UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
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 1-6780
RAYONIER INC.
Incorporated in the State of North Carolina
I.R.S. Employer Identification Number 13-2607329
50 North Laura Street, Jacksonville, FL 32202
(Principal Executive Office)
Telephone Number: (904) 357-9100
Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934 during the preceding l2 months and (2) has been subject to such filing requirements for the past 90 days.
YES x NO ¨
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 filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
As of October 22, 2007, there were outstanding 78,043,723 Common Shares of the Registrant.
TABLE OF CONTENTS
PART I.
FINANCIAL INFORMATION
Item l.
Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Statements of Income and Comprehensive Income for the Three and NineMonths Ended September 30, 2007 and 2006
Condensed Consolidated Balance Sheets as of September 30, 2007 and December 3l, 2006
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007and 2006
Notes to Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
Item 6.
Exhibits
Signature
RAYONIER INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands, except per share data)
SALES
Costs and Expenses
Cost of sales (the nine months ended September 30, 2007 includes$10.1 million fire loss charge)
Selling and general expenses
Other operating (income) expense, net
Equity in income (loss) of New Zealand joint venture
OPERATING INCOME BEFORE GAIN ON SALE OFNEW ZEALAND TIMBER ASSETS
Gain on sale of New Zealand timber assets
OPERATING INCOME
Interest expense
Interest and miscellaneous income, net
INCOME BEFORE INCOME TAXES
Income tax provision
NET INCOME
OTHER COMPREHENSIVE INCOME (LOSS)
Foreign currency translation adjustment
Amortization of pension and postretirement costs
COMPREHENSIVE INCOME
EARNINGS PER COMMON SHARE
Basic earnings per share
Diluted earnings per share
See Notes to Condensed Consolidated Financial Statements.
1
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands unless otherwise stated)
CURRENT ASSETS
Cash and cash equivalents
Accounts receivable, less allowance for doubtful accounts of $963 and $560
Inventory
Finished goods
Work in process
Raw materials
Manufacturing and maintenance supplies
Total inventory
Other current assets
Timber assets held for sale
Total current assets
TIMBER, TIMBERLANDS AND LOGGING ROADS,NET OF DEPLETION AND AMORTIZATION
PROPERTY, PLANT AND EQUIPMENT
Land
Buildings
Machinery and equipment
Total property, plant and equipment
Less - accumulated depreciation
INVESTMENT IN JOINT VENTURE
OTHER ASSETS
CURRENT LIABILITIES
Accounts payable
Bank loans and current maturities
Accrued taxes
Accrued payroll and benefits
Accrued interest
Accrued customer incentives
Liability for uncertain tax positions
Other current liabilities
Current liabilities for dispositions and discontinued operations
Total current liabilities
LONG-TERM DEBT
NON-CURRENT LIABILITIES FOR DISPOSITIONS ANDDISCONTINUED OPERATIONS
PENSION AND OTHER POSTRETIREMENT BENEFITS
OTHER NON-CURRENT LIABILITIES
COMMITMENTS AND CONTINGENCIES (Notes 10 and 12)
SHAREHOLDERS’ EQUITY
Common shares, 120,000,000 shares authorized, 78,001,932and 76,879,826 shares issued and outstanding
Retained earnings
Accumulated other comprehensive loss
2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
OPERATING ACTIVITIES
Net income
Non-cash items included in net income:
Depreciation, depletion and amortization
Non-cash cost of forest fire losses
Non-cash cost of real estate sold
Non-cash stock-based incentive compensation expense
Deferred income tax benefit
Other
(Increase) decrease in accounts receivable
Decrease in inventory
(Decrease) increase in accounts payable
Decrease (increase) in other current assets
Increase in accrued liabilities
(Decrease) increase in other non-current liabilities
Increase in other non-current assets
Expenditures for dispositions and discontinued operations
CASH PROVIDED BY OPERATING ACTIVITIES
INVESTING ACTIVITIES
Capital expenditures
Purchase of timberlands and wood chipping facilities
Purchase of real estate
Proceeds from sale of portion of New Zealand timber assets
Increase in restricted cash
CASH USED FOR INVESTING ACTIVITIES
FINANCING ACTIVITIES
Issuance of debt
Repayment of debt
Dividends paid
Issuance of common shares
Repurchase of common shares
Tax benefits on stock based compensation
CASH USED FOR FINANCING ACTIVITIES
EFFECT OF EXCHANGE RATE CHANGES ON CASH
CASH AND CASH EQUIVALENTS
Increase in cash and cash equivalents
Balance, beginning of year
Balance, end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
AND NONCASH INVESTING ACTIVITIES:
Cash paid during the period:
Interest
Income taxes
Non-cash investing activity:
Capital assets purchased on account
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.
BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of Rayonier Inc. and its subsidiaries (Rayonier or the Company), reflect all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the results of operations, financial position and cash flows for the periods presented. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires the use of certain estimates by management 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; 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 2006 Annual Report on Form 10-K.
New Accounting Standards
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157). This Standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It applies to other accounting pronouncements where the FASB requires or permits fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is required to adopt SFAS 157 in the first quarter of 2008 and has not yet determined the effect, if any, that the adoption will have on its results of operations or financial position.
2.
INCOME PER COMMON SHARE
The following table provides details of the calculation of basic and diluted earnings per common share:
Shares used for determining basic earnings percommon share
Dilutive effect of:
Stock options
Performance and restricted shares
Shares used for determining diluted earnings percommon share
Basic earnings per common share:
Diluted earnings per common share:
3.
FOREST FIRES
During the second quarter of 2007, the Company recorded a $10.1 million charge ($0.13 per share) in its Timber segment’s cost of sales for realized losses and an estimate of probable losses resulting from wildfires on approximately 64,000 acres of the Company’s timberlands in Southeast Georgia and Northeast Florida. The Company’s estimate was based primarily on aerial surveys as well as sample assessments made at the ground level. Company personnel were unable to access the entire 64,000 acres at ground level, which generally provides the best estimate of damage. The Company will continue to assess the damage during the balance of the year and believes that additional losses of $1.0 million to $3.0 million for timber damaged by fire are reasonably possible.
4
4.
INCOME TAXES
The Company is a real estate investment trust (REIT); therefore, if applicable Internal Revenue Code (Code) requirements are met, only the Company’s taxable REIT subsidiaries (which operate the Company’s non-REIT qualified businesses) are subject to corporate income taxes. However, the Company is subject to corporate income tax on built-in gains (the excess of fair market value over tax basis for property held by the Company upon REIT election at January 1, 2004) on taxable sales of property during the first ten years following its election to be taxed as a REIT. In accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109), the Company estimated the amount of timberland and other assets that will be sold in taxable transactions within the ten-year built-in gain period and retained deferred tax liabilities for such items. All deferred tax liabilities and assets related to the taxable REIT subsidiaries have also been retained.
Prohibited Transactions
As a REIT, the Company can be subject to a 100 percent tax on the gain resulting from “prohibited transactions.” The Company believes it did not engage in any prohibited transactions during the nine months ended September 30, 2007 and 2006, respectively.
Like-Kind Exchanges
Under current tax law, the built-in gain tax from the sale of REIT property can be eliminated if sales proceeds from “relinquished” properties are reinvested in similar property consistent with the requirements of the Code regarding like-kind exchanges (LKE), so long as the “replacement” property is owned at least until expiration of the ten-year built-in gain period (ten-year period which began on January 1, 2004). However, this does not restrict the Company’s ability to harvest timber on a pay-as-cut basis from such replacement property during the ten-year built-in gain period.
Undistributed Foreign Earnings
The Company has undistributed foreign earnings from its non-U.S. operations, which it intends to permanently reinvest overseas. The Company also intends to reinvest all future foreign earnings overseas. Therefore, no U.S. taxes have been provided on undistributed earnings.
