Glatfelter
Annual Report 2006

Plain-text annual report

noticeably different SALES OFFICES U.S. OPERATING LOCATIONS INTERNATIONAL OPERATING Spring Grove Facility 228 South Main Street Spring Grove, PA 17362 ph: 717-225-4711 fax: 717-225-6834 Chillicothe Facility 401 Paint Street ph: 740-772-3111 fax: 740-772-0024 Fremont Facility 2275 Commerce Drive Fremont, OH 43420 ph: 419-334-2673 fax: 419-334-9718 Chillicothe, OH 45601 Chillicothe, OH 45601 BP 2 76593 Gernsbach, Germany Spring Grove, PA 17362 Glatfelter Pulp Wood Company 228 South Main Street ph: 717-225-4711 fax: 717-225-2850 Pennsylvania 228 South Main Street Spring Grove, PA 17362 ph: 717-225-4711 x2565 fax: 717-225-5400 Chillicothe, Ohio 401 Paint Street ph: 740-772-3183 fax: 740-772-0125 North Carolina One King Road Pisgah Forest, NC 28768 ph: 828-877-2110 fax: 828-877-4086 Gernsbach, Germany Hördner Landstraße 3-7 ph: 49-7224-66-0 fax: 49-7224-66-274 Lydney, UK Church Road Lydney, Gloucestershire GL15 4NT United Kingdom ph: 44-0-1594-842235 fax: 44-0-1594 844213 Scaër, France BP 2 29390 Scaër, France ph: 33-0-2-98-66-42-00 fax: 33-2-98-59-0998 LOCATIONS Gernsbach Facility Hördner Landstraße 3-7 76593 Gernsbach, Germany ph: 49-7224-66-0 fax: 49-7224-66-274 Scaër Facility 29390 Scaër, France ph: 33-0-2-98-66-42-00 fax: 33-2-98-59-0998 Lanao del Norte Facility Bo. Maria Cristina 9217 Balo-I, Lanao del Norte Philippines ph: 632-893-7640 fax: 632-893-2819 Lydney Facility Church Road Lydney, Gloucestershire GL15 4NT United Kingdom ph: 44-0-1594-842235 fax: 44-0-1594 844213 OTHER LOCATIONS China Representative Office Century Financial Tower, 8F808 No 1 Suhua Road Suzhou-SIP, Jiangsu 215021 ph: 86-512-676-25077 fax: 86-512-676-25070 www.glatfelter.com © 2007 Glatfelter Glatfelter 2006 Annual Report Vision Our vision is to become the global supplier of choice in Specialty Papers and Engineered Products Our Core Values Integrity We are ethical and responsible in all of our business endeavors, all the time. Financial Discipline We are responsible for the prudent management of the resources entrusted to us and for the generation of financial value for all constituents. Respect for Coworkers We treat each other with honesty and respect. We recognize that what we have and what we will achieve is through the efforts of our employees. We will strive to provide them with rewarding challenges and opportunities for advancement. Customer Focus We are dedicated to understanding and anticipating the needs of our customers and helping them to achieve their business objectives. Environmental Responsibility We recognize that our business impacts the environment. We are committed to continuous environmental improvement and the prevention of pollution. We will be in compliance with all environmental laws and regulations. Social Responsibility We recognize our responsibility to contribute to the betterment of the communities in which we operate and the world in which we live. Noticeably Different… Glatfelter is noticeably different. Its people, products and performance stand out. Glatfelter is bigger, stronger and better. Growth of the legacy businesses was enhanced by two key acquisitions in 2006. Our business has been transformed, making us more efficient and flexible, strengthening the legacy business while expanding our global footprint in key markets. Our commitment to product innovation is driving volume growth and market share gains. This transformation is yielding results – solid performance outpacing the industry and most important – a clear plan to maintain the momentum. Officers and Directors Executive Officers George H. Glatfelter II Chairman and Chief Executive Officer Dante C. Parrini Executive Vice President and Chief Operating Officer John P. Jacunski Senior Vice President and Chief Financial Officer Timothy R. Hess Vice President and General Manager, Specialty Papers Business Unit Jeffrey J. Norton Vice President, General Counsel and Secretary Martin Rapp Vice President and General Manager, Composite Fibers Business Unit Mark A. Sullivan Vice President Global Supply Chain Directors Kathleen A. Dahlberg Founder and President/CEO Open Vision Partners Nicholas DeBenedictis Chairman and Chief Executive Officer Aqua America Corporation George H. Glatfelter II Chairman and Chief Executive Officer J. Robert Hall Chief Executive Officer Ardale Enterprises, LLC Richard C. Ill President and Chief Executive Officer Triumph Group, Inc. Ronald J. Naples Chairman and Chief Executive Officer Quaker Chemical Corporation Richard L. Smoot Retired Regional Chairman PNC Bank, NA Philadelphia/South Jersey Markets William T. Yanavitch II Vice President Human Resources and Administration Lee C. Stewart Investment Banker Daniel Stewart & Company David C. Elder Corporate Controller and Chief Accounting Officer Corporate Information World Headquarters P.H. Glatfelter Company 96 S. George Street Suite 500 York, PA 17401 ph: 717-225-4711 fax: 717-846-7208 www.glatfelter.com Stock Exchange New York Stock Exchange Stock Symbol GLT Annual Meeting of Shareholders May 3, 2007 10:00am EST York Expo Center, 334 Carlisle Avenue York, PA Transfer Agent, Dividend Disbursing Agent and Registrar Mellon Investor Services, LLC 85 Challenger Road Ridgefield Park, NJ 07660 ph: 800-756-3353 Information Sources For the latest quarterly business results or other information, visit www.glatfelter.com or contact: Investor Relations P.H. Glatfelter Company 96 S. George Street, Suite 500 York, PA 17401 ph: 717-225-4711 E-mail: ir@glatfelter.com Our Business Headquartered in York, Pennsylvania, Glatfelter is a global manufacturer of specialty papers and engineered products. U.S. operations include facilities in Spring Grove, Pennsylvania, and Chillicothe & Fremont, Ohio. International operations include facilities in Germany, France, the U.K. and the Philippines. Our products are marketed worldwide either through wholesale paper merchants, brokers and agents or direct to customers. The company’s common stock is traded on the New York Stock Exchange under the symbol GLT. Composite Fibers Food and Beverage • Tea bags • Coffee pods/pads and filters • Food casing papers Composite Laminates • Laminate countertops • Laminate furniture • Laminate flooring Technical Specialties • Stencil papers • Wet-wipe tissues • Adhesive tapes • Battery pasting papers • Cryogenics • Vacuum bags • Specialty non-wovens • Medical facemask • Wood veneer • Business forms Metallized Products • Glue-applied beverage labels • Holographic labels & wrap • Gift wrap Our Products Specialty Papers Book Publishing • Trade books – Best sellers – Book clubs – Business and professional – Digital print on demand • Textbooks – Elementary to high school & college – Computer software instruction books • Ancillary materials – Student workbooks – Teacher’s guides Carbonless & Forms • Carbonless Papers – Business forms – Invoices & receipts – Tax forms – Legal contracts • Magnetic Papers – Business cards – Sporting team schedules – Advertising specialties – Calendars – Direct mail & advertising inserts • Security Products and Forms – Checks – Government and regulatory secured documents – Tags – Ledgers Converting Papers • Envelopes • High-end retail shopping bags • Drawing & art papers • China markers Lightweight Printing Papers • Financial publications • Legal publications Digital Imaging • Point-of-purchase displays • Photo reproductions • Posters/Banners • Boarding passes • Venue tickets • Engineered drawings • Apparel tags • Billboards Casting and Specialty Release • Reflective signage • Fleet graphics • Simulated leather • Iron-on transfers • Vinyl films & foams • Gasketing • Adhesive tape Pressure Sensitive • Postage stamps • Stamp liners • Peel & stick labels Industrial Specialties • Fluorescent board & tabs • Playing cards • Greeting cards • Repositionable notes • Drinking/condiment cups • Coin wrappers • Flour bags Letter to Our Shareholders Dear Fellow Shareholder: As I reflect on the Glatfelter Company and the events of the past year, two concepts come to mind: transformation and differentiation. In 2006, your Board of Directors and leadership team took important strategic actions to change – and enhance – nearly every aspect of our business. Through acquisitions, we broadened our global footprint and constructed a highly specialized business model that emphasizes higher- margin niche products. Unrelenting activities to reduce Glatfelter’s cost structure have yielded results that exceeded our expectations. We also expanded the management team with executives whose skills complement our strategy, further honed our business capabilities in the areas of marketing and new product development and aggressively worked to strengthen the balance sheet. As a result of these actions, Glatfelter has truly transformed its business and our vision of being the global supplier of George H. Glatfelter II Chairman and Chief Executive Officer choice in Specialty Papers and Engineered Products is becoming a reality. Although we still have work to do, the Company’s solid performance supports our confidence in Glatfelter’s continued success. For example, in 2006 we: • Increased adjusted earnings by 57% to $0.55 per share; • Grew net sales in our Specialty Papers business by 82% to $693.7 million; • Grew Composite Fibers net sales by 48% to $292.8 million; • Exceeded targets in our EURO Cost Reduction Program by 54% generating $8 million in savings; • Achieved a 5% increase in the average selling price in the Specialty Papers Business Unit; and • Exceeded our annual goal of 50% of revenue generated from the sale of new products. These results, combined with crisp execution and our continued focus on the “few things that matter most,” enabled us to deliver a 34% return to Glatfelter’s shareholders over the past three years, significantly outperforming the Company’s peer group, which returned 11% over the same period. We are just beginning however, as Glatfelter is poised for sustained value creation, which in my view will further differentiate us from our peers. Glatfelter’s Foundation for Growth and Differentiation History has shown that acquisitions are easy to come by in this industry. However, good acquisitions – ones that result in value creation – are rarer. Making an acquisition that creates value is a matter of establishing strong criteria and exercising strict discipline, which is what we did in 2006 with our acquisitions of the facilities in Chillicothe, Ohio and Lydney, U.K. Chillicothe In April of 2006, we strengthened Glatfelter’s Specialty Papers business with the acquisition of Chillicothe and the subsequent shutdown of a less competitive facility in Neenah, Wisconsin. Chillicothe more than doubled our specialty papers capacity and created significant economies of scale. Even more compelling, however, is that this acquisition made us better, not simply bigger. Prior to our acquisition, more than $530 million had been invested in the Chillicothe facility to provide it with state-of-the-art production and converting capabilities. To capture the full benefit of this low-cost operating platform, in June of 2006, we began transferring 125,000 tons of higher-margin book paper products to Chillicothe from the Neenah facility and implemented a mill-wide operations improvement plan to enhance productivity and yields. We have made significant progress on these and other integration initiatives. Since the third quarter of 2006, book paper production volume at Chillicothe has increased by 29%, and total mill production volume has improved by 11%. Additionally, the production transfer to Chillicothe has displaced the unprofitable commodity paper grades that were previously produced there. In addition, Chillicothe’s carbonless paper products complement Glatfelter’s specialty product expertise. To improve results in this business, we exited certain unprofitable export products. This, together with lower industry demand impacted carbonless volumes during the year. However, we expect the Company’s strong market position and the carbonless paper price increases established in mid-2006 to help offset these declines and drive $6 million to $8 million of benefits in 2007. Already, the Chillicothe acquisition has been additive to our earnings, and we expect the acquisition to provide a substantial return on investment. As we move forward, Glatfelter’s Specialty Papers Business Unit will remain focused on achieving our integration objectives, further improving our cost structure, and accelerating revenue and margin growth across Glatfelter’s product lines. Lydney Like Chillicothe, the acquisition of the Lydney facility last year significantly enhanced Glatfelter’s growth profile. In addition to building on our strengths in long-fiber and wet laid non-woven products, such as tea and coffee filter papers, Lydney significantly extended our geographic reach into key markets that we had targeted for growth, such as the United Kingdom, Asia and the Americas. We received unconditional clearance from the European Commission in December for the Lydney acquisition and are actively integrating this business. We are on track to realize the expected financial upside from Lydney, including an increase to our EBITDA of approximately $11 million annually beginning at the end of 2007. The benefits provided by the Chillicothe and Lydney acquisitions affirm our belief that these were the right strategic transactions for our Company, and we remain as excited today as the day we announced them. Operational Excellence and Innovation Support Glatfelter’s Sustained Success While the integration of our two acquisitions remains critical to achieving our long-term growth goals, Glatfelter’s success also depends on our legacy businesses. To mitigate the cyclicality inherent in our industry, the strategy for our legacy businesses is focused on aggressively reducing costs and generating new demand through innovative, value-added products that better meet our customers’ needs. In 2006, we had solid performance here as well. Operational Excellence Following the restructuring of our North American operations in 2005, which generated $19 million in annual savings, we launched a similar program for our European operations in 2006. Through this program, which has now been fully implemented, we have redesigned our workforce, expanded supply-chain management strategies and enhanced new product development activities. These and other actions have enabled us to generate over $8 million of cost savings – nearly one year ahead of schedule. Innovation At Glatfelter, our commitment to innovation is driving volume growth, market share gains and margin expansion. In 2006, we launched a variety of new products to bolster Glatfelter’s position as the supplier of choice to our specialty paper customers. These products are helping our customers and Glatfelter better compete in the marketplace. In fact, new products helped drive a 16% volume growth in Glatfelter’s Composite Fibers business unit, including 11% growth in the Food & Beverage market segment. In addition, new products serving high-value niche segments continue to generate over 50% of the Company’s annual revenue. Timberland Monetization Program Progressing As part of our efforts to ensure that Glatfelter’s assets create the greatest value for shareholders, we announced plans in early 2006 to monetize a substantial portion of the Company’s timberland assets. Since that time, we have expanded our program to include an additional 20,000 acres in Pennsylvania. Our timberland strategy is expected to generate proceeds in excess of $150 million over the next two to four years, assuming, among other factors, acceptable market conditions. We completed nearly $17 million of timberland sales in 2006 and are targeting another $50 million in 2007. The proceeds from these sales will be used to reduce the Company’s debt as required by Glatfelter’s existing covenants. Looking Forward with Confidence 2006 was a year of transformation and differentiation for Glatfelter. We established leading positions in growing, niche markets around the world and, as a result, now benefit from higher margins than many other commodity producers. Through restructuring, we created a solid operating platform that offers efficiency and flexibility. From a financial perspective, we maintained discipline, particularly with respect to cost reductions and capital expenditures. We enter 2007 as a stronger company with a clear plan to maintain the momentum and establish a new generation of growth for Glatfelter’s shareholders. Our goals for 2007 include: • Aggressively integrate the Lydney facility and continue to improve Chillicothe’s operations to drive efficiencies up, and costs out; • Broaden our geographic footprint with particular emphasis upon high-margin food & beverage papers; • Continue to build on the strong performance of our legacy businesses through operational excellence and continuous improvement; and • Make smart and timely decisions to maximize the value of our timberlands assets and enhance the Company’s financial flexibility. Together with our Glatfelter PEOPLE around the world – all 3,700 of them – I am confident that we have the capabilities, products and vision necessary to capture the opportunities in our marketplace and deliver superior returns to our shareholders. On behalf of the Glatfelter team, I thank you for your continued support. Sincerely, George H. Glatfelter II Chairman & Chief Executive Officer March 21, 2007 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] [ ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2006 or Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file number 1-03560 P. H. Glatfelter Company (Exact name of registrant as specified in its charter) Pennsylvania (State or other jurisdiction of incorporation or organization) 96 South George Street, Suite 500 York, Pennsylvania 17401 (Address of principal executive offices) 23-0628360 (IRS Employer Identification No.) (717) 225-4711 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Class Common Stock, par value $.01 per share Name of Exchange on which registered New York Stock Exchange Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No F . Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No F . 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 at least the past 90 days. Yes F No . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy of information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No F . Based on the closing price as of June 30, 2006, the aggregate market value of Common Stock of the Registrant held by non-affiliates was $517.3 million. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large Accelerated F Accelerated Non-Accelerated. Common Stock outstanding on March 8, 2007 totaled 45,472,226 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference in this Annual Report on Form 10-K: Proxy Statement to be dated on or about March 21, 2007 (Part III). P. H. GLATFELTER COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended DECEMBER 31, 2006 Table of Contents Business Risk Factors Properties Legal Proceedings Submission of Matters to a Vote of Security Holders Executive Officers Market for the Registrant’s Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Financial Statements and Supplementary Data Controls and Procedures Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accountant Fees and Services Exhibits, Financial Statement Schedules PART I Item 1 Item 1A. Item 2 Item 3 Item 4 PART II Item 5 Item 6 Item 7 Item 7A. Item 8 Item 9A. PART III Item 10 Item 11 Item 12 Item 13 Item 14 PART IV Item 15 SIGNATURES CERTIFICATIONS SCHEDULE II Page 1 6 10 10 11 11 12 13 14 22 23 53 53 54 54 54 54 55 57 58 60 ITEM 1. BUSINESS Overview Glatfelter began operations in 1864 and today we believe we are one of the world’s leading manufacturers of and engineered specialty papers products. Headquartered in York, Pennsylvania, we own and operate paper mills located in Spring Grove, Fremont, Ohio, Pennsylvania, Gernsbach, Germany, Gloucestershire, the United Kingdom and Scaër, France, as well as an abaca pulp mill in the Philippines. Chillicothe and We serve customers in numerous markets, including book publishing, carbonless and forms, food envelope and converting, engineered products, and beverage, composite laminates and other highly technical niche markets. Many of in which we operate are characterized by higher-value- added products and, in some cases, by higher growth prospects and lower cyclicality than commodity paper markets. Examples of some of our key product offerings include papers for: the markets (cid:129) trade book publishing; (cid:129) tea bags and coffee filters; (cid:129) carbonless products; (cid:129) specialized envelopes; (cid:129) playing cards; (cid:129) pressure-sensitive postage stamps; (cid:129) metallized labels for beer bottles; and (cid:129) digital imaging applications. Recent Developments On March 13, 2006, we completed our acquisition of certain assets of JR Crompton, a global supplier of wet laid nonwoven products based in Manchester, United Kingdom. Since February 7, 2006, Crompton had been subject to insolvency proceedings before The High Court of Justice Chancery Division, Manchester District. Under the terms of our agreement with Crompton, we located in acquired Crompton’s Lydney mill, Gloucestershire, United Kingdom, for approximately $65 million based on currency exchange rates on that date. The facility employs approximately 240 people and had 2005 revenues of approximately $75 million. The Lydney mill, which is now included in our Composite Fibers business unit, produces a broad portfolio of wet laid nonwoven products, including tea bags and coffee filter papers, clean room wipes, lens tissue and dye filter paper, double-sided adhesive tape substrates and battery grid pasting tissue. The acquisition of the Lydney mill further strengthened our leading position in tea bags and coffee filter papers and is part of our long-term strategy to drive growth in our Composite Fibers business unit. On April 3, 2006, we completed our acquisition of of NewPage carbonless business operations the Corporation, for $83.3 million in cash. The acquired assets consist of a 400,000 ton-per-year paper making facility in Chillicothe, Ohio and coating operations based in Fremont, Ohio (collectively referred to as Chillicothe). Chillicothe had revenue of $441.5 million in 2005 and approximately 1,700 employees as of December 31, 2006. We executed the Chillicothe acquisition so that we could take advantage of Chillicothe’s scale and efficient manufacturing environment. As part of our integration plan for Chillicothe, we transferred the production of products manufactured at our former Neenah, WI facility to Chillicothe and permanently shut down our Neenah facility on June 30, 2006. On April 3, 2006, we entered into our new credit facility, which provides for a $200 million revolving credit facility and a $100 million term loan. Proceeds from our new credit facility were used to repay in full all amounts outstanding under our former revolving credit facility due June 2006, to finance the Chillicothe acquisition and for general corporate purposes. In addition, on April 28, 2006 we completed a $200 million bond offering, the proceeds of which were primarily used to prepay our $150 million bonds. Our Business Units We manage our business as two distinct units: the Europe-based Composite Fibers business unit and the North America-based Specialty Papers business unit. The following table summarizes consolidated net sales contribution of each of our business units for the past three fiscal years: relative net and the sales Dollars in thousands 2006 2005 2004 Net sales Business unit composition Specialty Papers Composite Fibers Other $986,411 $579,121 $543,524 70.3% 29.7 – 65.8% 34.2 – 62.1% 37.8 0.1 Total 100.0% 100.0% 100.0% Net tons sold by each business unit for the past three years were as follows: Specialty Papers Composite Fibers Other Total 2006 2005 2004 653,734 68,148 10 450,900 47,669 24 421,504 48,528 390 721,892 498,593 470,422 Specialty Papers Our North America-based Specialty Papers business unit focuses on papers for the production of high-quality hardbound books and other book publishing needs, carbonless papers designed for multiple end-uses, such as credit card receipts, forms and other applications, envelope & converting markets and highly technical customized products for the digital -1- GLATFELTER imaging, casting and release, pressure sensitive, and several niche technical specialty markets. Specialty Papers’ revenue composition by market consisted of the following for the years indicated: in thousands 2006 2005 2004 Book publishing Carbonless & Forms Envelope & converting Engineered products Other Total $166,605 266,647 103,042 137,007 20,359 $693,660 $157,269 – 91,751 129,936 1,967 $380,923 $142,756 – 81,582 113,098 – $337,436 that We believe we are the leading supplier of book publishing papers in the United States and one of two carbonless paper market leaders. Specialty Papers also is converted into specialized produces paper envelopes finishes and capabilities. These markets are generally more mature and, therefore, have modest growth characteristics. The market for carbonless papers is declining approximately 7% to 9% per year. in a wide array of colors, technical Specialty Papers’ highly engineered products include those designed for multiple end uses, such as papers for pressure-sensitive postage stamps, greeting and playing cards, digital imaging applications and for release paper applications. Such products comprise an array of distinct business niches that are in a continuous state of evolution. Many of these products are utilized in demanding, end-user applications. Some of our products are new and high growth while others are more mature and further along on the development curve. Because many of these products are technically complex and involve substantial customer- supplier development they command higher per ton values and generally exhibit greater pricing stability relative to commodity grade paper products. collaboration, specialized customer and As of April 3, 2006, our Specialty Papers business unit includes the Chillicothe operations. Composite Fibers Composite Fibers, based in Gernsbach, Germany, focuses on higher-value-added products, such as paper for tea bags and coffee pods/ pads and filters, decorative laminates used for furniture and flooring, and metallized products used in the labeling of beer bottles. Composite Fibers revenue composition by market consisted of the following for the years indicated: in thousands 2006 2005 2004 Food & Beverage Composite Laminates Metallized Technical Specialties and Other Total $180,258 50,734 40,078 21,681 $292,751 $103,070 42,948 35,541 16,578 $198,137 $107,482 47,342 33,286 17,122 $205,232 Our focus on products made from abaca pulp has made us one of the world’s largest producers of tea bag papers. The balance of this unit’s sales are comprised of overlay and technical specialty products, which include flooring and furniture overlay papers, metallized products, and papers for adhesive tapes, vacuum bags, holographic labels and gift wrap. Many of this unit’s papers are technically sophisticated. We believe we are well positioned to produce these extremely lightweight papers because we understand their complexities, which require the use of highly specialized fiber and specifically designed papermaking equipment. As of March 13, 2006, our Composite Fibers business unit includes the Lydney mill. Additional financial information for each of our business units is included in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Item 8 – Financial Statements, Note 20. Our Competitive Strengths Since commencing operations over 140 years ago, we believe that Glatfelter leading one of has developed into manufacturers of and engineered specialty papers products. We believe that the following competitive strengths have contributed to our success: the world’s include (cid:129) Leading market positions in higher-value, niche segments. We have focused our resources to achieve market-leading positions in certain higher-value, niche various highly segments. Our products technically specialized paper products designed for demanding end uses. Consequently, many of our products achieve premium pricing relative to that of commodity paper grades. In 2006, approximately 82% of our sales were derived from these higher-value, niche products. The specialized nature of these products generally provides greater pricing stability relative to commodity paper products. in be adaptable (cid:129) Customer-centric business focus. We offer a unique and diverse product line that can be customized to serve the individual needs of our customers. Our size allows us to develop close relationships with our key customers and development, our to product manufacturing, sales and marketing practices. We believe that this approach has led to the development of excellent customer relationships, defensible market positions, and increased pricing stability relative to commodity our customer-centric focus has been a key driver to our success in new product development. producers. Additionally, paper (cid:129) Significant investment in product development. In order to keep up with our customers’ ever-changing needs, we continually enhance our product offerings through product development. During 2006, 2005 and 2004, we investment significant in -2- GLATFELTER respectively, invested approximately $8.0 million, $4.9 million and $5.2 million, in product development activities. We derive a significant portion of our developed, revenue or from products these activities. Revenue improved as a result of generated from products developed, enhanced or improved within the five previous years as a result of these activities represented approximately 52%, 52% and 60% of net sales in the years ended 2006, 2005 and 2004, respectively. enhanced (cid:129) Integrated production. As a partially integrated producer, we are able to mitigate changes in the costs of certain raw materials and energy. Our Spring Grove and Chillicothe facilities are vertically integrated operations producing in excess of 85% of the annual pulp required for their paper production. The principal raw material used to produce this pulp is pulpwood, consisting of both hardwoods and softwoods. We own approximately 75,000 acres of timberlands and, in 2006, obtained approximately 20% of our pulpwood requirements for facility from Glatfelter-owned our Spring Grove timberlands, which helps stabilize our fiber costs in a highly fragmented market. Our Spring Grove and Chillicothe facilities also generate 100% of the steam and substantially all of the electricity required for their operations. In addition, our Philippine mill processes abaca fiber to produce abaca pulp, which is a key raw material used by our Composite Fibers business unit. Our Business Strategy Our vision is to become the global supplier of choice in specialty papers and engineered products. We