In the long history of P. H. Glatfelter Company, 1997 was a pivotal year. Early in the year, Chairman Emeritus P. H. Glatfelter III, a man who was a Company, industry and community leader, passed on. We continue to miss his presence.
It was also a year in which the Company moved forward with the execution of our long-term objective of growing our business. In the fourth quarter, we announced that we had agreed to acquire Schoeller and Hoesch (S&H), a German specialty paper producer. Further, we completed several projects during the year, including the installation of a new $15 million gravure coater for specialized coated paper production. All of our efforts in 1997 were designed to help us grow and enhance our business for the benefit of our shareholders and our customers.
By far, the most exciting event of 1997 was the announcement in November of our agreement to purchase S&H. We have stated previously that an ideal way to achieve our primary objective of increasing shareholder value is through the acquisition of a company which we believe will increase earnings and cash flow. The S&H acquisition, which was consummated on January 2, 1998, fits nicely into our existing business and puts us on the right path toward achieving our long-term goals of growing our specialty paper business and enhancing shareholder value. S&H, headquartered in Gernsbach, Germany, operates facilities in Germany, France, the Philippines and the United States. In addition to being a world leader in the production of tea bag papers, S&H manufactures tobacco papers; metalized papers for labels; vacuum cleaner filters; coffee filters; stencil papers; casing papers for sausages and other food products; lightweight printing papers; and melt-blown fleece used to absorb oil and chemical spills.
The acquisition of S&H will provide us with several strategic benefits: (1) it will strengthen our global position in tobacco papers; (2) it will diversify our product base; (3) it will provide potential synergies in technology and marketing; (4) it will position our Company as a worldwide force in highly engineered paper products; and (5) it will give us an increased international presence and additional manufacturing locations.
We are very excited about this new chapter in the Company's history. We are now in the process of working with our S&H management team members so that, together, we can maximize the benefits of this important relationship for the Company, our employees, our customers and our shareholders.
We were disappointed with 1997's financial results, particularly the decline in earnings. However, we are pleased to report that your Company's financial results held up well given the market conditions for uncoated papers.
Net income was 8% of net sales, which was better than most of the U.S. publicly traded paper companies' reported results for the year. Revenues for 1997 increased slightly over 1996 due to increased sales volume in 1997 of 7% that was nearly offset by lower average selling prices. Cost increases due to producing higher volume more than offset the marginally higher revenues. Volumes were higher as a result of less market-related downtime in 1997 as compared to 1996, primarily for our printing paper products, and productivity improvements at each of our locations. Selling prices for most printing papers deteriorated during 1996 and continued to deteriorate into 1997 before rebounding modestly in the second and third quarters of the year. Higher-than-normal paper inventories at customer and producer levels, generally as a result of excess printing paper capacity, was the major cause of lower average printing paper prices. Tobacco paper prices on average were lower in 1997 as compared to 1996 due to the effects of the strong U.S. dollar on our international business. Pricing was also adversely affected by cigarette paper capacity which came on line in China.
Other specialty paper products' profitability continued to be a bright spot as prices for those products declined only marginally during 1996 and early 1997 before recovering around mid-year. These products have consistently higher margins as compared to other printing paper products and enabled your Company to show comparatively better net income as a percentage of sales results than most of its competitors. These results support our strategy of continuing to grow in the production and sale of specialized products. This strategy was a major reason for our acquisition of S&H.
To finance the S&H acquisition, the Company borrowed DM 270 million (approximately $150 million) and assumed approximately DM 72 million of S&H debt (approximately $40 million). The Company's consolidated debt/capital ratio following the acquisition is approximately 1:1. The additional debt was provided by a multicurrency revolving credit facility. Interest rates were quite attractive; the average interest rate on the acquisition debt, which was borrowed predominately on a variable rate basis, was 4.27%. A focus for your Company over the next several years will be to reduce the debt level, which we believe can be accomplished through cash generation in our United States businesses, as well as at S&H.
We must continue to execute our strategy of becoming specialists in the paper industry. This should enable us to have both improved and more stable financial results in the future.
From an operational perspective, the performance of the Spring Grove mill in 1997 was extraordinary. Paper shipments of over 305,000 tons exceeded the previous record by 7%. All-time records were attained in the production of pulp, as well as in both coated and uncoated paper production. Internal production yields also reached unprecedented levels for the year.
The Neenah mill also achieved record levels of paper production in 1997. The shipment of over 153,000 tons reflected the greatest amount of paper ever shipped from the mill in a single year.
Volume at the Ecusta mill was 4% higher in 1997 than in 1996, due to strong manufacturing performance and mix shifts to heavier weight paper in some printing paper lines.
The challenge in 1998 will be to operate at even higher levels of productivity and to increase profitability by continuing to improve manufacturing efficiency and reduce cost.