Provision for Income Taxes
The Company’s effective tax rate before discrete items was 9.7 percent and 14.5 percent, and 14.2 percent and 14.6 percent in the three and nine months ended September 30, 2007 and 2006, respectively. The rates decreased principally due to higher REIT income in 2007. Including discrete items, the effective tax rate was 9.6 percent and 15.2 percent, and 4.8 percent and 9.4 percent for the three and nine months ended months ended September 30, 2007 and 2006, respectively. The 2007 discrete items included a net $5.5 million charge relating to the 2003 and 2004 IRS audits, a $3.6 million benefit from reducing a valuation allowance relating to Georgia income tax credits and a favorable $2.0 million return to accrual adjustment. The 2006 discrete items included a favorable adjustment for prior year IRS audit settlements.
The Company’s effective tax rate is below the 35 percent U.S. statutory tax rate primarily due to tax benefits associated with being a REIT, including post-REIT real estate appreciation and the effect of LKE transactions. Partially offsetting these benefits is the loss of tax deductibility on: (i) interest expense ($7.1 million in the quarter), (ii) the estimated forest fire loss ($10.1 million in the nine months ended September 30, 2007), and (iii) corporate overhead expenses associated with REIT activities ($3.7 million in the quarter). The net tax benefit from REIT activities for the third quarter of 2007 was $20.1 million compared to $11.6 million in the third quarter of 2006. The Company recognized $3.6 million in LKE tax benefits during the nine months ended September 30, 2007, compared to $4.1 million in the nine months ended September 30, 2006.
5
The following tables reconcile the Company’s income tax provision at the U.S. statutory tax rate to the reported provision and effective tax rate for the three and nine months ended September 30 (millions of dollars, except percentages):
Three months ended
September 30,
Income tax provision at U.S. statutory rate
REIT income not subject to federal tax
State and local income taxes, net of federal benefit
Permanent differences/other
Income tax provision before discrete items
Taxing authority settlements and FIN 48 adjustments
Change in valuation allowance
Return to accrual adjustments
Deferred tax adjustments/other
Income tax provision as reported
Nine months ended
Tax Audits
The following table provides detail of the tax years that remain subject to examination by the Internal Revenue Service (IRS) and other significant taxing jurisdictions:
Taxing Jurisdiction
U.S. Internal Revenue Service
State of Florida
State of Georgia
State of Alabama
New Zealand Inland Revenue
In the third quarter of 2006, the Company reached a settlement with the IRS regarding disputed issues for its 2000, 2001 and 2002 tax years, resulting in the reversal of $4.9 million of federal tax liabilities previously established for these years. As a result of the settlement, the Company recorded a tax refund receivable of approximately $8.2 million (plus interest) which was received in the third quarter of 2007.
6
In the third quarter of 2007, the IRS completed its examination of tax years 2003 and 2004. The Company is disputing one issue related to the taxability of a timberland sale the Company treated as an involuntary conversion in its 2003 tax year. The Company recorded a net discrete tax expense of $5.5 million as a result of the disputed issue and agreement on other tax issues.
The Company has other matters under review by various taxing authorities, including the examination of tax years 2005 and 2006 by the IRS. The Company believes its reported tax positions are technically sound and its uncertain tax position liabilities at September 30, 2007 adequately reflect the probable resolution of these items.
FIN 48 Disclosures
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (FIN 48), clarifies the accounting for uncertain tax positions recognized in an enterprise’s financial statements in accordance with SFAS 109. It prescribes a recognition threshold and measurement criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, it provides guidance on derecognition, classification, and interest and penalties. The Company adopted FIN 48 on January 1, 2007, which did not result in an adjustment to its opening balance of retained earnings. The disclosures associated with the adoption and the underlying uncertain tax positions follow:
(a)
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate at January 1, 2007 and September 30, 2007 is $5.1 million and $11.4 million, respectively.
