1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 -------------- () TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------------------- ------------------------ Commission File No. 1-3560 P. H. GLATFELTER COMPANY - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-0628360 - -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 96 South George Street, Suite 500, York, Pennsylvania 17401 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (717) 225-4711 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . --- --- Shares of Common Stock outstanding at April 30, 2001 were 42,462,113. 1
2 P. H. GLATFELTER COMPANY INDEX Part I - Financial Information Financial Statements: Condensed Consolidated Statements of Income - Three Months Ended March 31, 2001 and 2000 (Unaudited)...... 3 Condensed Consolidated Balance Sheets - March 31, 2001 (Unaudited) and December 31, 2000........................... 4 Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2001 and 2000 (Unaudited)............ 5 Notes to Condensed Consolidated Financial Statements (Unaudited)................................................. 6 Independent Accountants' Report............................................. 12 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................. 13 Quantitative and Qualitative Disclosures About Market Risk.................. 18 Part II - Other Information................................................. 18 Signature................................................................... 20 Index of Exhibits........................................................... 21 2
3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) (UNAUDITED) <TABLE> <CAPTION> Three Months Ended 3/31/01 3/31/00 ----------- ----------- <S> <C> <C> Revenues: Net sales $ 185,646 $ 187,658 Other income - net: Energy sales - net 2,312 2,466 Interest on investments and other - net 1,378 1,288 Gain from property dispositions, etc. - net 500 308 ----------- ----------- 4,190 4,062 Total revenues 189,836 191,720 Cost and expenses: Cost of products sold 145,921 154,151 Selling, general and administrative expenses 15,500 13,103 Interest on debt 4,442 4,380 Unusual item -- 3,336 ----------- ----------- 165,863 174,970 Income before income taxes 23,973 16,750 Income tax provision: Current 6,274 4,490 Deferred 2,335 1,616 ----------- ----------- Total 8,609 6,106 Net income $ 15,364 $ 10,644 =========== =========== Basic and diluted earnings per share $ 0.36 $ 0.25 =========== =========== </TABLE> See accompanying notes to condensed consolidated financial statements. 3
4 P. H. GLATFELTER COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) <TABLE> <CAPTION> 3/31/01 (unaudited) 12/31/00 ------------- ------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 89,142 $ 110,552 Accounts receivable - net 85,027 72,231 Inventories Raw materials 25,662 27,789 In-process and finished 44,364 43,819 Supplies 29,890 29,686 ------------- ------------- Total inventories 99,916 101,294 Prepaid expenses and other current assets 3,046 2,547 ------------- ------------- Total current assets 277,131 286,624 Plant, equipment and timberlands - net 544,475 552,768 Other assets 180,753 173,799 ------------- ------------- Total assets $ 1,002,359 $ 1,013,191 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,345 $ 1,419 Short-term debt 2,499 5,158 Accounts payable 37,108 45,869 Dividends payable 7,428 7,430 Income taxes payable 12,032 7,328 Accrued compensation and other expenses and deferred income taxes 43,804 51,980 ------------- ------------- Total current liabilities 104,216 119,184 Long-term debt 291,787 300,245 Deferred income taxes 157,788 155,360 Other long-term liabilities 66,113 65,699 ------------- ------------- Total liabilities 619,904 640,488 ------------- ------------- Commitments and contingencies Shareholders' equity: Common stock 544 544 Capital in excess of par value 41,525 41,669 Retained earnings 519,289 511,019 Accumulated other comprehensive income (2,048) (2,843) ------------- ------------- Total 559,310 550,389 Less cost of common stock in treasury (176,855) (177,686) ------------- ------------- Total shareholders' equity 382,455 372,703 ------------- ------------- Total liabilities and shareholders' equity $ 1,002,359 $ 1,013,191 ============= ============= </TABLE> See accompanying notes to condensed consolidated financial statements. 4
5 P. H. GLATFELTER COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (UNAUDITED) <TABLE> <CAPTION> Three Months Ended 3/31/01 3/31/00 ----------- ----------- <S> <C> <C> Cash flows from operating activities: Net income $ 15,364 $ 10,644 Items included in net income not using cash: Depreciation, depletion and amortization 11,840 11,820 Loss on disposition of fixed assets -- 98 Expense related to 401(k) plans 747 481 Change in assets and liabilities: Accounts receivable (14,409) (14,406) Inventories 151 4,932 Other assets and prepaid expenses (7,695) (5,471) Accounts payable, accrued compensation and other expenses, deferred income taxes and other long-term liabilities (14,327) (7,217) Income taxes payable 4,197 4,431 Deferred income taxes - noncurrent 2,488 2,791 ----------- ----------- Net cash provided by (used in) operating activities (1,644) 8,103 ----------- ----------- Cash flows from investing activities: Proceeds from disposal of fixed assets 16 40 Additions to plant, equipment and timberlands (9,468) (3,429) ----------- ----------- Net cash used in investing activities (9,452) (3,389) ----------- ----------- Cash flows from financing activities: Net payment of debt (2,797) (638) Dividends paid (7,418) (7,393) ----------- ----------- Net cash used in financing activities (10,215) (8,031) ----------- ----------- Effect of exchange rate changes on cash (99) 1 ----------- ----------- Net decrease in cash and cash equivalents (21,410) (3,316) Cash and cash equivalents: At beginning of year 110,552 76,035 ----------- ----------- At end of period $ 89,142 $ 72,719 =========== =========== Supplemental disclosure of cash flow information: Cash paid for: Interest $ 6,941 $ 7,168 Income taxes 383 265 </TABLE> See accompanying notes to condensed consolidated financial statements. 5
