Rayonier - 10-Q quarterly report FY

The unaudited financial statements reflect, in the opinion of Rayonier Inc. and subsidiaries (“Rayonier” or “the Company”), all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the results of operations, the financial position and the cash flows for the periods presented. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires the use of certain estimates by management (e.g., useful economic lives of assets) in determining the amount of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. There are risks inherent in estimating, and therefore, actual results could differ from those estimates. For a full description of the Company’s significant accounting policies, please refer to the Notes to Consolidated Financial Statements in the 2001 Annual Report on Form 10-K.

In April 2002, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 145, Rescission of FASB Statements No 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. As allowed by the FASB, the Company early adopted the Standard on April 1, 2002. During the second quarter of 2002, the Company refinanced $23.1 million of its revenue bonds. In accordance with the Standard, the write-off of the balance of the deferred financing fees of $0.2 million and the premium of $0.5 million paid upon the redemption of the original bonds were not classified as an extraordinary item in the Company’s Condensed Statements of Consolidated Income.

Certain items in prior year’s condensed consolidated financial statements have been reclassified to conform to the current year presentation.

The following table provides details of the calculation of basic and diluted earnings per common share (share and earnings per share amounts actual):

An analysis of shareholders’ equity for the six months ended June 30, 2002, and the year ended December 31, 2001, follows (share amounts actual):

Rayonier operates in three reportable segments: Performance Fibers, Timber and Land, and Wood Products and Trading.

Total assets by segment were as follows:

The amounts and relative contributions to sales and operating income (loss) attributable to each of Rayonier’s reportable segments were as follows (thousands of dollars):

Operating income (loss) as stated in the preceding tables and as presented in the Condensed Statements of Consolidated Income is equal to Segment income (loss). The income (loss) items below “Operating income” in the Condensed Statements of Consolidated Income are not allocated to segments. These items, which include interest (expense) income, miscellaneous income (expense) and income tax (expense) benefit, are not considered by Company management to be part of segment operations.

During the second quarter of 2002, the Company sold its New Zealand East Coast timberland operations and associated assets for $64.4 million. At closing the Company received $11.9 million in cash and a note receivable for $52.5 million. The note is payable in interest-bearing monthly payments through December 30, 2002. During June 2002, the Company received its first monthly installment payment of $2 million on the note receivable. Also, monthly payments have been and will be deposited in a trust, payable to Rayonier at December 30, 2002. In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the sale and results of operations were recorded as a discontinued operation. The Company recorded an after-tax loss from discontinued operations of approximately $1.3 million or $0.05 per share in the second quarter of 2002, consisting of an after-tax loss of approximately $1.7 million from the sale, net of after-tax income from East Coast operations of $0.4 million. The Condensed Statements of Consolidated Income, Condensed Statements of Consolidated Cash Flows and related Notes have been reclassified to present the East Coast operations as a discontinued operation. The East Coast operations and associated assets were previously reported in the Company’s Timber and Land and Wood Products and Trading segments.

Operating results of the discontinued operation are summarized below:

The Condensed Consolidated Balance Sheets, which have not been reclassified, include assets and liabilities of discontinued operations as follows:

A provision in the Company’s original agreement to purchase the East Coast property from the New Zealand government requires the Company, in the event of a sale, to guarantee five years of Crown Forest license obligations, estimated at $1.2 million per year. However, the purchaser (Huaguang Forests Co. Limited of China) is the primary obligor and has posted a performance bond with the New Zealand government.

The Company is exposed to various market risks, including changes in commodity prices, interest rates and foreign exchange rates. The Company’s objective is to minimize the economic impact of these market risks. Derivatives are used, as noted below, in accordance with policies and procedures approved by the Finance Committee of the Board of Directors and are managed by a senior executive committee, whose responsibilities include initiating, managing and monitoring resulting exposures. The Company does not enter into such financial instruments for trading purposes.

In our New Zealand timber operations and at our New Zealand medium density fiberboard (“MDF”) manufacturing facility, certain normal operating expenses, including contractor and license fees, care and maintenance of timberlands, salaries and wages, wood purchases and other production costs incurred in manufacturing MDF, are denominated in New Zealand dollars. Rayonier hedges US/New Zealand dollar currency rate-risk with respect to these operating expenditures (cash flow hedging).