The Glatfelter Pulp Wood Company, the wood procurement subsidiary of the P. H. Glatfelter Company, provided a record 956,000 tons of wood fiber to the Spring Grove mill in 1997. In addition to reaching this important milestone, the Pulp Wood Company celebrated the 50th Anniversary of Tree Farming in Pennsylvania with the rededication of Tree Farm No. 1 in Fairfield, Adams County. Tree Farm No. 1, the first in Pennsylvania, was rededicated in memory of Ray O. Brooks, who had forestry responsibility for that tree farm for more than 25 years. Ray, who passed away early in 1997, was a crusader for sustainable forestry, making sure that the health of these woodlands, as well as the wildlife which inhabits them, remains a priority of our forestry management program.
On the environmental front in 1997, we began the process of seeking ISO 14000 certification for the Company. ISO 14000 is a series of environmental management standards created by the International Organization for Standardization (ISO) to help business and industry effectively manage and monitor environmental affairs. The Company has made the commitment to improve its existing environmental management system using the ISO 14000 standards as a guideline and, furthermore, to seek third-party ISO 14000 certification for all of our operating locations in the next three years. These standards are strictly voluntary and the decision to embark on this project emphasizes the Company+s strong commitment to continuous environmental improvement.
In November 1997, the U. S. Environmental Protection Agency finalized the first part of the Cluster Rules, a set of air and water regulations governing the paper industry. These rules have been in the works for almost a decade. The recently released portion, which deals with bleached kraft pulp and paper mills, impacts primarily the Spring Grove mill. In this decade, we have spent almost $200 million for environmental improvements at the Spring Grove facility alone, and we did so with the Cluster Rules in mind. The modernization of the Spring Grove pulpmill, which was completed in 1995, as well as other environmental upgrades, puts the mill well on its way to compliance with the newly released Cluster Rules. Our Neenah and Ecusta mills will be affected by the next phase of the Cluster Rules, which should be finalized within the next two years. We do not believe the proposed rules will have a significant impact on the capital or operating expenditures of the Neenah and Ecusta mills.
1998 - Our outlook
With all the uncertainty in the world financial markets, preparing a short-term forecast is extremely challenging. On the one hand, the domestic printing paper industry is driven by the U.S. economy and indicators point to a continued positive growth picture. Over the next few years, we anticipate that the basics of printing paper supply and demand will continue to move in our favor and we expect to see modest increases in pricing. With the exception of one new 300,000 ton-per-year commodity machine scheduled for startup in 1998, no new printing-grade papermaking capacity in North America has been announced. This is a very good sign for the industry. U.S. inflation remains in check and both interest rates and unemployment are low. The Federal Reserve continues to adopt policies that keep economic growth at a sustainable level - not too fast and not too slow. Growth in the Gross Domestic Product (GDP) is expected to remain in the 2% range, as predicted by the economists that we follow.
On the other hand, a major potential problem has surfaced as we enter 1998 - the Asian crisis. With the collapse of Asian capital markets, the devaluing of most Asian currencies and the halt or drastic reduction of economic growth in many of those countries, the impact on the world economy and U.S. pulp and paper manufacturers is unknown.
Our concern is not so much related to our sales in these countries, but to the potential pulp and paper volume that may enter and disrupt U.S. markets. An increase in pulp and paper volume could lower prices on these products. Although lower prices would reduce our costs for purchased pulp, such savings would likely be more than offset by reduced revenues from the lower selling prices for our products. There is much uncertainty in the minds of industry analysts as well as in our own as to the length and severity of this potential problem. It certainly cannot be ignored.
The strong U.S. dollar will continue to remain a concern as 1998 unfolds. Hopefully, the value of the U.S. dollar will moderate, which will help to minimize the negative impact that the strong dollar had on our international sales profitability in 1997.
With regard to our financial printing papers, we expect demand for these grades will remain in line with the transaction-based activity in the U.S. financial equity and bond markets. We also expect specialty paper markets will continue modest growth, including those markets serviced by the newly acquired S&H organization.
With respect to tobacco papers, we will continue to focus on international growth as we recognize that domestic demand will probably decline. We expect to expand in the international marketplace through our existing customer base, as well as through new customers. Our acquisition of S&H, which provides us with a more complete tobacco papers product line, is anticipated to help us grow our tobacco papers business.
Our theme for this year's annual report is "Focused on Future Growth." I believe this accurately reflects the very foundation of our corporate mission.
We will continue to strive to maximize shareholder value within the context of the business in which we operate. We are constantly looking for opportunities to improve this business through internal and external growth.
On behalf of all of our employees who work diligently every day in the face of constantly changing world market conditions to make this the best corporation it can be, I thank you for your continued trust and support.
Chairman, President and
Chief Executive Officer February 6, 1998