (43.4)            (58.5)               (58.5)
         Spin-off of Crown Vantage Inc.                                                      (38.2)
         Change in equity component of minimum
            pension liability                           3.0              11.6                   .5
         Unrealized gain (loss) on securities          13.9               4.4                 (6.1)
         Foreign currency translation and other      (142.4)            (15.6)                35.5
------------------------------------------------------------------------------------------------------
                  Balance, end of year             (2,597.2)         (2,312.8)            (2,523.4)
------------------------------------------------------------------------------------------------------
                     Common shareholders' equity
                       (deficit), end of year      $  231.6          $  113.1             $ (324.5)
======================================================================================================
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

<PAGE>

NOTES
to consolidated
financial statements

                                                       FORT JAMES CORPORATION 35

NOTE 1
Summary of
Significant
Accounting
Policies


Basis of Presentation

The consolidated financial statements of Fort James Corporation ("Fort James" or
the "Company") have been prepared to give retroactive  effect to the merger of a
wholly-owned  subsidiary of James River  Corporation of Virginia ("James River")
with and into Fort  Howard  Corporation  ("Fort  Howard")  on August  13,  1997,
accounted  for as a pooling of interests  (see Note 2). In  connection  with the
merger,   James  River  was  renamed  Fort  James  Corporation.

Principles  of Consolidation

The  consolidated  financial  statements  present  the  operating results  and
financial   position  of  Fort  James  and  its  majority   owned subsidiaries.
Significant  intercompany  balances  and  transactions  have been eliminated.
Investments  in  unconsolidated  affiliates  which are at least 20% owned are
accounted for using the equity method and are stated at cost plus the Company's
share of  undistributed  earnings  and foreign  currency  translation
adjustments,  as applicable,  since acquisition.

Fiscal Year

Fort James' fiscal year  includes  the 52 or 53 weeks  ending on the last Sunday
in  December.  The years ended  December 28, 1997,  and December 29, 1996,  each
included 52 weeks while the year ended December 31, 1995,  included 53 weeks. In
1995, the Company changed  the  fiscal  year end of Jamont  N.V.,  part of the
European  Consumer Products  Business,  from  November 30 to December 31 to
eliminate the one-month lag in reporting.  The one-month lag was eliminated as
an adjustment to retained deficit.

Use of Estimates

Financial  statements  prepared in  conformity  with generally  accepted
accounting  principles require management to make estimates and  assumptions
that affect  amounts  reported  therein.  Actual results could differ from those
estimates.

Cash and Cash Equivalents

The Company invests cash in marketable  securities,  including  commercial
paper,  government  repurchase agreements, and time deposits, with original
maturities of three months or less. The carrying value of cash and cash
equivalents  approximates fair value because of the short maturity of these
investments.

Inventories

Inventories are stated at the lower of cost or market  and  include  the cost of
materials,  labor and manufacturing overhead. The last-in,  first-out cost flow
assumption is used for valuing  substantially all domestic  inventories other
than stores and supplies. Other inventories,  including  substantially all
inventories held by Fort Howard prior to the  merger  and  foreign subsidiaries,
are  valued  using  first-in, first-out or average cost assumptions.

Property,  Plant and Equipment

Property, plant  and  equipment  is  stated  at  cost,  less   accumulated
depreciation. Expenditures for improvements which increase asset values or
extend useful lives are  capitalized.  Maintenance  and repair costs are
expensed as incurred.  For financial reporting  purposes,  depreciation is
computed using the straight-line method over the estimated  useful lives of the
respective  assets,  which range from 20 to 50 years for  buildings and
generally 5 to 25 years for machinery and equipment. For income tax purposes,
depreciation is calculated using accelerated methods.  Certain assets are
depreciated using composite  depreciation  methods; accordingly,  no gain or
loss is recognized on partial sales or  retirements  of these assets.

Timber and Timberlands

Timber and timberlands are stated at cost less accumulated cost of timber
harvested.  Cost of timber harvested is recorded as  timber  is  cut  at  rates
which  are  determined  annually  based  on  the relationship of unamortized
timber cost to the estimated  volume of recoverable timber.

<PAGE>

NOTES
to consolidated
financial statements

36  FORT JAMES CORPORATION

Intangible  Assets

The excess of the purchase price over the fair value of  identifiable  net
assets of acquired  companies is allocated to goodwill and amortized over 40
years.  Goodwill is presented net of accumulated  amortization of $128.8 million
as of December 28, 1997, and $108.7 million as of December 29, 1996. Differences
between  the  Company's  carrying  value of  investments  in unconsolidated
affiliates  and its share of the  underlying  net assets of such affiliates are
amortized over periods of up to 40 years. The  recoverability  of goodwill is
periodically  evaluated  to  determine  whether  current  events or
circumstances  warrant  adjustments to the carrying  value.  Such  evaluation is
based  upon  whether  the  goodwill  is fully  recoverable  from  the  projected
undiscounted  cash  flows of the  assets and  businesses  to which the  goodwill
relates.

Interest Costs

The Company  capitalizes  interest costs as part of the cost of constructing
certain facilities and equipment.

(in millions)                            1997       1996      1995
---------------------------------------------------------------------
Total interest costs                    $362.8     $431.0    $545.3
Interest capitalized                     (11.0)      (6.6)     (9.0)
---------------------------------------------------------------------
         Net interest expense           $351.8     $424.4    $536.3
=====================================================================
                  Interest paid         $379.2     $417.6    $551.8
=====================================================================

Other Operating Expenses

Research and  development  expenditures  are  expensed as  incurred.  Direct and
readily  identifiable  indirect  research and  development  costs  totaled $40.9
million in 1997,  $49.8 million in 1996 and $56.1  million in 1995.  Advertising
costs are  expensed as incurred and  amounted to $102.9  million in 1997,  $94.4
million in 1996 and $101.6 million in 1995.

Foreign  Currency  Translation

The accounts of most foreign  subsidiaries  and  affiliates are measured using
local currency as the functional currency. For those entities,  assets and
liabilities are translated into U.S.  dollars at period-end  exchange rates, and
income and expense  accounts are translated at average monthly exchange rates.
Net exchange gains or losses  resulting from such  translation are excluded from
net earnings and accumulated as a separate  component of retained  deficit.
Gains and losses from foreign currency transactions are included in other
income. The U.S. dollar is used as the functional currency for subsidiaries and
affiliates  operating in highly inflationary economies,  for which both
translation adjustments and gains and losses on foreign currency  transactions
are included in other income.

    The change in the cumulative gain (loss)  included in the  translation
component of retained  deficit  resulting from the  translation of assets and
liabilities of foreign subsidiaries and affiliates,  net of the effect of
exchange rate hedges, was as follows:

(in millions)                     1997       1996        1995
---------------------------------------------------------------------
Balance, beginning of year     $  (5.3)     $ 10.3     $(33.6)
Translation adjustments         (139.4)      (11.7)      19.3
Related income tax effect         (3.0)       (3.9)      24.6
---------------------------------------------------------------------
       Balance,  end of  year  $(147.7)     $ (5.3)    $ 10.3
=====================================================================

Derivative Financial Instruments

The Company's debt structure and international  operations create  exposure to
interest rate and foreign  currency  exchange rate risks. To manage  these
risks,  derivative  financial  instruments  are  utilized  by the Company.  They
include interest rate swaps,  caps,  options and foreign exchange contracts.


<PAGE>





                                                       FORT JAMES CORPORATION 37

        The Company does not hold or issue financial  instruments for trading
purposes. Translation  gains and losses on hedges of net foreign  investments
are deferred and  accumulated  in the  foreign  currency  translation  component
of retained deficit.  Gains and losses on transactional  hedges are recognized
in income and offset the foreign exchange gains and losses on related
transactions. Unrealized gains and losses on interest  rate swap and option
agreements  accounted for as hedges are  deferred;  related  interest  income
and  expense is  recognized  as incurred.  The cost of interest  rate option
agreements  is amortized  over the respective  lives of the agreements.

        Occasionally,  the Company may terminate a derivative  financial
instrument. If an interest  rate swap,  cap or option is terminated because
related debt no longer exists, any gain or loss is recognized into income
immediately; otherwise,  the gain or loss is deferred and amortized to  interest
expense over the  remaining  periods  originally  covered  by the derivative
contract. If a foreign exchange contract hedging a net investment in a foreign
subsidiary is terminated, the gain or loss is recognized in a separate component
of equity, net of tax, consistent with the accounting treatment of the hedged
item.  If a transactional  hedge  is  terminated,  the  gain or loss is
recognized  in income.

Net Income  (Loss)  Per  Common  Share and Common  Share Equivalent

In February 1997, the Financial  Accounting  Standards Board ("FASB")
issued Statement No. 128,  "Earnings Per Share" ("SFAS 128"), which is effective
for periods ending after December 15, 1997, including interim periods.  Earnings
per share for the three years ended  December 28, 1997,  were  calculated  under
SFAS 128 as follows:

<TABLE>
<CAPTION>
                                             1997             1996             1995
                                        -------------------------------------------------
(in millions)                           Income   Shares  Income   Shares  Income   Shares
-----------------------------------------------------------------------------------------
<S> <C>
Income before extraordinary item        $104.5           $328.0           $159.9
Preferred stock dividends                (43.4)           (58.5)           (58.5)
-----------------------------------------------------------------------------------------
Amounts used to compute basic
         earnings per share               61.1    195.5   269.5    181.4   101.4    163.4
-----------------------------------------------------------------------------------------
Effect of dilutive securities:
         Options                                    2.5              1.7               .7
         Convertible preferred stock*     12.9      9.6
-----------------------------------------------------------------------------------------
Amounts used to compute diluted
         earnings per share             $ 74.0    207.6  $269.5    183.1  $101.4    164.1
=========================================================================================
</TABLE>

 *Series K, L and N preferred stocks were  antidilutive for all years
presented; Series P  preferred  stock  was  antidilutive  in 1996  and  1995.

Adoption  of Accounting Pronouncements

In 1997, the FASB issued Statement No. 130, "Reporting Comprehensive  Income,"
which will  require  the  Company to report and display comprehensive  income
and Statement No. 131  "Disclosures  about  Segments of an Enterprise  and
Related  Information"  which  establishes  standards for the way public
companies report information about operating segments in both interim and annual
financial  statements,  including related  disclosures about products and
services,  geographic areas, and major customers. The Company has not determined
what,  if any,  impact  Statement  No. 131 will have on the  reported  operating
segments  and the  related  disclosures. These  standards  will  be effective
for the Company's 1998 fiscal year.

Reclassifications

Certain amounts in the  financial  statements  and  supporting  footnote
disclosures  have been reclassified to conform to 1997 classifications including
a reclassification of customer  freight charges from net sales to cost of sales.
Reportable  segments for all periods have been  reconfigured  to include
bleached  board  operations (formerly in the North  American  Consumer  Products
segment) in the  Packaging segment  and to include  the  foodwrap  operations
(formerly  in the  Packaging segment) in the North American Consumer Products
segment.