6 P. H. GLATFELTER COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. EARNINGS PER SHARE ("EPS") Basic EPS excludes the dilutive impact of common stock equivalents and is computed by dividing net income by the weighted-average number of shares of common stock outstanding for the period. Diluted EPS includes the effect of potential dilution from the issuance of common stock, pursuant to common stock equivalents, using the treasury stock method. A reconciliation of the Registrant's basic and diluted EPS follows with the dollar and share amounts in thousands: <TABLE> <CAPTION> Three Months Ended March 31 ------------------------------ 2001 2000 ---------- ---------- Shares Shares ---------- ---------- <S> <C> <C> Basic EPS factors 42,418 42,267 Effect of potentially dilutive employee incentive plans: Restricted stock awards 130 62 Performance stock awards 29 39 ---------- ---------- Diluted EPS factors 42,577 42,368 ========== ========== Net income $ 15,364 $ 10,644 Basic and diluted EPS $ 0.36 $ 0.25 </TABLE> Basic and diluted EPS of $.25 for the three months ended March 31, 2000, as presented on the Condensed Consolidated Statement of Income, reflects the negative impact of an after-tax restructuring charge (unusual item) of $.05 per share (see Note 2). 2. UNUSUAL ITEM The Registrant announced in September 1999 that, effective January 1, 2000, prices would be increased for certain of its tobacco paper products. This initiative was required for the Registrant to remain a viable, high-quality supplier to its tobacco paper customers. As the Registrant expected, certain of these customers sought other suppliers after this announcement. As a result, the Registrant announced in December 1999 that it would begin reducing its tobacco paper manufacturing capacity at its Ecusta mill during 2000. During the first quarter of 2000, the Registrant finalized its plan of restructuring and shortly thereafter began to reduce the workforce at Ecusta. The workforce reduction has been completed and has resulted in the reduction of approximately 220 salaried and hourly jobs associated with the Registrant's tobacco paper production capacity. The Registrant accrued and charged to expense $3,336,000 ($2,120,000 after tax) in the first quarter of 2000 primarily as a result of the voluntary portion, specifically 42 salaried employees, of this restructuring. The amount of actual termination benefits paid and charged against the liability as of March 31, 2001 was $795,000. 6
7 3. RECENT ACCOUNTING PRONOUNCEMENTS AND RECLASSIFICATIONS On January 1, 2001, the Registrant adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated in a fair-value hedge, changes in the fair value of the derivative and the hedged item are recognized in earnings. If the derivative is designated in a cash-flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income ("OCI") and are recognized in the income statement when the hedged item affects earnings. SFAS No. 133 defines new requirements for designation and documentation of hedging relationships as well as ongoing effectiveness assessments and measurements to use hedge accounting. The ineffective portion of a hedging derivative's change in fair value is immediately recognized in earnings. For a derivative that does not qualify as a hedge, changes in fair value are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001 resulted in an $845,000 increase in OCI as a cumulative transition adjustment for derivatives designated in cash flow-type hedges prior to adopting SFAS No. 133. Due to its limited use of derivative instruments, the effect on earnings of adopting SFAS No. 133 was immaterial. During the fourth quarter of 2000, the Registrant adopted the provisions of the Emerging Issues Task Force ("EITF") Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs." In accordance with the provisions of EITF 00-10, certain shipping and handling costs that the Registrant had previously recorded as a deduction in determining net sales have been reclassified to cost of products sold. As a result of adopting EITF 00-10, the Registrant has reclassified such shipping and handling costs on its Condensed Consolidated Statement of Income for the three months ended March 31, 2000 to reflect comparable reporting. 4. INTEREST RATE SWAP AGREEMENTS In January 1999, the Registrant entered into two interest rate swap agreements, each having a total notional principal amount of DM 50,000,000 (approximately $22,500,000 as of March 31, 2001). Under these agreements, which were effective April 6, 1999 and July 6, 1999 and which expire December 22, 2002, the Registrant receives a floating rate of the three-month DM London Interbank Offered Rate ("LIBOR") plus twenty basis points and pays a fixed rate of 3.41% and 3.43%, respectively, for the term of the agreements. The Registrant's interest rate swap agreements convert a portion of the Registrant's borrowings from a floating-rate to a fixed-rate basis. Although the Registrant can terminate its swap agreements at any time, the Registrant intends to hold its swap agreements until maturity. 5. COMPREHENSIVE INCOME Comprehensive income was $16,159,000 and $10,182,000 for the first three months of 2001 and 2000, respectively. Comprehensive income includes the effects of changes in (1) certain currency exchange rates relative to the 7