In the Company’s Condensed Statements of Consolidated Income for the three and six months ended June 30, 2002, gains of approximately $0.1 million and $0.4 million, respectively, were recorded on foreign currency contracts reflecting primarily realized gains on contracts that matured, plus the time value changes for outstanding contracts. The Company recorded mark to market after-tax gains on foreign currency contracts of approximately $0.8 million in “Accumulated other comprehensive income (loss)” (“AOCI”) in the Condensed Consolidated Balance Sheet as of June 30, 2002. When the forecasted transactions come to fruition and are recorded, the amounts in AOCI are reclassified to the Condensed Statements of Consolidated Income. We expect to reclassify this amount into earnings during the next ten months.

At June 30, 2002, the Company held foreign currency forward contracts maturing through April 2003 totaling $11.0 million (nominal value). The largest amount of contracts outstanding during the first six months of 2002 totaled $13.1 million (nominal value).

In March 2002, the Company entered into an interest rate swap on $50 million of 6.15% fixed rate notes payable maturing in February 2004. The swap converts interest payments from fixed rates to floating rates and matures in February 2004. The interest rate swap qualifies as a fair value hedge under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. As such, the net effect from the interest rate swap is recorded as part of interest expense. The swap agreement settles every May 15, and November 15, until maturity. During the second quarter, the Company’s interest expense was reduced by $0.3 million. Based upon the current interest rates for similar transactions, the fair value of the interest rate swap agreement resulted in an asset of approximately $0.8 million and an increase in debt of approximately $0.8 million at June 30, 2002.

The Company considers the accounting for its environmental liabilities to be one of its critical accounting policies. Between 1985 and 1995, the Company sent contaminated soil excavated in connection with the cleanup of various closed wood processing sites to a third-party processor for recycling. The processing facility closed in 1995 and is the subject of a variety of environmental related charges by the EPA and the Louisiana Department of Environmental Quality. Also in dispute is disposal liability for approximately 150,000 tons of recycled material from Company sites that are still owned and retained by the processor. A consent decree was entered in 1998 approving sale of the processing facility and assumption by the buyer of responsibility for movement of all remaining recycled material to a landfill. The parties have been unable to complete the sale and the consent decree was vacated in May 2002. As a result, the status of the sale of the facility and ultimate responsibility for removal and disposal of the recycled material on-site are now uncertain. There are numerous possible outcomes, including the purchase of the facility by a third-party recycler, that will determine the Company’s ultimate liability, if any. None of these outcomes are considered sufficiently probable at this time to warrant the recognition of a liability in the Company’s financial statements. The Company is unable to formulate a range of possible losses. As such, the final outcome could have a material adverse effect on the Company’s results of operations.

The preparation of Rayonier’s financial statements requires estimates, assumptions and judgements that affect the Company’s assets, liabilities, revenues and expenses. The Company bases these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information it believes are reasonable. Actual results may differ from these estimates under different conditions. For a full description of the Company’s critical accounting policies, see the Management Discussion and Analysis in the 2001 Annual Report on Form 10-K.

Rayonier operates in three reportable segments: Performance Fibers, Timber and Land, and Wood Products and Trading. Performance Fibers includes two business units, Cellulose Specialties and Absorbent Materials. The Timber and Land segment includes two business units, Timber and Land.

The amounts and relative contributions to sales and operating income (loss) attributable to each of Rayonier’s reportable business segments were as follows (thousands of dollars):

Operating income (loss) as stated in the preceding tables and as presented in the Condensed Statements of Consolidated Income is equal to Segment income (loss). The income (loss) items below “Operating income” in the Condensed Statements of Consolidated Income are not allocated to segments. These items, which include interest (expense) income, miscellaneous income (expense) and income tax (expense) benefit, are not considered by Company management to be part of segment operations.

Sales and operating income for the second quarter of 2002 of $269 million and $40 million, respectively, were $67 and $25 million lower than the comparable period in the prior year. These declines were primarily due to a major land sale in the second quarter of 2001, that contributed $59 million in sales and $33 million in operating income. Excluding that transaction, sales decreased due to lower Performance Fibers volume, absorbent materials prices, Southeast U.S. timber volume and Northwest U.S. timber prices, but operating income increased due to lower Performance Fibers manufacturing costs, higher routine land sales and higher Northwest U.S. timber volumes.