<PAGE>

NOTES
to consolidated
financial statements

38  FORT JAMES CORPORATION

NOTE 2
Acquisitions,
Dispositions
and Other
Transactions

1997

Effective  August 13, 1997, in connection  with the merger,  the Company  issued
104.8  million  shares of its Common Stock in exchange  for all the  outstanding
common  stock of Fort Howard  based on a  conversion  ratio of 1.375 shares (the
merger  exchange  ratio) of the  Company's  Common  Stock for each share of Fort
Howard common stock, for a total value of $4.6 billion.  The merger qualified as
a tax-free  reorganization and has been accounted for as a pooling of interests.
Accordingly,  the Company's consolidated financial statements have been restated
for all  periods  prior to the  business  combination  to include  the  combined
financial  results of James  River and Fort  Howard.  Net sales,  income  before
extraordinary item and net income for the individual companies reported prior to
the merger were as follows:


                                      Six months        Year           Year
                                         Ended          Ended          Ended
                                        June 29,     December 29,   December 31,
(in millions)                             1997           1996           1995
--------------------------------------------------------------------------------
                                       (Unaudited)
[S] [C]
Net sales:
         James River                      $2,794.3       $5,971.9      $7,141.2
         Fort Howard                         812.2        1,580.8       1,620.9
Reclassifications                             65.6          154.4         125.8
--------------------------------------------------------------------------------
                  Total                   $3,672.1       $7,707.1      $8,887.9
================================================================================
Income before extraordinary item:
         James River                      $  138.3       $  157.3      $  126.4
         Fort Howard                         108.6          170.7          33.5
--------------------------------------------------------------------------------
                  Total                   $  246.9       $  328.0      $  159.9
================================================================================
Net income:
         James River                      $  138.3       $  157.3      $  126.4
         Fort Howard                         106.7          162.6          14.7
--------------------------------------------------------------------------------
                  Total                   $  245.0       $  319.9      $  141.1
================================================================================


The  consolidated  financial information  presented  above  reflects
reclassifications  of customer  freight expenses and certain  trade  promotions
to conform the  classifications  of Fort Howard to those of Fort James.  The
conforming of the  accounting  practices of Fort  James  and  Fort  Howard
resulted  in no  adjustments  to net  income  or shareholders'  equity.  There
were  no  significant  intercompany  transactions between  Fort James and Fort
Howard.

        Cash  proceeds  from asset  sales in 1997 totaling  $190.1  million were
primarily  from the sale of  timberlands  in the southeastern  U.S. and in Maine
pursuant to an ongoing  timberland  divestiture program.

1996

In  September 1996,  the Company  purchased  the  remaining  14% minority
interest in Jamont N.V.,  which is included in the  European  Consumer Products
Business,  under an existing put and call agreement for $199.9 million. Fort
James  recorded the acquisition  of the remaining  14% minority  interest, which
had a book value of $151 million, under the purchase method of accounting.

        In October  1996,  the Company  completed  the sale of its Inks
division of the Packaging Business, which included seven plants, for gross cash
proceeds of $27 million.  This division  manufactured  and sold high quality
inks for packaging applications with annual net sales of approximately $47
million. In August 1996, the Company completed the sale of its Flexible
Packaging  group for gross cash proceeds of $372.7 million.  The Flexible
Packaging group had ten manufacturing facilities, annual net sales of $483
million  and net assets  totaling  $336.7 million, which were net of total
liabilities of $8.4 million.  In May 1996, the Company completed the sale of its
specialty  operations  business,  which was a part of the North  American
Consumer  Products  Business,  for cash proceeds of approximately $30 million
and a combination of subordinated  long-term notes and preferred  stock.  The
specialty  operations  business  had annual net sales of approximately $125
million. Additionally in 1996, the Company sold its Handi-Kup foam cup
operations,  formerly  part of the North  American

<PAGE>





                                                       FORT JAMES CORPORATION 39

Consumer  Products Business, for approximately $52 million. The Handi-Kup
operations had annual net sales of approximately  $96 million.

1995

In August 1995, the Company completed the spin-off to  shareholders  of Crown
Vantage Inc.  ("Crown  Vantage")  which included a large part of the Company's
Communications  Papers  Business,  along with the specialty  paper-based portion
of its Packaging Business.  Net proceeds from Crown  Vantage's  financings
totaling $480 million and  pay-in-kind  notes valued at $85 million were
received by the Company as a result of the spin-off. These  amounts were treated
as a return of the  Company's  investment.  The book value of net assets spun
off to Crown Vantage less proceeds received totaled $38 million which was
recorded as an adjustment to retained  deficit.  The operating results of the
facilities  which now make up Crown Vantage were included in the consolidated
statements of operations and the  consolidated  statements of cash flows for the
eight months (35 weeks) ended August 27, 1995.

    In November  1995, the Company acquired the cutlery division of Benchmark
Holdings,  Inc. for $52.5 million.  In May 1995,  Fort James sold its option to
purchase its partners' 50% interest in the chemical  recovery and cogeneration
facility at the Pennington, Alabama, pulp and paper mill for $22.2 million. Fort
James retained ownership of the  remaining  50% interest in this  facility.

Summary

The purchase  prices of acquisitions were allocated to the acquired net assets
based on their respective fair values.  Acquisitions and dispositions are
summarized  below.

(in millions)                                       1997     1996     1995
---------------------------------------------------------------------------

Acquisitions of consolidated entities:
         Fair value of assets acquired                      $199.9   $55.2
         Liabilities assumed or created                               (2.7)
---------------------------------------------------------------------------
                  Cash paid for acquisitions                $199.9   $52.5
---------------------------------------------------------------------------
Dispositions  (other than Crown Vantage spin-off):
         Fair value of assets sold                  $190.1  $508.9   $13.7
         Non-cash consideration received                     (12.3)   (2.8)
---------------------------------------------------------------------------
                  Cash received from sale of assets $190.1  $496.6   $10.9
===========================================================================


NOTE 3
Restructure
and Other
Unusual
Items

In 1997, the Company  recorded a $454.2 million net charge for  restructure  and
other unusual items primarily  associated with the merger and integration of the
combined   operations.   Included  in  this  total  are  facility  closures  and
write-downs  of  redundant  property,  plant and  equipment  of $234.5  million,
severance  and  other  employee  related  costs  of  $103.1  million,   contract
termination  costs of $82.8 million,  transaction  costs of $54.2  million,  and
other  merger  related  costs  of  $49.2  million  offset  by  gains on sales of
timberlands of $69.6 million. As of December 28, 1997, payments of $87.8 million
have been made for these charges. The Company anticipates that substantially all
of the remaining  restructure  costs will be paid in 1998.

        The facility  closure costs represent the estimated loss on the closure
of facilities primarily in the North American and European Consumer Products
businesses that were necessary to eliminate  redundancies in the combined
company. The charge for property,  plant and equipment  represents  the
write-down to the net  realizable  value of less efficient  and  duplicate
machinery  and  equipment  not needed in the combined restructured manufacturing
operations. The severance and other employee related costs provide for a
reduction of  approximately  3,100 employees  related to the facility closures
duplicate position eliminations and streamlining of operations related to cost
reduction initiatives.  However, approximately 600 new jobs will be created from
the upgrade of remaining  manufacturing  facilities and expanded marketing  and
product   development   capabilities.   The  costs  of  contract terminations
are comprised primarily of supply and sales distributor  contracts.


<PAGE>

NOTES
to consolidated
financial statements

40 FORT JAMES CORPORATION

Transaction costs include  investment  bankers fees, legal fees, and other costs
paid for the consummation of the merger. An additional  estimated $60 million of
nonaccruable  merger-related  costs  will  be  recorded  in  1998  as  incurred.

        Additionally,  the Company had recorded restructuring and other items
charges of $10.7  million and $51.9 million in 1996 and 1995,  respectively.
These charges included $83.3 million of severance charges,  $63.5 million of
asset write-offs, and $5.0 million of transaction costs associated with the
Crown Vantage spinoff, offset by $89.2  million  in net gains on  business
dispositions  (see Note 2). Severance  charges related to approximately  1,250,
580 and 460 employees at the Company's European Consumer Products Business,
North American Consumer Products Business,   and  other   domestic manufacturing
and  corporate   facilities, respectively.  Asset write-downs  related to asset
consolidations in Europe and the  phase-out of certain  packaging  equipment. As
of December  28, 1997,  the amount  remaining in the  accruals for the 1996 and
1995 charges was  immaterial and is expected to be fully utilized in 1998.

NOTE 4
Other
Income

(in millions)                                         1997     1996     1995
-------------------------------------------------------------------------------
Equity in earnings of unconsolidated affiliates      $ 7.4     $ 7.7    $25.7
Interest income                                        8.6       8.1     11.4
Gain on sale of assets                                 9.6       3.4      4.7
Foreign currency exchange gains (losses)              (4.8)       .6      (.4)
Other, net                                              .6      (1.1)      .6
-------------------------------------------------------------------------------
                  Total other income                 $21.4     $18.7    $42.0
===============================================================================

NOTE 5
Income
Taxes

The components of income before income taxes, minority interests and
extraordinary item were as follows:

(in millions)                                        1997     1996      1995
-------------------------------------------------------------------------------
Domestic                                            $192.9    $405.9    $236.3
Foreign                                               79.4      97.7      52.8
-------------------------------------------------------------------------------
    Income before income taxes, minority interests
       and extraordinary item                       $272.3    $503.6    $289.1
===============================================================================

Income tax expense (benefit) excluding income taxes on extraordinary item,
consisted of the following:

(in millions)                                        1997      1996     1995
-------------------------------------------------------------------------------
Current:
         Federal                                    $135.4    $ 67.9   $ 66.2
         State                                        29.2      13.3      7.1
         Foreign                                      40.8      36.1      5.1
-------------------------------------------------------------------------------
             Total current income tax provision      205.4     117.3     78.4
-------------------------------------------------------------------------------
Deferred:
         Federal                                     (19.4)     42.0     18.5
         State                                       (15.6)      3.8      5.4
         Foreign                                      (6.4)      7.9     25.5
-------------------------------------------------------------------------------
             Total deferred income tax
               provision (benefit)                   (41.4)     53.7     49.4
-------------------------------------------------------------------------------
                  Income tax expense                $164.0    $171.0   $127.8
===============================================================================


<PAGE>

                                                       FORT JAMES CORPORATION 41


During 1997, 1996 and 1995, tax benefits credited to shareholders' equity, which
primarily related to the redemption of stock options, were $35.1 million, $3.0
million and $12.4 million, respectively. Cash payments for income taxes totaled
$125.9 million in 1997, $108.0 million in 1996 and $73.0 million in 1995. No
provision for income taxes has been made for $54.7 million of undistributed
earnings of certain of the Company's foreign subsidiaries and affiliates which
have been indefinitely reinvested. It is not practicable to determine the amount
of U.S. income tax which would be payable if such undistributed foreign earnings
were repatriated because any U.S. taxes payable on such repatriation would be
offset, at least in part, by foreign tax credits.

     The difference between the federal statutory income tax rate on income
before income taxes, minority interests, and extraordinary item and the
Company's effective income tax rate relates to the following:

<TABLE>
<CAPTION>
                                                             Percent of Pretax Income
                                                             ------------------------
                                                               1997     1996    1995
-------------------------------------------------------------------------------------
<S> <C>
Federal statutory income tax rate                              35.0%    35.0%   35.0%
State income taxes, net of federal income tax effect            3.2      2.5     3.6
Restructured operations                                         9.2
Nondeductible transaction expenses                              4.9
Federal audit settlement                                                (7.2)
Foreign losses not benefited                                                     3.6
Goodwill                                                        4.1      2.3     2.7
Other items, net                                                3.8      1.3    (3.2)
-------------------------------------------------------------------------------------
         Effective income tax rate on current income           60.2%    33.9%   41.7%
-------------------------------------------------------------------------------------
Effect of increase in income tax rate                                            2.5
-------------------------------------------------------------------------------------
         Effective income tax rate                             60.2%    33.9%   44.2%
=====================================================================================
</TABLE>


In August 1995, the French Parliament passed a law imposing a 10% tax surcharge
on the normal corporate tax rate. The Company recorded a $7.4 million charge
($6.3 million, net of minority interests) to increase the deferred tax liability
for the effect of this increase in tax rate.