8 U.S. dollar and (2) the fair value of derivative instruments held by the Registrant (see Note 3). 6. COMMITMENTS AND CONTINGENCIES The Registrant is subject to loss contingencies resulting from regulation by various federal, state, local and foreign governmental authorities with respect to the environmental impact of air and water emissions and noise from its mills, as well as the disposal of solid waste generated by its operations. To comply with environmental laws and regulations, the Registrant has incurred substantial capital and operating expenditures in past years. The Registrant anticipates that environmental regulation of its operations will continue to become more burdensome and that capital and operating expenditures will continue, and perhaps increase, in the future. In addition, the Registrant may incur obligations to remove or mitigate any adverse effects on the environment resulting from its operations, including the restoration of natural resources, and liability for personal injury and damage to property, including natural resources. Because environmental regulations are not consistent worldwide, the Registrant's ability to compete in the world marketplace may be adversely affected by capital and operating expenditures required for environmental compliance. Subject to permit approval, the Registrant has undertaken an initiative under the Voluntary Advanced Technical Incentive Program of the United States Environmental Protection Agency ("EPA") to comply with the new "Cluster Rule" regulations. This initiative, the Registrant's "New Century Project," will require capital expenditures currently estimated at approximately $30,000,000 to be incurred before April 2004. On September 7, 2000, the Pennsylvania Department of Environmental Protection ("DEP") issued to the Registrant a renewed wastewater discharge permit for the Spring Grove mill with an effective date of October 1, 2000. The renewed permit calls for reductions in the mill's discharge of color that the Registrant believes cannot be achieved at this time without a curtailment of operations. On September 7, 2000, DEP also issued to the Registrant an administrative order calling for achievement of the limitations in the permit on a schedule extending until 2007. Both the permit and the order contemplate adoption of an alternative limitation on color which would be less stringent. The Registrant expects to be able to meet the alternative limitation without a curtailment of operations under the schedule set forth in the order. Under the schedule set forth in the permit, however, the Registrant may not be able to meet the alternative limitation without a curtailment of operations. The Registrant has appealed the permit and the order to the Pennsylvania Environmental Hearing Board. After an evidentiary hearing, the Board granted a stay of the permit limitation during the pendency of the appeal. The Board did not grant a stay of the alternative limitation because it is not yet in effect, and will not come into effect until a change in the Pennsylvania Water Quality Standard for color is approved; in this case, "approval" includes an approval by EPA. The Pennsylvania Public Interest Research Group and several other parties (collectively "Penn PIRG") have appealed the alternative limitation and have also intervened in the Registrant's appeal of the permit. The Registrant is engaged in settlement discussions with Penn PIRG and DEP, but also continues to litigate all appeals vigorously. In June 1999, Penn PIRG brought a citizen suit under the Federal Clean Water Act and Pennsylvania Clean Streams Law seeking a reduction in the Spring Grove mill's discharge of color, civil penalties and costs of litigation. On February 7, 2001, the United States District Court granted partial summary judgment on liability to plaintiffs as to certain claims and granted summary judgment to the Registrant on others. The court has not scheduled 8
9 further proceedings with respect to any remedy until after it resolves the Registrant's pending motion for reconsideration. In 1999, EPA and DEP issued to the Registrant separate Notices of Violation ("NOVs") alleging violations of the federal and state air pollution control laws, primarily for purportedly failing to obtain appropriate preconstruction air quality permits in conjunction with certain modifications to the Registrant's Spring Grove mill. EPA announced that the Registrant was one of seven pulp and paper mill operators to have received contemporaneously an NOV alleging this kind of violation. EPA and DEP alleged that the Registrant's modifications produced (1) significant net emissions increases in certain air pollutants which should have been covered by appropriate permits imposing new emissions limitations, and (2) certain other violations. For all but one of the modifications cited by EPA, the Registrant applied for and obtained from DEP the preconstruction permits which the Registrant concluded were required by applicable law. EPA reviewed those applications before the permits were issued. DEP's NOV pertained only to the modification for which the Registrant did not receive a preconstruction permit. The Registrant conducted an evaluation at the time of this modification, and determined that the preconstruction permit cited by EPA and DEP was not required. The Registrant has been informed that EPA and DEP will seek substantial emissions reductions, as well as civil penalties, to which the Registrant believes it has meritorious defenses. Nevertheless, the Registrant is unable to predict the ultimate outcome of these matters or the costs involved. The Registrant faces a set of related threatened claims arising out of the presence of polychlorinated biphenyls ("PCBs") in sediments in the Fox River below Lake Winnebago and in Green Bay, downstream of the Registrant's Neenah mill. As described below, various sovereigns have formally notified seven parties ("PRPs"), of which the Registrant is one, that they are potentially responsible for investigation, cleanup and natural resource damages arising from this contamination under the federal Comprehensive Environmental Response, Compensation and Liability Act and other laws. The Wisconsin Department of Natural Resources ("DNR") notified the Registrant and other PRPs informally in 1990 that it wished to pursue cleanup of certain sediments in the Fox River under state law. DNR subsequently asserted claims under federal law as well for cleanup and for natural resource damages. Since 1998, DNR has been performing a remedial investigation and feasibility study ("RI/FS") of the Fox River and Green Bay under contract to the EPA. In February 1999, DNR issued a draft RI/FS report estimating the costs of potential remedies for the Fox River at between $0 and $721,000,000, but did not