(b)
The Company has recorded interest on the above unrecognized tax benefits of $1.1 million at January 1, 2007 and $3.2 million at September 30, 2007. The Company records interest (and penalties, if applicable) in non-operating expenses.
(c)
It is reasonably possible that within 12 months of September 30, 2007 the following unrecognized tax benefits could significantly decrease:
(i)
U.S. federal tax issues relating to the deemed taxability of foreign income.
•
The event that would cause such a change is the acceptance of IRS examination report for tax years 2005 – 2006.
An estimate of the reasonably possible change is a decrease of $0.9 million.
(ii)
U.S. federal tax issues relating to the deductibility of certain expenditures.
The event that would cause such a change is the completion of the IRS examination of tax years 2005 – 2006.
An estimate of the reasonably possible change is a decrease of $0.3 million.
(iii)
U.S. federal tax issues relating to utilization of foreign tax credits.
An estimate of the reasonably possible change is a decrease of $1.0 million.
(d)
It is reasonably possible that within 12 months of September 30, 2007 the following uncertain tax position could result in a change in tax benefits previously recognized:
U.S. federal tax issues relating to the taxability of a timberland sale treated as an involuntary conversion.
The event that would cause such a change is the settlement of the disputed issue at the Appeals administrative review level for tax year 2003.
An estimate of the range of the reasonably possible change is an increase of $4 million to a decrease of $2 million.
7
5.
RESTRICTED DEPOSITS
In order to qualify for LKE treatment, cash proceeds from real estate sales must be deposited with a third party intermediary and accounted for as restricted cash until qualifying replacement property is acquired. In the event that LKE purchases are not completed, the proceeds are returned to the Company and reclassified as cash after 180 days. As of September 30, 2007 and December 31, 2006, the Company had $1.6 million and $1.2 million, respectively, of proceeds from real estate sales classified as restricted cash in “Other assets,” which were on deposit with an LKE intermediary.
6.
An analysis of shareholders’ equity for the nine months ended September 30, 2007 and the year ended December 31, 2006 is shown below:
(Share and per share amounts not in thousands)
Balance, December 31, 2005
Dividends ($1.88 per share)
Issuance of shares under incentive stock plans
Stock-based compensation expense
Minimum pension liability adjustments
Tax benefit on stock-based compensation
Impact of adopting SFAS No. 158
Balance, December 31, 2006
Dividends ($1.44 per share)
Balance, September 30, 2007
7.
JOINT VENTURE INVESTMENT
The Company holds a 40 percent interest in a joint venture (JV) that owns approximately 351,000 acres of New Zealand timberlands, which is accounted for using the equity method of accounting. In addition to the Company having an equity investment, Rayonier New Zealand Limited (RNZ), a wholly-owned subsidiary of Rayonier Inc., serves as the manager of the JV forests, for which it receives a fee. Income from the JV is reported in the Timber segment as operating income since the Company manages the forests and its JV interest is an extension of its operations. While the JV is subject to New Zealand income taxes, its timber harvest operations are held within the REIT; therefore, the Company generally is not required to pay U.S. federal income taxes on its equity investment income.
A portion of the Company’s equity method investment is recorded at historical cost which generates a difference between the book value of the Company’s investment and its proportionate share of the JV’s net assets. The difference represents the Company’s unrecognized gain from RNZ’s sale of timberlands to the JV. The deferred gain is being recognized on a straight-line basis over nine years (the estimated number of years the JV expects to harvest from the timberlands).
8
On June 30, 2006, the Company sold 9.72 percent of its interest in the JV to AMP Capital Investors Limited, a subsidiary of the Australian Corporation AMP Limited, thereby reducing its investment in the JV from 49.72 percent to 40 percent. The Company received approximately $21.8 million in cash proceeds and recorded an after-tax gain of $6.5 million, or $0.08 per common share.