     In December 1996, following a retroactive amendment to the Internal Revenue
Code, the United States Tax Court issued a favorable decision allowing certain
deductions claimed by Fort Howard in the years 1988 through 1995. As a result of
this decision, Fort James realized a $36 million tax benefit representing the
reversal of taxes previously accrued for these years. The Internal Revenue
Service is currently reviewing Fort James' federal income tax returns for the
years 1989 through 1995. In the opinion of management, potential adjustments
resulting from these examinations will not have a material effect on the
Company's results of operations or financial condition.

     The income tax effects of temporary differences that gave rise to the net
deferred tax liability as of December 28, 1997, and December 29, 1996, were
related to the following:

(in millions)                                        1997              1996
--------------------------------------------------------------------------------
Property, plant and equipment                      $  904.4         $  928.3
Pension benefits                                       88.5             75.3
Other items                                            91.8             64.1
--------------------------------------------------------------------------------
                  Total deferred tax liabilities    1,084.7          1,067.7
--------------------------------------------------------------------------------
Accrued liabilities                                  (290.2)          (148.5)
Postretirement benefits other than pensions          (187.0)          (181.3)
Alternative minimum tax credit carryforwards          (87.7)           (99.5)
Intangibles                                           (77.4)           (59.6)
Tax loss carryforwards                                (26.3)           (62.7)
Other items                                           (66.1)           (43.4)
--------------------------------------------------------------------------------
                  Total deferred tax assets          (734.7)          (595.0)
--------------------------------------------------------------------------------
                  Valuation allowance                  86.4             79.3
--------------------------------------------------------------------------------
                     Net deferred tax liability    $  436.4         $  552.0
================================================================================


<PAGE>

NOTES
to consolidated
financial statements

FORT JAMES CORPORATION 42

The change in the valuation allowance from December 29, 1996, to December 28,
1997, is primarily related to the effects of a French law change offset by the
usage of foreign net operating losses not previously recognized. If recognized
in the future, $39.0 million of these tax benefits will be allocated to reduce
goodwill of certain acquired subsidiaries.

     As of December 28, 1997, the Company had $64.5 million of foreign net
operating loss carryforwards which expire primarily from 1998 through 2004 and
$1.8 million of foreign tax credit carryforwards which expire from 1998 through
2002. The Company also had alternative minimum tax ("AMT") credit carryforwards
of $87.7 million which have been reflected as a reduction of deferred taxes. AMT
credits may generally be carried forward indefinitely and used in future years
to the extent the Company's regular tax liability exceeds the AMT liability for
such future years.

NOTE 6
PENSION
  PLANS

Pursuant  to  pre-existing  James River  plans,  the  Company  sponsors  various
noncontributory  pension plans which cover  substantially all of the James River
employees, and also participates in several multiemployer retirement plans which
provide defined  benefits to those James River  employees  covered under certain
collective  bargaining  agreements.  Fort  Howard did not  sponsor  any  defined
benefit plans for its employees. Benefits under the majority of plans for hourly
employees are primarily based on stated  benefits per year of credited  service.
Benefits for salaried  employees are primarily related to compensation and years
of credited service.  The Company makes contributions to its plans sufficient to
meet the minimum funding  requirements  of applicable laws and regulations  plus
additional  amounts, if any, as the Company, in consultation with its actuaries,
deems to be  appropriate.  Contributions  to  multiemployer  plans are generally
based on negotiated labor contracts.  The Company's  contributions totaled $17.2
million,  $19.5 million and $32.6 million in 1997, 1996 and 1995,  respectively.
Plan  assets  consist   principally  of  equity  securities  and  corporate  and
government  obligations.

     The components of net pension (income) cost were as follows:

<TABLE>
<CAPTION>
(in millions)                                                   1997     1996     1995
----------------------------------------------------------------------------------------
<S> <C>
Service cost                                                  $  16.8  $  16.7  $  16.2
Interest accrued on projected benefit obligation                 86.1     84.8     95.5
Net investment (income) loss on plan assets:
         Actual                                                (303.1)  (162.9)  (246.0)
         Deferral of difference between actual and expected
                  investment income                             186.9     59.1    137.0
Net amortization                                                  5.3     11.9      8.8
Contributions to multiemployer pension plans                      4.5      4.6      5.1
----------------------------------------------------------------------------------------
         Net pension (income) cost                            $  (3.5) $  14.2  $  16.6
========================================================================================
</TABLE>

Net  amortization  included  amortization  of the  net  transition  assets,  net
experience  gains and losses,  and prior service costs over 15 to 20 years.  The
Company  incurred  termination  benefit and  curtailment  costs  associated with
enhanced  benefits in the 1997, 1996 and 1995 restructure  programs and business
dispositions.  Charges of $3.8  million,  $18.3  million  and $8.0  million  are
included with  restructure  and other unusual items for the years ended December
28, 1997, December 29, 1996, and December 31, 1995, respectively.

     The actuarial assumptions used in determining net pension (income) cost
were as follows:

                                                           1997    1996    1995
--------------------------------------------------------------------------------
Discount rate                                              7.75%   7.5%    8.6%
Assumed rate of increase in compensation levels             5.0%   5.0%    5.0%
Expected long-term rate of return on plan assets           10.0%  10.0%   10.0%
--------------------------------------------------------------------------------
<PAGE>

                                                       FORT JAMES CORPORATION 43

       The following table sets forth the funded status of the Company's plans:

<TABLE>
<CAPTION>
                                                                   1997                             1996
                                                     ------------------------------------------------------------
                                                          Assets    Accumulated            Assets    Accumulated
                                                          Exceed       Benefits            Exceed       Benefits
                                                     Accumulated         Exceed       Accumulated         Exceed
(in millions)                                           Benefits         Assets          Benefits         Assets
-----------------------------------------------------------------------------------------------------------------
<S> <C>
Actuarial present value of:
         Vested benefits                                $1,044.2         $102.8            $902.2         $164.0
         Nonvested benefits                                 36.9            9.1              31.6           17.6
-----------------------------------------------------------------------------------------------------------------
                  Accumulated benefit obligation         1,081.1          111.9             933.8          181.6
         Effect of projected future salary increases        29.7            1.9              22.8             .8
-----------------------------------------------------------------------------------------------------------------
                  Projected benefit obligation           1,110.8          113.8             956.6          182.4
-----------------------------------------------------------------------------------------------------------------
Plan assets at fair value                                1,478.1          103.2           1,200.4          158.0
-----------------------------------------------------------------------------------------------------------------
Plan assets in excess of (less than)
         projected benefit obligation                      367.3          (10.6)            243.8          (24.4)
Unrecognized net (gain) loss                              (190.0)           5.7             (82.6)          11.9
Unrecognized prior service cost                             38.8           20.1              33.3           30.9
Unrecognized net transition asset                           (6.8)          (1.5)             (7.7)          (3.0)
Minimum pension liability                                                 (22.5)                           (39.0)
-----------------------------------------------------------------------------------------------------------------
         Net pension  asset  (liability)                 $ 209.3         $ (8.8)          $ 186.8        $ (23.6)
=================================================================================================================
</TABLE>

As of December 28, 1997, benefit  obligations were determined using a discount
rate of 7.25% and an assumed rate of increase in compensation levels of 5.0%.
The effect of the  change in the  discount  rate and  other  actuarial
assumptions  was an increase in the  projected  benefit  obligation of $74.4
million.

    Other assets included  net  noncurrent  pension  assets of $223.0  million
as of December 28, 1997,  and $202.2  million as of December 29, 1996, exclusive
of the additional minimum  pension  liabilities.  As  of  December  28,  1997,
$22.5  million  of additional  minimum pension  liabilities for underfunded
plans were included in other long-term liabilities,  offset by an intangible
asset of $18.9 million and a charge of $2.1  million to retained  deficit,  net
of  deferred  taxes of $1.5 million.  As of December 29, 1996, the additional
minimum pension  liability of $39.0 million was offset by an intangible asset of
$30.5 million and a charge to retained  deficit of $5.1 million,  net of
deferred  taxes of $3.4  million.

    In 1995,  the Company spun off plans to Crown  Vantage.  Under certain
conditions, including the inability of Crown  Vantage to fund  required
contributions,  the Company has agreed to assume the liability for any
underfunded  benefits for the plans spun off. In the opinion of the Company's
management,  it is unlikely that these conditions will occur.

NOTE 7
POSTRETIREMENT
      BENEFITS
    OTHER THAN
    PENSIONS

Fort James  provides  certain  medical and life  insurance  benefits to eligible
retired   employees  under  the   pre-existing   James  River  and  Fort  Howard
postretirement benefit plans. The related postretirement benefit obligations are
valued  as  separate  plans.  All of the  Company's  retiree  medical  plans are
unfunded.


James  River Plans

Under the James  River  plans,  domestic  salaried employees  hired before
January 1, 1993,  generally  become eligible for retiree medical  benefits after
reaching  age 55 with 15  years  of  service  or after reaching  age 65.  Under
the salaried  plan,  post-age 65 eligible  retirees are reimbursed  for a
portion  of the  cost  of  premiums  of  Medicare  supplement insurance
policies,  based upon vested  years of service.  Post-age 65 salaried retirees
are  also  reimbursed  for  certain   prescription  drug  costs,  less
deductibles.  Pre-age  65  eligible  retirees  are paid a stated  percentage  of
covered  medical  expenses,  less  deductibles.  Salaried  employees hired after
January 1, 1993,  are not  eligible  for  retiree  medical  benefits.  Benefits,
eligibility and  cost-sharing  provisions for domestic hourly  employees vary by
location and collective  bargaining  unit.

<PAGE>

NOTES
to consolidated
financial statements

44 FORT JAMES CORPORATION

    The discount rate used in determining the net periodic  postretirement
benefit cost was 7.6% for 1997,  7.4% for 1996 and 8.5% for  1995.  The discount
rate  used in  determining  the  accumulated postretirement benefit obligation
was 7.1% and 7.6% as of December 28, 1997, and December 29, 1996, respectively.
The effect of the decrease in the discount rate was an increase in the
accumulated  benefit  obligation  of $19.4  million.  In addition,  other
actuarial  assumptions  were changed to reflect current trends. The effect of
these changes was a decrease in the accumulated benefit obligation of $9.5
million.

    The assumed  health care cost trend rate used in measuring the accumulated
postretirement benefit obligation begins at 7.25% in 1998, declining by .25% per
year through  2002,  .5% per year for 2003 through 2005 and .25% for 2006 to an
ultimate rate of 4.5%. If the health care cost trend rate assumptions were
increased by 1%, the accumulated  postretirement  benefit  obligation as of
December 28, 1997,  would have  increased by $39.3  million.  The effect of this
change  on the sum of the  service  cost and  interest  cost  components  of net
periodic  postretirement  benefit  cost for 1997 would have been an  increase of
$3.9 million.