select a preferred remedy. The Registrant does not believe that the no action remedy will be selected. The largest components of the costs of certain of the remedial alternatives are attributable to large-scale sediment removal by dredging. There is no assurance that the cost estimates in the draft RI/FS will not differ significantly from actual costs. Under ordinary procedures, the final RI/FS report will be issued along with a proposed remedial action plan ("PRAP"). EPA will consider comments on the PRAP and then will select a remedy for the site. EPA and DNR had stated publicly that the RI/FS would be issued in 2000. The expected date of issuance was subsequently delayed to the spring of 2001 and has now been further delayed. Based on current information and advice from its environmental consultants, the Registrant continues to believe that an aggressive effort, as included in certain remedial alternatives in the draft RI/FS, to remove PCB-contaminated sediment, much of which is buried under cleaner material or is otherwise unlikely to move and which is abating naturally, would be environmentally detrimental and, therefore, inappropriate. 9
10 In January 1997, DNR, the Wisconsin Department of Justice ("WDOJ"), and the seven PRPs entered into an agreement to conduct a cooperative natural resource damages assessment ("NRDA"). While that NRDA has not been completed, based upon work conducted to date, DNR and WDOJ have proposed to enter into a settlement with another PRP of its share of the natural resource damages liability. The proposed settlement does not state explicitly the total amount of natural resource damages, but it calls for such other PRP to spend $7,000,000 on resource restoration projects. The United States Fish and Wildlife Service ("FWS"), the National Oceanic and Atmospheric Administration ("NOAA"), four Indian tribes and the Michigan Attorney General claim to be trustees for natural resources injured by the PCBs in the Fox River and Green Bay. In June 1994, FWS notified the Registrant and other PRPs that it considered them potentially responsible for natural resource damages. The federal, tribal and Michigan agencies claiming to be trustees have proceeded with the preparation of an NRDA separate from the work performed by DNR. While the final report of assessment will be delayed until after selection of a remedy for the site, on October 25, 2000, the federal trustees released a restoration and compensation determination plan ("RCDP") that estimates natural resource damages for the site at between $176,000,000 and $333,000,000. The Registrant is seeking settlement with the Wisconsin agencies and with EPA for all of its liabilities for response actions and natural resource damages associated with the site. The Registrant believes that the federal, tribal and Michigan natural resource damages claims are without merit, and that the federal NRDA is technically and procedurally flawed. The Registrant further maintains that its share of any liability as among the seven identified PRPs is much less than one-seventh and that additional responsible parties exist other than the seven identified by the governments. The Registrant currently is unable to predict the ultimate costs to the Registrant related to this matter, because the Registrant cannot predict which remedy will be selected for the site or the ultimate amount of natural resource damages nor can the Registrant predict its share of these costs or damages. The Registrant continues to believe it is likely that this matter will result in litigation; however, the Registrant believes it will be able to persuade a court that removal of a substantial amount of PCB-contaminated sediments is not an appropriate remedy. There can be no assurance, however, that the Registrant will be successful in arguing that removal of PCB-contaminated sediments is inappropriate or that it would prevail in any resulting litigation. The amount and timing of future expenditures for environmental compliance, cleanup, remediation and personal injury, natural resource damage and property damage liability, including but not limited to those related to the lower Fox River and the Bay of Green Bay, cannot be ascertained with any certainty due to, among other things, the unknown extent and nature of any contamination, the extent and timing of any technological advances for pollution control, the remedial actions which may be required and the number and financial resources of any other responsible parties. The Registrant continues to evaluate its exposure and the level of its reserves, including, but not limited to, its share of the costs and damages (if any) associated with the lower Fox River and the Bay of Green Bay. The Registrant believes that it is insured against certain losses related to the lower Fox River, depending on the nature and amount thereof. Coverage, which is currently being investigated under reservation of rights by various insurance companies, is dependent upon the identity of the plaintiff, the procedural posture of the claims asserted and how such claims are characterized. The 10
11 Registrant does not know when the insurers' investigation as to coverage will be completed. The Registrant's current assessment, after consultation with legal counsel, is that ultimately it should be able to resolve these environmental matters without a long-term, material adverse impact on the Registrant. In the meantime, however, these matters could, at any particular time or for any particular period, have a material adverse effect on the Registrant's consolidated financial condition, liquidity or results of operations or result in a default under the Registrant's loan covenants. Moreover, there can be no assurance that the Registrant's reserves will be adequate to provide for future obligations related to these matters, that the Registrant's share of costs and/or damages for these matters will not exceed its available resources or that such obligations will not have a long-term, material adverse effect on the Registrant's consolidated financial condition, liquidity or results of operations. 7. SUBSEQUENT EVENT On May 1, 2001, the Registrant granted to each non-employee member of its Board of Directors options to purchase 1,500 shares of common stock for a total of 12,000 options granted. Such options become exercisable on May 1, 2002 at an exercise price of $14.44, which represents the average quoted market price of the Registrant's common stock on the date of grant, and expire on April 30, 2011. 8. DISCLOSURE STATEMENT In the opinion of the Registrant, the accompanying unaudited condensed consolidated financial statements contain all adjustments (which comprise only normal recurring accruals) necessary for a fair presentation of the financial information contained therein. These unaudited condensed consolidated financial statements should be read in conjunction with the more complete disclosures contained in the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000. 11