The Company’s investment in the JV was $62.6 million and $61.2 million, at September 30, 2007 and December 31, 2006, respectively. For the three and nine months ended September 30, 2007, the Company’s equity in earnings from the JV were $0.2 million and $1.2 million, respectively. For the three and nine months ended September 30, 2006, the Company’s equity in the JV’s losses were $0.1 million and $1.0 million, respectively.
8.
SEGMENT INFORMATION
Rayonier operates in four reportable business segments as defined by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131): Timber, Real Estate, Performance Fibers, and Wood Products. Timber sales include all activities that relate to the harvesting of timber. The Real Estate segment includes the sale of all properties, including timberlands and those designated for higher and better use (HBU). In 2006, the Real Estate segment entered into two participation agreements with developers as part of the Company’s strategy to move up the real estate value chain and, in the future, the Real Estate segment may also include revenue generated from properties with entitlements and infrastructure improvements. The assets of the Real Estate segment include HBU property held by TerraPointe LLC (TerraPointe), Rayonier’s wholly-owned real estate development subsidiary, and timberlands under contract to be sold, as previously reported in the Timber segment. Allocations of depletion expense and the non-cash cost basis of real estate sold are recorded when the Real Estate segment reports the sale of an asset from the Timber segment. The Performance Fibers segment includes two major product lines: Cellulose Specialties and Absorbent Materials. The Wood Products segment is comprised of the Company’s lumber operations. The Company’s remaining operations include purchasing, harvesting and selling timber acquired from third parties (log trading) and trading wood products. As permitted by SFAS 131, these operations are combined and reported in an “Other” category. Sales between operating segments are made based on fair market value and intercompany profit or loss is eliminated in consolidation. The Company evaluates financial performance based on the operating income of the segments.
Total assets, sales, operating income (loss) and depreciation, depletion and amortization by segment including corporate were as follows:
ASSETS
Timber (a)
Real Estate
Performance Fibers
Wood Products
Other Operations
Corporate and Other
TOTAL
In the third quarter 2007, the Company elected not to sell the forestry rights for $35 million of timber parcels located in Arkansas, Louisiana, Alabama and Texas and incorporated these parcels into its timberland management program. These parcels, which were acquired in the fourth quarter 2006, were previously stated as assets held for sale.
9
Timber
Corporate and other
OPERATING INCOME (LOSS)
DEPRECIATION, DEPLETION AND AMORTIZATION
Timber (b)
Nine months ended September 30, 2007 includes the $10.1 million estimated forest fire loss. Nine months ended September 30, 2006 includes the $7.8 million gain on sale of New Zealand timber assets.
Nine months ended September 30, 2007, includes the $9.6 million of non-cash cost related to forest fire losses.
Operating income (loss), as stated in the preceding tables and as presented in the Condensed Consolidated Statements of Income and Comprehensive Income, is equal to segment income (loss). Certain income (loss) items below “Operating income” in the Condensed Consolidated Statements of Income and Comprehensive 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.
10
9.
FINANCIAL INSTRUMENTS
Interest Rate Swap Agreements
Rayonier Forest Resources, L.P. (RFR), a wholly-owned subsidiary of Rayonier Inc., previously entered into an interest rate swap on $40 million of 8.288 percent fixed rate notes payable which matures on December 31, 2007. The swap converts interest payments from the fixed rate to six month LIBOR plus 4.99 percent and qualifies as a fair value hedge under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). As such, the net effect from the interest rate swap is recorded as interest expense. The interest rate differentials on the swap agreement settle every June 30 and December 31, until maturity. During the three and nine months ended September 30, 2007, this swap agreement increased interest expense by $0.2 million and $0.6 million, respectively. During the three and nine months ended September 30, 2006, this swap agreement increased the Company’s interest expense by $0.2 million and $0.5 million, respectively. Based upon current interest rates for similar transactions, the fair value of the interest rate swap agreement at September 30, 2007 and December 31, 2006 resulted in a liability of approximately $0.2 million and $0.8 million, respectively, with corresponding decreases in debt.