Sales and operating income of $538 million and $67 million, respectively, for the six months ended June 30, 2002, were $68 million and $35 million lower compared to the same period in the prior year. Excluding the major land sale, sales decreased slightly due to lower Performance Fibers volume and absorbent materials prices, Southeast U.S. timber volume and U.S. timber prices, while operating income was essentially flat.

Sales for the second quarter of 2002 were $124 million, down $22 million from the prior year second quarter due to lower absorbent materials volume and prices and lower cellulose specialties volume partially due to higher in-transit shipments. Operating income for the second quarter of 2002 of $11 million was $2 million below the prior year second quarter primarily due to lower fluff pulp prices (the major component of the absorbent materials business), and volumes, partially offset by lower manufacturing costs. Fluff pulp prices are impacted by commodity market paper pulp prices, which declined during 2001 and have continued to fall during 2002 due to the sluggish global economy.

Sales for the six months ended June 30, 2002, were $253 million, $31 million below the same period in the prior year due to lower absorbent materials prices and decreases in absorbent materials and cellulose specialties volumes. Operating income for the six months ended June 30, 2002, was $17 million, $11 million below the same period in the prior year, mainly due to lower absorbent materials prices and sales volumes, partly offset by favorable manufacturing costs.

Sales of $58 million for the second quarter of 2002 were $52 million below the prior year second quarter. The decrease was primarily due to the $59 million major land sale that occurred in the second quarter of 2001 and slightly lower timber sales. Operating income of $32 million for the second quarter of 2002 was $24 million lower than the prior year second quarter due to the major land sale in 2001. Excluding the major land sale, higher volume in the Northwest U.S and higher routine land sales in 2002 more than offset lower timber volume in the Southeast U.S. and lower prices in the Northwest U.S.

Sales and operating income of $119 million and $61 million, respectively, for the six months ended June 30, 2002, were $52 million and $31 million below the same period in the prior year. These decreases were principally due to the major land sale in 2001 and lower timber prices, partly offset by higher volume in the Northwest U.S. and higher routine land sales in 2002.

Sales for the second quarter of 2002 were $91 million compared to $83 million in the prior year second quarter. The operating results for the second quarters of both 2002 and 2001 were essentially breakeven. Sales increased due to higher lumber volume attributable to increased operating hours and improved productivity as well as favorable trading activity, partly offset by lower lumber prices compared to 2001. Second quarter 2002 lumber prices were adversely impacted as a result of Canadian producers’ shipping additional lumber to the U.S. prior to the implementation of the countervailing and anti-dumping duty on Canadian shipments.

Sales for the six months ended June 30, 2002, of $173 million were $14 million above the same period in the prior year. The increase was due to higher prices and volumes for both lumber and medium-density fiberboard partially offset by lower trading activity. The operating loss of $2 million for the six months ended June 30, 2002, was $5 million favorable compared to the same period in the prior year. This was due to improved trading margins and productivity, and lower lumber manufacturing costs.

Corporate and other expenses for the second quarter of 2002 were $2 million compared to $4 million in the prior year second quarter. The improvement resulted from the favorable impact of New Zealand foreign exchange rates and lower stock price-based incentive compensation. Corporate and other expenses for the six months ended June 30, 2002, were $9 million, $2 million lower than the same period in the prior year. The decrease primarily resulted from favorable New Zealand foreign exchange rates, slightly offset by higher stock price-based incentive compensation.

Interest expense for the second quarter of 2002 was $15 million, a decrease of $2 million from the prior year second quarter mainly due to lower debt. Interest expense for the six months ended June 30, 2002, was $30 million compared to $36 million for the same period in the prior year resulting from lower debt and slightly lower rates.

Interest and miscellaneous income (expense) for the second quarter of 2002 was an expense of $0.1 million compared to income of $0.7 million in the prior year second quarter. The unfavorable variance was due principally to $0.5 million of expense in the second quarter of 2002 for redemption premiums paid to refinance a tax-exempt bond issue at favorable rates.