12 INDEPENDENT ACCOUNTANTS' REPORT P. H. Glatfelter Company: We have reviewed the accompanying condensed consolidated balance sheet of P. H. Glatfelter Company and subsidiaries as of March 31, 2001 and the related condensed consolidated statements of income and cash flows for the three months ended March 31, 2001 and 2000. These financial statements are the responsibility of the Company's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of P. H. Glatfelter Company and subsidiaries as of December 31, 2000, and the related consolidated statements of income and comprehensive income, shareholders' equity and cash flows for the year then ended (not presented herein); and in our report dated February 2, 2001, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. As discussed in Note 3 to the condensed consolidated financial statements, the Company changed its method of accounting for derivative financial instruments as of January 1, 2001. Deloitte & Touche LLP Philadelphia, Pennsylvania April 17, 2001, except for Note 7 as to which the date is May 1, 2001 12
13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis contains forward-looking statements. See "Cautionary Statement" set forth in Item 5. RESULTS OF OPERATIONS A summary of the period-to-period changes in the principal items included in the Condensed Consolidated Statements of Income is shown below. <TABLE> <CAPTION> Three Months Ended March 31, 2001 and 2000 ------------------------------- Increase (Decrease) (dollars in thousands) <S> <C> <C> Net sales $(2,012) (1.1)% Other income - net 128 3.2% Cost of products sold (8,230) (5.3)% Selling, general and administrative expenses 2,397 18.3% Interest on debt 62 1.4% Income tax provision 2,503 41.0% Net income 4,720 44.3% </TABLE> Net Sales Net sales decreased $2,012,000, or 1.1%, for the first quarter of 2001 compared to the first quarter of 2000 due to a slight decline in sales volume. Average net selling prices remained flat as slightly improved pricing offset a weaker mix of products sold. Demand for most of the Registrant's product lines during the first quarter of 2001 was steady. The Registrant classifies its sales into two product groups: specialized printing papers and engineered papers (which includes tobacco papers). Net sales of specialized printing papers increased 1.5% in the first quarter of 2001 compared to the first quarter of 2000 due to a 2.7% increase in average net selling prices, resulting from favorable pricing, partially offset by a 1.1% decrease in sales volume. The decreased sales volume of specialized printing papers was largely due to reduced demand in the first quarter of 2001 versus the like period of 2000. The Registrant believes that overall market conditions for its products are relatively stable with only minor price decreases expected in the near term. Net sales of engineered papers for the three months ended March 31, 2001 were 3.9% lower than for the corresponding 2000 period. The decrease was primarily the result of continued demand erosion for the Registrant's tobacco papers. Although the Registrant recognized slightly increased prices for tobacco papers, a weaker product mix more than offset the increase in prices thereby contributing to the lower net sales. As explained in "UNUSUAL ITEM" below, the Registrant has maintained increased pricing for certain of its tobacco papers, which has resulted in reduced sales volume. Although demand remains stronger than expected and price increases to date have held, the Registrant expects that, in the long run, net sales of tobacco papers will continue to trend downward, with volume decreases more than offsetting any improvements in pricing. Future price changes will be impacted by changes in market pulp prices. Net sales of engineered papers, excluding tobacco papers, increased 4.8% in the first quarter of 2001 versus the like period of 2000 primarily as a result of a 5.5% increase in net sales volume. The increase in net sales volume was slightly offset by a 0.6% decrease in net average selling prices. The Registrant believes 13
14 it is difficult to characterize such engineered papers in terms of demand trends and pricing due to the fragmentation and small size of markets within this group. Other Income - Net Other income - net increased $128,000, or 3.2%, for the first quarter of 2001 compared to the corresponding period of 2000. Energy sales - net decreased $154,000 for the three months ended March 31, 2001 versus the comparable period in 2000. Interest on investments and other - net increased $90,000 in the first quarter of 2001 versus the same period in 2000 as a result of higher average cash balances. Gain from property dispositions, etc. - net increased $192,000 for the three months ended March 31, 2001 versus the like period in 2000. Cost of Products Sold and Gross Margin Cost of products sold decreased $8,230,000, or 5.3%, for the first quarter of 2001 versus the first quarter of 2000 as a result of the Registrant's cash savings project (as described below), strong productivity from its manufacturing facilities and increased pension income, which were partially offset by increased costs of energy and market pulp. Market pulp prices have dropped steadily