are continuously developing and refining strategies to strengthen our business and position it for the future. Execution of these strategies is intended to capitalize on our customer relationships, technology and people, as well as our leadership positions in certain product lines. In recent years, our industry has been challenged by a supply and demand imbalance, particularly for commodity-like products. While the industry has responded to take out under- performing capacity, the imbalance continues. To be in the current market environment, our successful strategy is focused on aggressively reducing costs and continually repositioning our product portfolio to increase our focus on higher-value, niche products and to better align our product offerings with our customers’ ever-changing needs. Certain key elements of our business strategy are outlined below: in several (cid:129) Reposition our product portfolio. By leveraging our specialty niche leadership positions segments, we plan to accelerate growth, improve margins returns through the optimization of our product portfolio. In 2006, approximately 82% of our total sales were and generate better financial composite products. derived from what we consider to be higher-value, niche products. Over time, we plan to increase our concentration on such products by driving growth in our sales of trade book papers, uncoated specialty fiber products and other products, specialty acquired recently The Chillicothe assets provide a significant scaleable production platform to support this strategy. We believe that this strategy will realign our business more closely with our customers’ needs and further reduce our exposure to the higher level of cyclicality experienced in commodity paper grades. (cid:129) Execute Composite Fibers’ growth plan. A core component of our long-term strategy is to drive growth in our Composite Fibers business unit. Currently, we are the leading producer of tea bag and coffee pod/pad papers in the world, and with the Lydney mill further acquisition we strengthened our competitive position. We believe that growth has characteristics as certain geographies move toward the use of tea bags as opposed to loose tea leaves. We believe that we are well positioned to capitalize on this growth by leveraging our strong customer relationships and leading position in this segment. promising segment have this (cid:129) Employ a low-cost to specialty efficiencies approach to improving workforce product manufacturing. While we are focused on higher- seek to employ a value, niche products, we our approach low-cost commodity-like, manufacturing activities. In 2004, we initiated the North American Restructuring Program that improved operating results by, among other and factors, implementing improved supply chain management processes. In the fourth quarter of 2005, we began the implementation of the European Optimization and Restructuring Program, or the EURO Program, a comprehensive series of actions designed to improve the performance of the Composite Fibers business unit. The pre-tax financial benefits of the EURO Program approximated $8 million in 2006. To further improve our production cost profile, in connection with the 2006 Chillicothe acquisition, we closed our Neenah facility and transferred its production to the more efficient Chillicothe facility. (cid:129) Maintain a strong balance sheet and preserve financial flexibility. We are focused on prudent financial management and the maintenance of a conservative capital structure. We are committed to maintaining a strong balance sheet and preserving our flexibility so that we may pursue opportunities, including strategic acquisitions, that will benefit our company. strategic -3- GLATFELTER and future internal wood concluded that (cid:129) Timberland Strategy. We completed an extensive study to determine the optimal approach for managing our timberlands in a way that creates the greatest value for our company. The study considered many factors including, among others, land valuations, external and fiber costs requirements. We the most advantageous approach is to sell 60,000 acres of higher and better use, or HBU, properties in an orderly fashion. In some cases, low-cost, low-risk opportunities may exist to add value to some of these acres through entitlements. It is estimated that once all 60,000 HBU acres are sold, earnings will be adversely impacted by approximately $0.04 to $0.07 per share, but we believe that the expected proceeds from these planned sales will outweigh this increased cost. Currently, we intend to retain the pure to mitigate the cost of timberland properties replacing internally generated wood with outside sources. Execution of our Timberland Strategy is expected to take approximately two to four more years to complete and is estimated to provide pre-tax cash proceeds totaling in excess of $150 million, assuming, among other factors, acceptable market conditions executed plan of carefully disposition. and a Raw Material and Energy The following table provides an overview of the estimated amount of principal raw materials (“PRM”) to be used by each of our manufacturing facilities on an annual basis: Specialty Papers Spring Grove Pulpwood Wood – and other pulps Chillicothe Pulpwood Wood – and other pulps Composite Fibers Gernsbach Wood – and other pulps Abaca pulp Synthetic fiber Lydney Wood – and other pulps Abaca pulp Synthetic fiber Scaër Wood pulp Abaca pulp Synthetic fiber Philippines Abaca fiber Estimated Annual Quantity (short tons) Percent of PRM Purchased 1,026,000 40,000 1,164,000 36,000 29,400 8,500 2,350 6,850 5,800 2,040 2,150 1,840 1,330 18,000 85% 100 100 100 100 11 100 100 11 100 100 11 100 100 Our Spring Grove mill is a vertically integrated operation producing approximately 85% of the annual pulp required for paper production. The principal raw material used to produce this pulp is pulpwood, of which both hardwoods and softwoods are used. At December 31, 2006, we owned approximately 75,000 acres of timberlands. In addition to this source of pulpwood, we are committed, under a Supply Agreement expiring in 2011, to buy at market prices a minimum annual amount of pine pulpwood averaging 34,425 tons per annum over the eight-year term of the agreement. The pulpwood purchased under this agreement is to be harvested from land we sold in March 2003. In addition to these sources, hardwoods are available within a relatively short distance of our mills. Softwoods are obtained primarily from Maryland, Delaware and Virginia. To protect our sources of pulpwood, we actively promote conservation and forest management among suppliers and woodland owners. Our Spring Grove, Pennsylvania facility generates 100% of the steam and electricity required for its operations. Principal fuel sources used by this facility are coal, recycled pulping chemicals, bark and wood waste, and oil. The facility consumes approximately 300,000 tons of coal annually. A new three year contract became effective January 1, 2007, which will increase our annual cost of coal by approximately $6 million. The Spring Grove facility produces more electricity than it requires. Excess electricity is sold to the local power company under a fixed-price long-term co- generation contract expiring in 2010. Energy sales, net of costs, were $10.7 million in 2006, $10.1 million in 2005 and $10.0 million in 2004. The continuation of this revenue stream at these levels is dependent on our ability to negotiate a contract for periods beyond 2010. As discussed elsewhere in this report, we entered into a new three-year coal supply agreement beginning in January 2007. The increased cost of coal under this contract will adversely effect net revenue from energy sales. Our Chillicothe mill is also a vertically integrated operation producing approximately 92% of its annual pulp requirements for paper production in 2006. The principal raw material used to produce this pulp is pulpwood, of which both hardwoods and softwoods are used. Pulpwood is sourced externally at market prices. Both hardwoods and softwoods are sourced primarily from Ohio, West Virginia and Kentucky. Our Chillicothe facility generates 100% of the steam and 85% of the electricity required for its operations. Principal the fuel Chillicothe facility are natural gas, coal, waste wood and black liquor, which is a byproduct of the pulp making process. The facility consumes approximately 900,000 MMBTUs of natural gas, 315,000 tons of coal and 300,000 tons of wastewood annually. Two new coal sources used by -4- GLATFELTER supply agreements were executed in the fourth quarter of 2006 and expire in December 2007 and November 2008. The Gernsbach, Scaër and Lydney facilities generate all of the steam required for their operations. The Gernsbach facility generated approximately 26% of its 2006 electricity needs and purchased the balance. The Scaër and Lydney facilities purchased all of their 2006 electric power requirements. Natural gas was used to produce substantially all internally generated energy at the Gernsbach, Scaër and Lydney facilities during 2006. Our Philippines mill processes abaca fiber to produce a specialized pulp. This abaca pulp production provides a unique advantage by supplying a key raw material used by our Composite Fibers business unit. Events may arise from the relatively unstable political and economic environment in which the Philippine facility operates that could interrupt the production of abaca pulp. Management periodically evaluates the availability of abaca pulp for our Composite Fibers business unit. Any extended interruption of the Philippine operation could have a material impact on our consolidated financial position and/or results of operations. We have approximately three months of abaca pulp supply available to us. In addition, we have established contingency plans for alternative sources of abaca pulp. However, the cost of obtaining abaca pulp from such alternative sources, if available, would likely be higher. Based on information currently available, we believe that we will continue to have ready access, for the foreseeable future, to all principal raw materials used in the production of our products. The cost of our raw material is subject to change, including, but not limited to, costs of wood and pulp products and energy. product investment New Product Development In order to keep up with our customers’ ever-changing needs, we are continually enhancing our product offerings through significant development in activities, including product customizations developed in partnership or close collaboration with our customers. We invested approximately $8.0 million, $4.9 million and $5.2 million in 2006, 2005 and 2004, respectively, on product development. Revenue generated from products developed, enhanced or improved within the these activities five previous years as a result of represented approximately 52%, 52% and 60% of net sales in the years ended 2006, 2005 and 2004, respectively. In determining revenue attributable to an product independently developed framework, which we believe to be generally accepted in the field of new product management. This framework categorizes products developed, enhanced or improved as those that (i) are activities, we development utilize new to the world, (ii) represent a product line new to our Company, (iii) are a new product within an existing product line, (iv) are a significant improvement of an (v) are repositioned into a new existing product, cost are application or market, or alternative to an existing product of the Company and seen by our customers as a new offering. Approximately 42% of our revenue attributable to developed, enhanced or improved products come from products that fit within category (ii) and (iii), above. lower (vi) a Concentration of Customers In 2006, 2005 and 2004, no single customer represented more than 10% of our consolidated net sales. is industry Competition Our highly competitive. We compete on the basis of the quality of our products, customer service, product development activities, price and distribution. We offer our products throughout in approximately 80 countries. Competition in the markets from companies of various sizes, some of which have greater financial and other resources than we do. the United States in which we and globally participate comes There are a number of companies in the United States that manufacture printing and converting papers. We believe we are the recognized leader in book publishing papers and compete in these markets with, among others, Domtar and Fraser. In the envelope sector we compete with, among others, International Paper, Domtar and Blue Ridge. In the carbonless paper and forms market, we compete with Appleton Papers. In our Specialty Papers engineered products markets and for the Composite Fibers business unit’s markets, competition is product line specific as the necessity for technical expertise and specialized manufacturing equipment limits the number of companies offering multiple product lines. We compete with specialty divisions of large companies such as, among others, Ahlstrom, International Paper, MeadWestvaco, Sappi and Stora technological Enso. Service, product performance, advances important competitive factors with respect to all our products. We believe our reputation in these areas continues to be excellent. product pricing and are Despite the production capacity that has been removed, capacity in the worldwide uncoated free- sheet industry continues to exceed demand in recent years. Environmental Matters We are subject to loss resulting from regulation by various contingencies federal, governmental foreign and authorities with respect to the environmental impact of our mills. To comply with environmental laws and state, local -5- GLATFELTER regulations, we have incurred substantial capital and operating expenditures in past years. For a discussion of Item 8. – Financial Statements and Supplementary Data – Note 19. environmental matters, see Employees The following table summarizes our workforce as of December 31, 2006: Location Union Employees Non- Union U.S. Corporate/Spring Grove Chillicothe/Fremont International Gernsbach, Germany Scaër, France Gloucestershire, UK (Lydney) Philippines Total 605 1,293 1,898 370 80 205 52 707 2,605 360 410 770 191 47 61 30 329 1,099 Total 965 1,703 2,668 561 127 266 82 1,036 3,704 Different locals of the United Steelworkers of America (USW), represent the hourly employees at our U.S. facilities. A five-year labor agreement in Spring Grove will end in January 2008. Negotiations for a new contract will begin in the first half of 2007. The negotiation approach is expected to take the same collaborative approach as the last negotiation held in Spring Grove during 2002 due to the continued positive relationship with the employees. The labor contract with the USW local unions representing the hourly employees the newly acquired facility in Chillicothe Ohio expired on August 1, 2006. On November 10, 2006, a new 3-year contract was ratified across the multiple local unions. at Various unions represent employees at our European facilities. New labor agreements covering employees at the Gernsbach, Germany and Scaër, France facilities were entered into effective May 1, 2005 that provided for wage increase averaging 1.5% over a 22 month period ending March 2007. Employees at our Lydney mill participate in a national trade agreement pursuant to which we negotiate separate union agreements. Such agreements generally cover a one year period from February 1 to January 31. We expect to begin union negotiations in late March 2007. Employees at our pulpmill in the Philippines are covered by a five-year labor agreement, which was negotiated at the end of 2002. We consider the overall relationship with our employees to be satisfactory. Available Information Our investor relations website address is www.glatfelter.com/e/invesstock.asp. We make available on our site free of charge our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and their and Current Reports on Form 8-K and other related information as soon as reasonably practical after they are filed with the Securities and Exchange Commission. In addition, our website includes a Corporate Governance page consisting of, among others, our Governance Principles and Code of Business Conduct, Board of Directors and Executive Officers, Nominating, Audit and Compensation Committees of the Board of Directors respective Charters, Code of Business Ethics for the CEO and Senior Financial Officers of Glatfelter, our “whistle-blower” policy and other related material. We intend to satisfy the disclosure requirement for any future amendments to, or waivers from, our Code of Business Conduct or Code of Business Ethics for the CEO and Senior Financial Officers by posting such information on our website. We will provide a copy of the Code of Business Conduct or the CEO and Senior Code of Business Ethics for Financial Officers, without charge, to any person who requests one, by calling (717) 225-2724. ITEM 1A. RISK FACTORS Risks Related to Our Business Our business and financial performance may be adversely affected by downturns in the target markets that we serve. in our Demand for our products in the markets we serve is primarily driven by consumption of the products we produce, which is most often affected by general economic conditions. In recent years, the global paper industry in which we compete has been adversely impacted by paper producing capacity exceeding the target demand for products. Downturns markets could result in decreased demand for our products. In particular, our business may be adversely affected during periods of economic weakness by the general softness in these target markets. Our results could be adversely affected if economic conditions weaken or fail to improve. Also, there may be periods during which demand for our products is insufficient to enable us to operate our production facilities in an economical manner. These conditions are beyond our ability to control and have had, and may continue to have, a significant impact on our sales and results of operations. In addition to fluctuations in demand for our products in the markets we serve, the markets for our paper products are also significantly affected by changes in industry capacity and output levels. There have been periods of supply/demand imbalance in the pulp and paper industry, which have caused pulp and paper prices to be volatile. The timing and magnitude of price increases or decreases in the pulp and paper market -6- GLATFELTER have generally varied by region and by product type. A sustained period of weak demand or excess supply would likely adversely affect pulp and paper prices. This could have a material adverse affect on our operating and financial results. Our industry is highly competitive and increased competition could reduce our sales and profitability. the demand capacity In recent years, the global paper industry in which we compete has been adversely affected by paper producing for exceeding products. As a result, the industry has taken steps to reduce underperforming capacity. However, slowing demand or increased competition could force us to lower our prices or to offer additional services at a to us, which could reduce our gross higher cost margins financial resources of certain of our competitors may enable them to commit larger amounts of capital in response to changing market conditions. Certain competitors may also have the ability to develop product or service innovations that could put us at a disadvantage. income. The greater and net Some of the factors that may adversely affect our ability to compete in the markets in which we participate include: (cid:129) the entry of new competitors into the markets we serve, including foreign producers; (cid:129) the willingness of commodity-based paper producers to enter our specialty markets when they are unable to compete or when demand softens in their traditional markets; (cid:129) the aggressiveness of our competitors’ pricing strategies, which could force us to decrease prices in order to maintain market share; (cid:129) our failure to anticipate and respond to changing customer preferences; (cid:129) our inability to develop new, improved or enhanced products; and (cid:129) our inability to maintain the cost efficiency of our facilities. If we cannot effectively compete in the markets in which we operate, our sales and operating results would be adversely affected. The cost of raw materials and energy used to manufacture our products could increase. We require access to sufficient and reasonably priced quantities of pulpwood, wood and other pulps, pulp substitutes, abaca fiber and certain other raw that facility materials. Our Spring Grove facility is a vertically integrated manufacturing generates approximately 85% of its annual pulp requirements. In addition, annual approximately 20% of pulpwood requirements in 2006 were satisfied from company-owned timberlands. However, while our Chillicothe facility makes its own pulp, it purchases wood for use in its pulp mill. Our Philippine mill purchases abaca fiber to make pulp, which we use to manufacture our composite fiber products at our Gernsbach, Scaër and Lydney facilities. its Coal is a principal source of fuel for our Spring Grove facility. Beginning in 2007 a new three-year coal supply contract will increase our annual cost of coal by approximately $6 million. Natural gas is the principal source of fuel for our and Composite Fibers’ business unit Chillicothe facilities. Natural increased significantly in the United States since 2000 and reached record highs in 2006. Prices for natural gas are expected to remain volatile for the foreseeable future. prices have gas We may not be able to pass increased raw materials or energy prices on to our customers if the market will not bear the higher price or where existing agreements with our customers do not allow us to pass along these cost increases. If price adjustments significantly trail increases energy prices our in raw materials or operating results could be adversely affected. We are subject to substantial costs and potential liability for environmental matters. releases expenditures. We regulation of We are subject to various environmental laws and regulations including that govern our operations, discharges into the environment, and the handling and disposal of hazardous substances and wastes. We are also subject to laws and regulations that impose liability and clean-up responsibility of hazardous for substances into the environment. To comply with environmental laws and regulations, we have incurred, and will continue to incur, substantial capital and anticipate operating that environmental operations will continue to become more burdensome and that capital and operating expenditures necessary to comply with environmental regulations will continue, and perhaps increase, environmental regulations are not consistent worldwide, our ability to compete in the world marketplace may be adversely affected by capital and operating expenditures required for environmental compliance. In addition, we may incur obligations to remove or mitigate any adverse effects on the environment, such as air and water quality, resulting from mills we operate or have operated. Potential future. Because our the in -7- GLATFELTER obligations include compensation for the restoration of natural resources, personal injury and property damages. with customers, suppliers and employees. Accordingly, our financial results may be adversely affected. In connection with the sale of our Ecusta Division in 2001, we are incurring landfill closure costs and may incur additional costs for recognized environmental concerns at the site of our former mill related to the presence of mercury and certain other contamination on and around the site; potentially hazardous conditions existing in the sediment and water column of the site’s water treatment and aeration and sedimentation basin (the “ASB”); and contamination associated with two additional landfills on the site that were not used by us. We are also liable for the costs of clean-up related to the presence of polychlorinated biphenyls, or PCBs, in the lower Fox River on which our former Neenah, Wisconsin mill was located. We have financial reserves for environmental matters but we cannot be certain that those reserves will be adequate to provide for future obligations related to these matters, that our share of costs and/or damages for these matters will not exceed our available resources, or that such obligations will not have a long-term, material adverse effect on our consolidated financial position, liquidity or results of operations. Our environmental issues are complicated and should be reviewed in context; please see a more detailed discussion of in Item 8 – Financial Statements, Note 19. these matters We may not achieve our anticipated synergies from our Chillicothe and Lydney acquisitions. and In 2006, we acquired Chillicothe and the Lydney mill. Inherent risks in business combinations such as these include the inability to successfully integrate the acquired production facility and its procurement, requirements, as marketing information administration finance functions. With respect to Chillicothe, although in 2006 we have made progress transitioning book products, we cannot assure you that we will be able to successfully produce the products in a cost effective manner necessary to provide higher levels of return. sales systems, as well and this acquisition and are With respect to the Lydney mill, in December 2006, we received unconditional regulatory clearance for in the process of implementing integration plans. However, we cannot assure you that these integration plans will be completed timely or that the full financial benefits of the acquisition will be realized. Our inability to successfully execute the plans discussed above may adversely affect our relationships We have operations in a politically and economically unstable location. We own and operate a pulp mill in the Philippines where the operating environment is unstable and subject to political unrest. Our Philippine pulp mill produces abaca pulp, a significant raw material used by our Composite Fibers business unit. Our Philippine pulp mill is currently the main provider of abaca pulp. There readily are limited suitable alternative sources of available abaca pulp in the world. In the event of a disruption in supply from our Philippine mill, there is no guarantee that we could obtain adequate amounts of abaca pulp from alternative sources at a reasonable price or at all. As a consequence, any civil disturbance, unrest, political that causes a disruption in supply could limit the availability of abaca pulp and would increase our cost of obtaining abaca pulp. Such occurrences could adversely impact our sales volumes, revenues and operating results. instability or other event We may not be able to develop new products acceptable to our customers. Our business strategy is market focused and includes investments in developing new products to meet the changing needs of our customers and to maintain our market share. Our success will depend in large part on our ability to develop and introduce new and enhanced products that keep pace with introductions by our competitors and changing customer preferences. If we fail to anticipate or respond adequately to these factors, then we may lose opportunities for business with both current customers. The success of our new product offerings will depend on several factors, including our ability to, and potential (cid:129) anticipate and properly identify our customers’ needs and industry trends; (cid:129) price our products competitively; (cid:129) develop and commercialize new products and applications in a timely manner; (cid:129) differentiate our products from our competitors’ products; and (cid:129) invest in research and development activities efficiently. Our inability to develop new products could adversely impact our business and ultimately harm our profitability. -8- GLATFELTER Our international operations pose certain risks We may be unable to generate sufficient cash flow that may adversely impact sales and earnings. labor controls, regulation, the United Kingdom, intellectual property, exchange We have significant operations and assets located in and the Germany, France, Philippines. Our international sales and operations are subject to a number of special risks, in addition to the risks of our domestic sales and operations, including trade differing protections of barriers, regional labor unrest, economic uncertainty, differing (and possibly more stringent) risk of governmental and expropriation, domestic tariffs, differing regulatory environments, difficulty in managing widespread operations and political instability and unrest. These factors may adversely affect our future profits. Also, in some foreign jurisdictions we may be subject to laws limiting the right and ability of entities organized or operating therein to pay dividends or remit earnings specified are met. Any such limitations would conditions restrict our flexibility in using funds generated in those jurisdictions. affiliated companies unless and foreign customs to Foreign currency exchange rate fluctuations could adversely affect our results of operations. We own and operate paper and pulp mills in the United Kingdom and the Germany, France, currency in Germany and local Philippines. The in the UK the British Pound France is the Euro, Sterling, and in the Philippines the currency is the Peso. During currency operations generated approximately 21% of our sales and 19.8% of operating expenses and British Pound Sterling operations represented 6.1% of net sales and 6.4% of operating expenses. The translation of the results from these international operations into U.S. dollars is subject to changes in foreign currency exchange rates. 