The effective tax rate for the second quarter of 2002 was 27.8 percent compared to 33.8 percent for the prior year second quarter. The six months ended June 30, 2002, effective tax rate was 28.0 percent compared to 33.6 percent for the same period in the prior year. During the second quarter and the six months ended June 30, 2002, the Company’s effective tax rate continued to be below the U.S. statutory and 2001 levels due to lower taxes on foreign operations.

The following table reconciles the Company’s income tax provision at the U.S. statutory tax rate to the reported provision and effective tax rate for the second quarters of 2002 and 2001 (in millions):

Income from continuing operations for the second quarter of 2002 was $18 million, or $0.62 per diluted common share, compared to $31 million, or $1.14 per diluted common share, for the prior year second quarter. The decrease is primarily due to the major land sale in 2001 partially offset by higher routine land sales in 2002 and lower interest expense and corporate and other operating costs. Income from continuing operations of $27 million, or $0.94 per diluted common share, for the six months ended June 30, 2002, was $17 million lower than the same period in the prior year. The decrease was due to the absence of the major land sale in 2001 and lower timber harvest volume, partially offset by higher routine land sales.

The Company had a loss of $1.3 million or $0.05 per share from discontinued operations in the second quarter of 2002. This consisted of income from operations of $0.4 million and a loss of $1.7 million on the sale of the discontinued operations. For the six months ended June 30, 2002, the loss from discontinued operations was $0.9 million or $0.04 per share.

The Company expects third quarter 2002 earnings to be lower than second quarter primarily due to seasonal volume declines in the Northwest U.S. timber operations.

Cash flow provided by operating activities from continuing operations of $129 million for the six months ended June 30, 2002, was $18 million lower than the same period in the prior year. The decrease was primarily from lower income in 2002 due to the absence of the major land sale, partially offset by lower working capital requirements. Cash provided by operating activities from continuing operations for the six months ended June 30, 2002, financed capital expenditures of $34 million, dividends of $20 million and debt payments of $82 million (net). Cash flow used for financing activities for the six months ended June 30, 2002, was supplemented by $14 million in new capital from the exercise of stock options, but reflected a decrease of $20 million from same period in the prior year due to higher debt repayments (net), in 2001. The Company repurchased 22,900 of its common shares during the six months ended June 30, 2002, for $1.1 million. No shares were repurchased in the first six months of 2001. Cash from discontinued operations provided an additional $19 million in 2002. On June 30, 2002, the Company had cash investments of $30.8 million, an increase of $25 million from year-end. The cash investments consisted of marketable securities with maturities at date of acquisition of 90 days or less.

The discussion below is presented to enhance the reader’s understanding of Rayonier’s ability to generate cash, its liquidity and its ability to satisfy rating agency and creditor requirements. This information includes two measures of financial results: EBITDA and Free Cash Flow. EBITDA is defined as earnings from continuing operations before significant non-recurring items, provision for dispositions, interest expense, income taxes, depreciation, depletion, amortization and the non-cash cost of land sales. Free Cash Flow is defined as EBITDA plus or minus significant non-recurring items, changes in working capital and long-term assets and liabilities (excluding the non-cash costs of land sales), less income taxes, interest expense, custodial capital spending and

EBITDA for the second quarter of 2002 was $78 million, $53 million below the prior year second quarter. The decrease was primarily due to the major land sale in 2001, which contributed $58 million to EBITDA, plus lower absorbent materials and timber prices, lower lumber and performance fibers manufacturing costs. These decreases were partly offset by higher routine land sales and lumber prices. EBITDA for the six months ended June 30, 2002, was $151 million, $56 million below the same period in the prior year, due to the major land sale in 2001.

Below is a reconciliation of Income from Continuing Operations to EBITDA for the respective periods (in millions except diluted per share amounts):

Free cash flow decreased $46 million, to $54 million for the first six months of 2002. The decrease resulted primarily from lower income in 2002 due to the absence of the 2001 major land sale and a $24 million increase in cash and short-term investments during the six months ended June 30, 2002, over the same period in the prior year. These were partially offset by lower working capital requirements.

Below is a reconciliation of Cash Provided by Operating Activities of Continuing Operations to Free Cash Flow for the respective periods (in millions except diluted per share amounts):