Fort Howard Plans

Under the Fort Howard plans,  domestic salaried and hourly  employees  generally
become eligible for retiree  medical  benefits after reaching age 55 with 10
years of service.  Those employees  retiring prior to February 1, 1990, who had
met certain  eligibility  requirements are entitled to  postretirement  health
care benefit  coverage.  These benefits,  including a percentage  of  medical
expenses  and   prescription   drugs,  are  subject  to deductibles,   copayment
provisions,  a  lifetime  maximum  benefit  and  other limitations. In addition,
those employees who retire after January 31, 1990, and meet  certain age and
years of service  requirements  may  purchase  health care benefit  coverage
from  Fort  James up to age 65.

    The  discount  rate  used in determining the net periodic  postretirement
benefit cost was 7.5% in 1997, 1996 and 1995. The discount rate used in
determining the accumulated  post-retirement benefit  obligation  was 7.1% in
1997 and 7.5% in both 1996 and 1995. The effect of the decrease in the discount
rate was an increase in the accumulated  benefit obligation  of $.2  million.
The  assumed  health  care cost trend rate used in measuring the accumulated
postretirement  benefit  obligation begins at 8.5% in 1998,  declining by 1% per
year through 2000 to an ultimate rate of 6.5%. If the health care cost trend
rate  assumptions  were increased by 1%, there would have been no material
effect on the accumulated  postretirement benefit obligation as of December 28,
1997, or the net periodic postretirement benefit cost for 1997.

    The components of net periodic postretirement benefit cost for Fort James
were as follows:

<TABLE>
<CAPTION>
(in millions)                                                   1997      1996     1995
---------------------------------------------------------------------------------------
<S> <C>
Service cost                                                   $ 6.6     $ 8.1    $10.5
Interest cost on accumulated postretirement benefit obligation  26.9      29.0     40.6
Net amortization                                                (9.8)     (7.7)    (9.1)
----------------------------------------------------------------------------------------
         Net  periodic   postretirement  benefit  cost         $23.7     $29.4    $42.0
========================================================================================
</TABLE>

Net amortization  included  amortization of prior service gains and
unrecognized net gains over  approximately 12 to 15 years. In 1997 and 1996, the
Company incurred curtailment gains of $11.4 million and $12.2 million,
respectively,  related to its  restructure  programs  and  business
dispositions.  In 1995,  the  Company incurred a curtailment  gain of $3.4
million related to revisions in eligibility requirements  and monthly  benefits
received  under the Fort Howard  plans.  In addition  to  the  curtailment gain,
the  accumulated  postretirement  benefit obligation as of December 31, 1995,
was reduced by $10.6 million which is being amortized  over 12 years,  the
average  remaining  service period of Fort Howard active employees.

<PAGE>

                                                       FORT JAMES CORPORATION 45

    Summary information on Fort James' plans was as follows:

<TABLE>
<CAPTION>
(in millions)                                            1997         1996
-----------------------------------------------------------------------------
<S> <C>
Accumulated postretirement benefit obligation:
         Retirees                                       $207.8       $191.0
         Fully eligible active participants               48.5         42.1
         Other active participants                       115.2        120.6
-----------------------------------------------------------------------------
Total accumulated postretirement benefit obligation      371.5        353.7
Unrecognized net gain                                     52.3         63.5
Unrecognized prior service gain                           73.5         81.1
-----------------------------------------------------------------------------
         Accrued  postretirement  benefit  obligation   $497.3       $498.3
=============================================================================
</TABLE>

As of December 28, 1997, and December 29, 1996, the Company has included
$22.5 million and  $22.4   million  of  accrued   postretirement   benefit costs
in  accrued liabilities,  respectively,  representing the estimated  current
portion of this liability.


     NOTE 8
    BALANCE
      SHEET
INFORMATION

Inventories


<TABLE>
<CAPTION>
(in millions)                                                        1997        1996
---------------------------------------------------------------------------------------
<S> <C>
Raw materials                                                       $184.3      $177.0
Finished goods and work in process                                   550.2       498.8
Stores and supplies                                                  159.4       160.9
---------------------------------------------------------------------------------------
                                                                     893.9       836.7
Subtraction to state certain inventories at last-in, first-out cost  (39.6)      (35.1)
---------------------------------------------------------------------------------------
         Total inventories                                          $854.3      $801.6
=======================================================================================
Valued at lower of cost or market:
         Last-in, first-out                                         $507.2      $365.7
         First-in, first-out or average                              347.1       435.9
---------------------------------------------------------------------------------------
         Total inventories                                          $854.3      $801.6
=======================================================================================
</TABLE>


Property, Plant and Equipment

<TABLE>
<CAPTION>
(in millions)                                                        1997        1996
---------------------------------------------------------------------------------------
<S> <C>
Land and improvements                                            $   216.2   $   214.6
Buildings                                                          1,142.5     1,154.3
Machinery and equipment                                            6,081.5     6,202.6
Construction in progress                                             327.4       263.0
---------------------------------------------------------------------------------------
                                                                   7,767.6     7,834.5
Accumulated depreciation                                          (3,218.8)   (2,925.4)
---------------------------------------------------------------------------------------
                                                                   4,548.8     4,909.1
Timber and timberlands, net                                           16.5        90.2
---------------------------------------------------------------------------------------
         Net property, plant and equipment                       $ 4,565.3   $ 4,999.3
=======================================================================================
</TABLE>


<PAGE>

NOTES
to consolidated
financial statements

46 FORT JAMES CORPORATION

Accrued Liabilities

<TABLE>
<CAPTION>

(in millions)                                                         1997       1996
----------------------------------------------------------------------------------------
<S> <C>
Restructure reserve                                                  $263.2     $ 60.0
Taxes payable, other than income taxes                                 75.7      102.6
Interest payable                                                       64.6       92.0
Employee insurance benefits                                            76.8       76.1
Compensated absences                                                   75.5       74.1
Other items                                                           357.2      401.0
----------------------------------------------------------------------------------------
         Total accrued liabilities                                   $913.0     $805.8
========================================================================================

</TABLE>

NOTE 9
INDEBTEDNESS

<TABLE>
<CAPTION>
                                         Weighted
                                          Average
(in millions)                       Interest Rate     Maturities       1997       1996
---------------------------------------------------------------------------------------
<S> <C>
Revolving credit facilities                  6.02%     2000-2002   $1,642.0   $  368.3
Commercial paper/credit agreements           4.67      2000-2002       89.5       57.9
5.57% - 6.88% notes                          6.67      1999-2007    1,232.1      463.1
7.75% - 8.38% notes                          8.06      2001-2023      454.1      555.4
9.25% notes                                  9.25      2001-2021      255.0      850.0
Subordinated notes                           9.52      2003-2006      123.1      916.6
Medium-term notes                            7.84      2000-2004      106.0      200.0
Revenue bonds                                7.29      2005-2023      107.7      109.3
Capital lease obligations                   10.21      2004-2017      180.4      170.6
Term loans                                                                       743.0
---------------------------------------------------------------------------------------
         Total                                                      4,189.9    4,434.2
         Less current portion                                          34.4      128.9
---------------------------------------------------------------------------------------
                  Long-term debt                                   $4,155.5   $4,305.3
=======================================================================================
</TABLE>


Minimum Principal Payments

Minimum principal payments on long-term debt, excluding commercial paper, credit
agreements and revolving credit borrowings, for the next five years are as
follows:

(in millions)           1998        1999        2000        2001        2002
--------------------------------------------------------------------------------
Scheduled  maturities  $34.4      $228.2       $53.5      $284.8      $186.8
================================================================================

If the current level of commercial  paper/credit  agreements  and revolving
credit  agreements  remains outstanding  until the  expiration of the underlying
or supporting  agreements, additional  payments of $47 million and $1,684
million would be required in 2000 and 2002,  respectively.  It is the Company's
current intention to refinance or renew such agreements prior to their
expiration.

    In connection with the merger, Fort James undertook a plan (the "Debt
Refinancing  Plan") designed to refinance an aggregate of approximately $2
billion  principal amount of debt of Fort James and Fort Howard.  In  connection
with the Debt  Refinancing  Plan,  the Company incurred  a $131.5  million,  net
of taxes,  extraordinary  loss for  prepayment penalties and the  write-off of
deferred loan costs.

    At the time of the merger, as the first  step in the Debt  Refinancing Plan,
Fort  James and Fort  Howard entered into a new $2.5 billion bank credit
facility (the "New Credit Facility") and borrowed $666 million  thereunder to
replace  certain of the pre-merger bank credit facilities.  Additionally, on
August 13, 1997, prior to the effectiveness of the merger,  Fort James
repurchased  and retired  $200  million in aggregate principal  amount of its
9.77% Senior Notes due 2014 with proceeds from previous divestitures  and excess
cash from  operations.  As the second step in the Debt Refinancing Plan, on
September 8, 1997, Fort Howard commenced cash tender offers for approximately
$1.47 billion of its outstanding  public debt securities and, upon expiration of
the

<PAGE>

                                                       FORT JAMES CORPORATION 47


tender offers in the fourth quarter, purchased a total of $1.28  billion of such
debt  securities  as follows:  (i) $89.9 million of 8 1/4% Senior Notes due
2002, (ii) $395.0 million of 9 1/4% Senior Notes due 2001, (iii) $559.3 million
of 9% Senior  Subordinated Notes due 2006 and (iv) $234.2 million of 10%
Subordinated Notes due 2003.  The tender  offers were funded  through a
combination of borrowings under the New Credit Facility and the issuance of $720
million aggregate  principal  amount  of  notes.  These  notes  were  issued on
September  29, 1997,  as follows:  (i) $100 million 6 1/2% Senior Notes due
2002, (ii) $320  million  6 5/8%  Senior  Notes due 2004 and (iii) $300  million
6 7/8% Senior  Notes due 2007.

    In January  1998,  the Company gave notice that it will exercise its call
option on its 10%  Subordinated  Notes due March 15, 2003,  in March of 1998 at
a premium  of 105% of the notes'  face value of $64.3  million. Costs associated
with the early  extinguishment  of debt are expected to be $4.2 million  (or
$2.6  million,  net of  taxes).  The  call  will be  financed  with borrowings
under the New Credit  Facility.

Revolving  Credit  Facilities

As of December 28, 1997, Fort James and its  consolidated  subsidiaries  had
revolving credit  agreements  with  various  domestic  and  foreign  banks
providing  for unsecured  borrowings of up to approximately  $2,790 million. The
interest rates associated  with the revolving  credit  agreements are primarily
based,  at the option of the  Company,  on the prime rate,  the London Interbank
Offered Rate ("LIBOR"),  the Paris Interbank  Offered Rate,  certificate of
deposit rates, or bankers'  acceptance  rates.  Annual commitment fees of up to
15 basis points on the unused portion of the  commitments may be incurred during
the revolving loan periods;  additionally,  certain  agreements provide for
facility fees which may range from 6 to 10 basis points of the  committed
amounts.  The majority of the Company's  domestic and foreign  revolving  credit
agreements,  totaling $2,500 million,  expire in August  2002;  the  remaining
agreements  expire  from 1998 through 2000.

Commercial  Paper and Credit  Agreements

As of December 28, 1997, the Company had domestic and foreign  commercial  paper
programs  providing for commercial paper issuances of up to $583.5 million. In
addition, the Company had agreements  with several banks  providing for other
borrowings,  dependent upon bank  availability.  These  obligations  generally
bear interest at below-prime rates. As of December 29, 1996, the outstanding
commercial paper and borrowings under credit  agreements  had average  interest
rates of 6.35%.  Because of the availability  of long-term  financing  through
the  Company's  global  revolving credit capacity and the Company's  intention
to refinance  commercial  paper and credit agreements borrowings, these
borrowings have been classified as long-term debt.