In addition, RFR holds an interest rate swap on $50 million of 8.288 percent fixed rate notes payable which also matures on December 31, 2007. The swap converts interest payments from the fixed rate to a six month LIBOR plus 4.7825 percent rate and qualifies as a fair value hedge under SFAS 133. As such, the net effect of the interest rate swap is recorded in interest expense. The swap agreement settles every June 30 and December 31, until maturity. During the three and nine months ended September 30, 2007, this swap agreement increased the Company’s interest expense by $0.3 million and $0.8 million, respectively. During the three and nine months ended September 30, 2006, this swap agreement increased the Company’s interest expense by $0.3 million and $0.6 million, respectively. Based upon current interest rates for similar transactions, the fair value of the interest rate swap agreement at September 30, 2007 and December 31, 2006 resulted in a liability of approximately $0.3 million and $0.9 million, respectively, with corresponding decreases in debt.
Commodity Swap Agreements
The Company enters into commodity forward contracts to fix some of its fuel oil and natural gas costs at its Performance Fibers mills. The Company’s commodity forward contracts do not qualify for hedge accounting under SFAS 133 and instead are required to be marked-to-market.
During the three and nine months ended September 30, 2007, the Company realized gains of $0.1 million and $0.3 million, respectively, on matured fuel oil forward contracts. The realized gains recorded on fuel oil forward contracts maturing during the three and nine months ended September 30, 2006 were $0.4 million and $1.5 million, respectively. At September 30, 2007, there were no outstanding fuel oil contracts. The mark-to-market valuation of outstanding fuel oil forward contracts at December 31, 2006 resulted in a liability of $0.4 million. The mark-to-market adjustments are recorded in “Other operating income/expense.”
During the three and nine months ended September 30, 2007, the Company realized a deminimus loss and gain, respectively, on matured natural gas forward contracts. During the three and nine months ended September 30, 2006, the Company realized losses of $0.2 million and $0.6 million, respectively, on matured natural gas forward contracts. At September 30, 2007, there were no outstanding natural gas contracts. At December 31, 2006, there was a $0.1 million liability associated with outstanding natural gas contracts. The mark-to-market adjustments are recorded in “Other operating income/expense.”
10.
GUARANTEES
The Company provides financial guarantees as required by creditors, insurance programs and foreign governmental agencies. As of September 30, 2007, the following financial guarantees were outstanding:
Standby letters of credit (1)
Guarantees (2)
Surety bonds (3)
Total
11
(1)
Approximately $62 million of the standby letters of credit serve as credit support for industrial revenue bonds. The remaining letters of credit support obligations under various insurance related agreements, primarily workers’ compensation and pollution liability policy requirements. These letters of credit expire at various dates during 2007 and are typically renewed as required.
(2)
In August 2006, the Company entered into a $250 million unsecured revolving credit facility. Under this agreement, the Company guarantees the borrowings of its subsidiaries, RFR and Rayonier TRS Holdings Inc. (TRS), and TRS guarantees the borrowings of the Company. At September 30, 2007, the TRS had $65.0 million of outstanding borrowings on the revolving credit facility guaranteed by the Company.
In conjunction with the sale of RNZ’s timberlands to the JV in October 2005, the Company guaranteed five years of Crown Forest license obligations. The JV is the primary obligor and has posted a bank performance bond with the New Zealand government. If the JV fails to pay the obligation, the New Zealand government will demand payment from the bank that posted the bond. The Company would have to perform if the bank defaulted on the bond. A deminimus liability, representing Rayonier’s obligation to perform, was recorded in accordance with FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. As of September 30, 2007, three annual payments, of $1.2 million each, remain. This guarantee expires in 2010.
In conjunction with a timberland sale and note monetization in the first quarter of 2004, the Company issued a make-whole agreement pursuant to which it guaranteed $2.5 million of obligations of a qualified special purpose entity that was established to complete the monetization. At September 30, 2007 and December 31, 2006, the Company has recorded a deminimus liability to reflect the fair market value of its obligation to perform under the make-whole agreement.
(3)
Rayonier has issued surety bonds primarily to secure timber in the State of Washington and to provide collateral for the Company’s workers’ compensation self-insurance program in that state. These surety bonds expire at various dates during 2007 and are renewed as required.
(4)
See Note 15 – Subsequent Event for information on guarantees associated with the October 2007 debt offering.
11.
LIABILITIES FOR DISPOSITIONS AND DISCONTINUED OPERATIONS
The Company’s dispositions and discontinued operations include its Port Angeles, WA mill, which was closed in 1997; Southern Wood Piedmont Company (SWP), which ceased operations in 1989 except for investigation and remediation activities; Eastern Research Division (ERD), which ceased operations in 1981; and other miscellaneous assets held for disposition. SWP has been designated a potentially responsible party (PRP), or has had other claims made against it, under the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and/or other federal or state statutes relating to the investigation and remediation of environmentally-impacted sites, with respect to ten former wood processing sites which are no longer operating.
An analysis of activity in the liabilities for dispositions and discontinued operations for the nine months ended September 30, 2007 and the year ended December 31, 2006, is as follows:
Balance, January 1,
Expenditures charged to liabilities
(Reductions)/additions to liabilities
Less: Current portion
Non-current portion
12
Rayonier has identified specific liabilities for three SWP sites (Augusta, GA, Spartanburg, SC, and East Point, GA) and Port Angeles, WA as material and requiring separate disclosure, which was presented in the Company’s 2006 Annual Report on Form 10-K. There have not been any significant changes in these sites’ estimated liabilities for the nine months ended September 30, 2007, and therefore separate disclosure is not presented herein. For an analysis of the liability activity for the three years ended December 31, 2006 and a brief description of these individually material sites, see the Company’s 2006 Annual Report on Form 10-K, Note 15 to Consolidated Financial Statements.
The Company currently estimates that expenditures for environmental remediation, monitoring and other costs for all dispositions and discontinued operations in 2007 and 2008 will be approximately $10 million and $7 million, respectively. Such costs will be charged against liabilities for dispositions and discontinued operations, which include environmental investigation, remediation and monitoring costs. The Company believes established liabilities are sufficient for costs expected to be incurred over the next 20 years with respect to its dispositions and discontinued operations. Remedial actions for these sites vary, but can include, among other remedies, removal of contaminated soils, groundwater recovery and treatment systems, and source remediation and/or control.
In addition, the Company is exposed to the risk of reasonably possible additional losses in excess of the established liabilities. As of September 30, 2007, this amount could range up to $30 million and arises from uncertainty over the effectiveness of treatments, additional contamination that may be discovered, changes in applicable law and the exercise of discretion in interpretation of applicable law and regulations by governmental agencies, and in environmental remediation technology.
The reliability and precision of cost estimates for these sites and the amount of actual future environmental costs can be impacted by various factors, including but not limited to significant changes in discharge or treatment volumes, requirements to perform additional or different remediation, changes in environmental remediation technology, the extent of groundwater contamination migration, additional findings of contaminated soil or sediment off-site, remedy selection, and the outcome of negotiations with federal and state agencies. Additionally, a site’s potential for “brownfields” (environmentally impacted site considered for re-development), or other similar projects, could accelerate expenditures as well as impact the amount and/or type of remediation required, as could new laws, regulations and the exercise of discretion in interpretation of applicable law and regulations by governmental agencies. Based on information currently available, the Company does not believe that any future changes in estimates, if necessary, would materially affect its consolidated financial position or results of operations.
12.
CONTINGENCIES
From time to time, Rayonier may become liable with respect to pending and threatened litigation and environmental and other matters. The following updates or repeats commentary included in the 2006 Annual Report on Form 10-K.
The Company has been named as a defendant in various lawsuits and claims arising in the normal course of business. While we have procured reasonable and customary insurance covering risks normally occurring in connection with our businesses, we have in certain cases retained some risk through the operation of self-insurance, primarily in the areas of workers compensation, property insurance, and general liability. In our opinion, these other lawsuits and claims, either individually or in the aggregate, are not expected to have a material effect on our financial position, results of operations, or cash flow.
In 1998, the U.S. Environmental Protection Agency (EPA) and the New Jersey Department of Environmental Protection (DEP) filed separate lawsuits against Rayonier Inc., and approximately 30 other defendants, in the U.S. District Court, District of New Jersey, seeking recovery of current and future response costs and natural resource damages under applicable federal and state law relating to a contaminated landfill in Chester Township, New Jersey, referred to as Combe Fill South (Combe). It is alleged that the Company’s former ERD in Whippany, New Jersey sent small quantities of dumpster waste, via a contract hauler, to Combe in the 1960s and early 1970s. The Company is working with other defendants in a joint defense group, which subsequently filed third-party actions against over 200 parties seeking contribution. A court-ordered, nonbinding alternative dispute resolution process has been ongoing for several years and, in March of 2006, a court-appointed neutral issued a report and recommendations. While settlement discussions have been active during the past quarter, no final agreement has yet been reached. The Company believes that its liabilities at September 30, 2007 adequately reflect the probable costs to be incurred upon the ultimate resolution of these matters.
13
Environmental Matters
The Company is subject to stringent environmental laws and regulations concerning air emissions, water discharges, waste handling and disposal, forestry operations, and real estate development. Such environmental laws and regulations include the Federal Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, as amended, CERCLA, the Endangered Species Act and similar state laws and regulations, and various state and local laws and regulations affecting forestry and real estate. Management closely monitors its environmental responsibilities, and believes that the Company is in substantial compliance with current environmental requirements. Notwithstanding Rayonier’s current compliance status, many of its operations are subject to stringent and constantly evolving environmental requirements which are often the result of legislation, regulation and negotiation. As such, contingencies in this area include, without limitation:
The Company’s manufacturing facilities operate in accordance with various permits, which often impose operating conditions that require significant expenditures to ensure compliance. Upon renewal and renegotiation of these permits, the issuing agencies often seek to impose new or additional conditions, which could adversely affect our operations and financial performance.
As environmental laws and regulations change, and administrative and judicial interpretations of new and existing laws and regulations are made, our operations may be adversely affected. For example, at our Performance Fibers mills, implementation of the EPA’s 1998 “Cluster Rules” (parallel rulemaking for air and water-based technology discharge limits for pulp and paper mills) with respect to certain portions of dissolving pulp mills has been delegated to the respective states, and since they have not yet been proposed, the timing and ultimate costs are uncertain.
In our forestry operations, federal, state and local laws and regulations intended to protect threatened and endangered animal and plant species and their habitat, as well as wetlands and waterways, limit, and in some cases may prevent, timber harvesting, road construction and other activities on private lands. For example, Washington, where the Company holds approximately 370,000 acres of timberlands, has among the most stringent forestry laws and regulations in the country.
Environmental requirements relating to real estate development, and especially in respect of wetland delineation and mitigation, stormwater management, drainage, waste disposal, and potable water supply and protection, may significantly impact the size, scope, timing, and financial returns of our projects. Moreover, multiple permits and approvals are often required for a project, and may involve a lengthy application process.
Over time, the complexity and stringency of environmental laws and regulations have increased significantly, and the cost of compliance with these laws and regulations has also increased. Similarly, the investigatory and remedial standards and requirements relating to our discontinued operations continue to tighten over time. In general, management believes these trends will continue.
Given all of these contingencies, it is the opinion of management that substantial expenditures will be required over the next ten years in the area of environmental compliance. See Note 11 – Liabilities for Dispositions and Discontinued Operations for additional information regarding the Company’s environmental liabilities.
13.
EMPLOYEE BENEFIT PLANS
The Company has four qualified non-contributory defined benefit pension plans which collectively cover substantially all of its employees and an unfunded plan that provides benefits in excess of amounts allowable under current tax law in the qualified plans. