Development of the Forestry Sector and its Customers

The global market for timber is currently enjoying a renaissance. Timber has become a trendy product as well as an increasingly valuable material for power generation, construction and other purposes. The worldwide demand for all types of timber rose strongly throughout 2006. In Austria demand was also characterized by a sharp rise in the demand for sawmill, industrial and energy timber. The interaction of several factors – an increase in capacity by sawmill operators in neighboring countries, the start of operations at numerous biomass power generation plants and a fuel pellet boom among private households – led to a significant increase in the sales opportunities open to the forestry sector. For the first time in many years, the price level rose by a substantial margin.

The first quarter of the reporting year was heavily influenced by the extremely long winter, high snow levels and resulting decline in timber production. This triggered supply bottlenecks and a decrease in production, which was generally offset during the course of the year. The forestry sector customers were generally able to pass on the increase in raw material prices to their customers, making 2006 a very profitable year for the entire timber industry.

One of the major challenges in 2006 was the production and supply of biomass. A large number of new power generation plants started operations during the year. ÖBf concluded agreements to supply the entire raw material requirements for several of these plants, and thereby took on a new dual role as both seller and buyer. This responsibility for guaranteeing supplies was met to the satisfaction of all parties, as demonstrated by the winter of 2006/07.

Uncertainty concerning supplies for industrial uses preoccupied the forestry sector throughout the entire year. However, all ÖBf activities during the fourth quarter and at the beginning of 2007 were successful: large forest areas were mobilized and stocks compiled by the industry and forestry companies in expectation of a severe winter were also placed in use. Last but not least, the mild winter resulted in full warehouses at mid-January and completely eased the supply situation.

The forecasts for 2007 were based on generally favorable developments, which led to a very positive mood throughout the entire branch.

However, the situation was suddenly changed by storms, above all Hurricane Kyrill, that swept across large parts of Europe and Austria in January and caused substantial damage to the forests. Estimates indicate that 3.1 million m3 of timber were thrown or broken, with the Innviertel, Mühlviertel and Waldviertel areas of Lower and Upper Austria leading the damage statistics. The estimates for wind throw in Europe range from 49 to 57 million m3. However, these quantities are contrasted with a total European timber harvest of 450 million m3 for the year.

Although the Austrian market can easily absorb the additional amounts resulting from this damage, the current high level of harvesting has created temporary capacity problems for industrial partners. These storms will create a volume gap over the long-term because sustainable timber harvest targets must still be met and the excess quantities must be offset by a later reduction in harvest volumes.

Development of the ÖBf Group

Investments in other companies
ÖBf AG invested € 6.8 million in the further expansion of its holdings during the past business year. Of this total, € 4.9 million was directed to the eco-biomass power station in Vienna-Simmering, in which ÖBf holds a stake of 33 1/3%. A further € 1.9 million were invested in Foria Forstmanagement GmbH, a joint venture with the Finnish state forestry company Metsähallitus.

ÖBf AG was also the determining company in the ÖBf Group during the 2006 Business Year from a financial point of view, which is demonstrated by the fact that Group earnings differ only slightly from the earnings recorded by ÖBf AG.

Consolidated revenues equaled € 194.7 million (2005: € 169.1 mill.) and profit on ordinary activities totaled € 18.1 million (2005: € 15.8 mill.). Investments in other companies generated € 0.8 million (2005: +0.1 mill.) of earnings (based on profit before ordinary activities). Of the € 2.3 million improvement in earnings, ÖBf AG was responsible for € 1.6 million and investments in other companies for € 0.7 million.

The positive contribution made by investments in other companies was supported by the outstanding development of the long-standing 25.1% holding in Mayr-Melnhof AG, which was highly successful with the sawmill in Leoben, Austria, and Mayr-Melnhof Holz Paskov sro, Paskov, Czech Republic. The excellent results recorded by Mayr-Melnhof offset the start-up losses reported by the investment in the eco-biomass power station in Vienna-Simmering and the full write-off of the investment in Foria Forstmanagement GmbH, which followed a shareholder resolution to dissolve this company. The remaining investments, including SWH Strom, Wärme aus Holz Heizwerke Errichtungs-Betriebs GmbH and Dachstein & Eishöhlen GmbH&Co KG, had only a minimal impact on Group results.

Transfer of pension obligations to the Republic of Austria and capital increase The pension obligations of ÖBf AG, which totaled € 100 million, were transferred to the Republic of Austria as of January 1, 2005. In exchange, ÖBf AG provided the Republic of Austria with a payment guarantee of the same amount. In the balance sheet as of December 31, 2004 this transaction is recognized as a reduction in the provisions for pensions to zero and a corresponding increase in other liabilities. The transaction was authorized by article 10 of a supplement to the Austrian Budget Act for 2005, "Amendment to the Austrian Federal Forests Act of 1996".

This law also provided for an increase in the share capital of ÖBf AG from € 14.535 million to € 150 million through the conversion of part of unappropriated capital, retroactive to December 31, 2003. At the end of the first quarter of 2005 the above-mentioned liability was paid through the transfer of € 100 million to the Republic of Austria. The funds required for this payment were raised in the form of a long-term, fixed-interest loan, which led to a corresponding increase in amounts due to financial institutions and a related change in the gearing ratio. Since this transaction only represented an exchange between interest-free debt and interest-bearing debt, the debt to equity ratio and asset coverage ratio remained largely unchanged.

Cash flow
Consolidated cash flow from operating activities totaled € 18.1 million in 2006 (2005: € 16.6 mill.). This figure includes the payment of usufructuary rights.

Development of ÖBf AG

Österreichische Bundesforste AG, as the parent company of the group and the major source of earnings, reported total output of € 205.8 million (2005: € 179.3 mill.) and profit on ordinary activities of € 17.3 million (2005: € 15.7 mill.) for the 2006 Business Year. This resulted in a clear improvement over the previous year, despite a decline of 10.2% or 154,000 m3 in sales of timber harvested by ÖBf employees and logging companies or farmers on ÖBf land. The favorable development of earnings was supported by growth in all three segments of ÖBf AG: Forestry/Timber, Property and Services.

Overview of the ÖBf segments

Forestry/Timber Segment
The core Forestry/Timber Segment generated 76.9% (2005: 77.1%) of total output recorded by ÖBf AG. As in the previous year, the development of business was influenced by a high volume of damaged timber. This situation resulted above all from a degree of bark beetle infestation that exceeded initial estimates. Specially directed measures held the total timber harvest to 1.785 million cm3, which is roughly 153,000 cm3 less than in the previous year.

In 2006 demand was extremely strong for the sustainable raw material timber by sawmill operators, industrial companies and energy producers. The improvement in average revenues during 2006 represents a continuation of the turnaround that began in 2005 after years of declining timber prices. The price level rose by 11% year-on-year.

The Forestry/Timber Segment comprises the timber supply business unit (shown separately in the table as timber logistics and raw timber production) as well as the forest technology and hunting & fisheries business units.

Property Segment
The Property Segment comprises the tourism & property (classified as rental and leasing in the table), water & ground resources and renewable energy business units. Developments in this segment during 2006 reflected the Group’s strategy, with both the volume of business and earnings showing a clear increase over 2005. Total output rose by 10.2%, while the share of total ÖBf output equaled 14.2% compared with 14.9% in 2005.

Services Segment
The Services Segment is the newest and, based on business volume, the smallest division of ÖBf. In 2006 it generated 4.2% of total output and recorded an increase of 43.3% in business. This segment contains the domestic service business unit, including domestic consulting, ecosystems management (including activities in the Donau-Auen and Kalkalpen national parks, also see the information under nature) and foreign consulting.

Earnings before interest and tax (EBIT) reached € 21.3 million in 2006 (2005: € 18.0 mill.). After the inclusion of financial results, profit on ordinary activities equaled € 17.3 million (2005: € 15.7 mill.) including usufructuary rights and € 25.5 million (2005: € 23.1 mill.) excluding usufructuary rights. Profit for the year amounted to € 16.4 million (2005: € 14.8 mill.). The Republic of Austria, as the sole owner of Österreichische Bundesforste, is entitled to receive fees for usufructuary rights equal to 50% of net profit for the year, or € 8.2 million in 2006 compared to € 7.4 million in 2005.

ÖBf defines order backlog as the demand for the raw material timber as well as the utilization of property, e.g. the leasing and rental of land and buildings.

As indicated in the description of the general market environment, ÖBf also profited from the strong demand for the raw material timber during 2006. In the core timber supply business unit, demand exceeded the sustainable volume that can be produced by ÖBf. The global market situation also led to a significant increase of 11% in average revenues recorded by ÖBf, in comparison with the 2005 Business Year.

The primary objective of leasing and rental activities is to develop the available resources continuously and carefully in harmony with general ecological conditions, and thereby meet the steadily rising demand for quantity and quality. That means the limiting factor for this area of business is also generally derived from the "production side". The total output generated by the leading and rental business units rose by 7.1% over the previous year. In 2006 these activities again recorded growth at a rate that exceeded the consumer price index by a substantial amount.

The mining business unit (gravel, stones), which is highly dependent on general economic developments and above all on the construction industry, recorded a significant improvement of 20% over the previous year.

Customer satisfaction
The first large-scale customer survey was carried out for the 2004 Business Year and resulted in a mark of 2.15 (1= best grade, 5= worst grade), which is acceptable but not quite satisfactory given the high goals of ÖBf. For this reason, measures were introduced in 2005 to improve customer satisfaction. Although the exact identification of cause and effect relationships is not possible in this area, the overall results were clearly positive. The 2005 survey brought an improvement to 1.92, which meets the goals of ÖBf (=<2).>

This value declined slightly to 2.03 in 2006. A closer analysis showed that this general decrease was clearly due to lower ratings from smaller and mid-sized timber purchasers, and primarily related to the unavailability of desired products and/or volumes – a result that is not surprising given the market situation. Nevertheless, ÖBf take these results very seriously. The survey also indicated an increase in the satisfaction of private customers. Particularly in the field of hunting and fisheries, clear improvements were achieved in comparison with the previous year.

Risk structure and risk management The company started work on the ÖBf risk management project in 2006. The goal of this undertaking is to develop an efficient system for the recognition, evaluation, management and reporting of risks. The first step involved the identification of risks that may affect ÖBf, and was based on a systematic representation of risk categories in relation to the company’s segments of business. These risks were also analyzed in connection with their relationship to business performance, financial operations, management, organizational and external factors.