Term Loans,  Notes and Debentures

Fort James' most restrictive  agreements contain  limitations on borrowings and
require maintenance of a minimum ratio of net  tangible  assets.  As of December
28,  1997,  under the most  restrictive provisions of Fort James' debt
agreements,  Fort James had additional  borrowing capacity of $1.9  billion.

    Certain of Fort James'  notes and revenue  bonds are collateralized by
assets consisting of property,  plant and equipment,  accounts receivable  and
inventories.  Such assets are  immaterial  in relation to total assets.

    NOTE 10
  FINANCIAL
INSTRUMENTS

The Company employs  derivative  financial  instruments  primarily to reduce its
exposure to adverse  fluctuations in interest rates and foreign  exchange rates.
These  financial  instruments,  when entered into,  are  designated as hedges of
underlying  exposures.  Because  of the high  correlation  between  the  hedging
instrument and the underlying  exposure being hedged,  fluctuations in the value
of  the  instruments  are  generally  offset  by  changes  in the  value  of the
underlying  exposures.   Fort  James  effectively  monitors  the  use  of  these
derivative  financial  instruments  through  the  use of  objective  measurement
systems, well-defined market and credit risk limits and timely reports


<PAGE>

NOTES
to consolidated
financial statements

48 FORT JAMES CORPORATION

to senior management  according to prescribed  guidelines.  Virtually all of the
Company's derivatives  are  "over-the-counter"  instruments.

    The estimated fair values of derivatives  used to hedge or modify the
Company's  risks  fluctuate  over time. These  fair  value  amounts  should  not
be viewed in  isolation,  but rather in relation  to  the  fair  values  of  the
underlying  hedged   transactions  and investments,  and the overall  reduction
in exposure to adverse  fluctuations in interest rates,  foreign  exchange
rates,  and other market risks.

    The notional amounts of the derivative  financial  instruments do not
necessarily  represent amounts  exchanged by the parties and,  therefore,  are
not a direct  measure of Fort James' exposure through its use of derivatives.
The amounts  exchanged are calculated  by  reference  to the  notional  amounts
and by other  terms of the derivatives,  such as interest rates, exchange rates
or other financial indices.

Credit Risk

Fort James has established strict counterparty credit guidelines and only enters
into  transactions  with financial  institutions that are investment grade.
Counterparty  exposures are monitored and any downgrade in credit rating
receives  immediate  review.  To minimize the  concentration of credit risk, the
Company  enters  into  derivative  transactions  with a portfolio  of  financial
institutions.  As a  result,  the  Company  considers  the risk of  counterparty
default to be minimal.

Interest Rate  Management

Fort James has  implemented a policy to maintain the percentage of fixed and
variable rate debt within certain parameters.  The Company enters into interest
rate swap agreements that maintain the  fixed/variable  mix within these defined
parameters.  These  contracts had maturities  ranging from one to two years on
December 28, 1997.  Variable  rates are  predominantly  linked to  LIBOR.
Additionally,  the  Company  enters  into interest  rate cap  agreements  that
entitle  it to  receive  from a  financial institution the amount,  if any, by
which the interest payments on variable rate debt exceed pre-specified  interest
rates through 1999. During 1997, the Company unwound $648 million in notional
amount of interest  rate swaps at a cost of $8 million which is being  amortized
through  January 1999.

    The fair value of the Company's financial instruments related to its
indebtedness were as follows:

<TABLE>
<CAPTION>
                                                       1997                             1996
                                         --------------------------------------------------------------
                                         Carrying Value                   Carrying Value
                                               or Gross                         or Gross
                                               Notional         Fair            Notional          Fair
(in millions)                                    Amount(1)     Value              Amount(1)      Value
-------------------------------------------------------------------------------------------------------
<S> <C>
Long-term debt, including current maturities    $(4,190)     $(4,291)            $(4,434)      $(4,586)
Interest rate swaps                               1,138           (8)              1,286           (15)
Interest rate caps                                  500                              500             1
-------------------------------------------------------------------------------------------------------
</TABLE>

(1) Long-term debt amount is carrying value;  interest rate swap and cap amounts
    are notional  amounts.

The estimates of fair values of the Company's  financial instruments  related to
indebtedness  are  based on  quoted  market  prices of comparable  instruments
or on  current  rates  available  to  the  Company  for financial instruments
with similar terms and remaining maturities.  Based on the Company's  total
indebtedness  at December 28, 1997, a 10 basis point  interest charge would
impact the fair value of the total debt portfolio by  approximately $12.3
million. This exposure would be offset by a $.2 million change to the fair value
of the  interest  rate  swap  portfolio.  The  weighted-average  pay rate
exceeded the weighted-average  receive rate under the interest rate contracts by
 .6% and .3%,  respectively,  for the years ended December 28, 1997, and December
29, 1996.


<PAGE>

                                                       FORT JAMES CORPORATION 49

Foreign Currency Management

Most of Fort James foreign currency exposures are managed on a consolidated
basis, which allow for the netting of certian exposures and thus, take advantage
of any natural offsets. The Company enters into forward exchange contracts and
purchase currency options which mature in one year or less (principally
European currencies) to hedge firm and anticipated purchase committments and
firm sales commitments denominated in foreign currencies. As of December 28,
1997, and December 29, 1996, the Company had net unrealized gains (losses) of
$.5 million and $(.1) million, respectively, on a national amount of $304
million and $47 million, respectively, for these hedge instruments.

    In January and February 1997, the Company unwound $470 million in notional
amount of foreign exchange contracts, along with related interest rate
agreements, at a cost of $31.5 million, net of tax benefits that was recorded
as a charge to equity. These foreign exchange contracts were designated as
hedges of a portion of the Company's net investment to its European Consumer
Products Business and were terminated prior to their original expiration in
September 1998.

NOTE 11
COMMON
 STOCK

Fort James has 500 million authorized shares of common stock, $.10 par value
("Common Stock"), of which 209,306,016 shares were outstanding as of December
28, 1997. Common shares reserved for issuance as of December 28, 1997, were as
follows:

                                                                            1997
--------------------------------------------------------------------------------
Stock option plans                                                     7,585,221
Incentive stock plan                                                   9,901,347
Deferred stock plan                                                      261,456
Director stock ownership plan                                             95,589
Conversion of Series K preferred stock                                 2,674,953
Conversion of Series L preferred stock                                 5,449,305
Conversion of Series N preferred stock                                 1,439,313
--------------------------------------------------------------------------------
    Total common shares reserved for issuance                         27,407,184
================================================================================

During 1996 and 1995, the Company issued 14.5 million shares of Common Stock at
$14.73 per share and 34.7 million shares of Common Stock at $8.73 per share,
respectively. The net proceeds to the Company were primarily used to prepay or
redeem a portion of its indebtedness.

Shareholder Rights Plan

Under a shareholder rights plan, preferred stock purchase rights ("Rights") are
issued at the rate of one Right for each share of Common Stock. Each Right
entitles its holder to purchase one one-thousandth of a share of Series M
Cumulative Participating Preferred Stock ("Series M") at an exercise price of
$150, subject to adjustment. The Rights will only be exercisable if a person or
group acquires, has the right to acquire, or has commenced a tender offer for
15% or more of the outstanding Common Stock. The Rights are nonvoting, pay no
dividends, expire on March 1, 1999, and may be redeemed by the Company for $.01
per Right at any time before the tenth day (subject to adjustment) after a 15%
position is acquired. The Rights have no effect on earnings per share until they
become exercisable.

    After the Rights are exercisable, if the Company is acquired in a merger or
other business combination, or if 50% or more of the Company's assets are sold,
each Right will entitle its holder (other than the acquiring person or group) to
purchase, at the then-current exercise price, common stock of the acquiring
person having a value of twice the exercise price. In addition, in the event
a 15% or greater shareholder (i) acquires the Company through a merger where
Fort James is the surviving corporation, (ii) engages in certain self-dealing
transactions, or (iii) increases his ownership other than through a cash tender
offer providing fair value to all holders of Common Stock, each Right will
entitle its holder (other than the acquiring person or group) to purchase, at
the then-current exercise price, Common Stock having a value of twice the
exercise price.


<PAGE>

NOTES
to consolidated
financial statements

50 FORT JAMES CORPORATION

  NOTE 12
PREFERRED
    STOCK

The Company is authorized to issue up to five million shares of preferred stock,
$10 par value.  The preferred  shares are issuable in series,  each with varying
dividend rates,  redemption  rights,  conversion terms,  liquidation  values and
voting rights. Outstanding series of preferred stock were as follows:

<TABLE>
<CAPTION>
                        Depositary Shares
          -------------------------------------------   Preferred          Annual         Liquidation Value
          Liquidation          Shares         Annual       Shares          Dividend       ------------------
                Value     Outstanding       Dividend  Outstanding       Requirement           (in millions)
            Per Share            1997      Per Share         1997     (in millions)         1997        1996
------------------------------------------------------------------------------------------------------------
<S> <C>
Series K*         $50                        $3.3750    1,999,795             $6.7       $100.0      $100.0
Series L           50       3,998,700         3.5000      999,675             14.0        199.9       200.0
Series N           50       1,056,168         3.5000      264,042              3.7         52.8        52.8
Series O                                                                                               98.1
Series P                                                                                              287.5
------------------------------------------------------------------------------------------------------------
         Total                                          3,263,512            $24.4       $352.7      $738.4
============================================================================================================
</TABLE>

*Amounts listed for Series K are for preferred shares.

As of December 28, 1997, the Company has reserved  250,000  preferred shares for
the issuance of Series M preferred stock under the  Shareholder  Rights Plan. In
1997, the Series O 8 1/4%  Cumulative  Preferred  Stock ("Series O") was
redeemed for $98.1 million and the Series P 9%  Cumulative  Convertible
Preferred  Stock ("Series P") was converted to 15.3 million  shares of Common
Stock in a non-cash financing  transaction  of  $287.5  million.

    The  Series  K  $3.375  Cumulative Convertible  Exchangeable  Preferred
Stock  ("Series K") is  convertible at the option of the holder  into  Common
Stock at $37.38 per common  share (or 1.3376 shares of Common Stock for each
preferred share).  The Series K is redeemable by the  Company  at  $50  per
share  plus  accrued  dividends.  The  Series  K  is exchangeable  at the option
of the  Company for 6.75%  Convertible  Subordinated Debentures due November 1,
2016, at $50 principal  amount per share of Series K. If issued,  these
debentures will be convertible  into Common Stock on the same terms as the
Series K.

    The Series L $14.00 Cumulative  Convertible  Exchangeable Preferred  Stock
("Series  L") and the Series N $14.00  Cumulative  Convertible Exchangeable
Preferred  Stock  ("Series  N")  are  each  held  in the  form  of depositary
shares,  with  each  depositary  share  representing  a  one-quarter interest in
a preferred share.  The Series L and the Series N depositary  shares are
convertible  at the option of the holder  into  Common  Stock at $36.69 per
common share (or 1.3626 shares of Common Stock per depositary share). The Series
L and Series N depositary  shares are each  redeemable by the Company at $50 per
depositary  share plus accrued  dividends.  The Series L and Series N depositary
shares are each  exchangeable  at the option of the Company  for 7%  Convertible
Subordinated  Debentures  due  October  1,  2017,  at $50  principal  amount per
depositary  share. If issued,  these  debentures will be convertible into Common
Stock on the same terms as the depositary shares.