2006, Euro functional for our international operations in which the product in part, on the relative strength of Our ability to maintain our products’ price is competitiveness the reliant, currency is denominated compared to the currency of the market into which it is sold and the functional currency of our competitors. Changes in the rate of exchange of foreign currencies in relation to the U.S. dollar and other currencies may adversely impact our ability to offer products in certain markets at acceptable prices or our results of operations. to simultaneously fund our operations, finance capital expenditures, satisfy obligations and make dividend payments on our common stock. Our business is capital intensive and requires significant expenditures for equipment maintenance and new or enhanced equipment, for environmental compliance matters and to support our business strategies and research and development efforts. We expect to meet all of our near- and longer-term cash needs from a combination of operating cash flow, cash and cash equivalents, sale of timberlands, our existing credit facility or other bank lines of credit and other long- term debt. If we are unable to generate sufficient cash flow from these sources, we could be unable to meet our near and longer-term cash needs or make dividend payments. We may be unable to achieve expected proceeds from a sale of our timberlands. including the One of our primary business strategies is to sell 60,000 acres of higher and better use, or HBU, properties over a two to four year period. Our ability to sell these timberlands for the expected price depends on market conditions, similar availability properties sale that would compete with our properties. As a result, we may be unable to generate the pre-tax proceeds of more than $150 million we expect from the sale of these timberlands. It is estimated that our pre-tax cost of fiber will increase when all HBU acres are sold. These costs could be higher than estimated which could adversely affect our financial results. for of Our indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the notes. of As amount indebtedness. We have now and will continue to have, a significant of December 31, 2006, we had $64.8 million of indebtedness outstanding under our revolving credit facility, $96.0 million of indebtedness outstanding under our term loan facility, $200 million of indebtedness outstanding under our 71⁄8% fixed rate bonds and $34.0 million of indebtedness outstanding under our note payable to SunTrust. Our indebtedness could materially and adversely affect us in a number of ways. For example, it could: (cid:129) make it more difficult for us to satisfy our obligations with respect to the notes; (cid:129) increase our vulnerability to adverse economic and industry conditions; -9- GLATFELTER (cid:129) require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital corporate expenditures purposes; other general and (cid:129) limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; (cid:129) place us at a disadvantage compared to our competitors that have less debt; and (cid:129) limit our ability to borrow additional funds, including for future acquisitions, to meet our operating expenses and for other purposes. In addition, a substantial portion of our debt, including borrowings under our new credit facility, bears interest at variable rates. If market interest rates increase, variable-rate debt will create higher debt service requirements, which could adversely affect our cash flow. While we may enter into agreements limiting our exposure to higher interest rates, any such agreements may not offer complete protection from this risk. ITEM 2. PROPERTIES Our leased corporate offices are located in York, Pennsylvania. We own and operate paper mills located in Spring Grove, Pennsylvania; Chillicothe, Ohio; the United Kingdom; Gernsbach, Germany; and Scaër, France. In addition, we own and operate a pulp mill in the Philippines. Substantially all of the equipment used in our papermaking and related operations, with the exception of some leased vehicles, is also owned. All of our properties, other than those that are leased, are free from any material liens or encumbrances. We consider all of our buildings to be in good structural condition and well maintained and our properties to be suitable and adequate for present operations. The following table summarizes the estimated production capacity of each of our facilities: Estimated Annual Production Capacity (short tons) Specialty Papers Spring Grove Chillicothe Composite Fibers Gernsbach Scaër Lydney Philippines 315,000 66,000 400,000 7,500 38,000 11,400 6,100 15,700 12,240 Uncoated Coated Uncoated Coated Lightweight Metallized Lightweight Lightweight Abaca pulp The Spring Grove facility includes five uncoated paper machines that have been rebuilt and modernized from time to time. It has an off-line combi-blade coater and a Specialty Coater (“S-Coater”), which together yield a potential annual production capacity for coated paper of approximately 66,000 tons. Since uncoated paper is used in producing coated paper, this is not additional capacity. We view the S-Coater as an important asset that allows us to expand our more profitable engineered paper products business. The Spring Grove facility also includes a pulpmill that has a production capacity of approximately 650 tons of bleached pulp per day. We have a precipitated calcium carbonate (“PCC”) plant at our Spring Grove facility that produces PCC at a lower cost than could be purchased from others and lowers the need for higher-priced raw material typically used for increasing the opacity and brightness of certain papers. The Chillicothe facility operates four paper machines which together yield a potential annual production capacity of uncoated and carbonless paper of approximately 400,000 tons. In addition, this location has produces 7,500 tons per year of other coated paper. This that has a production capacity of approximately 955 tons of bleached pulp per day. facility also includes a pulpmill Our Philippines facility consists of a pulpmill that supplies a majority of the abaca pulp requirements of the Composite Fibers paper mills. The Gernsbach facility includes five uncoated paper machines with an aggregate annual lightweight capacity of about 38,000 tons. In 2003, we rebuilt a paper machine with new state-of-the-art inclined wire technology. We believe this machine provides us greater flexibility and technological capabilities. The Gernsbach facility also has the capacity to produce 11,400 tons of metallized papers annually, using a lacquering machine and two metallizers. We purchase the base paper used to manufacture the metallized paper. The Scaër facility operates two paper machines with an annual lightweight capacity of 6,100 tons and the Lydney facility operates three paper machines with an annual lightweight capacity of 15,700 tons. ITEM 3. LEGAL PROCEEDINGS outcome We are involved in various lawsuits that we consider to be ordinary and incidental to our business. The ultimate cannot be these predicted with certainty; however, we do not expect such lawsuits individually or in the aggregate, will have a material adverse effect on our consolidated financial position, liquidity or results of operations. lawsuits of For a discussion of commitments, legal proceedings Item 8 – Financial and related contingencies, Statements and Supplementary Data – Note 19. see -10- GLATFELTER ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. accounting and consulting firm, where he served in various capacities. Not Applicable – no matters were submitted to a vote of security holders during the fourth quarter of 2006. EXECUTIVE OFFICERS The following table sets forth certain information with respect to our executive officers as of March 1, 2007. Name Age Office with the Company George H. Glatfelter II Dante C. Parrini John P. Jacunski Timothy R. Hess Jeffrey J. Norton Martin Rapp 55 42 41 Chairman and Chief Executive Officer Executive Vice President and Chief Operating Officer Senior Vice President and Chief Financial Officer 40 Vice President and General Manager, Specialty Papers Business Unit 48 Vice President, General Counsel and Secretary 47 Vice President and General Manager, Composite Fibers Business Unit Mark A. Sullivan William T. Yanavitch II 52 Vice President Global Supply Chain 46 Vice President Human Resources and David C. Elder 38 Administration Corporate Controller and Chief Accounting Officer Officers are elected to serve at the pleasure of the Board of Directors. Except in the case of officers elected to fill a new position or a vacancy occurring at some other date, officers are generally elected at the organizational meeting of the Board of Directors held immediately after the annual meeting of shareholders. George H. Glatfelter II is our Chairman and Chief Executive Officer. From April 2000 to February 2001, Mr. Glatfelter was Chairman, President and Chief Executive Officer. From June 1998 to April 2000, he was Chief Executive Officer and President. Mr. Glatfelter serves as a director of Met-Pro Corporation. Dante C. Parrini became Executive Vice President and Chief Operating Officer in February 2005. Prior to this, Mr. Parrini was Senior Vice President and General Manager, a position he held since January 2003. From December 2000 until January 2003, Mr. Parrini was Vice President – Sales and Marketing. From July 2000 to December 2000, he was Vice President – Sales and Marketing, Glatfelter Division and Corporate Strategic Marketing. John P. Jacunski became Senior Vice President & Chief Financial Officer in July 2006. From October 2003 until July 2006, he was Vice President and Corporate Controller. Mr. Jacunski was previously Vice President and Chief Financial Officer at WCI Steel, Inc. from June 1999 to October 2003. From May 1995 to June 1999 he was WCI’s Corporate Controller. Prior to joining WCI, an international Mr. Jacunski was with KPMG, Timothy R. Hess has been Vice President and General Manager – Specialty Papers Business Unit since February 2006. Prior the Company’s Director of Specialty Papers Business Unit, a position he held since January 2004. From 1994 until technical, January 2004, Mr. Hess held various development manufacturing, positions with Glatfelter. to this he was business sales and Jeffrey J. Norton joined us in May 2005 and serves as Vice President, General Counsel and Secretary. Prior to joining Glatfelter, Mr. Norton was with Exelon Corporation, a $15 billion energy corporation, for 14 years where he was Assistant General Counsel. as Vice President Martin Rapp joined Glatfelter in August 2006 and and General Manager – serves Composite Fibers Business Unit. Prior this Mr. Rapp was Vice President and General Manager of Avery Dennison’s Roll Materials Business in Central and Eastern Europe since August 2002. From May 2000 until July 2002 Mr. Rapp was Partner and Managing Director of BonnConsult. to Mark A. Sullivan was appointed Vice President, Global Supply Chain in February 2005. Mr. Sullivan joined our company in December 2003, as Chief Procurement Officer. His experience includes a broad array of operations and supply chain management responsibilities during 20 years with the DuPont Company. He served with T-Mobile USA as an and Concur independent contractor during 2003, Technologies from 1999 until 2002. William T. Yanavitch II rejoined the Company in May 2005 as Vice President Human Resources and Administration. Mr. Yanavitch as Vice President Human Resources from July 2000 until his resignation in January 2005 at which time he became Corporate Human Resources Manager of Constellation Energy. From October 1998 to July 2000, Mr. Yanavitch was Director of Human Resources for the Ceramco and Trubyte Divisions of Dentsply. served David C. Elder became Corporate Controller and Chief Accounting Officer in July 2006 after joining the company in January 2006. Prior to joining the company, Mr. Elder was Corporate Controller for YORK International Corporation, a position he held since December 2003. Prior thereto, he was the Director, Financial for YORK International Corporation from August 2000 to December 2003. and Analysis Planning -11- GLATFELTER PART II ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Common Stock Prices and Dividends Declared STOCK PERFORMANCE GRAPH Information The following table shows the high and low prices of our common stock traded on the New York Stock Exchange under the symbol “GLT” and the dividend declared per share for each quarter during the past two years. Quarter 2006 Fourth Third Second First 2005 Fourth Third Second First High Low Dividend $15.95 16.23 19.84 18.65 $15.11 14.92 14.93 15.47 $13.26 12.98 14.45 13.12 $12.41 12.00 10.95 12.86 $0.09 0.09 0.09 0.09 $0.09 0.09 0.09 0.09 As of March 8, 2007, we had 1,726 shareholders of record. A number of the shareholders of record are nominees. The following chart compares the yearly percentage change in the cumulative total return on our common stock during the five years ended December 31, 2006, with the cumulative total return on the S&P MidCap 400 Index and the Company’s Peer Group (1). The comparison on December 31, 2001, in our common stock, and in each assumes the reinvestment of dividends. $100 was foregoing invested assumes indices and of Comparison of 5 Year Cumulative Total Return Assumes Initial Investment of $100 December 2006 180.00 160.00 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 2001 2002 2003 2004 2005 2006 GLATFELTER S&P 400 MidCap Index - Total Return Peer Group 1) The Company’s Peer Group consists of companies in the same industry as the Company. The returns of each Company in the Peer Group have been weighted according to their respective stock market capitalization for purposes of arriving at the Peer Group average. The members of the Peer Group are as follows: Bowater, Inc., Chesapeake Corporation, MeadWestvaco Corporation, Pope and Talbot, Inc., Potlatch Corporation, Schweitzer-Mauduit International, Inc., and Wausau Mosinee Paper Mills Corporation. Certain of the comparable companies are included in the S&P MidCap 400, and therefore are represented in both indices in the performance chart. -12- GLATFELTER ITEM 6. SELECTED FINANCIAL DATA Summary of Selected Consolidated Financial Data As of or for the year ended December 31 In thousands, except per share Net sales Energy sales, net Total revenue Shutdown and restructuring charges and unusual items Gains on dispositions of plant, equipment and timberlands Gains from insurance recoveries Income (loss) from continuing operations Income (loss) per share from continuing operations Basic Diluted Total assets Total debt Shareholders’ equity Cash dividends declared per common share 2006 2005 2004 2003 2002 $ 986,411 10,726 $ 579,121 10,078 $ 543,524 9,953 $ 533,193 10,040 $540,347 9,814 997,137 (30,318) 17,394 205 (12,236) (0.27) (0.27) 1,225,643 397,613 388,368 0.36 589,199 (1,564) 22,053 20,151 38,609 0.88 0.87 1,044,977 207,073 432,312 0.36 553,477 (20,375) 58,509 32,785 56,102 1.28 1.27 1,052,270 211,227 420,370 0.36 543,233 (24,995) 32,334 – 12,986 0.30 0.30 1,027,019 254,275 371,431 0.53 550,161 (2,241) 1,304 – 37,637 0.87 0.86 953,202 220,532 373,833 0.70 1. The above Summary of Selected Consolidated Financial Data, and the comparability thereof, includes the impact of certain charges and gains from asset dispositions and insurance recoveries. For a discussion of these items that affect the comparability of this information, see Item 8 – Financial Statements and Supplemental Data Notes 4 to 6. -13- GLATFELTER ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS statements Forward-Looking on Form 10-K includes Statements This Annual Report forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All fact, statements other than statements of historical including statements regarding industry prospects and future consolidated financial position or results of operations, made in this Report on Form 10-K are forward looking. We use words such as “anticipates”, “believes”, “expects”, “future”, “intends” and similar to identify forward-looking statements. expressions Forward-looking reflect management’s current expectations and are inherently uncertain. Our significantly from such actual expectations. The includes following forward-looking statements regarding expectations of, among others, net sales, costs of products sold, non-cash pension capital expenditures and liquidity, all of which are inherently difficult to predict. Although we make such statements based on assumptions that we believe to be reasonable, there can be no assurance that actual results will not differ materially from our expectations. Accordingly, we identify among others, which could cause our results to differ from forecasted or any results that might be projected, estimated in any such forward-looking statements: following important results may differ environmental discussion income, factors, costs, the i. ii. iii. iv. v. vi. variations in demand for, or pricing of, our products; changes in the cost or availability of raw materials in particular market pulp, pulp we use, substitutes, and abaca fiber, and changes in energy-related costs; our ability to develop new, high value-added Specialty Papers and Composite Fibers; production the impact of competition, changes in industry paper the construction of new mills, the closing of mills and capital to changes expenditures or productivity increases; incremental including capacity, due our ability to successfully integrate the operations of the recently acquired Chillicothe and Lydney facilities; and other cost environmental effects compliance, cleanup, damages, remediation or restoration, or personal injury or property damages related thereto, such as the costs of of natural resource restoration or damages related to the presence of polychlorinated biphenyls (“PCBs”) in the lower Fox River on which our former Neenah mill was located; and the costs of former Ecusta environmental matters at our Division mill; the gain or loss of significant customers and/or on- going viability of such customers; risks associated with our international operations, political including economic environments in currency and fluctuations exchange rates; local and geopolitical events, including war and terrorism; enactment of adverse state, federal or foreign tax or other legislation or changes in government policy or regulation; vii. viii. ix. x. xi. adverse results in litigation; xii. xiii. xiv. disruptions in production and/or increased costs due to labor disputes; our ability to successfully execute our timberland strategy to realize the value of our timberlands; and our ability to finance, consummate and integrate future acquisitions. Introduction We manufacture, both domestically and internationally, a wide array of specialty papers and engineered products. Substantially all of our revenue is earned from the sale of our products to customers in numerous markets, publishing, including envelope & converting, carbonless papers and forms, food and beverage, decorative laminates for furniture and flooring, and other highly technical niche markets. book units compared stronger market conditions when Overview Our results of operations for 2006 in each of our reflect 2005. business Domestically, the Specialty Papers business unit’s results in the comparison are positively influenced by additional volumes associated with the April 2006 Chillicothe acquisition and improved selling prices. However, input costs in 2006 are higher, primarily energy and raw material costs. with Our Composite Fibers business unit’s results have also been positively influenced by additional volumes associated with the Lydney acquisition as well as improved demand across all of this unit’s product categories. Average selling prices, however, have remained flat to lower in the comparison. -14- GLATFELTER These items decreased earnings by $36.7 million, or $0.82 per diluted share in 2006. Comparatively, the items identified above positively affected earnings in 2005 by $23.0 million, or $0.53 per diluted share. any other information for Business Units Results of individual business units are presented based on our management accounting practices and management structure. There is no comprehensive, authoritative body of guidance for to accounting accounting equivalent management principles generally accepted in the United States of America; therefore, the financial results of individual business units are not necessarily comparable with company. The similar management accounting process uses assumptions and allocations to measure performance of the business units. Methodologies are refined from time to time as management accounting practices are enhanced and businesses change. The costs incurred by support areas not directly aligned with the business unit are allocated primarily based on an estimated utilization of support area services or included in “Other and Unallocated” in the following table. Certain prior period information has been reclassified to conform to the current period presentation. effects of asset dispositions Management evaluates business unit results of operations before non-cash pension income, shutdown and restructuring related charges, acquisition integration costs, and insurance recoveries because it believes this is a more meaningful representation of the operating performance of its core papermaking businesses, the profitability of business units and the extent of cash flow generated from core operations. This presentation is closely aligned with the management and operating structure of our company. It is also on this basis that the Company’s performance is evaluated internally and by the Company’s Board of Directors. The analysis of our financial results for 2006 reflects the following significant items: 1) We completed the $65 million acquisition of J R Crompton’s Lydney mill on March 13, 2006. This mill’s approximately $75 million; 2005 was revenue in 2) On April 3, 2006, we completed the acquisition of carbonless paper operation of of Chillicothe, NewPage Corporation with 2005 revenue $441.5 million, for $83.3 million in cash; the 3) In April 2006, we refinanced our bank credit facility with a $100 million term loan and a $200 million revolving credit facility in addition to the issuance of $200 million 71⁄8% bonds to replace our $150 million 67⁄8% notes due July 2007; 4) On June 30, 2006, we ceased production at our Neenah, WI facility and recorded shutdown related charges totaling $54.4 million; 5) We incurred acquisition integration costs totaling $13.6 million in connection with the Chillicothe and Lydney acquisitions; and 6) During 2006, we sold 5,923 acres of timberland for aggregate proceeds of $17.1 million. RESULTS OF OPERATIONS 2006 versus 2005 The following table sets forth summarized results of operations: In thousands, except per share Net sales Gross profit Operating income Net income (loss) Earnings (loss) per diluted share Year Ended December 31 2006 2005 $986,411 105,294 94 (12,236) (0.27) $579,121 97,176 70,183 38,609 0.87 The consolidated results of operations for the years ended December 31, 2006 and 2005 include the following significant items: In thousands, except per share After-tax Income (loss) Diluted EPS 2006 Gains on sale of timberlands Shutdown and restructuring charges Acquisition integration costs Debt redemption premium Insurance recoveries 2005 Gains on sale of timberlands Insurance recoveries Restructuring charges $ 8,812 $ 0.20 (35,212) (8,647) (1,820) 130 11,258 12,719 (1,017) (0.79) (0.19) (0.04) — 0.26 0.29 (0.02) -15- GLATFELTER Business Unit Performance In thousands, except tons Net sales Energy sales, net Total revenue Cost of products sold Gross profit (loss) SG&A Shutdown and restructuring charges Gains on dispositions of plant, equipment and timberlands Gain on insurance recoveries Total operating income (loss) Nonoperating income (expense) Income (loss) before income taxes Supplementary Data Net tons sold Depreciation expense Year Ended December 31 Specialty Papers 2006 2005 Composite Fibers 2006 2005 Other and Unallocated Total 2006 2005 2006 2005 $693,660 10,726 704,386 635,143 69,243 50,285 – – – 18,958 – $18,958 $380,923 10,078 391,001 340,629 50,372 39,876 – – – 10,496 – $10,496 $292,751 – 292,751 246,797 45,954 28,458 – – – 17,496 – $17,496 $198,137 – $198,137 166,153 31,984 21,282 – – – 10,702 – $10,702 $– – – 9,903 (9,903) 13,738 30,318 (17,394) (205) (36,360) (22,322) $(58,682) $61 – 61 (14,759) 14,820 6,475 1,564 (22,053) (20,151) 48,985 (10,043) $38,942 $986,411 10,726 997,137 891,843 105,294 92,481 30,318 (17,394) (205) 94 (22,322) $(22,228) $579,121 10,078 589,199 492,023 97,176 67,633 1,564 (22,053) (20,151) 70,183 (10,043) $60,140 653,734 $32,824 450,900 $35,781 68,148 $17,197 47,669 $14,866 10 $– 24 $– 721,892 $50,021 498,593 $50,647 Sales and Costs of Products Sold In thousands Net sales Energy sales – net Total revenues Costs of products sold Gross profit Gross profit as a percent of Net sales Year Ended December 31 2006 2005 Change $986,411 10,726 997,137 891,843 $105,294 $579,121 10,078 589,199 492,023 $97,176 $407,290 648 407,938 399,820 $8,118 10.7% 16.8% The following table sets forth the contribution to consolidated net sales by each business unit: Business Unit Specialty Papers Composite Fibers Total Percent of total 2006 2005 70.3% 29.7 65.8% 34.2 100.0% 100.0% Net sales totaled $986.4 million for the year ended December 31, 2006, an increase of $407.3 million, or 70.3%, compared to the same period a year ago. Net sales from the acquisition of Chillicothe’s carbonless and forms business and the Lydney mill totaled $329.9 million. These acquisitions are reported in the Specialty Papers and Composite Fibers business units, respectively. Organic growth was driven by a 4.0% increase in volume and $21.3 million from higher average selling prices in the Specialty Papers business unit. Excluding results of the Lydney mill, Composite Fibers’ volumes shipped increased 15.6%. The translation of foreign currencies unfavorably impacted this business unit’s net sales by $2.5 million and average selling prices declined $3.5 million compared to the same period a year ago. In connection with the Chillicothe acquisition, we facility. permanently shutdown our Neenah, WI Products previously manufactured at the Neenah facility have been transferred to Chillicothe. The results of operations for 2006 include related pre-tax charges of $54.4 million, of which $25.4 million is reflected in the consolidated income statement as components of cost of products sold and $29.0 million is reflected as “Shutdown and restructuring charges.” Costs of products sold totaled $891.8 million for 2006, an increase of $399.8 million compared with the previous year As discussed above, the 2006 costs of products sold includes a $25.4 million charge for inventory write-downs and accelerated depreciation on property and equipment abandoned in connection with the Neenah shutdown. In addition to the shutdown charges, the increase in costs of products sold was primarily due to the inclusion of the Chillicothe and Lydney acquisitions and the effect of increased shipping volumes. In addition, higher raw material and energy prices increased costs of products sold by approximately $12.1 million. Non-Cash Pension Income Non-cash pension income results from the over-funded status of our pension plans. The amount of pension income recognized each year is determined using various actuarial assumptions and certain other factors, including the fair value of our pension assets as of the beginning of the year. The following summarizes non-cash pension income, before the curtailment charges recorded in connection with the Neenah shutdown during 2006: In thousands Recorded as: Costs of products sold SG&A expense Total Year Ended December 31 2006 2005 Change $15,480 1,513 $16,993 $14,844 1,673 $16,517 $636 (160) $476 Selling, general and administrative (“SG&A”) expenses totaled $92.5 million in 2006 compared to $67.6 million a year ago. The increase was due to $13.6 million of acquisition integration costs and $16.2 million from the inclusion of the Chillicothe and Lydney acquisitions in the current period’s results of operations. SG&A expenses in 2005 included a -16- GLATFELTER $2.7 million charge for certain matters related to our former Ecusta division. In addition, the comparison was favorably affected by lower professional and legal fees in the period to period comparison. Gain on Sales of Plant, Equipment and Timberlands During 2006, 2005 and 2004, we completed sales of in 2004, the corporate aircraft. The following table summarizes these transactions. timberlands and, Dollars in thousands Acres Proceeds Gain 2006 Timberlands Other Total 2005 Timberlands Other Total 2004 Timberlands Corporate Aircraft Other Total 5,923 n/a 2,488 n/a 4,482 n/a n/a $17,130 3,941 $21,071 $21,000 1,778 $22,778 $56,586 2,861 724 $60,171 $15,677 1,717 $17,394 $20,327 1,726 $22,053 $55,355 2,554 600 $58,509 environmental matter. Insurance Recoveries During the 2006 and 2005, we reached successful resolution of certain claims under insurance policies related to the Fox recoveries River totaled included $0.2 million in 2006 and $20.2 million in 2005. All recoveries were received in cash prior to the end of the applicable period. operations Insurance results the in of Shutdown and Restructuring Charges – Neenah Facility Shutdown As of June 30, 2006 we permanently shutdown our Neenah facility. The charge incurred in connection with this action was recorded as follows: In thousands Recorded as: Costs of products sold Shutdown and restructuring charge Total Year Ended December 31, 2006 $25,371 29,074 $54,445 The following table summarizes shutdown reserve activity during 2006: In thousands Non-cash charges Accelerated depreciation Inventory write-down Pension curtailments and other retirement benefit charges Total non cash charges Cash charges Severance and benefit continuation Contract termination costs Other Total cash charges Total Less non-cash- charges and cash payments Beg. balance Amount Accrued $22,466 2,905 $(22,466) (2,905) 7,675 33,046 (7,675) (33,046) Balance $– – – – 7,653 11,367 2,379 21,399 $54,445 (6,026) (11,367) (1,229) (18,622) $(51,668) 1,627 – 1,150 2,777 $2,777 $– – – – – – – – $– The Neenah facility supported our Specialty Papers business unit. Shutdown of this facility resulted in the elimination of approximately 200 positions. We do not expect any material additional shutdown related charges in 2007. As part of the Neenah shutdown, we terminated our long-term steam supply contract, as provided for within the agreement, resulting in a termination fee of approximately $11.4 million. The results of operations for 2006 and 2005, also include $1.2 million and $1.6 million, respectively, of charges related to the European Restructuring and Optimization (EURO) Program. Non-operating income (expense) During April 2006, we completed the placement of a $200 million bond offering, the proceeds of which were used to redeem the then outstanding $150 million notes scheduled to mature in July 2007. In connection with the early redemption, a charge of $2.9 million, related to a redemption premium and the write-off of unamortized debt recorded in Consolidated Statement of Income as Non-operating expense under the caption “Other-net”. issuance costs, was Income taxes In 2006 we recorded an income tax benefit at an effective rate of 45.0% compared to an income tax provision at an effective rate of 35.8%. The beneficial higher effective tax rate in 2006 was primarily due to the effect of state tax law changes and the effect of tax credits, partially offset by the resolution of certain tax matters. Foreign Currency We own and operate paper and pulp mills the United in Germany, France, Kingdom and the Philippines. The local currency in Germany and France is the Euro, in the UK the British Pound Sterling, and in the Philippines the currency is the Peso. During 2006, Euro functional currency operations generated approximately 21.0% of our sales and 19.8% of operating expenses and British Pound Sterling operations represented 6.1% of net sales and 6.4% of operating expenses. The translation of the results from these international operations into U.S. dollars is subject to changes in foreign currency exchange rates. The table below summarizes the effect from foreign currency translation on 2006 reported results compared to 2005: In thousands Net sales Costs of products sold SG&A expenses Income taxes and other Net loss Year Ended December 31 Favorable (unfavorable) $2,455 (4,045) (258) 37 $(1,811) -17- GLATFELTER The above table only presents financial reporting impact of foreign currency translations. It does not present the impact of certain competitive advantages or disadvantages of operating or competing in multi-currency markets. the The consolidated results of operations for the years ended December 31, 2005 and 2004 include the following significant items: In thousands, except per share After-tax Income (loss) Diluted EPS RESULTS OF OPERATIONS 2005 versus 2004 The following table sets forth summarized results of operations: In thousands Net sales Gross profit Operating income Net income Earnings per diluted share Year Ended December 31 2005 $579,121 97,176 70,183 38,609 0.87 2004 $543,524 92,414 103,394 56,102 1.27 2005 Gains on sale of timberlands Insurance recoveries Restructuring charges 2004 Gains on sale of timberlands and corporate aircraft Insurance recoveries Restructuring charges $11,258 12,719 (1,017) $34,151 21,310 (12,723) $0.26 0.29 (0.02) $0.78 0.48 (0.29) The items above from continuing operations by $23.0 million, or $0.52 per diluted share in 2005, and by $42.7 million, or $0.97 per diluted share, in 2004. increased earnings Business Units The following table sets forth profitability information by business unit and the composition of consolidated income from continuing operations before income taxes: Year Ended December 31 In thousands, except tons Net sales Energy sales, net Total revenue Cost of products sold Gross profit SG&A Restructuring charges Gains on dispositions of plant, equipment and timberlands Gain on insurance recoveries Total operating income (loss) Nonoperating income (expense) Income (loss) from continuing operations before income taxes Supplementary Data Net tons sold Depreciation expense Specialty Papers 2004 2005 Composite Fibers 2004 2005 $380,923 10,078 391,001 340,629 50,372 39,876 – – – 10,496 – $337,436 9,953 347,389 312,136 35,253 36,617 – – – (1,364) – $198,137 – 198,137 166,153 31,984 21,282 – – – 10,702 – $205,232 – 205,232 163,843 41,389 23,067 – – – 18,322 – Other and Unallocated Total 2005 2004 2005 2004 $61 – 61 (14,759) 14,820 6,475 1,564 (22,053) (20,151) 48,985 (10,043) $856 – 856 (14,916) 15,772 255 20,375 (58,509) (32,785) 86,436 (12,631) $579,121 10,078 589,199 492,023 97,176 67,633 1,564 $543,524 9,953 553,477 461,063 92,414 59,939 20,375 (22,053) (20,151) 70,183 (10,043) (58,509) (32,785) 103,394 (12,631) $10,496 $(1,364) $10,702 $18,322 $38,942 $73,805 $60,140 $90,763 450,900 $35,781 421,504 $37,186 47,669 $14,866 48,528 $14,412 24 – 390 – 498,593 $50,647 470,422 $51,598 Sales and Costs of Products Sold In thousands Net sales Energy sales – net Total revenues Costs of products sold Gross profit Gross profit as a percent of Net sales Year Ended December 31 2005 $579,121 10,078 589,199 492,023 $97,176 2004 $543,524 9,953 553,477 461,063 $92,414 16.8% 17.0% Change $35,597 125 35,722 30,960 $4,762 The following table sets forth the contribution to consolidated net sales by each business unit: Business Unit Specialty Papers Composite Fibers Tobacco Papers Total Year Ended December 31 2005 2004 65.8% 34.2 – 100.0% 62.1% 37.8 0.1 100.0% Net sales totaled $579.1 million in 2005, an increase of $35.6 million, or 6.6%, compared to a year ago. This growth was primarily driven by strengthened product pricing and a 7.0% increase in volumes shipped in the Specialty Papers business unit compared with the same period of 2004. Higher pricing for Specialty Papers’ products increased revenue by $17.6 million compared to 2004. Composite Fibers’ volumes shipped declined approximately 1.8% and lower selling prices, on a constant by $7.4 million. Costs sold increased $31.0 million in the comparison. In addition to the effect of raw material and energy prices increased costs of products sold by approximately $11.1 million. Lower labor costs realized from the 2004 North American Restructuring Program were substantially offset by higher spending on supplies and maintenance and by the impact of significant market related downtime in the Composite Fibers business unit. increased shipping volumes, higher of products decreased currency revenue basis, -18- GLATFELTER Non-Cash Pension Income Non-cash pension income results from the considerably over-funded status of our pension plans. The amount of pension income is determined using various recognized each year factors, and certain other assumptions actuarial including the fair value of our pension assets as of the beginning of the year. The following summarizes non- cash pension income for each period: In thousands Recorded as: Costs of products sold SG&A expense Total Year Ended December 31 2005 2004 Change $14,844 1,673 $16,517 $15,937 1,405 $17,342 $(1,093) 268 $(825) The following summarizes SG&A expenses, restructuring charges, gains from asset dispositions and other nonrecurring items: In thousands SG&A expenses Restructuring charges Gains on dispositions of plant, equipment and timberlands Gains from insurance recoveries Year Ended December 31 2005 $67,633 1,564 2004 $59,939 20,375 Change $7,694 (18,811) (22,053) (20,151) (58,509) (32,785) 36,456 12,634 Selling, General and Administrative (“SG&A”) expenses increased $7.7 million in the comparison primarily due to a $2.7 million charge to increase our reserve for costs associated with environmental matters at the former Ecusta facility located in North Carolina, $2.1 million of additional variable compensation and $2.0 million of higher litigation related costs. Restructuring Charges In 2005 we announced the EURO Program, a comprehensive series of initiatives designed to improve the performance of our Composite Fibers business unit. In the fourth quarter of 2005 we recorded restructuring charges totaling $1.6 million associated with the related work force efficiency plans at the Gernsbach, Germany facility. This charge reflects severance, early retirement and related costs for the 55 effected employees. We expect to incur cash out lays in this amount over the next 24 month period. The restructuring charge incurred in 2004 related to the North American Restructuring Program and certain actions related to the Neenah facility. Insurance Recoveries During 2005 and 2004, we reached successful resolution of certain claims under insurance policies related to the Fox River environmental matter. Insurance recoveries included in the results of operations totaled $20.2 and $32.8 million in 2005 and 2004, respectively, and were received in cash. Any additional insurance recoveries are expected to be insignificant. Income Taxes The Company’s effective tax rates for 2005 and 2004 were 35.8% and 38.2%, respectively. The lower effective tax rate in 2005 was primarily due to decreased amounts of timberland sales in 2005, which are taxed at higher effective rates, and the effect of tax credits and the related impact on valuation allowances relative to the level of pre-tax income. in Germany, France local Foreign Currency We own and operate paper and the and pulp mills currency in Germany and Philippines. The the the Euro, while in the Philippines France is ended year the Peso. During the currency is operations generated these December 31, 2005, approximately 29% of our sales and 30% of operating expenses. The translation of the results from these international operations into U.S. dollars is subject to changes in foreign currency exchange rates. LIQUIDITY AND CAPITAL RESOURCES expenditures Our business is capital for intensive and requires enhanced significant equipment, for environmental compliance matters and to support our business strategy and research and development efforts. The following table summarizes cash flow information for each of the years presented. new or In thousands Cash and cash equivalents at beginning of period Cash provided by (used for) Operating activities Investing activities Financing activities Effect of exchange rate changes on cash Net cash (used) provided Cash and cash equivalents at end of period Year Ended December 31 2006 $57,442 (28,427) (181,831) 173,388 1,413 (35,457) $21,985 2005 $39,951 42,868 (8,029) (15,158) (2,190) 17,491 $57,442 During 2006, operations used $28.4 million of cash compared to $42.9 million of cash provided by operating activities in the prior year. The change in the comparison was primarily due $20.0 million of lower insurance recoveries in the year-to-year, the use of $21.7 million to settle a cross currency rate swap that matured in June 2006, $22.4 million used for working capital associated with the Lydney acquisition, $18.6 million of Neenah shutdown related payments made during 2006, partially offset by improved earnings from operations. The changes in investing cash flows primarily reflect the use of approximately $158.4 million to fund the Chillicothe and Lydney mill acquisitions and increased capital expenditures of $13.4 million. The acquisitions were financed with borrowings under our revolving credit facility and new term loan. During 2006 and 2005, cash dividends paid on common stock totaled approximately $16.0 million and $15.8 million. Our Board of Directors determines what, -19- GLATFELTER if any, dividends will be paid to our shareholders. Dividend payment decisions are based upon then- therefore, existing historical are not necessarily indicative of future payments. and and, conditions of dividend payments factors trends As more fully discussed in Item 8 – Financial Statements, Note 17, on April 3, 2006 we refinanced the revolving credit facility set forth in the table below. The significant terms of the new credit facility are also set forth therein. In addition, on April 28, 2006, we completed a private placement offering of $200 million aggregate principal amount of our 71⁄8% Senior Notes due 2016. We used the net proceeds to redeem $150 million aggregate principal amount of our outstanding 67⁄8% notes due July 2007, plus the payment of the applicable redemption premium and accrued interest. The following table sets forth our outstanding long-term indebtedness: In thousands Revolving credit facility, due April 2011 Term Loan, due April 2011 Revolving credit facility, due June 2006 71⁄8% Notes, due May 2016 67⁄8% Notes, due July 2007 Note payable – SunTrust, due March 2008 Total long-term debt Less current portion Long-term debt, excluding current portion December 31 2006 $64,795 96,000 – 200,000 – 34,000 394,795 (19,500) $375,295 2005 $– – 19,650 – 150,000 34,000 203,650 (19,650) $184,000 The significant terms of the debt obligations are set and Item 8 – Financial Statements in forth Supplementary Data, Note 17. We are subject to loss contingencies resulting from regulation by various federal, state, local and foreign authorities with governmental the impact of mills we operate, or have environmental laws and operated. To comply with environmental respect to regulations, we have incurred substantial capital and operating expenditures in past years. We anticipate that environmental regulation of our operations will continue to become more burdensome and that capital and operating expenditures necessary to comply with environmental regulations will continue, and perhaps increase, in the future. In addition, we may incur obligations to remove or mitigate any adverse effects on the environment resulting from our operations, resources and including the restoration of natural liability for personal to property and natural resources. See Item 8 – Financial Statements – Note 19 for a summary of significant environmental matters. injury and for damages We expect to meet all of our near- and longer-term cash needs from a combination of operating cash flow, cash and cash equivalents, sales of timberland, our existing credit facility or other bank lines of credit and other long-term debt. However, as discussed in Item 8 – Financial Statements and Supplementary Data – Note 19, an unfavorable outcome of various environmental matters could have a material adverse impact position, consolidated liquidity and/or results of operations. financial our on Off-Balance-Sheet Arrangements As of December 31, 2006 and 2005, we had not entered into any off-balance-sheet arrangements. A financial derivative instrument to which we are a party and indebtedness, which solely consists of guarantees of obligations of subsidiaries and a partnership, are reflected in the consolidated balance sheets included herein and in Supplementary Data. Item 8 – Financial Statements Contractual Obligations The following table sets forth contractual obligations as of December 31, 2006. In thousands Long-term debt (1) Operating leases (2) Purchase obligations (3) Other long term obligations (4) Total Total $562,275 18,699 63,651 103,410 $748,035 2007 $44,649 3,539 45,733 8,850 $102,771 Payments Due During the Year Ended December 31, 2010 to 2011 $136,545 1,973 140 18,290 $156,948 2008 to 2009 $119,331 5,102 17,778 16,596 $158,807 2012 and beyond $261,750 8,085 – 59,674 $329,509 (1) Represents principal and interest payments due on long-term debt. We have $200 million of debt maturing in May 2016 and bearing a fixed rate of interest at 71⁄8%, payable semiannually, $34 million note maturing in March 2008 and bearing a fixed rate of interest of 3.82%. In addition, at December 31, 2006, $65 million was outstanding under our revolving credit facility and $96 million was outstanding under a term loan. Both the revolving credit facility and the term loan bear a variable interest rate (6.20% as of December 31, 2006) and mature in April 2011. (2) Represents rental agreements for various land, buildings, and computer and office equipment. (3) Represents open purchase order commitments and other obligations, primarily for pulpwood contracts with minimum annual purchase obligations. In certain situations, prices are subject to variations based on market prices. In such situations, the information above is based on prices in effect at December 31, 2006 or expectations based on historical experience and/or current market conditions. (4) Represents expected benefits to be paid pursuant to medical retirement plans and nonqualified pension plans over the next ten years. -20- GLATFELTER financial preceding discussion of results analysis and and position Critical Accounting Policies and Estimates our The consolidated of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, long- lived assets, pension and post-retirement obligations, environmental liabilities and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. contingent assets We believe the following represent the most estimates used in the significant preparation of our consolidated financial statements. and subjective Inventory Reserves We maintain reserves for excess and obsolete inventories to reflect our inventory at the lower of its stated cost or market value. Our estimate for excess and obsolete inventory is based future demand and upon our market conditions. If actual market conditions are more or less favorable than those we have projected, we may need to increase or decrease our reserves for excess and obsolete inventories, which could affect our reported results of operations. assumptions about assets, underlying Long-lived Assets We evaluate the recoverability of our long-lived assets, including property, equipment and intangible assets periodically or whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Our evaluations include analyses based on the cash flows generated by information, the including estimated future operating results, trends or other determinants of fair value. If the value of an asset determined by these evaluations is less than its carrying amount, a loss is recognized for the difference between the fair value and the carrying value of the asset. Future adverse changes in market conditions or poor operating results of the related business may indicate an inability to recover the carrying value of the assets, thereby possibly requiring an impairment charge in the future. profitability Pension and Other Post-Retirement Obligations Accounting for defined-benefit pension plans, and any assumptions, curtailments requires various thereof, including, but not limited to, discount rates, expected rates of return on plan assets and future compensation growth rates. Accounting for our retiree medical plans, and any curtailments thereof, also requires various assumptions, which include, but are not limited to, discount rates and annual rates of increase in the per capita costs of health care benefits. We evaluate these assumptions at least once each year or as facts and circumstances dictate and make changes as conditions warrant. Changes to these assumptions will increase or decrease our reported income, which will result in changes to the recorded benefit plan assets and liabilities. on based existing legislation Environmental Liabilities We maintain accruals for losses associated with environmental obligations when it is probable that a liability has been incurred and the amount of the liability can be reasonably and estimated remediation technologies. These accruals are adjusted periodically as assessment and remediation actions continue and/or further legal or technical information develops. Such undiscounted liabilities are exclusive of any insurance or other claims against third parties. Recoveries of environmental remediation costs from other parties, including insurance carriers, are recorded as assets when their receipt is assured beyond a reasonable doubt. Income Taxes We record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in our balance sheets, as well as operating loss and tax credit carry forwards. These deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when such amounts are expected to reverse or be utilized. We regularly review our deferred tax assets for recoverability based on historical income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax If we are unable to generate planning strategies. sufficient there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to increase the valuation allowance against our deferred tax assets, which may result in a substantial increase in our effective tax rate and a material adverse impact on our reported results. future taxable income, or taxable if Other significant accounting policies, not involving the same level of uncertainties as those discussed above, are nevertheless important to an understanding of the Consolidated Financial Statements. Refer to Item 8 – Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements for additional accounting policies. -21- GLATFELTER ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Dollars in thousands Long-term debt Average principal outstanding At fixed interest rates – Bond At fixed interest rates – SunTrust Note At variable interest rates Weighted-average interest rate Year Ended December 31 At December 31, 2006 2007 2008 2009 2010 2011 Carrying Value Fair Value $200,000 34,000 149,983 $200,000 8,500 134,545 $200,000 – 114,858 $200,000 – 92,358 $200,000 – 19,574 $200,000 34,000 160,795 $394,795 $204,980 32,914 160,795 $398,689 On fixed interest rate debt – Bond On variable interest rate debt – SunTrust Note On variable interest rate debt 7.13% 3.82 6.20 7.13% 3.82 6.19 7.13% — 6.19 7.13% — 6.18 7.13% — 6.17 Our market risk exposure primarily results from changes in interest rates and currency exchange rates. At December 31, 2006, we had long-term debt outstanding of $394.8 million, of which $160.8 million or 40.7% was at variable interest rates. Eurocurrency rate, at our option, plus a margin. At December 31, 2006, the interest rate paid was 6.20%. A hypothetical 100 basis point increase or decrease in the interest rate on variable rate debt would increase or decrease annual interest expense by $1.6 million. The table average principal above presents outstanding and related interest rates for the next five years. Fair values included herein have been determined based upon rates currently available to us for debt with similar terms and remaining maturities. Variable-rate represents borrowings under our revolving credit facility that incur interest based on the domestic prime rate or a outstanding debt We are subject to certain risks associated with changes in foreign currency exchange rates to the extent our operations are conducted in currencies other than the U.S. Dollar. During 2006, Euro functional currency operations generated approximately 21% of our sales and 19.8% of operating expenses and British Pound Sterling operations represented 6.1% of net sales and 6.4% of operating expenses. -22- GLATFELTER an LLP, Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, has been audited by Deloitte & Touche public independent accounting firm, as stated in their report appearing herein, which expresses unqualified opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. registered our that over control internal limitations the inherent The Company’s management, including the chief executive officer and chief financial officer, does not expect financial reporting will prevent or detect all errors and all frauds. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based, in part, on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING is for internal responsible Management of P. H. Glatfelter Company (the “Company”) establishing and maintaining adequate internal control over financial reporting. The Company’s over financial reporting is a process designed under the supervision of the chief executive and chief financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. control As of December 31, 2006, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We excluded from our assessment the internal control over financial reporting at the Lydney and Chillicothe facilities, which were acquired on March 13, 2006, and April 3, 2006, respectively, and whose total assets constitute a combined 24% of total assets, and which represented a combined 33% percent of total net sales, of the consolidated financial statement amounts as of and for the year ended December 31, 2006. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2006 is effective to provide reasonable assurance regarding the reliability of financial reporting financial and the preparation of in external statements accordance with generally accounting accepted in the United States. the Company’s reporting principles purposes for Our financial transactions records fairly that, reflect internal control over reporting includes policies and procedures that pertain to the in reasonable detail, maintenance of accurately and and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures are being made only in accordance with authorizations of management; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our financial statements. -23- GLATFELTER REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of P. H. Glatfelter Company We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that (the “Company”) P. H. Glatfelter and subsidiaries financial maintained effective internal control over reporting as of December 31, 2006, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in on Internal Control Over Management’s Report Financial Reporting, management excluded from its assessment the internal control over financial reporting at the Lydney and Chillicothe facilities, which were acquired on March 13, 2006, and April 3, 2006, respectively, a combined 24% of total assets, and which represented a combined 33% percent of the consolidated financial statement amounts as of and for the year ended December 31, 2006. Accordingly, our audit did not include the internal control over financial reporting at the Lydney and Chillicothe facilities. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. and whose constitute total net sales, of assets total We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal evaluating control management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. reporting, financial over control over A company’s financial internal reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in the reasonable detail, accurately and fairly reflect are reasonable the assets of assurance the transactions and dispositions of that company; (2) provide transactions recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. and directors of company; the including reporting, financial collusion or Because of the inherent limitations of internal the control over possibility of improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. the internal control over In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal of December 31, 2006, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. reporting as financial control over of We have also audited, in accordance with the the Public Company Accounting standards Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2006, of the Company and our report dated March 15, 2007, expressed an unqualified opinion on these financial statements and included an explanatory paragraph regarding the adoption of Statement of Financial “Employers’ Accounting Accounting for Defined Benefit Pension and Other Postretirement FASB Statements No. 87, 88, 106, and 132(R),” as of December 31, 2006. Standards No. amendment Plans – an 158, of Deloitte & Touche LLP Philadelphia, Pennsylvania March 15, 2007 -24- GLATFELTER REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of P. H. Glatfelter Company We have audited the accompanying consolidated balance sheets of P. H. Glatfelter Company and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, such consolidated financial statements present fairly, in all material respects, the financial position of P. H. Glatfelter Company and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 12 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement FASB Statements No. 87, 88, 106, and 132(R),” as of December 31, 2006. amendment Plans – an of of We have also audited, in accordance with the standards the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2007, expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Deloitte & Touche LLP Philadelphia, Pennsylvania March 15, 2007 -25- GLATFELTER P. H. GLATFELTER COMPANY and SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME In thousands, except per share amounts Net sales Energy sales – net Total revenues Costs of products sold Gross profit Selling, general and administrative expenses Shutdown and restructuring charges Gains on disposition of plant, equipment and timberlands, net Insurance recoveries Operating income Other nonoperating income (expense) Interest expense Interest income Other – net Total other nonoperating expense Income (loss) before income taxes Income tax provision (benefit) Net income (loss) Weighted average shares outstanding Basic Diluted Earnings (loss) Per Share Basic Diluted Year Ended December 31 2005 2006 2004 $986,411 10,726 $579,121 10,078 $543,524 9,953 997,137 891,843 105,294 92,481 30,318 (17,394) (205) 94 (24,453) 3,132 (1,001) (22,322) (22,228) (9,992) $(12,236) 589,199 492,023 97,176 67,633 1,564 (22,053) (20,151) 70,183 (13,083) 2,012 1,028 (10,043) 60,140 21,531 $38,609 553,477 461,063 92,414 59,939 20,375 (58,509) (32,785) 103,394 (13,385) 2,012 (1,258) (12,631) 90,763 34,661 $56,102 44,584 44,584 44,013 44,343 43,856 44,023 $(0.27) (0.27) $0.88 0.87 $1.28 1.27 The accompanying notes are an integral part of the consolidated financial statements. -26- GLATFELTER P. H. GLATFELTER COMPANY and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS Dollars in thousands, except par values Assets Current assets Cash and cash equivalents Accounts receivable (less allowance for doubtful accounts: 2006 – $3,613; 2005 – $931) Inventories Prepaid expenses and other current assets Total current assets Plant, equipment and timberlands – net Other assets Total assets Liabilities and Shareholders’ Equity Current liabilities Current portion of long-term debt Short-term debt Accounts payable Dividends payable Environmental liabilities Other current liabilities Total current liabilities Long-term debt Deferred income taxes Other long-term liabilities Total liabilities Commitments and contingencies Shareholders’ equity Common stock, $.01 par value; authorized – 120,000,000 shares; issued – 54,361,980 shares (including shares in treasury: 2006 – 9,540,770; 2005 – 10,229,734) Capital in excess of par value Retained earnings Deferred compensation Accumulated other comprehensive loss Less cost of common stock in treasury Total shareholders’ equity December 31 2006 2005 $21,985 $57,442 128,255 192,281 32,517 375,038 528,867 321,738 62,524 81,248 22,343 223,557 478,828 342,592 $1,225,643 $1,044,977 $19,500 2,818 86,488 4,035 5,489 74,960 193,290 375,295 182,659 86,031 837,275 – $19,650 3,423 31,132 3,972 7,575 74,126 139,878 184,000 206,269 82,518 612,665 – 544 42,288 519,489 – (32,337) 529,984 (141,616) 388,368 544 43,450 547,810 (2,295) (5,343) 584,166 (151,854) 432,312 Total liabilities and shareholders’ equity $1,225,643 $1,044,977 The accompanying notes are an integral part of the consolidated financial statements. -27- GLATFELTER P.H. GLATFELTER COMPANY and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS In thousands Operating activities Net income (loss) Adjustments to reconcile to net cash (used) provided by operations: Depreciation, depletion and amortization Pension income Restructuring charges and unusual items Deferred income tax provision Gains on dispositions of plant, equipment and timberlands, net Share-based compensation Change in operating assets and liabilities Accounts receivable Inventories Other assets and prepaid expenses Liabilities Net cash (used) provided by operations Investing activities Purchase of plant, equipment and timberlands Proceeds from disposal of plant, equipment and timberlands Proceeds from sale of subsidiary, net of cash divested Acquisition of Chillicothe Acquisition of Glatfelter – UK (Lydney) Net cash (used) provided by investing activities Financing activities Net proceeds from (repayments of) revolving credit facility Net proceeds from $100 million term loan facility Net proceeds from $200 million 71⁄8% note offering Repayment of $150 million 67⁄8% notes Payment of dividends Proceeds from stock options exercised Tax benefit of stock options exercised Year Ended December 31 2005 2006 2004 $(12,236) $38,609 $56,102 50,021 (16,993) 37,066 (12,726) (17,394) 2,335 (17,622) (8,869) 4,413 (36,422) (28,427) (44,460) 21,071 – (89,217) (69,225) 50,647 (16,517) 1,564 3,020 (22,053) 630 (5,876) (6,195) 3,995 (4,956) 42,868 (31,024) 22,450 545 – – 51,598 (17,342) 16,483 17,364 (58,509) 655 470 (4,276) (12,721) (10,240) 39,584 (18,587) 60,171 525 – – (181,831) (8,029) 42,109 42,527 94,829 196,440 (152,675) (16,023) 7,498 792 (733) – – – (15,839) 1,414 – (44,888) – – – (15,782) 917 – Net cash provided (used) by financing activities 173,388 (15,158) (59,753) Effect of exchange rate changes on cash Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of period Cash and cash equivalents at the end of period 1,413 (2,190) (35,457) 57,442 17,491 39,951 2,445 24,385 15,566 $21,985 $57,442 $39,951 Supplemental cash flow information Cash paid for Interest Income taxes $26,218 17,579 $12,378 17,443 $11,713 3,256 The accompanying notes are an integral part of the consolidated financial statements. -28- GLATFELTER P. H. GLATFELTER COMPANY and SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY For the Years Ended December 31, 2006, 2005 and 2004 In thousands, except shares outstanding Balance at January 1, 2004 Net income Other comprehensive income Foreign currency translation adjustments Other comprehensive income Comprehensive income Tax effect on employee stock options exercised Cash dividends declared Issuance of restricted stock units, net Delivery of treasury shares Performance shares 401(k) plans Director compensation Employee stock options exercised – net Balance at December 31, 2004 Net income Other comprehensive income Foreign currency translation adjustments Additional minimum pension liability, net of tax benefits of $2,831 Other comprehensive income Comprehensive income Tax effect on employee stock options exercised Cash dividends declared Issuance of restricted stock units, net Delivery of treasury shares Restricted stock awards 401(k) plans Director compensation Employee stock options exercised – net Net loss Foreign currency translation adjustments Adjustment to minimum pension liability prior to adoption of SFAS No. 158 Other comprehensive income Comprehensive income Reversal of minimum pension liability under SFAS No. 158 Additional net pension liability, net of tax benefit of $27,318 Adoption of SFAS No. 123(R) Tax effect on employee stock options exercised Cash dividends declared Share-based compensation expense – RSU Delivery of treasury shares Performance Shares 401(k) plans Director compensation Employee stock options exercised – net Common Stock Capital in Excess of Par Value $544 $40,469 Retained Earnings $484,756 56,102 Deferred Compen- sation Accumulated Other Comprehensive Income (Loss) Treasury Stock $– $ 2,690 $(157,028) Total Shareholders’ Equity $371,431 56,102 6,078 6,078 (15,802) (1,275) 525,056 38,609 (1,275) 8,768 (9,619) (4,492) (14,111) (15,855) (1,020) 544 38 1,725 (57) (170) (12) (165) 41,828 76 1,894 (84) (21) (243) 275 1,015 105 1,082 (154,551) 917 123 1,657 547,810 (12,236) (2,295) (5,343) (151,854) 12,343 583 12,926 3,909 (43,829) 2,295 (16,085) (2,295) 792 1,107 7 46 8 (827) 200 1,608 105 8,325 6,078 62,180 38 (15,802) 450 218 845 93 917 420,370 38,609 (14,111) 24,498 76 (15,855) 874 833 102 1,414 432,312 (12,236) 12,926 690 3,909 (43,829) 792 (16,085) 1,107 207 1,654 113 7,498 Balance at December 31, 2005 544 43,450 Balance at December 31, 2006 $544 $42,288 $519,489 $– $(32,337) $(141,616) $388,368 The accompanying notes are an integral part of the consolidated financial statements. -29- GLATFELTER P. H. GLATFELTER COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION in and P. H. Glatfelter Company subsidiaries (“Glatfelter”) is a manufacturer of specialty papers and engineered York, products. Headquartered Pennsylvania, our manufacturing facilities are located in Spring Grove, Pennsylvania; Chillicothe and Freemont, Ohio; Gloucestershire, the United Kingdom; Gernsbach, Germany; Scaër, France and the Philippines. Our products are marketed throughout the United States and in over 80 paper other merchants, brokers and agents or directly to customers. through wholesale countries, either 2. ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of Glatfelter and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. preparation Accounting Estimates The of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingencies as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the estimates and assumptions used in the preparation of these consolidated financial statements are reasonable, based upon currently available facts and known circumstances, but recognizes that actual results may differ from those estimates and assumptions. Cash and Cash Equivalents We classify all highly liquid instruments with an original maturity of three months or less at the time of purchase as cash equivalents. Inventories Inventories are stated at the lower of cost or market. Raw materials and in-process and finished inventories of our domestic manufacturing operations are valued using the last-in, first-out (LIFO) method, and the supplies inventories are valued principally using the foreign average-cost method. that valued operations approximates average cost. Inventories using a method our are at Plant, Equipment and Timberlands For financial reporting purposes, depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. For income taxes purposes, depreciation is primarily calculated using accelerated methods or U.S. Treasury Department procedures. Provision is established statute lives over by made for deferred income taxes applicable to this difference. The range of estimated service lives used to calculate financial reporting depreciation for principal items of plant and equipment are as follows: Buildings Machinery and equipment Other 10 – 45 Years 7 – 35 Years 4 – 40 Years Maintenance and Repairs Maintenance and repairs costs are charged to income and major renewals and betterments are capitalized. At the time property is retired or sold, the net carrying value is eliminated and any resultant gain or loss is included in income. Valuation of Long-lived Assets and Goodwill We evaluate long-lived assets for impairment when a specific event indicates that the carrying value of an asset may not be recoverable. Recoverability is assessed based on estimates of future cash flows expected to result from the use and eventual disposition of the asset. If the sum of expected undiscounted cash flows is less than the carrying value of the asset, an impairment loss is recognized. Goodwill is reviewed for impairment on a discounted cash flow basis at least annually. Impairment losses, if any, are recognized for the amount by which the carrying value of the asset exceeds its fair value. if any, retirement obligations, Asset Retirement Obligations – In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations”, as interpreted by Financial Accounting Standards Board Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of SFAS No. 143 (“FIN No. 47”), we in the accrue asset period in which obligations relating to future asset retirements are incurred. Under these standards, costs are to be accrued at estimated fair value, and a related long-lived asset is capitalized. Over time, the liability is accreted to its settlement value and the capitalized cost is depreciated over the useful life of the related asset for which the obligation exists. Upon settlement of the liability, we recognize a gain or loss for any difference between the settlement amount and the liability recorded. with retirement indeterminate settlement dates are not recorded until such dates can be reasonably estimated. At December 31, 2006, we do not have any obligations required to be accrued under FIN No. 47. obligations Asset Income Taxes Income taxes are determined using asset and the liability method of accounting for -30- GLATFELTER to not deemed subsidiaries in accordance with SFAS No. 109 income taxes (“SFAS No. 109”). Under SFAS No. 109, tax expense includes US and international income taxes plus the provision for US taxes on undistributed earnings of be international permanently invested. Tax credits and other incentives reduce tax expense in the year the credits are claimed. Certain items of income and expense are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported in deferred income taxes. Deferred tax assets are recognized if it is more likely than not that the assets will be realized in future years. The Company establishes a valuation allowance for deferred tax assets for which realization is not likely. to on and further legal or existing Costs the amount of the liability can be reasonably estimated remediation legislation based technologies. environmental related remediation are charged to expense. These accruals are adjusted periodically as assessment and remediation actions continue and/or technical information develops. Such undiscounted liabilities are exclusive of any insurance or other claims against third parties. Environmental costs are capitalized if the costs extend the life of the asset, increase its capacity and/or mitigate contamination from future operations. Recoveries of environmental remediation costs from other parties, including insurance carriers, are recorded as assets when their receipt is assured beyond a reasonable doubt. or prevent Company The contingencies “Accounting for Contingencies.” tax in accordance with SFAS No. 5, accounts income for Treasury Stock Common stock purchased for treasury is recorded at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on the weighted-average cost basis. Foreign Currency Translation Our subsidiaries outside the United States use their local currency as the functional currency. Accordingly, translation gains and losses and the effect of exchange rate changes on transactions designated as hedges of net foreign investments are included as a component of other comprehensive income (loss). Transaction gains and losses are included in income in the period in which they occur. Revenue Recognition We recognize revenue on product sales when the customer takes title and assumes the risks and rewards of ownership. We record revenue net of an allowance for customer returns and rebates. totaled Revenue from energy sales is recognized when electricity is delivered to the customer. Certain costs associated with the production of electricity, such as fuel, labor, depreciation and maintenance are netted against for presentation on the Consolidated energy sales Statements of Income. Costs netted against energy sales and $8.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. Our current contract to sell electricity generated in excess of our own use expires in the year 2010 and requires that the customer purchase all of our excess electricity up to a certain level. The price for the electricity is determined pursuant to a formula and varies depending upon the amount sold in any given year. $8.4 million, $7.3 million Accumulated Other Comprehensive Income The amounts reported on the consolidated Statement of Shareholders’ Equity for other Comprehensive income consist of $43.8 million of additional pension liability and $11.5 million of gains from foreign currency translation adjustments, net of tax. Stock-based Compensation Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment” utilizing the modified prospective method. This standard requires employee stock options and other stock-based compensation awards to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25, and allowed under the original provisions of SFAS No. 123, “Accounting for Stock-Based of SFAS No. 123(R) did not have a material effect on our consolidated results of operation or financial position. Compensation”. adoption The Pro Forma Information No compensation expense has been recognized for the issuance of non- qualified stock options. No stock options were granted in 2006 or 2005. The weighted-average grant-date fair value of options granted during 2004 was $3.31. The fair value of each option on the date of grant was estimated using the Black-Scholes option-pricing model using the following weighted-average assumptions: Risk-free interest rate Expected dividend yield Expected volatility Expected life 2004 4.50% 3.17 35.00 6.5 yrs Environmental Liabilities Accruals for losses associated with environmental obligations are recorded when it is probable that a liability has been incurred and -31- GLATFELTER The following table forma information as if compensation expense for all stock- based compensation had been determined consistent with the fair value method of SFAS No. 123. forth pro sets In thousands, except per share Net income as reported Add: stock-based compensation expense included in reported net income, net of tax Less: stock-based compensation expense determined under fair value based method for all awards, net of tax Pro forma Basic earnings per share Diluted earnings per share Reported Pro forma Reported Pro forma Year Ended December 31 2005 2004 $38,609 $56,102 757 16 (786) $38,580 (339) $55,779 $0.88 0.88 0.87 0.87 $1.28 1.27 1.27 1.27 Earnings Per Share Basic earnings per share are computed by dividing net income by the weighted-average common shares outstanding during the respective periods. Diluted earnings per share are computed by dividing net income by the weighted-average common shares and common share equivalents outstanding during the period. The share equivalents is considered in the diluted earnings per share computation using the treasury stock method. common dilutive effect of Fair Value of Financial Instruments The amounts reported on the Consolidated Balance Sheets for cash and cash equivalents, accounts receivable, other assets, and short-term debt approximate fair value. The following table sets forth carrying value and fair value of long-term debt: 2006 2005 Carrying Value Fair Value Carrying Value Fair Value Long-term debt $394,795 $398,689 $203,650 $206,652 3. RECENT PRONOUNCEMENTS Effective December 31, 2006 we adopted the provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment to FASB Statements No. 97, 88, 106, and 132(R)”, (“SFAS No. 158”) which requires entities to recognize the over funded or under funded status of pension plans and other post retirement benefit plans. In the year of adoption, the effect of recognizing additional liabilities is effected through a charge to accumulated income. Accordingly, the accompanying financial statements include an after tax charge of $43.8 million to adopt SFAS No. 158. comprehensive other The following table provides a breakdown of the incremental statement on individual line items in the consolidated balance sheet at December 31, 2006: applying this effect of In millions Other assets Other long-term liabilities Deferred income taxes Accumulated other comprehensive loss Before SFAS No. 158 $371.4 $ 71.9 206.6 7.6 Effect of SFAS No. 158 $(49.7) $ 14.1 (23.9) (39.9) After adoption of SFAS No. 158 $321.7 $86.0 182.7 (32.3) In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which will become effective for the Company on January 1, 2007. The Interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We will be required to apply the provisions of FIN 48 to all tax positions upon initial adoption with any cumulative effect adjustment to adoption, management retained estimates adjustment of approximately $3 million to $5 million will be charged to retained earnings to increase reserves for uncertain tax positions, which is subject to revision as we complete our analysis. to be recognized as an adjustment earnings. Upon that cumulative effect a In September 2006, SFAS No. 157, Fair Value issued. SFAS No. 157, which Measurements was defines framework for establishes value, fair measurement and requires expanded disclosures about the fair value measurements, is effective for us beginning January 1, 2008. We do not expect the adoption of SFAS No. 157 to have a material impact on our consolidated financial position or results of operations. a 4. ACQUISITIONS and liabilities of Lydney On March 8, 2006, we entered into a definitive agreement to acquire, through Glatfelter-UK Limited (“GLT-UK”), a wholly-owned subsidiary, certain assets J R Crompton Limited (“Crompton”), a global supplier of wet laid non-woven products based in Manchester, United Kingdom. On February 7, 2006, Crompton was placed into Administration, the U.K. equivalent of bankruptcy. Effective March 13, 2006, we completed our and related purchase of Crompton’s Lydney mill -32- GLATFELTER located in Gloucestershire, UK for inventory, £37.5 million (US $65.0 million) in cash in addition to $4.2 million of transaction costs. The Lydney facility employs about 240 people, produces a broad portfolio of wet laid non-woven products, including tea and coffee filter papers, clean room wipes, lens tissue, dye filter paper, double-sided adhesive tape substrates and battery grid pasting tissue, and had 2005 revenues of approximately £43 million (US $75 million). The purchase price was financed with existing cash balances and borrowings under our credit facility. Pursuant to the terms of the agreement, the Company has guaranteed all of the obligations of GLT- UK thereunder. The following table summarizes the preliminary allocation of the purchase price to assets acquired and liabilities assumed: In thousands Assets acquired: Inventory Property and equipment Intangibles and other assets Less acquisition related liabilities Total $8,389 56,883 8,536 73,808 (4,583) $69,225 The amounts set forth above ascribed to intangible assets and other primarily consists of technology and trade marks. We are currently conducting discovery on five sets of claims to the Bristol, England Employment Tribunal for unfair dismissal and failure to consult with union prior to staffing reductions and the sale of the Lydney mill. All of the claims relate to the period prior to the sale of the Lydney mill to Glatfelter. We are vigorously as defending these claims. The indicated in schedules of is approximately $1.4 million claimed, filed to date amount loss The following table summarizes the preliminary allocation of the purchase price to assets acquired and liabilities assumed: In thousands Assets acquired: Accounts receivable Inventory Property and equipment Prepaid pension and other assets Intangibles – customer relationships Less acquisition related liabilities including accounts payable and accrued expenses Total $43,618 91,580 1,959 11,416 6,074 154,647 (65,430) $89,217 Financial Pro-Forma Information The information necessary to provide certain pro forma financial data for the Chillicothe acquisition relative to net income and earnings per share is not readily available due to the nature of the accounting and reporting to the structure of acquisition date. Pro forma consolidated net sales for the 2006 and 2005 were approximately $1.1 billion and $1.0 billion, respectively, assuming the acquisition occurred at the beginning of the respective periods. For the full year 2005, on a pro forma basis, net income was $40.9 million and diluted EPS was $0.92. the acquired operation prior This unaudited pro forma financial information above the is not necessarily indicative of what operating results would have been had the acquisition been completed at the beginning of the respective period nor is it indicative of future results. 5. NEENAH FACILITY SHUTDOWN In connection with our agreement to acquire the Chillicothe operations, we committed to a plan to permanently close the Neenah, WI facility. Production at this facility ceased effective June 30, 2006 and certain products previously manufactured at the Neenah facility have been transferred to Chillicothe. The following table summarizes shutdown reserve activity during the year ended December 31, 2006: Chillicothe On April 3, 2006, we completed our acquisition of Chillicothe, the carbonless business operations of NewPage Corporation, for $83.3 million in cash, in addition to approximately $5.9 million of transaction and other related costs. The Chillicothe assets consist of paper making facility in Chillicothe, Ohio with annual production capacity approximating 400,000 tons-per-year and coating operations based in Fremont, Ohio. Chillicothe had revenue of $441.5 million in 2005 and a total of approximately 1,700 employees. The Chillicothe acquisition was financed with borrowings under our credit facility. In thousands Non-cash charges Accelerated depreciation Inventory write-down Pension curtailments and other retirement benefit charges Total non cash charges Cash charges Severance and benefit continuation Contract termination costs Other Total cash charges Total -33- GLATFELTER Beg. balance Amount Accrued Less non- cash charges and cash payments $22,466 2,905 $(22,466) (2,905) 7,675 33,046 (7,675) (33,046) Balance $– – – – 7,653 11,367 2,379 21,399 $54,445 (6,026) (11,367) (1,229) (18,622) $(51,668) 1,627 – 1,150 2,777 $2,777 $– – – – – – – – $– The Neenah shutdown resulted in the elimination of approximately 200 position that had been supporting our Specialty Papers business unit. Approximately $25.4 million of the Neenah shutdown related charges are recorded as part of costs of products sold in the accompanying statements of income. The amounts severance and benefit continuation are accrued for recorded the accompanying consolidated balance sheets. liabilities current other in as As part of the Neenah shutdown, we terminated our long-term steam supply contract, as provided for within the agreement, resulting in a termination fee of approximately $11.4 million. 6. RESTRUCTURING CHARGES comprehensive European Restructuring and Optimization Program (“EURO Program”) During the fourth quarter of 2005, we began to implement this restructuring program, series of a initiatives designed to improve the performance of our Composite Fibers business unit. In 2006 and 2005, we recorded restructuring charges of $1.2 million and $1.6 million, respectively, associated with the related work force efficiency plans at the Gernsbach, Germany facility. This charge reflects severance, early retirement and related costs for the affected employees. We expect to incur cash out lays in this amount over the next 24 month period. North American Restructuring Program The North American Restructuring Program, which was initiated in the second quarter of 2004, was designed to improve operating results by enhancing product and service offerings in Specialty Papers’ book publishing markets, growing revenue from uncoated specialty papers, reducing our workforce at our Spring Grove facility by approximately 20%, and implementing In improved supply chain management processes. conjunction with this initiative, we negotiated a new labor agreement that enables us to achieve targeted workforce reduction levels at our Spring Grove, PA the new labor agreement, we facility. As part of offered a voluntary early retirement benefits package to eligible termination benefits resulted in a charge of $16.5 million in 2004, substantially all of which was for enhanced pension benefits, post-retirement medical benefits and other related employee severance costs. In addition, we recorded restructuring charges totaling $0.7 million, severance and related pension and other post for employment benefits (“OPEB”) associated with the elimination of certain non-represented positions. employees. These special Amounts representing enhanced pension benefits will be paid from our pension plan assets and are recorded as a reduction to the carrying value of our prepaid pension assets. The amounts for OPEB benefits were recorded as “Other long-term liabilities” in the accompanying Consolidated Balance Sheets. We will pay the OPEB benefits as they are incurred over the course of the affected employees’ benefit period. 7. GAIN ON DISPOSITIONS OF PLANT, EQUIPMENT AND TIMBERLANDS During 2006, 2005 and 2004, we completed sales of timberlands and, in 2004, the corporate aircraft. The following table summarizes these transactions. Dollars in thousands 2006 Timberlands Other Total 2005 Timberlands Other Total 2004 Timberlands Corporate Aircraft Other Total Acres Proceeds Gain 5,923 n/a 2,488 n/a 4,482 n/a n/a $17,130 3,941 $21,071 $21,000 1,778 $22,778 $56,586 2,861 724 $60,171 $15,677 1,717 $17,394 $20,327 1,726 $22,053 $55,355 2,554 600 $58,509 8. EARNINGS PER SHARE The following table sets forth the details of basic and diluted earnings per share (EPS): In thousands, except per share Net income (loss) 2006 $(12,236) 2005 $38,609 2004 $56,102 Weighted average common shares outstanding used in basic EPS Common shares issuable upon exercise of dilutive stock options, restricted stock awards and performance awards Weighted average common shares outstanding and common share equivalents used in diluted EPS Basic EPS Diluted EPS 44,584 44,013 43,856 — 330 167 44,584 $(0.27) (0.27) 44,343 $0.88 0.87 44,023 $1.28 1.27 The following table sets forth the potential common shares outstanding for stock options and restricted stock units that were not included in the computation of diluted EPS for the period indicated, because their effect would be anti-dilutive. In thousands Potential common shares 2006 1,280 2005 758 2004 1,664 9. GAIN ON INSURANCE RECOVERIES During 2006, 2005 and 2004, we reached successful resolution of certain claims under insurance policies related to the Fox River environmental matter. Insurance recoveries included in the results of operations totaled $0.2 million, $20.2 million and $32.8 million in 2006, 2005 and 2004, respectively, and were received in cash. -34- GLATFELTER 10. INCOME TAXES Income taxes are recognized for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. The effects of income taxes are measured based on enacted tax laws and rates. The provision for income taxes from operations consisted of the following: In thousands Current taxes Federal State Foreign Deferred taxes Federal State Foreign Income tax provision (benefit) Year Ended December 31 2005 2004 2006 $1,009 1,013 712 2,734 (11,903) (2,970) 2,147 (12,726) $(9,992) $14,881 3,145 485 18,511 3,239 (1,905) 1,686 3,020 $21,531 $8,982 5,262 3,053 17,297 14,292 101 2,971 17,364 $34,661 The following are domestic and foreign components of pretax income from operations: In thousands United States Foreign Total pretax income (loss) Year Ended December 31 2005 $55,865 4,275 $60,140 2006 $(30,010) 7,782 $(22,228) 2004 $78,627 12,136 $90,763 A reconciliation between the income tax provision, computed by applying the statutory federal income tax rate of 35% to income before income taxes from operations, and the actual income tax: Federal income tax provision at statutory rate State income taxes, net of federal income tax benefit Foreign income tax rate differential Tax credits Provision for tax matters, net Other Total provision for income taxes Year Ended December 31 2005 2004 2006 (35.0)% 35.0% 35.0% (6.7) 3.8 (8.1) 3.8 (2.8) (45.0)% 1.3 (0.2) (3.1) 2.2 0.6 35.8% 3.9 0.5 (0.9) 0.3 (0.6) 38.2% The sources of deferred income taxes were as follows at December 31: 2006 2005 Current Asset (Liability) $8,239 4,460 1,983 – 182 – 2,453 472 – 17,789 (59) $17,730 Non- current Asset (Liability) Current Asset (Liability) Non- current Asset (Liability) $5,310 2,199 $6,082 1,134 $8,817 2,832 20,266 (112,686) (88,719) (10,701) – (5,293) 29,459 (160,165) (22,494) $(182,659) 1,992 – (430) – (45) 2,285 – 11,018 (26) $10,992 10,683 (117,492) (98,261) (10,897) – (4,315) 20,467 (188,166) (18,103) $(206,269) In thousands Reserves Compensation Post-retirement benefits Property Pension Installment Sale Inventories Other Tax carry forwards Subtotal Valuation allowance Total Current and non-current deferred tax assets and liabilities are included in the following balance sheet captions: In thousands Prepaid expenses and other current assets Other current liabilities Deferred income taxes Year Ended December 31 2006 2005 $18,018 288 182,659 $11,209 217 206,269 (“NOL”) At December 31, 2006, we had state and foreign tax net operating loss carryforwards of $106.8 million and $7.0 million, respectively. These future NOL carryforwards taxable income, if any. The state NOL carryforwards expire between 2007 and 2026; the foreign NOL carryforwards do not expire. to offset available are In addition, we had federal charitable contribution carryforwards of $7.4 million, which expire in 2008, federal foreign tax credit carryforwards of $0.3 million, which expire in 2013, and various state tax credit totaling $0.8 million, which expire carryforwards between 2007 and 2020. We have established a valuation allowance of the net deferred tax assets, $22.5 million against primarily due to the uncertainty regarding the ability to utilize state tax carryforwards and certain deferred foreign tax credits. We operate within multiple taxing jurisdictions and in the normal course of business are examined in various jurisdictions. Tax accruals related to the estimated outcome of these examinations are recorded in accordance with SFAS No. 5. The reversal of accruals is recorded when examinations are completed, statutes of limitations close or tax laws change. A net expense of $0.8 million was recorded recorded in 2005, and in 2006, $1.3 million was $0.3 million was recorded in 2004 related to domestic and foreign examination audits and risks. Tax credits and other incentives reduce tax expense in the year the credits are claimed. In 2006, we recorded tax credits of $1.8 million related to research and development, fuels tax and the electricity production tax credits. In 2005 and 2004 similar tax credits of $1.8 million and $0.8 million, respectively, were recorded. be At December 31, 2006 and 2005, unremitted subsidiaries outside the United States earnings of deemed totaled permanently to $69.9 million and $57.9 million, respectively. Because the unremitted earnings of subsidiaries are deemed to be permanently reinvested as of December 31, 2006, no deferred tax liability has been recognized in our consolidated financial statements. reinvested -35- GLATFELTER 11. STOCK-BASED COMPENSATION On April 25, 2005, shareholders approved the P. H. Glatfelter 2005 Long Term Incentive Plan (“2005 Plan”) to authorize, among other things, the issuance of up to 1,500,000 shares of Glatfelter common stock to eligible participants. The 2005 Plan, which replaced the 1992 Long Term Incentive Plan, provides for the issuance of restricted stock units, restricted stock awards, non-qualified stock options, performance and incentive stock options performance units. As of December 31, 2006, 1,348,626 shares of common stock were available for future issuance under the 2005 Plan. shares, Restricted Stock Units The following table summarizes RSU activity during the past three years. Units Beginning balance Granted Forfeited Ending balance In thousands Compensation expense 2006 2005 2004 290,662 145,398 (24,906) 411,154 157,280 158,982 (25,600) 290,662 – 165,680 (8,400) 157,280 $1,107 $919 $332 The weighted average grant fair value per unit for awards in 2006, 2005 and 2004 was $16.10, $13.98 and $10.98. As of December 31, 2006, unrecognized compensation expense for outstanding RSUs totaled $3.0 million. The weighted average remaining period over which the expense will be recognized is 3.25 years. Awards of RSU are made under our 2005 Plan. Under terms of the awards, the RSUs vest based solely on the passage of time on a graded scale over a three, four, and five-year period. Non-Qualified Stock Options The following table summarizes the activity with respect to non-qualified options to purchase shares of common stock granted: Outstanding at beginning of year Granted Exercised Canceled Outstanding at end of year 2006 2005 2004 Weighted- Average Exercise Price $14.06 – 13.38 17.27 14.17 Weighted- Average Exercise Price $14.65 – 12.67 17.30 14.06 Shares 2,098,612 – (111,542) (433,861) 1,553,209 Shares 1,553,209 – (560,239) (86,760) 906,210 Weighted- Average Exercise Price $14.71 11.18 12.61 15.51 14.65 Shares 2,304,339 51,250 (72,850) (184,127) 2,098,612 Exercisable at end of year 906,210 $14.17 1,547,422 $14.07 1,956,439 $15.17 The following table summarizes information about stock options outstanding at December 31, 2006: $10.78 to $12.41 12.95 to 14.44 15.44 to 17.16 17.54 to 18.78 In December 2003, the Compensation Committee accelerated the vesting of options granted during December 2001 and December 2002, to become fully vested as of January 1, 2004. Vesting was accelerated for an aggregate of 639,610 shares, of which 98,300 were previously vested under their original terms. Since the options’ exercise price was greater than the market value of the underlying common stock at the time vesting was accelerated, no compensation expense was recognized. All options expire on the earlier of termination or, in to some termination of employment, or ten years from the date of grant. a defined period subsequent instances, The exercise price represents the average quoted market price of Glatfelter common stock on the date of Options Outstanding Options Exercisable Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price 3.1 4.4 5.0 1.7 4.0 $12.10 13.36 15.47 18.39 Shares 191,960 374,000 251,900 88,350 906,210 Weighted- Average Exercise Price $12.10 13.36 15.47 18.39 Shares 191,960 374,000 251,900 88,350 906,210 grant, or the average quoted market prices of Glatfelter common stock on the first day before and after the date of grant for which quoted market price information was available if such information was not available on the date of grant. 