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Geographic Spread Helps Sappi Perform in Tough Markets During Q3

Press release from the issuing company

JOHANNESBURG, South Africa--July 31, 2002--Sappi, the world's leading producer of coated woodfree paper, today announced results for the third quarter 2002. * Results - Highlights * Headline earnings per share up 4 US cents on previous year * North America improves and Europe and Southern Africa perform well * Cash flows remain strong * Successful debt restructuring Commenting on the results, Eugene van As, Executive Chairman of Sappi said that despite the difficult market conditions throughout the sector, Sappi's geographic spread had enabled the group as a whole to deliver a solid performance. "Although the performance of our North American business improved in the quarter, conditions in the US market remain very challenging," he said, "and there is still a significant contrast between the poor performance in North America and the good results reported by our European and Southern African businesses. However, Sappi's geographic spread continues to underpin our ability to deliver solid results in a sector that is experiencing extremely challenging conditions". Results for the Quarter Net profit before exceptional items of US$66 million was up 20% on the same quarter last year. Earnings per share before exceptional items were 28 US cents, 4 US cents up on last year and 2 US cents up on the sequential quarter. Basic earnings per share were 29 US cents. Cash flow (EBITDA) for the quarter was a strong US$188 million, slightly above the prior quarter, and free cashflow before the acquisition investment was US$180 million. There was a US$39 million reduction in working capital in the quarter. The acquisition of the Potlatch fine paper division for approximately US$480 million was funded by debt. Because of our strong cash flow the net impact after expending US$480 million was an increase in net debt compared to the previous quarter of only US$378 million to US$1,572 million from US$1,194 million. Debt to total capitalization is just below 40%. Sappi's US denominated bond issue in June was a great success. The group raised US$750 million in two tranches: US$500 million 10 year and US$250 million 30 year. The bonds priced with coupons of 6.75% and 7.50% respectively, as low as any in the sector. The proceeds of the bonds have been used to extend the maturity of debt. "The effect of extending maturities, whilst replacing very low variable interest short term debt, will mean a short term increase in finance costs," said Don Wilson, Sappi's Finance Director. "However the group is of the view that the benefits of improving the capital structure at favorable long-term rates outweigh the short-term penalty, and we will enter into interest rate swaps in respect of a portion of our fixed long term debt to variable rates to soften the impact." Operational Review Fine Paper Overall, markets for coated woodfree paper have not shown the recovery seen in other sectors, mainly as a result of continued poor advertising spend, although analysts continue to expect advertising expenditure to pick up later this calendar year. Whilst merchants appear to have started restocking in Europe, in the USA inventories remain low. Producers have continued to curtail production to match output to demand. Industry shipments of coated fine paper improved by 8% in Europe compared to a year earlier but declined 5% compared to the seasonally stronger previous quarter. Industry shipments in the USA were 2.5% down year on year but 4% up compared to the previous quarter. Imports into the USA continue to represent approximately 23% of coated fine paper sales despite the relatively weaker US dollar. North America prices remain very weak with continued downward pressure on coated free sheet prices by domestic producers. The group's order books in Europe have lengthened partly due to exports, but in North America they remain short. Sappi curtailed approximately 100,000 tons of pulp and paper production during the quarter to match supply to demand, compared to 150,000 tons in the second quarter. Against this background, the fine paper division's operating income increased 25.6% to US$54 million representing a return on net operating assets of 7.9%. In Europe the sales volume held up well in the seasonally quiet early summer and was similar to the prior quarter. Efforts to increase prices were only partly successful. We have been able to raise indent prices in some markets but in other, notably in Southern Europe, price levels fell. The strengthening of the Euro against the US dollar helped to counteract the dollar increase in purchased pulp prices. The return on net operating assets in the European business was 17.2%, slightly lower than the previous quarter. In North America the market for coated fine paper remained weak. Operating profit, prior to non-recurring integration costs of approximately US$13 million, improved versus the prior quarter by approximately US$7 million. The results include the coated freesheet business and Cloquet mill acquired from Potlatch from 13 May 2002. Commenting on the progress of the Potlatch acquisition, Bill Sheffield CEO of Sappi Fine Paper said: "The integration has proceeded well and the benefits of synergies will start to impact results in the next quarter. The mill was closed for a few days after which we restarted it with a workforce of 550 people, about 20% less than the previous work force. The mill is currently running at higher rates than previously. We have also integrated and streamlined the sales force and moved the production to Cloquet and other Sappi mills. The combination of Sappi and the acquired business lost some market share as we shed unprofitable business and in the transition lost some sales of the Potlatch products, as we had expected. We anticipate recovering most of these sales. Price developments were in line with the market". "Operating margins on North American assets," he added, "are on track to improve. The North American market continued to be profitable when the sales of products from our European business are included." The South African Fine Paper business had a good quarter. Order books remained strong in local markets partly as a result of import substitution. Average prices realized were 19% higher than last year in Rand terms, although, as a result of the weakening of the Rand year on year, they were 10% lower in dollars. Return on net operating assets increased to 47.3%. Forest Products The group's Forest Products division had a good quarter with local demand remaining firm for all pulp and paper products. Some local and export price increases were implemented, but many local prices still remain below international levels. John Job, CEO of Forest Products said that local demand for packaging paper was strong. "Our export markets also started to show signs of improved demand and pricing," he said. "Demand for dissolving pulp has firmed modestly during the quarter, which resulted in improved sales volumes, and prices are expected to firm. Viscose manufacturers have announced new capacity, which is encouraging for future demand." The division's operating performance continues to be favorably affected by the weak Rand/Dollar exchange rate. The Rand's depreciation has however led to increased inflation, which is expected to lead to higher input costs going forward. The return on net operating assets was a strong 22.2%. Splitting the role of Chairman and Chief Executive The process of finding a successor to the chief executive is well underway. The board is not yet able to make an announcement. Outlook Although there is some improvement in orders in most of the group's markets, North American demand for coated fine paper remains patchy. Pulp prices have continued to increase steadily to approximately US$490 per ton for NBSK in July. Pulp inventories at both consumers and producers are at reasonably low levels as a result of improved consumption and production discipline. The relative strength of the Euro compared to the US dollar is expected to enhance the dollar earnings of Sappi's European business because its sales are predominantly in Euros, while part of its costs (particularly purchased pulp) is in US dollars. It is estimated that, other things remaining unchanged, a 10% strengthening in the Euro would result in approximately 13 US cents improvement in earnings per share. For Sappi's Southern African businesses a strengthening of the rand against the dollar of approximately 10% would result in approximately 11 US cents reduction in earnings per share. On balance, however, the weakening of the US dollar is favorable to Sappi. Commenting on the picture going forward, van As said: "Improved demand for coated paper is largely dependent on improved advertising expenditure, which we expect in the coming months provided recent shocks in the US financial markets do not further affect economic growth. A further slight improvement in quarterly earnings per share in the final quarter is expected given current conditions."