      NOTE 13
     EMPLOYEE
BENEFIT PLANS

The Company applies APB Opinion No. 25 and related Interpretations in accounting
for its stock-based compensation plans. Had compensation cost for the
Company's stock-based compensation plans been determined based on the fair value
at the grant dates for awards under those plans consistent with the method of
FASB Statement 123, "Accounting for Stock-Based Compensation," pro forma net
income (loss) and earnings per share would have been as follows:

(in millions, except per share amounts)           1997         1996        1995
--------------------------------------------------------------------------------
Net income (loss)                                $(37.4)     $315.2      $139.3
Earnings per  share--basic                       $ (.41)     $ 1.42      $  .49
Earnings per  share--diluted                     $ (.33)     $ 1.40      $  .49
--------------------------------------------------------------------------------

Pursuant to the merger,  all of Fort Howard's  options became fully vested,
thereby  increasing the impact of pro forma  compensation cost in 1997.  Fort
James'  stock  option  plans  provide for the granting of options to pur-

<PAGE>

                                                       FORT JAMES CORPORATION 51


chase common stock to certain directors,  officers and key employees. Options
are granted at exercise  prices  equal to the fair market value of such stock as
of the date of grant and have terms of ten years.  Fort James'  options  vest in
two or three equal annual installments. Effective with the merger, Fort Howard's
options  were  automatically  converted  into Fort  James  options at the merger
exchange ratio. As of December 28, 1997,  there were 655 employees and directors
holding  options.
    Stock option  activity,  including the retroactive  effect of converting
Fort Howard's options into Fort James' options, was as follows:

<TABLE>
<CAPTION>
                                                   1997                   1996                1995
                                          --------------------------------------------------------------------
                                                       Weighted-             Weighted-              Weighted-
                                                        Average               Average                Average
                                                        Exercise             Exercise                Exercise
(in thousands, except per share amounts)    Shares       Price      Shares     Price     Shares       Price
--------------------------------------------------------------------------------------------------------------
<S> <C>
Balance, beginning of year                   10,543      $18.34      9,437     $16.86     11,039      $17.52
         Granted                                354       40.27      2,416      23.90      2,225       22.82
         Forfeited                             (117)      27.41       (150)     23.61       (176)      20.62
         Exercised                           (4,373)      14.53       (951)     14.95     (3,477)      21.99
         Expired                               (109)      20.53       (209)     27.77       (174)      28.62
--------------------------------------------------------------------------------------------------------------
Balance, end of year                          6,298      $21.83     10,543     $18.34      9,437      $16.86
==============================================================================================================
Exercisable                                   5,026                  6,679                 6,698
Available for grant                           2,692                  2,707
Weighted-average fair value of
   options granted during the year           $13.22                  $7.26                 $6.96
==============================================================================================================
</TABLE>

The fair value of each option grant,  including the retroactive effect of
converting Fort Howard's options  into Fort James'  options,  was  estimated  on
the grant date using the Black-Scholes option-pricing model with the following
assumptions:
<TABLE>
<CAPTION>
                                                 Fort James               Fort Howard
                                   ----------------------------------  ------------------
                                        1997       1996       1995       1996      1995
------------------------------------------------------------------------------------------
<S> <C>
Dividend  yield                         1.50%      2.00%      2.00%      0.00%     0.00%
Volatility  rate                       27.56%     27.26%     26.02%     19.26%    24.32%
Risk-free  interest  rate               6.27%      6.18%      6.37%      6.07%     5.51%
Expected option life                  5 years    5 years    5 years    5 years   5 years
==========================================================================================
</TABLE>

The following table summarizes information about fixed stock options
outstanding, as of December 28, 1997:

<TABLE>
<CAPTION>
(in thousands, except year and per share amounts)

                               Options Outstanding                            Options Exercisable
                  -------------------------------------------------    --------------------------------
       Range of                 Weighted-Average
       Exercise        Number          Remaining   Weighted-Average         Number    Weighted-Average
         Prices   Outstanding   Contractual Life     Exercise Price    Exercisable      Exercise Price
-------------------------------------------------------------------------------------------------------
<S> <C>
$11.19 - $14.36       2,153          4.3 years              $13.21          2,153            $13.21
$15.63 - $22.97       1,469          7.4 years               19.64          1,464             19.63
$23.07 - $31.87       1,720          7.1 years               26.44            971             26.36
$32.25 - $40.66         956          8.2 years               36.31            438             33.66
-------------------------------------------------------------------------------------------------------
         Total        6,298                                                 5,026
=======================================================================================================
</TABLE>

Restricted and Incentive Stock

Pursuant to the 1996 Stock Incentive Plan and the Director Stock Ownership Plan,
the  Company  may also grant  restricted  stock and  incentive  stock  awards to
certain  directors,  officers  and key  employees.  Restricted  stock  awards of
925,901 and  715,650  shares of Common  Stock were  granted in 1997 and 1996 (of
which 2,994 and 2,825  shares were  deferred) at a  weighted-average  grant date
fair  value of $43.57 and $26.79  per  share,  respectively.  Awards  granted to
officers and key employees will vest in three to eight years, with the potential
for earlier  vesting of certain awards based on the Company's  performance,  and
awards granted to

<PAGE>

NOTES
to consolidated
financial statements
52 FORT JAMES CORPORATION


directors will vest one year from the date of grant. Incentive stock awards of
114,112 and 150,000  shares of Common Stock were granted in 1997 and 1996 at a
weighted-average  grant  date fair value of $43.05 and $26.44 per share,
respectively. Vesting of these shares is based on the Company's financial
performance.  The Company recognized  compensation expense related to restricted
and incentive stock awards of $13.1 million in 1997 and $3.0 million in 1996. As
of December 28, 1997,  there were 8,497,000  shares available for grant pursuant
to the 1996 Stock  Incentive  Plan which may be granted as  options,  restricted
stock or incentive stock.  Effective with the merger,  the Company authorized an
additional  8 million  shares  available  for grant  pursuant  to the 1996 Stock
Incentive  Plan. The Director Stock  Ownership Plan has 90,000 shares  available
for grant as of December  28,  1997.

Stock Plans for  Employees

    The  Company's StockPlus  Investment  Plan is available to  substantially
all of James River's domestic  employees.   Several  alternative   investment
funds  are  available, including an investment fund consisting of Common Stock.
Participating employees may  contribute,  through  periodic  payroll deductions,
up to  10%  of  their compensation.  Participant contributions of up to 6% of
compensation are matched by the Company at a 60% rate.  Additionally  the
Company may make  discretionary contributions of up to 1% of all eligible
employees' base salary to the plan. As of December 28, 1997,  there were 15,000
participants in the plan, and the plan held 9 million  shares of Common  Stock
and $140  million of other  investments. Company  contributions to this plan
totaled $12.1 million in 1997, $16.8 million in 1996 and $15.2  million in 1995.
    A  substantial  majority  of Fort  Howard's employees are covered by defined
contribution  plans.  The Company makes annual discretionary  contributions
under these plans. Participants may also contribute a percentage of their
compensation to the plans. As of December 28, 1997, there were  approximately
6,000  participants  in these plans,  and the plans held .9 million  shares of
Common Stock.  Company  contributions  to these plans totaled $16.3  million in
1997 and 1996 and $13.2  million  in 1995.
    In addition, the Company maintains a stock purchase plan for the benefit of
certain  Canadian employees.  As of December 28, 1997,  59,000 shares of Common
Stock were held in this plan.

NOTE 14
Related
Party
Transactions

As of  December  28,  1997,  Morgan  Stanley,  Dean  Witter  Discover & Co. (the
surviving  Corporation in the June 1, 1997,  merger of Morgan Stanley Group Inc.
("Morgan  Stanley  Group")  with and into Dean Witter  Discover & Co.) ("Morgan
Stanley,  Dean Witter") and certain of its affiliates  owned 3% of Common Stock.
As of December  29, 1996,  Morgan  Stanley  Group and certain of its  affiliates
controlled 26% of Fort Howard's common stock.

    Morgan Stanley & Co. Incorporated ("MS&Co"),  an affiliate  of Morgan
Stanley,  Dean  Witter,  has served as lead underwriter  with  respect to Fort
James' and Fort  Howard's  common  stock and public debt offerings and has
received  underwriting fees of $5 million in 1997, $3  million  in 1996 and $7
million  in 1995 in  connection  with  such  public offerings.  MS&Co is also a
market  maker with respect to Fort  Howard's  public debt securities.  MS&Co
also periodically  provided  financial advisory services for  Fort  Howard  for
which  it  received  customary  fees.  Additionally,  in connection with the
merger,  Fort Howard paid MS&Co approximately $20 million in fees for its
services as an investment advisor.

<PAGE>

                                                      FORT JAMES CORPORATION 53
NOTE 15
Commitments
and Contingent
Liabilities

Operating Leases

The Company  leases  certain  facilities,  vehicles and  equipment  over varying
periods.  None of the agreements contain unusual renewal or purchase options. As
of December  28,  1997,  future  minimum  rental  payments  under  noncancelable
operating leases were as follows:

                                    Minimum
(in millions)                       Rentals
--------------------------------------------
1998                                $  29.3
1999                                   25.4
2000                                   23.4
2001                                   19.2
2002                                   12.7
2003 and thereafter                    48.2
--------------------------------------------
  Total future minimum rentals       $158.2
============================================

Rent expense totaled $83.2 million in 1997, $88.6 million in 1996 and $87.6
million in 1995.

Litigation and Environmental  Matters

The  Company  is  party  to  various  legal  proceedings generally   incidental
to  its  business  and  is  subject  to  a  variety  of environmental  and
pollution  control laws and regulations.  As is the case with other companies in
similar industries,  Fort James faces exposure from actual or potential  claims
and legal  proceedings.

    During 1994,  James River was sued in Morgan County,  Alabama,  in a class
action and in Bridgeport,  Connecticut,  by certain former  holders of James
River's 10 3/4%  Debentures due October 1, 2018, all of which were  retired by
means of a tender offer to all holders or redeemed on November 2, 1992. In
general, the complaints alleged violations of a covenant prohibiting  use of
lower cost borrowed  funds to redeem the  Debentures  before October 1, 1998,
and of various  disclosure  obligations,  and sought damages in excess of $50
million plus punitive  damages in excess of $500 million.  In June 1997,  the
Alabama court granted James River summary  judgement on the remaining claims,
and dismissed the action.  The plaintiffs  have appealed to the Alabama Supreme
Court.  The  Company  believes  the Alabama  case is without  merit and intends
to defend it vigorously.  Most of the holders  electing out of the class are
plaintiffs in the  Connecticut  case. In 1996 and 1997, the Company  settled the
claims  of  an  institutional   holder  and  the  Connecticut   plaintiffs,
representing  approximately  55 percent of the  debentures,  for a total of $1.4
million plus reimbursement of attorney's fees.

    In May 1997, the Attorney General of the State of Florida filed a civil
action in the Gainesville  Division of the United States  District Court for the
Northern  District of Florida  against the Company  and eight  other
manufacturers  of sanitary  paper  products  alleging violations  of federal and
state  antitrust  and unfair  competition  laws.  The complaint  seeks civil
penalty under Florida law of $1 million for each alleged violation  against each
defendant,  an unspecified  amount of treble damages and injunctive relief. Over
the following weeks, additional civil class actions were filed in various
federal and state courts against the same  defendants  alleging violations of
federal and state  antitrust  statutes and seeking  treble damages and
injunctive  relief.  Pursuant  to  the  order  of  the  Judicial  Panel  on
Multidistrict  Litigation,  the  federal  cases  were  consolidated  in the U.S.
District  Court for the  Northern  District of Florida at  Gainesville.  Similar
state actions are proceeding in California  and Tennessee.  The litigation is in
its early  stages.  The Company  believes  these cases are without  merit and is
vigorously  defending  both  federal and state  actions.

    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 condition of Fort James but could materially affect consolidated
results of operations in a given year.

<PAGE>

NOTES
to consolidated
financial statements


54  FORT JAMES CORPORTATION

    In addition,  Fort James has been identified as a potentially  responsible
party ("PRP"),  along with others,  at various U.S.  Environmental  Protection
Agency ("EPA")  designated  superfund sites and is involved in remedial
investigations and actions under federal and state laws. Among these sites, the
Company,  along with six other current and former  operators of pulp and paper
facilities,  has been  identified as a PRP by the U.S. Fish and Wildlife Service
and other state and  federal  agencies,  including  the  EPA,  and  tribal
entities,  regarding contamination of the lower Fox River by hazardous
substances.  The agencies and tribes seek primary  restoration of the river, and
natural resources damages. At this  time,  the  Company,  in  conjunction  with
other  PRPs,  has  agreed  to participate  with the State of Wisconsin  in the
funding of primary  restoration studies  and  a  natural  resources   damages
assessment  and  is  engaged  in negotiations  with federal and state agencies
and tribes to resolve  outstanding claims.

    In 1997, the Company adopted the American  Institute of Certified Public
Accountants Statement of Position 96-1,  "Environmental  Remediation  Liability"
which had no material effect on the Company's consolidated financial position or
results of operations. It is the Company's policy to accrue remediation costs on
an  undiscounted  basis when it is probable that such costs will be incurred and
when  a  range  of  loss  can  be  reasonably  estimated.  Fort  James'  accrued
environmental  liabilities,  including  remediation and landfill  closure costs,
totaled $55.4  million and $57.0  million as of December 28, 1997,  and December
29,  1996,  respectively.  The  Company  periodically  reviews the status of all
significant existing or potential  environmental issues and adjusts its accruals
as  necessary.  The  accruals  do not  reflect  any  possible  future  insurance
recoveries.  Estimates of costs for future remediation are necessarily imprecise
due to, among other things, the identification of presently unknown  remediation
sites and the allocation of costs among  potentially  responsible  parties.  The
Company  believes  that  its  share  of the  costs of  cleanup  for its  current
remediation  sites will not have a material  adverse impact on its  consolidated
financial  position but could have a material effect on consolidated  results of
operations  in a given  year.  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 PRP at additional  sites in the future or that the costs  associated with such
additional  sites would not be material.

    In 1997, the EPA published rules which contain  regulations  affecting pulp
and paper industry discharges of wastewater and gaseous emissions,  commonly
referred to as the "cluster rules." These rules require  changes in the pulping
and bleaching  processes  presently used in some U.S. pulp mills, including
several of Fort James' mills. Based on its evaluation of the rules,  the Company
believes that capital  expenditures of approximately $100 million may be
required, the majority of which will be spent during the next three to four
years.

NOTE 16
Segment
Information

The Company  operates  in the  following  industry  segments:  (i) the  Consumer
Products  segment,  which consists of the  manufacture and marketing of personal
care  products  including  tissue and towels and  disposable  tabletop  products
including napkins,  plates and cutlery organized along retail and away-from-home
market channels;  (ii) the Packaging  segment  manufactures  folding cartons and
paperboard principally for food and other consumer products  manufacturers;  and
(iii) the  Communications  Papers  segment  manufactures  and  markets  uncoated
business and printing papers serving the commercial printing and office markets.
The  Company's  operations  are  principally  domestic  other than the  Consumer
Products segment, which includes the European Consumer Products Business.

<PAGE>
FORT JAMES CORPORATION 55
<TABLE>
<CAPTION>
                                     Consumer Products
                                ---------------------------                            Intersegment
                                        North                        Communications     elimination/
(in millions)                          America       Europe     Packaging    Papers       Corporate        Total
----------------------------------------------------------------------------------------------------------------
<S> <C>
1997
Net Sales                              $4,360.0     $1,828.1     $782.9      $467.7       $(179.7)     $7,259.0
Segments results before restructure
   and other unusual items                845.4        202.4       81.3        19.8         (92.0)      1,056.9
Restructure and other unusual items      (138.3)       (90.4)     (25.2)       (3.9)       (196.4)       (454.2)
-----------------------------------------------------------------------------------------------------------------
Income from operations                    707.1        112.0       56.1        15.9        (288.4)        602.7
Depreciation and amortization             274.3        114.5       52.9        48.4           7.2         497.3
Capital expenditures                      313.0         69.0       55.0        36.4          32.5         505.9
Total assets                            3,520.7      2,191.1      612.3       570.8         838.3       7,733.2
=================================================================================================================
1996
Net sales                              $4,362.0     $1,980.2   $1,139.9     $ 456.7       $(231.7)     $7,707.1
Segment results before restructure
   and other unusual items                753.3        177.1       91.9        22.2        (124.5)        920.0
Restructure and other unusual items       (13.1)       (42.0)      49.0                      (4.6)        (10.7)
-----------------------------------------------------------------------------------------------------------------
Income from operations                    740.2        135.1      140.9        22.2        (129.1)        909.3
Depreciation and amortization             269.4        128.4       72.1        48.6           7.1         525.6
Capital expenditures                      272.2         96.3       78.6        34.1          18.3         499.5
Total assets                            3,527.5      2,607.5      585.2       603.4         833.3       8,156.9
=================================================================================================================
1995
Net sales                              $4,440.6     $1,949.9   $1,659.9      $1,091.4     $(253.9)     $8,887.9
Segment results before restructure
   and other unusual items                583.5         63.5       76.1         191.2       (79.0)        835.3
Restructure and other unusual items        (5.1)       (22.3)      (7.1)         (2.2)      (15.2)        (51.9)
-----------------------------------------------------------------------------------------------------------------
Income from operations                    578.4         41.2       69.0         189.0       (94.2)        783.4
Depreciation and amortization             255.8        137.5       83.7         103.1         6.6         586.7
Capital expenditures                      231.2         94.5      113.0          45.7         4.1         488.5
Total assets                            3,661.4      2,793.1      949.7         672.4       834.7       8,911.3
=================================================================================================================
</TABLE>

Intersegment sales are recorded at market prices and are eliminated in
consolidation. Corporate assets consist primarily of cash and cash equivalents,
current deferred income taxes, investments in uncolsolidated affiliates, and the
net pension asset. During each of the three years in the period ended December
28, 1997, export sales to foreign markets from the Company's domestic operations
represented less than 10% of total sales to unaffili- ated customers; no single
customer accounted for more than 10% of total sales in any year.

NOTES
to consolidated
financial statements

56 FORT JAMES CORPORTATION


NOTE 17
Fort James
Operating
Company

The Consolidated Financial statements for Fort James Operating Company ("FJOC"),
which includes the merged  operations of Fort Howard,  have been omitted because
certain securities registered under the Securities Act of 1933, of which FJOC is
an obligor (thus subjecting them to reporting  requirements  under Section 13 or
15(d) of the  Securities  Exchange Act of 1934),  are fully and  unconditionally
guaranteed by Fort James.  Financial  information relating to FJOC is presented
herein in accordance with Staff Accounting  Bulletin 53 as an addition to the
notes to the  financial  statements of Fort James.  Summarized  financial
information for Fort James Operating Company is as follows:

<TABLE>
<CAPTION>
                                                     1997       1996        1995
--------------------------------------------------------------------------------
<S> <C>
Condensed income statement information:
         Net sales                               $4,851.6    $5,179.1   $6,324.3
         Gross profit                             1,435.5     1,384.5    1,331.0
         Income (loss) before extraordinary item    (65.5)      175.3       12.2
         Net income (loss)                         (167.1)      167.2       (6.6)
Condensed balance sheet information:
         Current assets                             928.4      843.2
         Noncurrent assets                        3,292.8    3,458.2
         Current liabilities                        861.1      715.8
         Noncurrent liabilities                   5,850.4    5,064.4
         Deficit                                 (1,629.2)  (1,478.8)
================================================================================
</TABLE>
<PAGE>
                                                       FORT JAMES CORPORATION 57
NOTE 18
Selected
Quarterly
Financial
Data
(Unaudited)

<TABLE>
<CAPTION>                                                                                     Per Diluted Common Share
                                                                                     -----------------------------------------
                                                           Income                    Income
                                                           (Loss)                    (Loss)
                                                           Before                    Before
                                                           Extra-          Net       Extra-                    Stock Price
(in millions, except                            Gross    ordinary       Income     ordinary   Dividends    -------------------
per share amounts)               Net Sales     Profit        Item       (Loss)         Item    Declared     High        Low
------------------------------------------------------------------------------------------------------------------------------
<S> <C>
December 1997:(a,b,c,d)
         1st Quarter              $1,817.8     $539.7      $  97.2      $  95.9      $  .43      $.15     $36 1/4      $29 1/4
         2nd Quarter               1,854.3      568.2        149.7        149.1         .68       .15      38 7/8       27 1/4
         3rd Quarter               1,825.4      555.0         68.7         23.5         .29       .15      45 1/16      36 5/8
         4th Quarter               1,761.5      518.4       (211.1)      (295.5)      (1.05)      .15      47 1/8       36 1/16
------------------------------------------------------------------------------------------------------------------------------
December 1996:(e,f,g,h)
         1st Quarter              $1,981.0     $532.9      $  47.4      $  47.4      $  .19      $.15    $ 28 1/8      $22 3/8
         2nd Quarter               2,014.6      563.1         66.9         63.6         .29       .15      27 3/8       24 3/4
         3rd Quarter               1,925.9      567.1        114.0        114.0         .51       .15      27 1/4       24 5/8
         4th Quarter               1,785.6      479.8         99.7         94.9         .45       .15      34 1/4       27 5/8
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a)  Results for the fourth  quarter of 1997  included a  restructure  charge of
     $458.0 million ($317.6  million net of taxes,  or $1.53 per share).

(b) Results for the  third  quarter  of 1997  included  a  nonrecurring  charge
    related  to transaction  costs of $53.9  million  (or $.25 per  share).

(c) Results for the second quarter of 1997 included a  nonrecurring  gain on the
    sale of timberlands of $57.7 million  ($35.2 million net of taxes,  or $.16
    per share).

(d) Results for  the  first,  second,  third  and  fourth  quarters  of  1997
    included  net extraordinary  charges for the early extinguishment of debt of
    $1.3 million, $.6 million,  $45.2  million  (or $.22 per  share)  and $84.4
    million  (or $.41 per share),  respectively.

(e) Results  for the fourth  quarter  of 1996  included nonrecurring  charges of
    $10.6 million  ($8.2 million net of taxes,  or $.04 per share)  for
    severance  costs,   asset   write-downs  and  net  gains  on  asset
    dispositions.