12. RETIREMENT PLANS AND OTHER POST- RETIREMENT BENEFITS We have both funded and, with respect to our international operations, unfunded noncontributory defined-benefit pension plans covering substantially all of our employees. The benefits are based, in the case of certain plans, on average salary and years of service and, in the case of other plans, on a fixed amount for each year of the service. Plan provisions and funding meet -36- GLATFELTER Income requirements of Security Act of 1974. We use a December 31- measurement date for all of our defined benefit plans. the Employee Retirement We also provide certain health care benefits to eligible retired employees. These benefits include a comprehensive medical plan for retirees prior to age 65 and fixed supplemental premium payments to retirees over age 65 to help defray the costs of Medicare. The plan is not funded and claims are paid as reported. In millions Change in Benefit Obligation Balance at beginning of year Service cost Interest cost Plan amendments Actuarial (gain)/loss Chillicothe acquisition Benefits paid Balance at end of year Change in Plan Assets Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Chillicothe acquisition Benefits paid Fair value of plan assets at end of year Funded status at end of year Unrecognized prior service cost Unrecognized loss Net amount recognized Pension Benefits 2006 2005 Other Benefits 2006 2005 $316.3 6.0 20.1 5.4 (13.6) 66.2 (21.7) $378.7 $471.6 58.7 (10.0) 80.4 (21.7) $579.0 $200.3 – – $200.3 $295.2 3.7 16.3 – 21.6 – (20.5) $316.3 $465.6 24.2 2.3 – (20.5) $471.6 $155.3 19.6 70.4 $245.3 $48.3 1.7 3.0 – (1.6) 11.2 (4.7) $57.9 $– – 15.2 – (4.7) $10.5 $(47.4) – – $(47.4) $46.7 1.1 2.7 (1.4) 3.4 – (4.2) $48.3 $– – 4.2 – (4.2) $– (48.3) (7.5) 23.2 $(32.6) The net prepaid pension cost for qualified pension plans is primarily included in “Other assets,” and the accrued pension cost for non-qualified pension plans and accrued post-retirement benefit costs are primarily included in “Other long-term liabilities” on the Consolidated Balance Sheets at December 31, 2006 and 2005. The amounts forth for “Employer contributions” include a $12.2 million transfer from the qualified pension plan assets to a post-retirement medical plan sub-account pursuant to Section 420 of the Internal Revenue Code. Such amounts are to be used to satisfy certain post-retirement health care expenses. set Amounts recognized in the consolidated balance sheet consist of the following as of December 31: In millions Other assets Other long-term liabilities Other assets – intangible asset Accumulated other comprehensive income, pre- tax Net amount recognized Pension Benefits 2006 2005 Other Benefits 2006 2005 $230.4 (30.1) – $264.7 (28.6) 1.9 $– (47.4) – $– (32.6) – – $200.3 7.3 $245.3 – $(47.4) – $(32.6) The components recognized as of “Accumulated other comprehensive income” consist of the following on a pre-tax basis: amounts In millions Prior service cost/(credit) Net actuarial loss Pension Benefits 2006 Other Benefits 2006 $20.2 37.5 $ (5.7) 19.2 The accumulated benefit obligation for all defined benefit pension plans was $366.7 million and $297.7 million at December 31, 2006 and 2005, respectively. The weighted-average in computing the benefit obligations above were as follows: assumptions used Pension Benefits 2006 2005 Other Benefits 2006 2005 Discount rate – benefit obligation Future compensation growth rate 5.75% 5.50% 5.75% 5.50% 4.0 4.0 – – Information for pension plans with an accumulated benefit obligation in excess of plan assets was as follows: In millions Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 2006 $30.2 28.4 – 2005 $30.3 28.6 – Net periodic benefit (income) cost includes the following components: In millions Pension Benefits Service cost Interest cost Expected return on plan assets Amortization of transition asset Amortization of prior service cost Recognized actuarial loss Net periodic benefit income Special termination benefits Curtailment and settlement Total net periodic benefit income Other Benefits Service cost Interest cost Expected return on plan assets Amortization of prior service cost Recognized actuarial loss Net periodic benefit cost Special termination benefits Total net periodic benefit cost Year Ended December 31 2006 2004 2005 $6.0 20.1 (44.9) – 1.8 – (17.0) 4.4 – $(12.6) $3.7 16.3 (39.4) – 2.3 0.5 (16.6) – – $(16.6) $1.7 3.0 – (0.7) 1.3 5.3 3.3 $8.6 $1.1 2.7 – (0.7) 1.3 4.4 – $4.4 $3.9 16.1 (39.4) (0.8) 2.4 0.4 (17.4) – 11.4 $(6.0) $1.0 2.4 – (0.7) 1.2 3.9 5.2 $9.1 The estimated net loss and prior service cost for our defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $0.6 million and $2.3 million, respectively. -37- GLATFELTER The weighted-average assumptions computing the net periodic benefit information above were as follows: in used (income) cost In millions Pension Benefits Discount rate – benefit expense Future compensation growth rate Expected long-term rate of return on plan assets Other Benefits Discount rate – benefit expense Expected long-term rate of return on plan assets Year Ended December 31 2006 2004 2005 5.5% 4.0 5.75% 6.25% 4.0 4.0 8.5 8.5 8.5 5.5% 5.75% 6.25% – – – To develop the expected long-term rate of return assumption, we considered the historical returns and the future expected returns for each asset class, as well as the target asset allocation of the pension portfolio. This resulted in the selection of the 8.5% long-term rate of return on plan assets assumption for 2006 and 2005. Assumed health care cost trend rates at December 31 were as follows: Health care cost trend rate assumed for next year Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) Year that the rate reaches the ultimate rate 2006 10.0% 5.0 2013 2005 11.0% 5.0 2013 Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage-point change in assumed health care cost trend rates would have the following effects: In thousands Effect on: One Percentage Point increase decrease December 31, 2006 or 2005. Our investment policy prohibits the investment in certain securities without the approval of the Finance Committee of the Board of Directors. Regarding Fixed Income securities, the weighted-average credit quality will be at least “AA” with a “BBB” minimum credit quality for each issue. Cash Flow We do not to make contributions to our qualified pension plans in 2007. Contributions and benefit payments expected to be made in 2007 under our non-qualified pension plans and other benefit plans are summarized below: expect In thousands Nonqualified pension plans Other benefit plans 2,190 3,643 The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: In thousands 2007 2008 2009 2010 2011 2012 through 2016 Pension Benefits $21,525 21,177 20,954 20,849 21,517 116,352 Other Benefits $5,373 5,142 4,699 5,034 5,500 36,939 Defined Contribution Plans We maintain 401(k) plans for certain hourly and salaried employees. Employees may contribute up to 15% of their salary to these plans, subject to certain restrictions. We will match a portion of the employee’s contribution, subject to certain limitations, in the form of shares of Glatfelter common stock. The expense associated with our 401(k) match was $1.2 million, $0.6 million and $0.7 million in 2006, 2005 and 2004, respectively. Post-retirement benefit obligation Total of service and interest cost components $5,415 522 $(4,759) (450) 13. INVENTORIES Plan Assets Glatfelter’s pension plan weighted- average allocations at December 31, 2006 and 2005, by asset category, are as follows: Asset Category Equity securities Cash and fixed income Total 2006 2005 71% 70% 29 30 100% 100% Our objective is to achieve an above-market rate of return on our pension plan assets. Based upon this objective, along with the timing of benefit payments and the risks associated with various asset classes investment, we have established the available for following asset allocation guidelines: Inventories, net of reserves were as follows: In thousands Raw materials In-process and finished Supplies Total 2006 $38,539 107,811 45,931 $192,281 2005 $16,392 39,930 24,926 $81,248 If we had valued all inventories using the average- cost method, inventories would have been $13.3 million and $12.7 million higher than reported at December 31, 2006 and 2005, respectively. During 2005 we liquidated certain LIFO inventories, the effect of which did not have a significant impact on results of operations. Equity Fixed Income & Other Minimum Target Maximum 70% 30 60% 20 80% 40 Real estate can be between 0% and 5% of the target equity allocation. Glatfelter stock can also be between 0% and 5% of the target equity allocation, although stock as of there were no holdings of Glatfelter -38- GLATFELTER 14. PLANT, EQUIPMENT AND TIMBERLANDS 17. LONG-TERM DEBT Plant, equipment and timberlands at December 31 Long-term debt is summarized as follows: were as follows: In thousands Land and buildings Machinery and equipment Other Accumulated depreciation Construction in progress Timberlands, less depletion Plant, equipment and timberlands – net 2006 2005 $135,836 911,964 86,606 (617,444) 516,962 9,759 2,146 $528,867 $132,962 888,660 82,098 (641,070) 462,650 13,940 2,238 $478,828 In thousands Revolving credit facility, due April 2011 Term Loan, due April 2011 Revolving credit facility, due June 2006 71⁄8% Notes, due May 2016 67⁄8% Notes, due July 2007 Note payable – SunTrust, due March 2008 Total long-term debt Less current portion Long-term debt, excluding current portion December 31 2006 2005 $64,795 96,000 – 200,000 – 34,000 394,795 (19,500) $375,295 $– – 19,650 – 150,000 34,000 203,650 (19,650) $184,000 15. GOODWILL AND INTANGIBLE ASSETS The following table sets forth information with respect to goodwill and other intangible assets which are recorded in the caption “Other assets” in the accompanying Consolidated Balance Sheets: In thousands Goodwill – Composite Fibers Specialty Papers Customer relationships Composite Fibers Technology and trademark Customer relationships Total intangibles Accumulated amortization Net intangibles Aggregate amortization expense: 2006 Estimated amortization expense: 2007 2008 2009 2010 2011 December 31 2006 2005 $15,198 $10,381 $5,958 $– 4,659 346 10,963 (638) $10,325 $– $638 $978 978 978 978 978 In connection with the Lydney Mill acquisition, we recorded $3.5 million of goodwill. The balance of the increase in goodwill was due to foreign currency translation adjustments. 16. OTHER CURRENT LIABILITIES Other current liabilities consist of the following: In thousands Accrued payroll and benefits Other accrued compensation and retirement benefits Income taxes payable Cross currency rate swap Accrued rebates Other accrued expenses Total December 31 2006 2005 $31,729 $18,828 7,828 602 – 17,849 16,952 $74,960 6,320 15,480 16,370 1,002 16,126 $74,126 On April 3, 2006, we, along with certain of our subsidiaries as borrowers and certain of our subsidiaries as guarantors, entered into a credit agreement with certain financial institutions. Pursuant to the credit agreement, we may borrow, repay and reborrow revolving credit loans in an aggregate principal amount not to exceed $200 million outstanding at any time. All borrowings under our credit facility are unsecured. The revolving credit commitment expires on April 2, 2011. In addition, on April 3, 2006, pursuant to the credit agreement, we received a term loan in the principal amount of $100 million. Quarterly repayments of principal outstanding under the term loan begin on March 31, 2007 with the final principal payment due on April 2, 2011. Borrowings under the credit agreement bear interest, at our option, at either (a) the bank’s base rate described in the credit agreement as the greater of the prime rate or the federal funds rate plus 50 basis points, or (b) the EURO rate based generally on the London Interbank Offer Rate, plus an applicable margin that varies from 67.5 basis points to 137.5 basis points according to our corporate credit rating determined by S&P and Moody’s. We have the right to prepay the term loan and revolving credit borrowings in whole or in part without premium or penalty, subject to timing conditions related to the interest rate option chosen. If certain prepayment events occur, such as a sale of assets or the incurrence of additional indebtedness in excess of $10.0 million in the aggregate, we must repay a specified portion of the term loan within five days of the prepayment event. The credit agreement contains a number of customary covenants for financings of this type that, among other things, restrict our ability to dispose of or create liens on assets, incur additional indebtedness, repay other indebtedness, create liens on assets, make acquisitions and engage in mergers or consolidations. We are also required to comply with specified financial tests and ratios, each as defined in the credit agreement, including a consolidated minimum net worth test and a maximum debt to earnings before interest, taxes, -39- GLATFELTER depreciation and amortization (“EBITDA”) ratio. A breach of these requirements, of which there were none at December 31, 2006, would give rise to certain remedies under the credit agreement, among which are the termination of the agreement and acceleration of the outstanding borrowings plus accrued and unpaid interest under the credit facility. This new credit facility replaced our prior credit facility which would have matured in June 2006. A portion of the proceeds from the new credit facility were used to finance the Chillicothe acquisition. On April 28, 2006, we completed an offering of $200.0 million aggregate principal amount of our 71⁄8% Senior Notes due 2016. Net proceeds from this offering totaled approximately $196.4 million, after deducting the and expenses relating to the offering. We primarily used the net proceeds to redeem $150.0 million aggregate principal amount of our outstanding 67⁄8% notes due July 2007, plus the payment of the applicable redemption premium and accrued interest. commissions and other fees Interest on these Senior Notes accrues at the rate of 71⁄8% per annum and is payable semiannually in arrears on May 1 and November 1, commencing on November 1, 2006. Prior to May 1, 2011, we may redeem all, but not less than all, of the notes at a redemption price equal to 100% of the principal amount thereof plus accrued and unpaid interest, if any, plus a “make-whole” premium. On or after May 1, 2011, we may redeem some or all of the notes at specified redemption prices. In addition, prior to May 1, 2009, we may redeem up to 35% of the aggregate principal amount of the notes using the net proceeds from certain equity offerings. The 71⁄8% Senior Note agreement contains a “cross- default” clause that provides if there were to be an event of default under the credit agreement discussed earlier, we would also be in default under the 71⁄8% Senior Notes. is of and acres received recorded as On March 21, 2003, we sold approximately as timberlands 25,500 consideration a $37.9 million 10-year interest bearing note receivable from the timberland buyer. The note receivable in the accompanying consolidated balance sheet. We pledged this note as collateral under a $34.0 million promissory note payable to SunTrust Financial (the “Note Payable”). The Note Payable bears interest at a fixed rate of 3.82% for five years at which time we can elect to renew the obligation. “Other assets” The following schedule sets forth the maturity of our long-term debt during the indicated year. In thousands 2007 2008 2009 2010 2011 Thereafter $19,500 52,000 22,500 22,500 78,295 200,000 P. H. Glatfelter Company guarantees debt obligations of all its subsidiaries. All such obligations are recorded in these consolidated financial statements. At December 31, 2006 and 2005, we had $8.1 million and $4.3 million, respectively, of letters of credit issued to us by a financial institution. The letters of credit are for the benefit of certain state workers compensation insurance agencies in conjunction with our amounts were outstanding under the letters of credit. We bear the credit risk on this amount to the extent that we do not comply with the provisions of certain agreements. Outstanding letters of credit reduce amounts available under our revolving credit facility. program. No self-insurance 18. SHAREHOLDERS’ EQUITY The following table summarizes outstanding shares of common stock: In thousands Shares outstanding at beginning of year Treasury shares issued for: Restricted stock performance awards 401(k) plan Director compensation Employee stock options exercised Shares outstanding at end of year Year Ended December 31, 2004 2005 2006 43,782 43,950 44,132 14 108 7 560 44,821 – 62 9 111 44,132 19 69 7 73 43,950 19. COMMITMENTS, CONTINGENCIES AND LEGAL PROCEEDINGS Contractual Commitments The following table summarizes the minimum annual payments due on similar noncancelable operating leases remaining contractual obligations having initial or contractual terms obligations primarily represent minimum purchase commitments under energy and pulp wood supply contracts and other purchase obligations. in excess of one year. Other and other In thousands 2007 2008 2009 2010 2011 Leases $3,539 2,738 2,364 1,110 863 Other $45,733 12,702 5,076 140 – At December 31, 2006, required minimum annual payments due under operating leases and other similar contractual obligations aggregated $18.7 million and $63.7 million, respectively. -40- GLATFELTER Ecusta Division Matters At December 31, 2006, we had reserves for various matters associated with our former Ecusta Division. Activity in these reserves during the period indicated is summarized below. In thousands Balance, Jan. 1, 2006 Accruals Payments Other Adjustments December 31, 2006 Balance, Jan. 1, 2005 Accruals Payments December 31, 2005 Balance, Jan. 1, 2004 Accruals Payments December 31, 2004 Ecusta Environmental Matters $ 8,105 – (903) – $ 7,202 $ 6,391 2,700 (986) $ 8,105 $ 7,600 – (1,209) Workers’ Comp $1,913 – (504) – $1,409 $2,144 – (231) $1,913 $2,200 – (56) Other $ 3,300 – (3,262) (38) $ – $ 3,300 – – $ 3,300 $ 1,393 1,907 – Total $13,318 – (4,669) (38) $ 8,611 $11,835 2,700 (1,217) $13,318 $11,193 1,907 (1,265) $ 6,391 $2,144 $ 3,300 $11,835 With respect to the reserves set forth above as of December 31, 2006, $1.2 million is recorded under the caption “Other current liabilities” and $7.4 million is recorded under the caption “Other long-term liabilities” in the accompanying condensed consolidated balance sheets. The following discussion provides more details on each of these matters. Background Information In August 2001, pursuant to an acquisition agreement (the “Acquisition Agreement”), we sold the assets of our Ecusta Division to four related entities, consisting of Purico (IOM) Limited, an Isle of Man limited liability company (“Purico”), and RF&Son Inc. (“RF”), RFS US Inc. (“RFS US”) and RFS Ecusta Inc. (“RFS Ecusta”), each of which is a Delaware corporation, (collectively, the “Buyers”). the Buyers In August 2002, shut down the manufacturing operation of the pulp and paper mill in Pisgah Forest, North Carolina, which was the most significant operation of the Ecusta Division. On October 23, 2002, RFS Ecusta and RFS US (the separately filed for bankruptcy under “Debtors”) Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy cases were later converted to Chapter 7 proceedings. In accordance with the provisions of the Acquisition Agreement, we notified the Buyers of third party claims (“Third Party Claims”) made against us for which we sought indemnification from the Buyers. The certain Third Party Claims primarily environmental matters, benefits, workers’ compensation claims and vendor payables. post-retirement relate to paper mill and related real property, were sold to several third parties unrelated to the Buyers (the “New Buyers”). Ecusta Environmental Matters Beginning in including the April 2003, government authorities, North Carolina Department of Environment and Natural Resources (“NCDENR”), initiated discussions with us and the New Buyers regarding, among other environmental issues, certain landfill closure liabilities associated with the Ecusta mill and its properties. The discussions focused on NCDENR’s desire to establish a plan and secure financial resources to close three landfills located at the Ecusta facility and to address other environmental matters at the facility. During the third quarter of 2003, the discussions ended with NCDENR’s conclusion to hold us responsible for the closure of three landfills. Accordingly, we reserves approximating $7.6 million representing estimated closure costs. In March 2004 and September 2005, the NCDENR issued us separate orders requiring the closure of two of the three landfills at issue. We have completed the closure of these two landfills and are in the process of closing the third. established In October 2004, one of the New Buyers entered into a Brownfields Agreement with the NCDENR relating to the Ecusta mill, pursuant to which that New Buyer was to be held responsible for certain specified environmental concerns. and potential evaluation remediation our In September 2005, NCDENR sought participation, pursuant to a proposed consent order, in the of environmentally hazardous conditions at the former Ecusta mill site. In January 2006, NCDENR modified its proposed consent order to include us and the company (the “Prior Owner”) from whom our predecessor, Ecusta Corporation, purchased the Ecusta mill. NCDENR and the United States Environmental Protection Agency (“USEPA”) have indicated that if neither party enters into a consent order EPA intends to list the mill site on the National Priorities List and pursue assessment and the Comprehensive the site under remediation of Environmental Responsibility, Compensation and Liability Act (more commonly known as “Superfund”). In addition to calling for the assessment, closure, and post-closure monitoring and maintenance of the third landfill for which we since have been directed to close, the proposed consent order would impose an obligation to assess and remediate the following: i. mercury and certain other contamination on and around the site; Effective August 8, 2003, the assets of RFS Ecusta and RFS US, which substantially consist of the pulp and ii. potentially hazardous conditions existing in the sediment and water column of the site’s water -41- GLATFELTER treatment and aeration and sedimentation basin (the “ASB”); and iii. contamination associated with two additional landfills on the site that were not used by us. taken by the agencies in the absence of a consent order (and against whom) and what remediation, if any, will be required if are performed. and when additional assessments With respect to the concerns set forth above (collectively, the “NCDENR matters”) we contend that the Prior Owner is responsible for the mercury contamination; and that the New Buyers, as owner and operator of the ASB, are responsible for addressing any issues associated with the ASB, including closure, and that the New Buyers, in a May 2004 agreement, expressly agreed to indemnify and hold us harmless from certain environmental liabilities, which include most, if not all, of the NCDENR matters. We continue to have discussions with NCDENR and USEPA concerning our remedial potential actions, if any, which may be necessary. and appropriate responsibilities In addition, it is possible the New Buyers may not have sufficient cash flow to satisfy certain ongoing obligations to NCDENR and us. Specifically, the New Buyers are obligated (i) to treat leachate and stormwater runoff from the landfills, which we are currently required to manage, and (ii) to pump and treat contaminated groundwater in the vicinity of a former caustic building at the site. If the New Buyers should default on these obligations, it is possible that NCDENR will require us to make appropriate arrangements for these obligations and to be responsible for the remediation of certain contamination on and around the site (collectively, the “New Buyers Matters”). As a result of NCDENR’s September 2005 communication with us and our assessment of the range of likely outcomes of the NCDENR Matters and the New Buyers Matters, our results of operations for 2005 included a $2.7 million charge to increase our reserve for estimated costs associated with the Ecusta environmental matters. The addition to the reserve includes estimated operating costs associated with the obligations of the New Buyer discussed above. Estimated costs to perform an assessment of certain risks posed by further characterization of the presence of mercury, sediment other in the ASB and treatment contamination. Since this initial accrual no further changes have been made. of to The 2005 reserves relating additional environmental assessment activities were premised, in part, on the belief that it might be mutually beneficial to us and NCDENR if we were to agree to perform the assessment activities, without accepting responsibility for any subsequently required remediation. While it now appears clear that NCDENR and EPA will not accept such an arrangement, it is uncertain what action will be are assessment remediation will and the New Buyers. We In addition, it is unclear how liability for any required be or apportioned among the Prior Owner, Glatfelter, the Buyers also in negotiations with potential buyers of the property (the “Potential Buyers”) and the New Buyers concerning the possibility of entering into (i) a consent order with EPA, the Potential Buyers, and the New Buyers which would allocate assessment and remediation obligations between us and the Potential Buyers, and (ii) an agreement with the Potential Buyers and the New Buyers that would allocate and remediation activities at the property between them and us. However, the outcome of these negotiations is uncertain. For the foregoing reasons, in part, our recorded reserve does not include costs associated with further remediation activities that we may be required to perform, the range of which we are currently unable to estimate, however, they could be significant. of performing assessment cost the The New Buyers’ ability to fulfill their obligations to NCDENR and us, in the absence of sufficient cash flow from their operations, may be dependent on their ability to complete a sale of the site. Notwithstanding a potential sale of the property, and with respect to alleged mercury contamination at the site, i) the extent of contamination, if any, is unknown, ii) it is unclear whether we will be required to remediate iii) the apportionment of liability amongst us, the Prior Owner and/or the New Buyers is unknown; and iv) the ultimate costs to remedy are not reasonably estimable based on information currently available to us. Accordingly, no amounts for such potential actions have been included in our reserve discussed above. If we are required to complete additional remedial actions, further charges would be required, and such amounts could be material. the site We are evaluating potential legal claims and defenses we may have with respect to any other parties including previous owners of and their obligations and/or cost recoveries. The Prior Owners of the site have filed a declaratory judgment in the US District Court asking the courts to order us to indemnify the Prior Owner for any costs related to the remediation of mercury contamination. In response we filed an answer denying that we are responsible for such costs and a counterclaim against the Prior Owner fraud and negligent alleging, among others things, misrepresentation by the Prior Owner regarding mercury contamination. -42- GLATFELTER Separately, we are evaluating options presented to us by potential buyers of the property, including offers for us to contribute monetarily to the cost to remediate on-site contamination. To date we believe we are adequately reserved to accomplish such an alternative, however, there are no assurances the regulators will accept such a proposal. We are also evaluating options for ensuring that the New Buyers fulfill their obligations with respect to the New Buyers Matters. We are uncertain as to what including, among additional Ecusta-related claims, others, environmental matters, government oversight and/or government past costs, if any, may be asserted against us. Workers’ Compensation Prior to 2003, we established reserves related to potential workers’ compensation claims associated with the former Ecusta Division, which at that time were estimated to total approximately $2.2 million. In the fourth quarter of 2005, the North Carolina courts issued a ruling that held us liable for workers’ compensation claims of certain employees that were injured during their employment at the Ecusta facility prior to our sale of the Division. Since this ruling, we have made payments as indicated in the reserve analysis presented earlier in this Note 19. for Other In October 2004, the bankruptcy trustee for the estates of RFS Ecusta and RFS US filed a complaint the in the U.S. Bankruptcy Court Western District of North Carolina against certain of the Buyers and other related parties (“Defendant Buyers”) and us. The complaint alleged, among other things, that the Defendant Buyers engaged in fraud and fraudulent transfers and breached their fiduciary duties. With respect to Glatfelter, the complaint alleged that we aided and abetted the Defendant Buyers in their purported actions in the structuring of the acquisition of the Ecusta Division and asserts a claim against us under the Bankruptcy Code. The trustee sought damages from us in an amount not less than $25.8 million, plus interest, and other relief. seeking, among other The bankruptcy trustee filed another complaint, also in the U.S. Bankruptcy Court for the Western District of North Carolina, against us, certain banks and other parties, things, damages totaling $6.5 million for alleged breaches of (the “Breach Claims”), the Acquisition Agreement release of certain amounts held in escrow totaling $3.5 million (the “Escrow Claims”) and recoveries of unspecified amounts the Acquisition Agreement and a related agreement. We have previously reserved such escrowed amounts and they were recorded in the accompanying Condensed Consolidated Balance Sheets long-term liabilities.” allegedly payable under “Other as All of the bankruptcy trustee’s actions against us were settled pursuant to an agreement approved by the United States District Court for the Western District of North Carolina on September 8, 2006. Under the terms of the settlement, the trustee received approximately $3.1 million of the amounts previously held in escrow and for which we had previously reserved. The trustee also retained a $1.6 million certificate of deposit that one of the Debtors had posted with the State of North compensation Carolina obligations. As part of the settlement, we assigned any claims we may have had against the Defendant Buyers to the trustee and will receive a percentage of the trustee’s recovery from such parties, if any. certain workers’ to insure to respect reported with Fox River – Neenah, Wisconsin We have previously potential environmental claims arising out of the presence of polychlorinated biphenyls (“PCBs”) in sediments in the lower Fox River and in the Bay of Green Bay, downstream of our Neenah, Wisconsin facility. We acquired the Neenah facility in 1979 as part of the acquisition of the Bergstrom Paper Company. In part, this facility used wastepaper as a source of fiber. At no time did the Neenah facility utilize PCBs in the pulp and paper making process, but discharges from the facility containing PCBs from wastepaper may have occurred from 1954 to the late 1970s. Any PCBs that the Neenah facility discharged into the Fox River resulted from the presence of PCBs in NCR»-brand carbonless copy paper in the wastepaper that was received from others and recycled. under of Green Bay, As described below, various state and federal governmental agencies have formally notified nine potentially responsible parties (“PRPs”), including us, that they are potentially responsible for response costs and “natural resource damages” (“NRDs”) arising from PCB contamination in the lower Fox River and in the Bay the Comprehensive Environmental Response, Compensation and Liability Act statutes. The other identified PRPs are NCR Corporation, Appleton Paper Inc., Georgia Pacific Corp. (formerly Fort Howard Corp. and Fort James), WTM I Company (“WTM I”, a subsidiary of Chesapeake Corp.), Riverside Paper Corporation, U.S. Paper Mills Corp. (a subsidiary of Sonoco Products Company), Company, and Menasha Corporation. (“CERCLA”) and other Products Sonoco CERCLA establishes a two-part liability structure that makes responsible parties liable for (1) “response costs” associated with the remediation of a release of hazardous substances and (2) NRDs related to that release. Courts have interpreted CERCLA to impose joint and several liabilities on responsible parties for -43- GLATFELTER response costs, subject to equitable allocation in certain instances. Prior to a final settlement by all responsible parties and the final cleanup of the contamination, uncertainty regarding the application of such liability will persist. The areas of the lower Fox River and in the Bay of Green Bay in which PCB contamination exists are commonly referred to as Operable Unit 1 (“OU1”), which consists of Little Lake Butte des Morts, the portion of the river that is closest to our Neenah facility, Operable Unit 2 (“OU2”), which is the portion of the river between dams at Appleton and Little Rapids, and Operable Units 3 through 5 (“OU3–5”), 20 miles downstream of our Neenah facility. approximately area an The following summarizes the status of our potential exposure: Response Actions the OU1 and OU2 On January 7, 2003, Wisconsin Department of Natural Resources (the “Wisconsin DNR”) and the Environmental Protection Agency (“EPA”) issued a Record of Decision (“ROD”) for the cleanup of OU1 and OU2. Subject to extenuating circumstances and alternative solutions provided for in the ROD, of approximately 784,000 cubic yards of sediment from OU1 and no active remediation of OU2. The ROD also requires the monitoring of the two operable units. On July 1, 2003, WTM I Company entered into an Administrative Order on Consent (“AOC”) with EPA and the Wisconsin DNR regarding the implementation of the Remedial Design for OU1. the ROD requires removal the pay approximately $27 million, In the first quarter of 2004, the United States District Court for the Eastern District of Wisconsin approved a consent decree regarding OU1 (“the OU1 Consent Decree”). Under terms of the OU1 Consent Decree, Glatfelter and WTM I Company each agreed to of which $25.0 million from each was placed in escrow to fund response work associated with remedial actions specified in the ROD. The remaining amount that the parties agreed to pay under the Consent Decree includes payments for NRD, and NRD assessment and other past costs incurred by the governments. In addition, EPA agreed to take steps to place $10 million from another source into escrow for the OU1 cleanup, all of which has been received. The terms of the OU1 Consent Decree and the underlying escrow agreement restrict the use of the funds to qualifying remediation activities or restoration activities at the lower Fox River site. The response remediate OU1, work is being managed and/or performed by Glatfelter and WTM I, with governmental oversight, and funded by the amounts placed in escrow. Beginning in mid 2004, Glatfelter and WTM I have performed activities others, to construction of de-watering and water-treatment facilities, dredging of portions of OU1, dewatering of the dredged materials, and hauling of the dewatered sediment to an authorized disposal facility. Since the start of these activities, approximately 200,000 cubic yards of contaminated sediment has been dredged. including, among settlement each company would lose funds, contained in the The terms of the OU1 Consent Decree include provisions to be followed should the escrow account be depleted prior to completion of the response work. In this event, each company would be notified and be provided an opportunity to contribute additional funds to the escrow account and to extend the remediation effort. Should the OU1 Consent Decree be terminated due to insufficient the protections and the governments may turn to one or both parties for the completion of OU1 clean up. In such a situation, the governments may also seek response work from a third party, or perform the work themselves and seek response including costs from any or all PRPs for the site, Glatfelter. Based on information currently available to us, subject to i) government approval of the use of alternative remedies as proposed by us and WTM I; ii) the successful negotiation of acceptable and cost-effective the proposed remediation contracts activities; and iii) effective implementation of the chosen technologies by the remediation contractor, and together with anticipated earnings on the funds currently on deposit in the escrow account and other assets available, we believe the required remedial actions can be completed for amounts reserved. If the Consent Decree is terminated due to the insufficiency of the escrow funds, each remain potentially Glatfelter responsible for the costs necessary to complete the remedial action. and WTM I complete to Based on the remediation activities completed to date, contract proposals received for the remaining remediation work, and the availability of potential alternative remedies under the ROD, we believe the between total $68 million and $137 million. of OU1 will remediation cost In late 2006, Glatfelter and WTM I jointly submitted a final closure plan to Wisconsin DNR and the use of EPA. The final closure plan proposes alternative remedies if accepted as proposed, could be completed for amounts currently in escrow, future earnings on the fund and other assets available. The agencies have issued comments on our plan that, -44- GLATFELTER including requests for additional data related to a number of technical components of the closure plan. Further, the agencies have expressed their concern that the cost of the ultimately accepted closure plan may exceed the balance of the escrow fund and an expression of interest in obtaining financial assurances that, in the event the ultimate closure plan should exceed financial resources currently allocated to the remedy, adequate funds would be readily available. In addition, the such absence of agencies assurance, a notice of potential Insufficiency Determination under the Consent Decree. Negotiations to address the agencies’ concerns have to recently begun. The government’s willingness accept the plan is uncertain and any changes required to it would likely necessitate an increase to our reserves. Any such changes would require additional cash to be contributed and such amounts could be material. they may issue indicated that in the recorded in the As of December 31, 2006, our portion of the escrow account totaled approximately $6.6 million, of which accompanying $4.5 million is Consolidated Balance Sheet under the caption “Prepaid expenses and other current assets” and $2.1 million is included under the caption “Other assets.” As of December 31, 2006, our reserve for environmental liabilities, for OU1 remediation activities, totaled $7.7 million. all of which is OUs 3 – 5 On July 28, 2003, the EPA and the Wisconsin DNR issued a ROD (the “Second ROD”) for the cleanup of OU3 – 5. The Second ROD calls for the removal of 6.5 million cubic yards of sediment and certain monitoring of $324.4 million but could, according to the Second ROD, from approximately $486.6 million. The most $227.0 million significant is removal by attributable dredging. to component of large-scale estimated costs cost within a estimated sediment range cost the an to at During the first quarter of 2004, NCR Corp. and Georgia Pacific Corp. entered into an AOC with the United States EPA under which they agreed to perform the Remedial Design thereby accomplishing a first step towards remediation. for OUs 3-5, In February 2007, we, along with the other PRPs involved in the OU2 and OU3 – 5 matters, received a General Notice Letter from the EPA demanding that each PRP advise the EPA of their intentions to enter into settlement negotiations in March 2007 with a good faith offer to settle due by April 1, 2007. We do not believe that we have more than a de minimis share of any equitable distribution of responsibility for OU3 – 5 after taking into account the location of our Neenah facility relative to the site and considering other work or funds committed or expended by us. However, uncertainty regarding responsibilities for the cleanup of these sites continues allocation or over due apportionment of responsibility. If we are ordered to complete more than what we believe to be our fair share of any remediation efforts, the costs to do so would be significant. to disagreement fair a Natural Resource Damages The ROD and Second ROD do not place any value on claims for NRDs associated with this matter. As noted above, NRD claims are distinct from costs related to the primary remediation of a Superfund site. Calculating the value of NRD claims is difficult, especially in the absence of a completed remedy for the underlying contamination. The State of Wisconsin, the United States Fish and Wildlife Service (“FWS”), the National Oceanic and Atmospheric Administration (“NOAA”), four Indian tribes and the Michigan Attorney General have asserted that they possess NRD claims related to the lower Fox River and the Bay of Green Bay. tribal federal, for NRDs. The In September 1994, FWS notified the then- identified PRPs that it considered them potentially and responsible Michigan agencies claiming to be NRD trustees have proceeded with the preparation of an NRD assessment. While the final assessment has yet to be completed, the federal trustees released a plan on October 25, 2000 that values NRDs for injured natural resources that allegedly fall under their trusteeship between $176 million and $333 million. We believe that the federal NRD assessment is technically and procedurally flawed. We also believe that the NRD claims alleged by the various alleged trustees are legally and factually without merit. The OU1 Consent Decree required that Glatfelter and WTM I each pay the governments $1.5 million for NRDs for the Fox River site, and $150,000 for NRD assessment costs. Each of these payments was made in return for credit to be applied toward each settling company’s potential liability for NRDs associated with the Fox River site. Other Information The Wisconsin DNR and FWS have each published studies, the latter in draft form, estimating the amount of PCBs discharged by each identified PRP to the lower Fox River and the Bay of Green Bay. These reports estimate our Neenah facility’s share of the volumetric discharge to be as high as 27%. We do not believe the volumetric estimates used in these studies are accurate because (a) the studies themselves disclose that they are not accurate and (b) the volumetric are based on estimates existing assumptions studies unsupported contained in the that are by -45- GLATFELTER evidence. We believe that our volumetric contribution is significantly lower than the estimates set forth in these studies. Further, we do not believe that a volumetric allocation would constitute an equitable distribution of liability for the contamination. Other the potential factors, such as the location of contamination, the location of discharge and a party’s role in causing discharge must be the allocation to be equitable. considered in order for The classification of our environmental liabilities is based on the development of the underlying Fox River OU1 remediation plan and execution of the related escrow agreement for the funding thereof. The reserve balance declined as a result of payments associated with remediation activities under the OU1 Consent Decree and items related to the Fox River matter. We did not record charges associated with the Fox River matter to our results of operations during the past three years. for We have entered into scientific studies interim cost-sharing agreements with four of the other PRPs, pursuant to which such PRPs have agreed to share both defense costs relating to PCBs and costs discharged into the lower Fox River. These interim cost-sharing agreements have no bearing on the final allocation of costs related to this matter. Based upon our evaluation of the magnitude, nature and location of the to the river and the various discharges of PCBs relationship identified of contamination, we believe our share of any liability among the identified PRPs is much less than our per capita share of the cost sharing agreement. discharges those to We exist there also believe additional that potentially responsible parties other than the identified PRPs. For instance, certain of the identified PRPs discharged their wastewater through public wastewater treatment facilities, which we believe makes the owners of such facilities potentially responsible in this matter. We also believe that entities providing wastepaper- containing PCBs to each of the recycling mills are also potentially responsible for this matter. While the OU1 Consent Decree provides a resolving both ours and negotiated framework for WTM I liability for the costs for completing the remediation of OU1, it does not completely resolve our potential liability related to the Fox River. We anticipate this matter may result in litigation, but cannot or timing, magnitude of such litigation. We currently are unable to predict our ultimate cost related to this matter. predict nature, extent the Reserves for Fox River Environmental Liabilities for reserves those environmental matters existing environmental We have for liabilities and for which it is probable that a claim will be made and for which the amount of the obligation is reasonably estimable. summarizes following information with respect to such reserves. table The In millions Recorded as: Environmental liabilities Other long-term liabilities Total December 31, 2006 December 31, 2005 $5.5 2.2 $7.7 $7.6 9.2 $16.8 Other than with respect to the OU1 Consent Decree, the amount and timing of future expenditures for environmental compliance, cleanup, remediation and personal injury, NRDs and property damage liabilities cannot be ascertained with any certainty due to, among other things, the unknown extent and nature of any contamination, any technological advances for pollution abatement, the response actions that may be required, the availability of qualified remediation contractors, equipment, and landfill space, and the number and financial resources of any other PRPs. timing extent and the of Range of Reasonably Possible Outcomes Based on currently available information, including actual remediation costs incurred to date, we believe that the remediation of OU1 can be satisfactorily completed for the amounts provided under the OU1 Consent Decree. Our assessment is dependent, in part, on government approval of the use of alternative remedies in OU1 as proposed by us and WTM I, on the successful negotiation of complete remediation activities, and an effective implementation of the chosen technologies by the remediation contractor. However, if we are unsuccessful in managing our costs to implement the ROD or if alternative remedies are not accepted by government authorities, additional charges may be necessary and such amounts could be material. acceptable contracts to The OU1 Consent Decree does not address response costs necessary to remediate the remainder of the Fox River site and only addresses NRDs and claims for reimbursement of government expenses to a limited find extent. Due liability, CERCLA imposes uncertainty persists exposure with respect to the remainder of the Fox River site. interpretations several joint regarding our to judicial that and Based on our currently available analysis of information and experience regarding the cleanup of hazardous substances, we believe that it is reasonably possible that our costs associated with the lower Fox River and the Bay of Green Bay may exceed our original reserves by amounts that may prove to be insignificant or that could range, in the aggregate, up to approximately $150 million, over a period that is undeterminable but that could range beyond 20 years. We believe that the -46- GLATFELTER likelihood of an outcome in the upper end of the monetary range is significantly less than other possible outcomes within the range and that the possibility of an outcome in excess of the upper end of the monetary range is remote. In our estimate of the upper end of the range, we have considered: (i) the remedial actions agreed to in the OU1 Consent Decree and our belief that the required work can be accomplished with the funds to be escrowed under the OU1 Consent Decree; and (ii) no active remediation of OU2. We have also assumed dredging for the remainder of the Fox River site as set forth in the Second ROD, although at a significantly higher cost than estimated in the Second ROD. We have also assumed our share of the ultimate liability to be 18%, which is significantly higher than we believe is appropriate or than we will incur, and a level of NRD claims and claims for reimbursement of expenses from other parties that, although reasonably possible, is unlikely. current reserves In estimating both our for environmental remediation and other environmental liabilities and the possible range of additional costs, we have assumed that we will not bear the entire cost of remediation and damages to the exclusion of other known PRPs who may be jointly and severally liable. The ability of other PRPs to participate has been taken into account, generally based on their financial condition and probable contribution. Our evaluation of the other PRPs’ financial condition included the review of publicly Furthermore, we information. available believe corporate or these PRPs have contractual relationships with additional entities that may shift to those entities some or all of the monetary obligations arising from the Fox River site. The relative probable contribution is based upon our knowledge that at least two PRPs manufactured the paper, and arranged for the disposal of the wastepaper, that included the PCBs and consequently, in our opinion, bear a higher level of responsibility. financial certain of the In addition, our assessment is based upon the various and location of magnitude, nature discharges of PCBs to the river and the relationship of those discharges to identified contamination. We continue to evaluate our exposure and the level of our reserves, including, but not limited to, our potential share of the costs and NRDs, if any, associated with the Fox River site. at could, however, Summary Our current assessment is that we should be able to manage these environmental matters without a long-term, material adverse impact on the Company. These matters any particular time or for any particular year or years, have a material adverse effect on our consolidated financial position, liquidity and/or results of operations or could result in a default under our loan covenants. Moreover, there can be no assurance that our reserves will be adequate to provide for future obligations related to these matters, that our share of costs and/or damages for these matters will not exceed our available resources, or that such obligations will not have a long-term, material adverse effect on our consolidated financial position, results of operations. With regard to the Fox River site, if we are not successful in managing the implementation of the OU1 Consent Decree and/or if we are ordered to implement the remedy such the developments could have a material adverse effect on our consolidated financial position, liquidity and results of operations and may result in a default under our loan covenants. Second ROD, liquidity or proposed in In addition to the specific matters discussed above, we are subject to loss contingencies resulting from regulation by various federal, state, local and foreign governments with respect to the environmental impact of our mills. To comply with environmental laws and regulations, we have incurred substantial capital and operating expenditures in past years. We anticipate that environmental regulation of our operations will continue to become more burdensome and that capital and operating expenditures necessary to comply with environmental regulations will continue, and perhaps increase, in the future. In addition, we may incur obligations to remove or mitigate the adverse effects, if any, on the environment resulting from our operations, resources and including the restoration of natural liability for personal to property and natural resources. injury and for damages We are also involved in other lawsuits that are ordinary and incidental to our business. The ultimate outcome of these lawsuits cannot be predicted with certainty; however, we do not such lawsuits in the aggregate or individually will have a material adverse effect on our consolidated financial position, liquidity or results of operations. expect that -47- GLATFELTER 20. SEGMENT AND GEOGRAPHIC INFORMATION The following table sets forth profitability and other information by business unit for the year ended December 31: In millions Net sales Energy sales, net Total revenue Cost of products sold Gross profit (loss) SG&A Restructuring charges Gains on dispositions of plant, equipment and timberlands Gain on insurance recoveries Total operating income (loss) Nonoperating income (expense) Income (loss) before income taxes Supplemental Data Plant, equipment and timberlands, net Capital expenditures Depreciation expense Specialty Papers 2005 2006 2004 2006 Composite Fibers 2005 2004 Other and Unallocated 2005 2006 2004 2006 $693,660 $380,923 $337,436 $292,751 $198,137 $205,232 – 205,232 163,843 41,389 23,067 – 9,953 347,389 312,136 35,253 36,617 – – 198,137 166,153 31,984 21,282 – – 292,751 246,797 45,954 28,458 – 10,078 391,001 340,629 50,372 39,876 – 10,726 704,386 635,143 69,243 50,285 – $– – – 9,903 (9,903) 13,738 30,318 $61 – 61 (14,759) 14,820 6,475 1,564 $856 $986,411 10,726 997,137 891,843 105,294 92,481 30,318 – 856 (14,916) 15,772 255 20,375 Total 2005 2004 $579,121 $543,524 9,953 553,477 461,063 92,414 59,939 20,375 10,078 589,199 492,023 97,176 67,633 1,564 – – – – – – – – – – – – (17,394) (22,053) (58,509) (17,394) (22,053) (58,509) (205) (20,151) (32,785) (205) (20,151) (32,785) 18,958 10,496 (1,364) 17,496 10,702 18,322 (36,360) 48,985 86,436 94 70,183 103,394 – – – – – – (22,322) (10,043) (12,631) (22,322) (10,043) (12,631) $18,958 $10,496 $(1,364) $17,496 $10,702 $18,322 $(58,682) $38,942 $73,805 $(22,228) $60,140 $90,763 $315,556 $335,745 $351,086 $213,311 $143,083 $169,326 6,617 14,412 9,611 14,866 7,976 17,197 11,970 37,186 21,413 35,781 36,484 32,824 – – – – – – – $528,867 44,460 – 50,021 – $478,828 $520,412 18,587 51,598 31,024 50,647 books hardbound Our North America-based Specialty Papers business unit focuses on papers for the production of high-quality book and publishing needs, carbonless papers designed for multiple end-uses, such as credit card receipts, forms and other applications, envelope & converting markets and highly technical customized products for the digital imaging, casting and release, pressure sensitive, and several niche technical specialty markets. other Composite Fibers, based in Gernsbach, Germany, focuses on higher-value-added products, such as paper for tea bags and coffee pods/pads and filters, decorative laminates used for and furniture metallized products used in the labeling of beer bottles. and flooring, Results of individual business units are presented based on our management accounting practices and management structure. There is no comprehensive, for management of guidance authoritative body accounting principles to generally accepted in the United States of America; therefore, the financial results of individual business units are not necessarily comparable with similar information for any other company. The management accounting process uses assumptions and allocations to accounting equivalent the business performance units. of measure Methodologies are refined from time to time as management accounting practices are enhanced and businesses change. The costs incurred by support areas not directly aligned with the business unit are allocated primarily based on an estimated utilization of support area services. Management evaluates results of operations before non-cash pension income, restructuring related charges, unusual items, acquisition integration costs, effects of asset dispositions and insurance recoveries because it believes this is a more meaningful representation of its core papermaking the operating performance of businesses, the profitability of business units and the extent of cash flow generated from core operations. This presentation is closely aligned with the management and operating structure of our company. It is also on this basis that Company’s performance is evaluated internally and by the Company’s Board of Directors. We sell a significant portion of our specialty papers through wholesale paper merchants. No individual customer than 10% of our accounted for more consolidated net sales in 2006, 2005 or 2004. Our net sales to external customers and location of net plant, equipment and timberlands are summarized below. Net sales are attributed to countries based upon origin of shipment. In thousands United States Germany United Kingdom Other Total Net sales $719,720 173,267 60,115 33,309 $986,411 2006 Plant, Equipment and Timberlands – Net $315,556 128,290 63,061 21,960 $528,867 -48- GLATFELTER 2005 Plant, Equipment and Timberlands – Net $335,745 123,685 – 19,398 $478,828 2004 Plant, Equipment and Timberlands – Net $351,086 149,513 – 19,813 $520,412 Net sales $353,284 156,337 – 33,903 $543,524 Net sales $399,705 143,227 – 36,189 $579,121 21. GUARANTOR FINANCIAL STATEMENTS Our 71⁄8% Senior Notes have been fully and unconditionally guaranteed, on a joint and several basis, by certain of our 100%-owned domestic subsidiaries, PHG Tea Leaves, Inc., Mollanvick, Inc., The Glatfelter Pulp Wood Company, GLT International Finance, LLC, Glenn-Wolfe, Inc., Glatfelter Holdings, LLC and Glatfelter Holdings II, LLC. The following presents our consolidating statements of income and cash flow for the years ended December 31, 2006, 2005 and 2004 and our consolidating balance sheets as of December 31, 2006 and 2005. These financial statements reflect P. H. Glatfelter Company (the parent), the guarantor subsidiaries (on a combined basis), the non- guarantor subsidiaries (on a combined basis) and elimination entries necessary to combine such entities on a consolidated basis. Condensed Consolidating Statement of Income for the year ended December 31, 2006 In thousands Net sales Energy sales – net Total revenues Costs of products sold Gross profit Selling, general and administrative expenses Shutdown and restructuring charges Gains on dispositions of plant, equipment and timberlands, net Gains from insurance recoveries Operating income (loss) Non-operating income (expense) Interest expense Other income (expense) – net Total other income (expense) Income (loss) before income taxes Income tax provision (benefit) Net income (loss) Parent Company $693,661 10,726 704,387 647,877 56,510 60,119 29,073 (1,761) (205) Guarantors $ 36,432 – 36,432 33,340 3,092 2,501 – (15,960) – (30,716) 16,551 (20,942) 12,453 (8,489) (39,205) (26,969) (463) 53,273 52,810 69,361 24,776 Non Guarantors Adjustments/ Eliminations $292,750 – 292,750 247,041 $(36,432) – (36,432) (36,415) 45,709 29,861 1,245 327 – 14,276 (3,048) (5,477) (8,525) 5,751 1,908 (17) – – – – (17) – (58,118) (58,118) (58,135) (9,707) Consolidated $986,411 10,726 997,137 891,843 105,294 92,481 30,318 (17,394) (205) 94 (24,453) 2,131 (22,322) (22,228) (9,992) $ (12,236) $ 44,585 $ 3,843 $(48,428) $ (12,236) Condensed Consolidating Statement of Income for the year ended December 31, 2005 In thousands Net sales Energy sales – net Total revenues Costs of products sold Gross profit Selling, general and administrative expenses Shutdown and restructuring charges Gains on dispositions of plant, equipment and timberlands, net Gains from insurance recoveries Operating income Non-operating income (expense) Interest expense Other income (expense) – net Total other income (expense) Income (loss) before income taxes Income tax provision (benefit) Net income (loss) Parent Company $380,906 10,078 390,984 326,433 64,551 44,381 – (881) (20,151) 41,202 (10,730) 4,957 (5,773) 35,429 (3,180) Guarantors $ 34,334 – 34,334 33,101 1,233 1,798 – (21,213) – 20,648 – 41,773 41,773 62,421 23,695 Non Guarantors Adjustments/ Eliminations Consolidated $198,254 – 198,254 167,157 $(34,373) – (34,373) (34,668) $579,121 10,078 589,199 492,023 31,097 21,454 1,564 41 – 8,038 (2,353) (1,330) (3,683) 4,355 1,808 295 – – – – 295 – (42,360) (42,360) (42,065) (792) 97,176 67,633 1,564 (22,053) (20,151) 70,183 (13,083) 3,040 (10,043) 60,140 21,531 $ 38,609 $ 38,726 $ 2,547 $(41,273) $ 38,609 -49- GLATFELTER Condensed Consolidating Statement of Income for the year ended December 31, 2004 Guarantors Non Guarantors Adjustments/ Eliminations Consolidated In thousands Net sales Energy sales – net Total revenues Costs of products sold Gross profit Selling, general and administrative expenses Shutdown and restructuring charges Gains on dispositions of plant, equipment and timberlands, net Gains from insurance recoveries Operating income Non-operating income (expense) Interest expense Other income (expense) – net Total other income (expense) Income (loss) before income taxes Income tax provision (benefit) Net income (loss) Parent Company $337,416 9,953 347,369 299,150 48,219 34,492 19,704 (3,356) (32,785) $33,798 – 33,798 30,116 3,682 2,181 671 (55,630) – 30,164 56,460 (10,875) 31,074 20,199 50,363 (5,739) – 33,364 33,364 89,824 34,715 $56,102 $55,109 $206,203 – 206,203 165,151 $(33,893) – (33,893) (33,354) 41,052 24,154 1 477 – 16,420 (2,510) (1,378) (3,888) 12,532 6,313 $6,219 (539) (888) (1) – – 350 – (62,306) (62,306) (61,956) (628) $(61,328) $543,524 9,953 553,477 461,063 92,414 59,939 20,375 (58,509) (32,785) 103,394 (13,385) 754 (12,631) 90,763 34,661 $56,102 Condensed Consolidating Balance Sheet as of December 31, 2006 In thousands Assets Current assets Cash and cash equivalents Other current assets Plant, equipment and timberlands – net Other assets Total assets Liabilities and Shareholders’ Equity Current liabilities Long-term debt Deferred income taxes Other long-term liabilities Total liabilities Shareholders’ equity Parent Company Guarantors Non Guarantors Adjustments/ Eliminations Consolidated $10,098 233,688 302,606 1,275,240 $675 11,837 12,945 1,004,992 $11,212 114,983 213,316 (153,452) $– (7,455) – (1,805,042) $21,985 353,053 528,867 321,738 $1,821,632 $1,030,449 $186,059 $(1,812,497) $1,225,643 $156,679 329,516 142,394 804,675 1,433,264 388,368 $2,753 – 18,112 91,418 112,283 918,166 $36,375 45,779 29,472 25,844 137,470 48,589 $(2,517) – (7,319) (835,906) (845,742) (966,755) $193,290 375,295 182,659 86,031 837,275 388,368 Total liabilities and shareholders’ equity $1,821,632 $1,030,449 $186,059 $(1,812,497) $1,225,643 -50- GLATFELTER Condensed Consolidating Balance Sheet as of December 31, 2005 In thousands Assets Current assets Cash and cash equivalents Other current assets Plant, equipment and timberlands – net Other assets Parent Company Guarantors Non Guarantors Adjustments/ Eliminations Consolidated $14,404 90,964 322,208 1,065,934 $30,615 1,936 13,537 746,701 $12,390 76,118 143,083 14,677 $33 (2,903) – (1,484,720) $57,442 166,115 478,828 342,592 Total assets $1,493,510 $792,789 $246,268 $(1,487,590) $1,044,977 Liabilities and Shareholders’ Equity Current liabilities Long-term debt Deferred income taxes Other long-term liabilities Total liabilities Shareholders’ equity $75,465 150,000 174,854 660,879 1,061,198 432,312 $2,772 – 10,585 36,581 49,938 742,851 $61,629 34,000 24,003 85,441 205,073 41,195 $12 – (3,173) (700,383) (703,544) (784,046) $139,878 184,000 206,269 82,518 612,665 432,312 Total liabilities and shareholders’ equity $1,493,510 $792,789 $246,268 $(1,487,590) $1,044,977 Condensed Consolidating Statement of Cash Flows for the year ended December 31, 2006 In thousands Net cash provided (used) by Operating activities Investing activities Purchase of plant, equipment and timberlands Proceeds from disposal plant, equipment and timberlands Acquisition of Lydney mill and Chillicothe Total investing activities Financing activities Net (repayments of) proceeds from indebtedness Payment of dividends Other Total financing activities Effect of exchange rate on cash Net decrease in cash Cash at the beginning of period Cash at the end of period Parent Company Guarantors Non Guarantors Adjustments/ Eliminations Consolidated $(75,477) $23,804 $13,860 $9,386 $(28,427) (35,527) (957) (7,976) 4,632 (89,217) (120,112) 199,016 (16,023) 8,290 191,283 – (4,306) 14,404 $10,098 16,436 (69,225) (53,746) – – – – 2 (29,940) 30,615 3 – (7,973) (8,476) – – (8,476) 1,411 (1,178) 12,390 $675 $11,212 – – – – (9,419) – – (9,419) – (33) 33 $– (44,460) 21,071 (158,442) (181,831) 181,121 (16,023) 8,290 173,388 1,413 (35,457) 57,442 $21,985 -51- GLATFELTER Condensed Consolidating Statement of Cash Flows for the year ended December 31, 2005 In thousands Net cash provided (used) by Operating activities Investing activities Purchase of plant, equipment and timberlands Proceeds from disposal plant, equipment and timberlands Proceeds from sale of subsidiary, net of cash dividend Total investing activities Financing activities Net (repayments of) proceeds from indebtedness Payment of dividends Proceeds from stock options exercised Total financing activities Effect of exchange rate on cash Net increase (decrease) in cash Cash at the beginning of period Cash at the end of period Parent Company Guarantors Non Guarantors Adjustments/ Eliminations Consolidated $28,694 $42,318 $(12,497) $(15,647) $42,868 (20,319) 55 – (20,264) – (15,839) 1,414 (14,425) – (5,995) 20,399 (1,094) 981 – (113) – (12,001) – (12,001) (1) 30,203 412 (9,611) 21,414 545 12,348 (4,153) – – (4,153) (2,189) (6,491) 18,881 $14,404 $30,615 $12,390 – – – – 3,420 12,001 – 15,421 – (226) 259 $33 (31,024) 22,450 545 (8,029) (733) (15,839) 1,414 (15,158) (2,190) 17,491 39,951 $57,442 Condensed Consolidating Statement of Cash Flows for the year ended December 31, 2004 In thousands Net cash provided (used) by Operating activities Investing activities Purchase of plant, equipment and timberlands Proceeds from disposal plant, equipment and timberlands Proceeds from sale of subsidiary, net of cash dividend Total investing activities Financing activities Net (repayments of) proceeds from indebtedness Payment of dividends Proceeds from stock options exercised Total financing activities Effect of exchange rate on cash Net increase (decrease) in cash Cash at the beginning of period Cash at the end of period Parent Company Guarantors Non Guarantors Adjustments/ Eliminations Consolidated $73,396 $(5,540) $25,630 $(53,902) $39,584 (10,847) 3,826 – (7,021) (30,000) (15,782) 917 (44,865) – 21,510 (1,111) $20,399 (1,123) 56,121 – 54,998 – (56,000) – (56,000) – (6,542) 6,954 $412 (6,617) 224 525 (5,868) (13,049) – – (13,049) 2,445 9,158 9,723 $18,881 – – – – (1,839) 56,000 – 54,161 – 259 – $259 (18,587) 60,171 525 42,109 (44,888) (15,782) 917 (59,753) 2,445 24,385 15,566 $39,951 -52- GLATFELTER 22. QUARTERLY RESULTS (UNAUDITED) In thousands, except per share Net sales Gross Profit Net Income (loss) 2006 $160,606 279,720 277,489 268,596 2005 $143,896 145,283 146,780 143,162 2006 $20,265 5,733 37,903 41,393 2005 $28,594 19,833 25,616 23,133 2006 $(11,865) (20,722) 5,368 14,983 2005 $6,290 1,709 3,663 26,947 First Second Third Fourth The information set forth above includes the following, on an after-tax basis: In thousands First Second Third Fourth Restructuring Charges and Unusual Items 2006 $(17,398) (14,731) (1,901) (428) 2005 $— — — (1,017) Gains on Sales of Plant, Equipment and Timberlands, and Other Asset Sales 2006 $— — 264 8,576 2005 $— — 259 11,517 Diluted Earnings (loss) Per Share 2006 $(0.27) (0.46) 0.12 0.33 2005 $0.14 0.04 0.08 0.61 Insurance Recoveries 2006 2005 $— 130 — — $— 1,430 — 11,289 ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of December 31, 2006, have concluded that, as of the evaluation date, our disclosure controls and procedures were effective. Internal Control Over Financial Reporting. In addition, effective October 1, 2006, we completed the outsourcing of our domestic payroll processing system to a nationally recognized payroll services provider. As part of our evaluation of the related internal controls, we obtained a Service Auditors report prepared in accordance with Statement on Auditing Standard No. 70. There were no other changes in our internal control over financial reporting during the year ended December 31, 2006, that have materially affected or is reasonably likely to materially affect our internal control over financial reporting. over financial Management’s report on the Company’s internal control reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) and the related report of our independent registered public accounting firm are included in Item 8. – Financial Statements and Supplementary Data. Changes in Internal Control over Financial Reporting the these paper operation carbonless associated with On March 13, 2006, we completed the acquisition of the Lydney mill from J R Crompton Limited and on April 3, 2006, we completed the acquisition of Chillicothe, of NewPage Corporation. We performed due diligence procedures acquisitions. Subsequent to closing the acquisitions much of the completed financial pursuant to third party servicing agreements between us and the sellers. Beginning in the third quarter of 2006, we assumed more complete control for all financial acquired accounting operations. We are in the process of more fully integrating the respective financial reporting processes and the related internal controls applicable to these newly acquired entities. functions were accounting functions related the to PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE this Directors The required under information with respect Item is to directors incorporated herein by reference to our Proxy Statement, to be dated on or about March 21, 2007. Our board of directors has determined that, based on the relevant experience of the members of the Audit Committee, the members are audit committee financial experts as this term is set forth in the applicable regulations of the SEC. of the Registrant The Executive Officers information with respect to the executive officers required under this Item is set forth in Part I of this report. rules of We have adopted a Code of Business Ethics for the CEO and Senior Financial Officers in compliance with and Exchange applicable Commission that applies to our chief executive officer, chief financial officer and our principal accounting officer or controller, or persons performing similar functions. A copy of the Code of Ethical Business Conduct is filed as the Securities -53- GLATFELTER an exhibit to this Annual Report on Form 10-K and is available at www.glatfelter.com. our website, charge, free on of ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ITEM 11. EXECUTIVE COMPENSATION The information required under incorporated herein by Statement, to be dated on or about March 21, 2007. reference to this Item is our Proxy ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required under incorporated herein by Statement, to be dated on or about March 21, 2007. reference to this Item is our Proxy The information required under incorporated herein by Statement, to be dated on or about March 21, 2007. reference to this Item is our Proxy ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required under incorporated herein by Statement, to be dated on or about March 21, 2007. reference to this Item is our Proxy Our Chief Executive Officer has certified to the New York Stock Exchange that he is to aware of any violations by the Company of the NYSE corporate governance listing standards. -54- GLATFELTER PART IV ITEM 15. EXHIBIT AND, FINANCIAL STATEMENT SCHEDULES. (a) 1. i. ii. iii. iv. Our Consolidated Financial Statements as follows are included in Part II, Item 8: Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004 Consolidated Balance Sheets as of December 31, 2006 and 2005 Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004 Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004 v. Notes to Consolidated Financial Statements for the Years Ended December 31, 2006, 2005 and 2004 2. Financial Statement Schedules (Consolidated) are included in Part IV: i. Schedule II – Valuation and Qualifying Accounts – For Each of the Three Years in the Period Ended December 31, 2006 (b) Exhibit Index Exhibit Number 2 (a) Description of Documents Incorporated by Reference to Exhibit (Filing) Asset Purchase Agreement, dated February 21, 2006, among NewPage Corporation, Chillicothe Paper Inc. and P. H. Glatfelter Company (b) Agreement for Sale of Assets (Lydney), dated March 8, 2006, by and among J R Crompton Limited, Nicholas James Dargan and 3 (a) William Kenneth Dawson, as administrators and Glatfelter-UK Limited and the Company Articles of Amendment dated April 27, 1977, including restated Articles of Incorporation, as amended by: Statement of Reduction of Authorized Shares dated May 12, 1980 Statement of Reduction of Authorized Shares dated September 23, 1981 Statement of Reduction of Authorized Shares dated August 2, 1982 Statement of Reduction of Authorized Shares dated July 29, 1983 i. Articles of Merger dated January 30, 1979 ii. iii. iv. v. vi. Articles of Amendment dated April 25, 1984 vii. viii. ix. Articles of Amendment dated April 23, 1986 Statement of Reduction of Authorized Shares dated October 15, 1984 Statement of Reduction of Authorized Shares dated December 24, 1985 Statement of Reduction of Authorized Shares dated July 11, 1986 Statement of Reduction of Authorized Shares dated March 25, 1988 Statement of Reduction of Authorized Shares dated November 9, 1988 Statement of Reduction of Authorized Shares dated April 24, 1989 x. xi. xii. xiii. xiv. Articles of Amendment dated November 29, 1990 xv. Articles of Amendment dated June 26, 1991 xvi. Articles of Amendment dated August 7, 1992 xvii. Articles of Amendment dated July 30, 1993 xviii. Articles of Amendment dated January 26, 1994 Articles of Incorporation, as amended through January 26, 1994 (restated for the purpose of filing on EDGAR) By-Laws as amended through December 13, 2006, filed herewith. Indenture, dated as of April 28, 2006, by and between the Company and SunTrust Bank, as trustee relating to 71⁄8 Notes due 2016. Registration Rights Agreement, dated April 28, 2006, among the Company, the Guarantors named therein and the Initial Purchasers (incorporated by reference to Exhibit 4.2 to the Current Report on Form 8-K filed by the Company on May 3, 2006) relating to 71⁄8 Notes due 2016. First Supplemental Indenture, dated as of September [(cid:129)], 2006, among Glatfelter Holdings, LLC, Glatfelter Holdings II, LLC, the Existing Subsidiary Guarantors named therein and SunTrust Bank relating to 71⁄8 Notes due 2016. P. H. Glatfelter Company Management Incentive Plan, adopted as of January 1, 1994, as amended and restated December 19, 2000 and effective January 1, 2001.** P. H. Glatfelter Company 2005 Management Incentive Plan, adopted as of April 27, 2005.** P. H. Glatfelter Company Supplemental Executive Retirement Plan, as amended and restated effective April 23, 1998 and further amended December 20, 2000.** Description of Executive Salary Continuation Plan.** P. H. Glatfelter Company Supplemental Management Pension Plan, effective as of April 23, 1998.** P. H. Glatfelter Company 1992 Key Employee Long-Term Incentive Plan, as amended December 20, 2000.** P. H. Glatfelter Company 2005 Long-Term Incentive Plan, adopted as of April 27, 2005.** 4 10 (b) (c) (a) (b) (c) (a) (b) (c) (d) (e) (f) (g) (g) (A) Form of Top Management Restricted Stock Unit Award Certificate.** (g) (B) Form of Non-Employee Director Restricted Stock Unit Award Certificate** (h) (i) P. H. Glatfelter Company Deferred Compensation Plan for Directors, effective as of April 22, 1998.** Change in Control Employment Agreement by and between P. H. Glatfelter Company and George H. Glatfelter II, dated as of December 31, 2005.** -55- GLATFELTER 2.1 10 3(a) 3(a) 3(a) 3(a) 3(a) 3(a) 3(a) 3(b) 3(b) (3) 3(b) 3(b) 3(b) 3(b) 3(b) 3(b) 3(b) 3(b) 3(b) 3(c) 4.1 4.2 4.3 10(a) 10.4 10(c) 10(g) 10(f) 10(g) 10.1 10.2 10.3 10(h) 10(i) February 21, 2006 Form 8-K March 31, 2006 Form 10-Q 1993 Form 10-K 1993 Form 10-K 1993 Form 10-K 1993 Form 10-K 1993 Form 10-K 1993 Form 10-K 1994 Form 10-K 1984 Form 10-K 1985 Form 10-K March 31, 1986 Form 10-Q 1986 Form 10-K 1987 Form 10-K 1988 Form 10-K 1989 Form 10-K 1990 Form 10-K 1991 Form 10-K 1992 Form 10-K 1993 Form 10-K 1993 Form 10-K 1993 Form 10-K May 3, 2006 Form 8-K May 3, 2006. Form 8-K September 22, 2006 Form S-4/A 2000 Form 10-K** April 27, 2005 Form 8-K 2000 Form 10-K** 1990 Form 10-K** 1998 Form 10-K** 2000 Form 10-K** April 27, 2005 Form 8-K April 27, 2005 Form 8-K April 27, 2005 Form 8-K 1998 Form 10-K** 2005 Form 10-K Exhibit Number Description of Documents (j) (j) (k) (l) (m) (n) (o) (p) (q) (r) (s) (t) (u) (v) 14 21 23 31.1 31.2 32.1 32.2 (A) Form of Change in Control Employment Agreement by and between P. H. Glatfelter Company and certain employees, dated as of December 31, 2005.** Schedule of Change in Control Employment Agreements.** Agreement between the State of Wisconsin and Certain Companies Concerning the Fox River, dated as of January 31, 1997, among P. H. Glatfelter Company, Fort Howard Corporation, NCR Corporation, Appleton Papers Inc., Riverside Paper Corporation, U.S. Paper Mills, Wisconsin Tissue Mills Inc. and the State of Wisconsin. Credit Agreement, dated as of April 3, 2006, by and among the Company, certain of the Company’s subsidiaries as guarantors, the banks party thereto, PNC Bank, National Association, as agent for the banks under the Credit Agreement, PNC Capital Markets LLC and Credit Suisse Securities (USA) LLC, as joint arrangers and bookrunners, and Credit Suisse Securities (USA) LLC, as syndication agent. Contract for the Purchase and Bargain Sale of Property (exhibits omitted) Term Loan Agreement, dated as of March 21, 2003, among GPW Timberlands, LLC, (a wholly owned subsidiary of the Registrant) and SunTrust Bank, as Administrative Agent. Consent Decree for Remedial Design and Remedial Action at Operable Unit 1 of the Lower Fox River and Green Bay site by and among the United States of America and the State of Wisconsin v. P. H. Glatfelter Company and WTMI Company (f/k/a Wisconsin Tissue Mills, Inc.) Compensatory Arrangements with Certain Executive Officers, filed herewith.** Summary of Non-Employee Director Compensation, (effective January 1, 2005).** Service Agreement between the Registrant (through a wholly owned subsidiary) and Martin Rapp, filed herewith.** Form of Stock-Only Stock Appreciation Right Award Certificate, filed herewith** Form of 2007 Top Management Restricted Stock Unit Award Certificate, filed herewith** Consulting Agreement between the Registrant and John C. van Roden, Jr., filed herewith.** P.H. Glatfelter Company Management Incentive Plans, effective January 1, 1982, as amended and restated effective January 1, 1994.** Code of Business Ethics for the CEO and Senior Financial Officers of Glatfelter. Subsidiaries of the Registrant, filed herewith. Consent of Independent Registered Public Accounting Firm, filed herewith. Certification of George H. Glatfelter II, Chairman and Chief Executive Officer of Glatfelter, pursuant to Section 302(a) of the Sarbanes-Oxley Act Of 2002, filed herewith. Certification of John P. Jacunski, Senior Vice President and Chief Financial Officer of Glatfelter, pursuant to Section 302(a) of the Sarbanes-Oxley Act Of 2002, filed herewith. Certification of George H. Glatfelter II, Chairman and Chief Executive Officer of Glatfelter, pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, 18 U.S.C. Section 1350, filed herewith. Certification of John P. Jacunski, Senior Vice President and Chief Financial Officer of Glatfelter, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, filed herewith. ** Management contract or compensatory plan Incorporated by Reference to Exhibit (Filing) 10(j)A 2005 Form 10-K 10(j) 10(i) 10.1 10(m) 10.3 10.2 10.1 2005 Form 10-K 1996 Form 10-K April 7, 2006 Form 8-K 2002 Form 10-K March 31, 2003 Form 10-Q October 1, 2003 Form 8-K/A – No. 1 December 15, 2004 Form 8-K 10(a) 14 1993 Form 10-K 2003 Form 10-K -56- GLATFELTER SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. March 15, 2007 P. H. GLATFELTER COMPANY (Registrant) By /s/ George H. Glatfelter II George H. Glatfelter II Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated: Signature Capacity Date March 15, 2007 March 15, 2007 March 15, 2007 /s/ George H. Glatfelter II George H. Glatfelter II Chairman and Chief Executive Officer /s/ John P. Jacunski John P. Jacunski Senior Vice President and Chief Financial Officer /s/ David C. Elder David C. Elder Corporate Controller and Chief Accounting Officer March 15, 2007 /s/ Kathleen A. Dahlberg Kathleen A. Dahlberg March 15, 2007 /s/ Nicholas DeBenedictis Nicholas DeBenedictis March 15, 2007 /s/ Richard C. III Richard C. III March 15, 2007 /s/ J. Robert Hall J. Robert Hall March 15, 2007 /s/ Ronald J. Naples Ronald J. Naples March 15, 2007 /s/ Richard L. Smoot Richard L. Smoot March 15, 2007 /s/ Lee C. Stewart Lee C. Stewart -57- GLATFELTER Principal Executive Officer and Director Principal Financial Officer Controller Director Director Director Director Director Director Director CERTIFICATION PURSUANT TO SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002 I, George H. Glatfelter II, certify that: 1. I have reviewed this Annual Report on Form 10-K for the year ended December 31, 2006 of P.H. Glatfelter Company (“Glatfelter”); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. Glatfelter’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for Glatfelter and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to Glatfelter, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of Glatfelter’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in Glatfelter’s internal control over financial reporting that occurred during Glatfelter’s most recent fiscal quarter (the fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, Glatfelter’s internal control over financial reporting; and 5. Glatfelter’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to Glatfelter’s auditors and the audit committee of the Glatfelter’s board of directors: (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect Glatfelter’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in Glatfelter’s internal control over financial reporting. Date: March 15, 2007 By: /s/ George H. Glatfelter II George H. Glatfelter II Chairman and Chief Executive Officer -58- GLATFELTER CERTIFICATION PURSUANT TO SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002 I, John P. Jacunski, certify that: 1. I have reviewed this Annual Report on Form 10-K for the year ended December 31, 2006 of P.H. Glatfelter Company (“Glatfelter”); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. Glatfelter’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for Glatfelter and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to Glatfelter, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of Glatfelter’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in Glatfelter’s internal control over financial reporting that occurred during Glatfelter’s most recent fiscal quarter (the fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, Glatfelter’s internal control over financial reporting; and 5. Glatfelter’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to Glatfelter’s auditors and the audit committee of the Glatfelter’s board of directors: (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect Glatfelter’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in Glatfelter’s internal control over financial reporting. Date: March 15, 2007 By: /s/ John P. Jacunski John P. Jacunski Senior Vice President and Chief Financial Officer -59- GLATFELTER P. H. GLATFELTER COMPANY AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULE For Each of the Three Years in the Period Ended December 31, 2006 Valuation and Qualifying Accounts Allowance for Schedule II In thousands Balance, beginning of year Provision (a) Write-offs, recoveries and discounts allowed Other (b) Balance, end of year Doubtful Accounts 2005 $2,364 382 2006 $931 2,771 2004 $3,115 868 Sales Discounts and Deductions 2005 $2,217 2,788 2004 $2,038 3,964 2006 $2,405 3,153 (137) 48 $3,613 (1,726) (89) $931 (1,643) 24 $2,364 (2,795) 182 $2,945 (2,711) (249) $2,045 (3,947) 162 $2,217 The provision for doubtful accounts is included in administrative expense and the provision for sales discounts and deductions is deducted from sales. The related allowances are deducted from accounts receivable. (a) Includes $1.8 million of acquired allowances in connection with the Chillicothe and Lydney acquisition. (b) Relates primarily to changes in currency exchange rates. -60- GLATFELTER Our vision is to become the global supplier of choice in Specialty Papers and Engineered Products Vision Our Core Values Integrity Financial Discipline of financial value for all constituents. Respect for Coworkers opportunities for advancement. Customer Focus achieve their business objectives. Environmental Responsibility regulations. Social Responsibility and the world in which we live. Noticeably Different… We are ethical and responsible in all of our business endeavors, all the time. We are responsible for the prudent management of the resources entrusted to us and for the generation We treat each other with honesty and respect. We recognize that what we have and what we will achieve is through the efforts of our employees. We will strive to provide them with rewarding challenges and We are dedicated to understanding and anticipating the needs of our customers and helping them to We recognize that our business impacts the environment. We are committed to continuous environmental improvement and the prevention of pollution. We will be in compliance with all environmental laws and We recognize our responsibility to contribute to the betterment of the communities in which we operate Glatfelter is noticeably different. Its people, products and performance stand out. Glatfelter is bigger, stronger and better. Growth of the legacy businesses was enhanced by two key acquisitions in 2006. Our business has been transformed, making us more efficient and flexible, strengthening the legacy business while expanding our global footprint in key markets. Our commitment to product innovation is driving volume growth and market share gains. This transformation is yielding results – solid performance outpacing the industry and most important – a clear plan to maintain the momentum. Officers and Directors Executive Officers George H. Glatfelter II Chairman and Chief Executive Officer Dante C. Parrini Executive Vice President and Chief Operating Officer John P. Jacunski Senior Vice President and Chief Financial Officer Timothy R. Hess Vice President and General Manager, Specialty Papers Business Unit Jeffrey J. Norton Vice President, General Counsel and Secretary Martin Rapp Vice President and General Manager, Composite Fibers Business Unit Mark A. Sullivan Vice President Global Supply Chain Directors Kathleen A. Dahlberg Founder and President/CEO Open Vision Partners Nicholas DeBenedictis Chairman and Chief Executive Officer Aqua America Corporation George H. Glatfelter II Chairman and Chief Executive Officer J. Robert Hall Chief Executive Officer Ardale Enterprises, LLC Richard C. Ill President and Chief Executive Officer Triumph Group, Inc. Ronald J. Naples Chairman and Chief Executive Officer Quaker Chemical Corporation Richard L. Smoot Retired Regional Chairman PNC Bank, NA Philadelphia/South Jersey Markets William T. Yanavitch II Vice President Human Resources and Administration Lee C. Stewart Investment Banker Daniel Stewart & Company David C. Elder Corporate Controller and Chief Accounting Officer Corporate Information World Headquarters P.H. Glatfelter Company 96 S. George Street Suite 500 York, PA 17401 ph: 717-225-4711 fax: 717-846-7208 www.glatfelter.com Stock Exchange New York Stock Exchange Stock Symbol GLT Annual Meeting of Shareholders May 3, 2007 10:00am EST York Expo Center, 334 Carlisle Avenue York, PA Transfer Agent, Dividend Disbursing Agent and Registrar Mellon Investor Services, LLC 85 Challenger Road Ridgefield Park, NJ 07660 ph: 800-756-3353 Information Sources For the latest quarterly business results or other information, visit www.glatfelter.com or contact: Investor Relations P.H. Glatfelter Company 96 S. George Street, Suite 500 York, PA 17401 ph: 717-225-4711 E-mail: ir@glatfelter.com noticeably different SALES OFFICES U.S. OPERATING LOCATIONS Pennsylvania 228 South Main Street Spring Grove, PA 17362 ph: 717-225-4711 x2565 fax: 717-225-5400 Chillicothe, Ohio 401 Paint Street Chillicothe, OH 45601 ph: 740-772-3183 fax: 740-772-0125 North Carolina One King Road Pisgah Forest, NC 28768 ph: 828-877-2110 fax: 828-877-4086 Spring Grove Facility 228 South Main Street Spring Grove, PA 17362 ph: 717-225-4711 fax: 717-225-6834 Chillicothe Facility 401 Paint Street Chillicothe, OH 45601 ph: 740-772-3111 fax: 740-772-0024 Fremont Facility 2275 Commerce Drive Fremont, OH 43420 ph: 419-334-2673 fax: 419-334-9718 Gernsbach, Germany Hördner Landstraße 3-7 76593 Gernsbach, Germany ph: 49-7224-66-0 fax: 49-7224-66-274 Glatfelter Pulp Wood Company 228 South Main Street Spring Grove, PA 17362 ph: 717-225-4711 fax: 717-225-2850 Lydney, UK Church Road Lydney, Gloucestershire GL15 4NT United Kingdom ph: 44-0-1594-842235 fax: 44-0-1594 844213 Scaër, France BP 2 29390 Scaër, France ph: 33-0-2-98-66-42-00 fax: 33-2-98-59-0998 INTERNATIONAL OPERATING LOCATIONS Gernsbach Facility Hördner Landstraße 3-7 76593 Gernsbach, Germany ph: 49-7224-66-0 fax: 49-7224-66-274 Scaër Facility BP 2 29390 Scaër, France ph: 33-0-2-98-66-42-00 fax: 33-2-98-59-0998 Lanao del Norte Facility Bo. Maria Cristina 9217 Balo-I, Lanao del Norte Philippines ph: 632-893-7640 fax: 632-893-2819 Lydney Facility Church Road Lydney, Gloucestershire GL15 4NT United Kingdom ph: 44-0-1594-842235 fax: 44-0-1594 844213 OTHER LOCATIONS China Representative Office Century Financial Tower, 8F808 No 1 Suhua Road Suzhou-SIP, Jiangsu 215021 ph: 86-512-676-25077 fax: 86-512-676-25070 www.glatfelter.com © 2007 Glatfelter Glatfelter 2006 Annual Report 

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