from January 2001 through April 2001. The Registrant expects that market pulp prices will continue to decrease slightly through the second quarter of 2001 and then remain constant through the third quarter of 2001. The Registrant continued to realize the benefits of its cash savings project, known as "DRIVE," in the first quarter of 2001. Such savings began in the second quarter of 2000 and have been offset slightly, in the short term, by the Registrant's costs of implementing the project (see "Selling, General and Administrative Expenses" below). The Registrant remains on pace to achieve its DRIVE target which has been increased from $50,000,000 to $53,000,000 in sustainable, annual cash savings. As of March 31, 2001, the Company had implemented portions of the DRIVE project that will realize approximately $30,000,000 per year in sustainable cash savings. Income resulting from the overfunded status of the Registrant's defined benefit pension plans and other postretirement benefit plans decreased cost of products sold by $7,036,000 and $5,281,000 for the first quarter of 2001 and the same quarter of 2000, respectively. This improved level of income was primarily the result of long-term investment performance of the plans' assets. Marginal cost of products sold per ton decreased 4.3% for the first quarter of 2001 versus the same period of 2000, resulting in an increase in gross margin per ton of 19.9%. As a result of the aforementioned items, gross margin as a percentage of net sales increased to 21.4% for the first quarter of 2001 from 17.9% for the like quarter of 2000. Selling, General and Administrative Expenses Selling, general and administrative expenses for the first quarter of 2001 were $2,397,000, or 18.3%, higher than for the first quarter of 2000. This increase was primarily a result of increased legal and professional expenses, which included outside consulting services associated with the Registrant's IMPACT (see "IMPACT PROJECT" below) and DRIVE projects. Additionally, incentive compensation costs increased in the first quarter of 2001 versus the same period of 2000 attributable to higher earnings in the 2001 period. Pension income reduced selling, general and administrative expenses by $1,612,000 and $1,074,000 for the first quarter of 2001 and the same quarter of 2000, respectively. 14
15 Interest on Debt - Net Interest on debt - net increased $62,000, or 1.4%, for the three months ended March 31, 2001 versus the comparable period of 2000. Income Tax Provision The income tax provision increased $2,503,000, or 41.0%, for the first quarter of 2001 versus the first quarter of 2000. The increase was primarily due to higher income before income taxes in 2001 versus 2000 and was offset slightly by a lower effective income tax rate. UNUSUAL ITEM The Registrant's tobacco papers business has suffered from extremely low pricing in recent years as a result of overcapacity in the tobacco papers industry and declining domestic consumption of tobacco products. To combat such depressed pricing, the Registrant announced in September 1999 that, effective January 1, 2000, prices would be increased for certain of its tobacco paper products. This initiative was required for the Registrant to remain a viable, high-quality supplier to its tobacco paper customers. As the Registrant expected, certain of these customers sought other suppliers after this announcement. As a result, the Registrant announced in December 1999 that it would begin reducing its tobacco paper manufacturing capacity at its Ecusta mill during 2000. During the first quarter of 2000, the Registrant finalized its plan of restructuring and shortly thereafter began to reduce the workforce at Ecusta. The workforce reduction has been completed and has resulted in the reduction of approximately 220 salaried and hourly jobs associated with the Registrant's tobacco paper production capacity. This reduction in jobs is lower than originally estimated due to stronger customer demand than anticipated. The Registrant accrued and charged to expense $3,336,000 ($2,120,000 after tax, or $.05 per share) in the first quarter of 2000 primarily as a result of the voluntary portion, specifically 42 salaried employees, of this restructuring. The amount of actual termination benefits paid and charged against the liability as of March 31, 2001 was $795,000. IMPACT PROJECT In July 2000, the Registrant initiated its IMPACT project, which is focused on identifying and implementing changes to the Registrant's organization and its business processes. The initial phase, the preliminary design work, has been completed. The second phase of the IMPACT project, which includes the installation of an enterprise resource planning system, is underway and is expected to extend over the next few years. Total spending on the IMPACT project is expected to be approximately $49,000,000, of which approximately $45,000,000 is capital related. During 2000, the Registrant spent approximately $5,200,000 on the IMPACT project. FINANCIAL CONDITION Liquidity Cash and cash equivalents decreased $21,410,000 during the first three months of 2001, principally due to cash used in investing activities and financing activities of $9,452,000 and $10,215,000, respectively. Cash used in investing activities was substantially for additions to plant, equipment and timberlands, and cash used in financing activities was for dividend payments and net payment of debt. Cash used in operations further decreased cash and cash equivalents by $1,644,000. 15