(f) Results for the third quarter of 1996 included a nonrecurring gain of $46.9
    million  ($24.2  million net of taxes,  or $.12 per share) for the Flexible
    Packaging  disposition and nonrecurring charges of $16.6 million ($10.4
    million net of taxes, or $.05 per share) for severance costs.

(g) Results for the second quarter and first quarter of 1996 included
    nonrecurring  charges of $7.0 million ($4.2 million net of taxes,  or $.02
    per share) and $23.4 million ($14.3 million net of taxes, or $.09 per
    share), respectively,  for severance costs and net losses on asset
    dispositions.

(h) Results for the second and fourth quarters of 1996 included net
    extraordinary  charges for the early extinguishment of debt of $3.3  million
    (or $.02 per  share)  and $4.8  million  (or $.02 per  share), respectively.

<PAGE>

MANAGEMENT
responsibility
statement

58 FORT JAMES CORPORATION

The management of Fort James  Corporation is  responsible  for the  preparation,
integrity and fair  presentation of the  consolidated  financial  statements and
other information  contained in this Annual Report.  The consolidated  financial
statements have been prepared in accordance with generally  accepted  accounting
principles,   and  include,   where  necessary,   amounts  which  are  based  on
management's  best  estimates and judgments.
    The Company  maintains a system of internal  accounting  controls  designed
to provide  reasonable  assurance  that assets are  safeguarded,  transactions
are executed and recorded in  accordance with proper authorizations, and
financial records are maintained so as to permit the  preparation  of  reliable
financial  statements.  The  system of  internal controls is enhanced  by
written  policies  and  procedures,  an  organizational structure  which
provides  appropriate  division of  responsibilities,  careful selection and
training of qualified people,  and a program of periodic audits by both internal
auditors and independent  accountants.  The control environment is further
enhanced by the Company's  "Standards of Business Conduct Policy" which sets
standards of  professionalism  and integrity for employees  worldwide.
    The Audit  Committee of the Board of Directors,  composed  entirely of
non-employee directors,  meets periodically with management,  the internal
auditors,  and the independent  accountants to review the adequacy of internal
accounting controls, reported financial results,  and the nature,  extent and
results of internal and external audits.  The independent  accountants and
internal auditors have direct and independent access to the Audit Committee.

/s/ Miles L. Marsh

Miles L. Marsh
Chairman of the Board
and Chief Executive Officer

/s/ Ernst A. Haberli

Ernst A. Haberli
Executive Vice President and
Chief Financial Officer



REPORT
of independent
accountants

The Board of  Directors  and  Shareholders  of Fort James  Corporation:

We have audited the accompanying  consolidated  balance sheets of Fort James
Corporation as of December 28, 1997,  and  December 29, 1996,  and the related
consolidated statements of operations,  cash flows,  and changes in capital
accounts for each of the three fiscal years in the period ended December 28,
1997. These financial statements are the  responsibility of the management of
Fort James  Corporation. Our responsibility is to express an opinion on these
financial  statements based on our audits.

    We conducted our audits in accordance  with  generally  accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable  assurance about whether the financial  statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

    In our opinion,  the  financial  statements  referred to above present
fairly, in all material  respects,  the consolidated  financial position of Fort
James Corporation  as of December  28, 1997,  and  December  29, 1996,  and the
consolidated  results of its operations and its cash flows for each of the three
fiscal years in the period ended December 28, 1997, in conformity with generally
accepted accounting principles.


/s/ Coopers & Lybrand, L.L.P.


Richmond, Virginia
February 3, 1998

<PAGE>

SELECTED
financial data(a)


                                                       FORT JAMES CORPORATION 59

<TABLE>
<CAPTION>
(in millions, except ratios and per share amounts)   1997           1996          1995         1994         1993(b)
-------------------------------------------------------------------------------------------------------------------
<S> <C>
Operations

         Net sales                                 $7,259.0      $7,707.1       $8,887.9     $7,103.7      $6,166.6
         Costs and expenses                         6,202.1       6,787.1        8,052.6      6,670.3       5,788.8
         Restructure and other unusual items          454.2          10.7           51.9          9.6       1,980.4
         Interest expense                             351.8         424.4          536.3        523.3         480.4
         Income (loss) before income taxes,
             minority interests
             and extraordinary item                   272.3         503.6          289.1        (70.7)     (2,039.7)
         Extraordinary item, net of taxes            (131.5)         (8.1)         (18.8)       (28.2)        (12.0)
         Net income (loss)                            (27.0)        319.9          141.1        (83.3)     (2,052.4)
         Net income (loss) applicable to
             common shares                            (70.4)        261.4           82.6       (129.1)     (2,085.2)
====================================================================================================================
Financial Position, End of Year

         Total current assets                      $1,916.5      $1,808.6       $2,161.9     $2,255.1      $1,530.1
         Property, plant and equipment              4,565.3       4,999.3        5,339.3      6,000.9       4,899.7
         Other assets                                 614.5         619.0          638.4        573.2         918.0
         Goodwill                                     636.9         730.0          771.7        776.0         153.3
         Total assets                               7,733.2       8,156.9        8,911.3      9,605.2       7,501.1
         Total current liabilities                  1,583.9       1,542.0        1,425.1      1,946.0       1,120.6
         Current debt                                  34.4         128.9          107.5        562.7         210.0
         Long-term debt                             4,155.5       4,305.3        5,406.3      5,857.6       5,052.6
         Minority interests                            10.4          11.3          165.3        154.9           7.0
         Preferred stock                              352.7         738.4          740.3        740.3         454.1
         Common shareholders' equity (deficit)        231.6         113.1         (324.5)      (727.1)       (566.8)
====================================================================================================================
Common Stock Information
         Per Share of Common Stock (diluted)
            Net income (loss) before
              extraordinary item                  $    .35      $   1.47        $     62      $ (.75)      $ (15.47)
            Extraordinary item                        (.63)         (.04)           (.12)       (.21)          (.09)
            Net income (loss)                         (.28)         1.43             .50        (.96)        (15.56)
            Annual rate of dividends
              declared                                 .60           .60             .60         .60            .60
            Book value                                1.11           .60           (1.89)      (5.42)         (4.23)
         Common Stock Market Price
            High                                 $   47.13       $ 34.25        $  37.38      $24.75       $  23.38
            Low                                      27.25         22.38           20.00       15.63          16.25
            Year-end                                 37.50         34.00           24.13       21.00          18.50
         Weighted-average number of common shares
                  and equivalents                    207.6         183.1           164.1       134.1          134.0

====================================================================================================================
Other Data
         Capital expenditures
             (excluding acquisitions)            $   505.9       $ 499.5        $  488.5     $435.3        $  496.6
         Depreciation and amortization expense       497.3         525.6           586.7      509.8           493.8
         Return on average capital employed           16.6%         13.0%           11.1%       6.4%            5.5%
         Return on net sales                           6.1%          4.4%            2.2%       (.7)%          (1.0)%
         Ratio of total debt to total capitalization  87.6%         83.7%           90.5%      97.5%          102.1%
         Current ratio                                1.21          1.17            1.52       1.16            1.37
         Cash dividend payout ratio                   +100%         34.3%           76.9%      +100%           +100%
         Ratio of earnings to interest                 3.0           2.2             1.6         .9              .9
====================================================================================================================
</TABLE>

(a) Reflects effect of a 6.5-for-one Fort Howard stock split in 1995.
(b) Includes a charge of $1.98 billion related to the write-off of goodwill.

Book value per common share:
Common shareholders' equity (deficit) divided by outstanding shares of common
stock.

Return on average capital employed:
Income (loss) before restructure charges, extraordinary item, interest expense
and income taxes, divided by average capital employed. Capital employed is
calculated as total assets, excluding assets held for sale, minus non-interest
bearing current liabilities.

Return on net sales:
Income (loss) before after-tax restructure charges and extraordinary item,
divided by net sales.

Ratio of total debt to total capitalization:
Total debt divided by the sum of total debt, minority interests, preferred stock
and common shareholders' equity (deficit).

Current Ratio:
Total current assets divided by total current liabilities.

Cash dividend payout ratio:
The sum of common and preferred stock cash dividends, divided by net income
(loss).

Ratio of earnings to interest:
Income (loss) before restructure charges, extraordinary items, interest expense
and income taxes, divided by total interest cost. Total interest cost is
interest expense plus capitalized interest.

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Exhibit 13 - Appendix A

Earnings per share, diluted bar chart as defined by the following data points:

(in dollars)                                        1995       1996       1997
As reported                                        $0.50      $1.43      $(0.28)
Excluding nonrecurring charges (net of tax)         0.81       1.35        1.97


Net sales bar chart as defined by the following data points:

(in billions)                                       1995       1996        1997
As reported                                        $8.89      $7.71       $7.26


Operating income bar chart as defined by the following data points:

(in millions)                                      1995       1996         1997
As reported                                      $783.4     $909.3     $  602.7
Excluding nonrecurring charges (net of tax)       835.3      920.0      1,056.9


Net sales by segment ratio bar chart as defined by the following data points:

                                                   1997

North American Consumer Products                    59%
European Consumer Products                          25%
Packaging                                           10%
Communications Papers                                6%


Operating Income - North American Consumer Products bar chart as defined by the
following data points:

(in millions)                                1996               1997
1st Quarter                                $177.6             $204.6
2nd Quarter                                 184.2              231.1
3rd Quarter                                 217.8              219.9
4th Quarter                                 173.7              189.8




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Operating Income - European Consumer Products bar chart as defined by the
following data points:

(in millions)                                    1996               1997
1st Quarter                                     $31.1              $52.4
2nd Quarter                                      48.8               52.9
3rd Quarter                                      54.5               48.3
4th Quarter                                      42.7               48.8

Operating Income - Packaging bar chart as defined by the following data points:

(in millions)                                    1996              1997
1st Quarter                                     $29.8             $21.2
2nd Quarter                                      24.0              23.8
3rd Quarter                                      22.9              22.7
4th Quarter                                      15.2              13.6

Operating Income - Communications Papers bar chart as defined by the following
data points:

(in millions)                                     1996            1997
1st Quarter                                       $4.2           $(3.6)
2nd Quarter                                        3.2             0.4
3rd Quarter                                        4.8            11.0
4th Quarter                                       10.0            12.0
                                                         

Interest Expense bar chart as defined by the following data points:

(in millions)                                   1995       1996       1997
Interest expense                                $536       $424       $352


Capital Expenditures and Cash Flow from Operations bar chart as defined by the
following data points:

(in millions)                                 1995         1996        1997
Capital expenditures                          $489       $  500        $506
Cash flow from operations                      766        1,085         764




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Total Debt bar chart as defined by the following data points:

(in billions)                            1995           1996           1997
Total debt                              $5.51          $4.43          $4.19


Working Capital bar chart as defined by the following data points:

(in millions)                              1995           1996           1997
Working capital                            $737           $267           $333


Total Capitalization bar chart as defined by the following data points:

(in billions)                                    1995      1996      1997
Total debt                                       $5.51     $4.43     $4.19
Minority interests                                 .17       .01       .01
Total preferred stock                              .74       .74       .35
Common shareholders' equity                      (0.32)     0.11      0.23


Annual Rate of Cash Dividends Per Common Share bar chart as defined by the
following data points:

(in dollars)                                     1995         1996       1997
Annual rate of cash dividends                    $.60         $.60       $.60

Total Assets bar chart as defined by the following data points:

(in billions)                                   1995     1996    1997
Current assets                                 $2.16    $1.81   $1.92
Net fixed and other assets                      6.75     6.35    5.82