16 To finance the acquisition of S&H Papier-Holding GmbH, on December 22, 1997, the Registrant entered into a $200,000,000 multi-currency revolving credit facility ("Revolving Credit Facility") with a syndicate of major lending institutions. The Revolving Credit Facility enables the Registrant to borrow up to the equivalent of $200,000,000 in certain currencies in the form of revolving credit loans with a final maturity date of December 22, 2002, and with interest periods determined, at the Registrant's option, on a daily or one- to six-month basis. Interest on the revolving credit loans is at variable rates based, at the Registrant's option, on the Eurocurrency Rate or the Base Rate (lender's prime rate), plus applicable margins. Margins are based on the higher of the Registrant's debt ratings as published by Standard & Poor's and Moody's. As of March 31, 2001, the Registrant's outstanding borrowings were DM 307,800,000 (approximately $138,700,000) under the Revolving Credit Facility. In January 1999, the Registrant entered into two interest rate swap agreements, each having a total notional principal amount of DM 50,000,000 (approximately $22,500,000 as of March 31, 2001). Under these agreements, which were effective April 6, 1999 and July 6, 1999 and which expire December 22, 2002, the Registrant receives a floating rate of the three-month DM LIBOR plus twenty basis points and pays a fixed rate of 3.41% and 3.43%, respectively, for the term of the agreements. On July 22, 1997, the Registrant issued $150,000,000 principal amount of 6-7/8% Notes due July 15, 2007. Interest on the Notes is payable semiannually on January 15 and July 15. The Notes are redeemable, in whole or in part, at the option of the Registrant at any time at a calculated redemption price plus accrued and unpaid interest to the date of redemption, and constitute unsecured and unsubordinated indebtedness of the Registrant. The net proceeds from the sale of the Notes were used primarily to repay certain short-term unsecured debt and related interest. The Registrant expects to meet all its near- and long-term cash needs from a combination of internally generated funds, cash, cash equivalents and its existing Revolving Credit Facility or other bank lines of credit and, if prudent, other long-term debt. Interest Rate Risk The Registrant uses its Revolving Credit Facility and proceeds from the issuance of its 6-7/8% Notes to finance a significant portion of its operations. The Revolving Credit Facility provides for variable rates of interest and exposes the Registrant to interest rate risk resulting from changes in the DM LIBOR. The Registrant uses interest rate swap agreements to hedge, partially, interest rate exposure associated with the Revolving Credit Facility. All of the Registrant's derivative financial instrument transactions are entered into for non-trading purposes. To the extent that the Registrant's financial instruments expose the Registrant to interest rate risk and market risk, they are presented in the table below. The table presents principal cash flows and related interest rates by year of maturity for the Registrant's Revolving Credit Facility and 6-7/8% Notes as of March 31, 2001. For interest rate swap agreements, the table presents notional amounts and the related reference interest rates by year of maturity. Fair values included herein have been determined based upon (1) rates currently available to the Registrant for debt with similar terms and remaining maturities, and (2) estimates obtained from dealers to settle interest rate swap agreements. 16
17 <TABLE> <CAPTION> Year of Maturity Fair (dollar amounts in thousands) Value at Debt: 2001 2002 2003 2004 2005 Thereafter Total 3/31/01 ---- ---- ---- ---- ---- ---------- --------- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Fixed rate -- $ 1,345 $ 1,007 $ 872 $ 728 $ 437 $ 150,000 $ 154,389 $ 157,333 Average interest rate 6.86% 6.86% 6.87% 6.87% 6.87% 6.87% Variable rate -- $ -- $138,743 $ -- $ -- $ -- $ -- $ 138,743 $ 138,743 Average interest rate 4.64% 4.64% -- -- -- -- Interest rate swap agreements: Variable to fixed swaps -- $ -- $ 45,076 $ -- $ -- $ -- $ -- $ 45,076 $ 782 Average pay rate 3.42% 3.42% -- -- -- -- Average receive rate 5.20% 5.20% -- -- -- -- </TABLE> As required by Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," the Registrant was required to record the interest rate swaps from the table above on the balance sheet at fair value beginning January 1, 2001. SFAS No. 133, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Because these swaps are designated in a cash-flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income ("OCI") and are recognized in the income statement when the hedged item affects earnings. The adoption of SFAS No. 133 on January 1, 2001 resulted in an $845,000 increase in OCI as a cumulative transition adjustment for derivatives designated in cash flow-type hedges prior to adopting SFAS No. 133. Due to its limited use of derivative instruments, the effect on earnings of adopting SFAS No. 133 was immaterial. Capital Expenditures The Registrant expended $9,468,000, including $3,357,000 for the IMPACT project, on capital projects for the first three months of 2001 compared to $3,429,000 for the first three months of 2000. Capital spending is expected to be approximately $70,000,000, of which approximately $25,000,000 relates to the Registrant's IMPACT project, during 2001. Business Strategies For more than a year, the Registrant has been developing strategies to position its business for the future. Execution of these strategies is intended to result in a reorganization of the Registrant's business to capitalize on its strengths in customer relationships, technology and people and its leadership positions in certain markets. Internally, the Registrant is working to improve the efficiency of its operations. Externally, the Registrant is looking to strengthen its business through strategic alliances and joint ventures, as well as potential acquisition opportunities or dispositions of under-performing or non-strategic assets. ENVIRONMENTAL MATTERS The Registrant is subject to loss contingencies resulting from regulation by various federal, state, local and foreign governmental authorities with respect to the environmental impact of air and water emissions and noise from its mills, as well as the disposal of solid waste generated by its operations. To comply with environmental laws and regulations, the Registrant has incurred substantial capital and operating expenditures in past years. During 2000, 1999 and 1998, the Registrant incurred approximately $16,700,000, $15,800,000 and $17,700,000, respectively, in operating costs related to complying with environmental laws and regulations. The Registrant anticipates that environmental regulation of its operations will continue to become more burdensome and that capital and operating expenditures will continue, and perhaps increase, in the future. In addition, the Registrant may incur obligations to remove or mitigate any adverse effects on the environment resulting from its operations, including the restoration of natural resources, and liability for personal injury and damage to property, including natural resources. In particular, the Registrant remains open to negotiations 17
18 with EPA and DEP regarding the NOVs under the federal and state air pollution control laws. The Registrant continues to negotiate with the State of Wisconsin and the United States regarding natural resources damages and response costs related to the discharge of PCBs and other hazardous substances in the lower Fox River, on which the Registrant's Neenah mill is located. The Registrant also is in settlement discussions with DEP and Penn PIRG regarding the wastewater discharge permit for its Spring Grove mill. The costs associated with such matters are presently unknown but could be substantial and perhaps exceed the Registrant's available resources. The Registrant's current assessment, after consultation with legal counsel, is that ultimately it should be able to resolve these environmental matters without a long-term, material adverse impact on the Registrant. In the meantime, however, these matters could, at any particular time or for any particular period, have a material adverse effect on the Registrant's consolidated financial condition, liquidity or results of operations. Moreover, there can be no assurance that the Registrant's reserves will be adequate to provide for future obligations related to these matters or that such obligations will not have a long-term, material adverse effect on the Registrant's consolidated financial condition, liquidity or results of operations. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk See the discussion under the headings "Liquidity" and "Interest Rate Risk" in Item 2 as well as Note 4 to the Registrant's unaudited condensed consolidated financial statements. PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Registrant's Annual Meeting of Shareholders was held on April 25, 2001. All of the Board of Directors' nominees for election as Directors were elected by the shareholders. Each was elected to a term expiring in 2004. The votes cast for election of Directors were as follows: <TABLE> <CAPTION> For Withheld ---------- --------- <S> <C> <C> Robert P. Newcomer 36,776,436 4,060,336 John M. Sanzo 36,773,748 4,060,336 </TABLE> Item 5. Other Information Cautionary Statement Any statements set forth herein or otherwise made in writing or orally by the Registrant with regard to its goals for revenues, cost reductions and return on capital, expectations as to industry conditions and the Registrant's financial results and cash flow, demand for or pricing of its products, development of new products, environmental matters and other aspects of its business may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Registrant makes such statements based on assumptions that it believes to be reasonable, there can be no assurance that actual results will not differ materially from the Registrant's expectations. Accordingly, the Registrant identifies the following important factors, among others, which could cause its results to differ from any results which might be projected, forecasted or estimated by the Registrant in any such forward-looking statements: (i) variations in demand for or pricing of its products; (ii) the Registrant's ability to identify, finance and consummate future alliances or acquisitions; (iii) the Registrant's ability to develop new, high value-added engineered products; (iv) the Registrant's ability to identify and implement its planned cost reductions pursuant to its DRIVE project and changes to its business processes contemplated by its IMPACT project; (v) changes in the cost or 18
19 availability of raw materials used by the Registrant, in particular market pulp, pulp substitutes and wastepaper; (vi) changes in energy-related costs; (vii) changes in industry paper production capacity, including the construction of new mills, the closing of mills and incremental changes due to capital expenditures or productivity increases; (viii) the gain or loss of significant customers; (ix) cost and other effects of environmental compliance, cleanup, damages, remediation or restoration, or personal injury or property damage related thereto, such as costs associated with the NOVs issued by EPA and DEP, the costs of natural resource restoration or damages related to the presence of PCBs in the lower Fox River on which the Registrant's Neenah mill is located and the effect of complying with the wastewater discharge limitations of the Spring Grove mill permit which the Registrant is currently appealing; (x) significant changes in cigarette consumption, both domestically and internationally; (xi) enactment of adverse state, federal or foreign legislation or changes in government policy or regulation; (xii) adverse results in litigation; (xiii) fluctuations in currency exchange rates; and (xiv) disruptions in production and/or increased costs due to labor disputes. Item 6. Exhibits (a) Exhibits Number Description of Documents ------ ------------------------ 3(ii) By-Laws, as amended April 25, 2001 15 Letter in Lieu of Consent Regarding Review Report of Unaudited Interim Financial Information (b) REPORTS ON FORM 8-K Item 5 Current Report on Form 8-K dated February 7, 2001 filed February 15, 2001. 19
20 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. P. H. GLATFELTER COMPANY Date: May 15, 2001 C. Matthew Smith Chief Financial Officer 20
21 INDEX OF EXHIBITS Number Description of Documents - ------ ------------------------ 3(ii) By-Laws, as amended April 25, 2001 15 Letter in Lieu of Consent Regarding Review Report of Unaudited Interim Financial Information 21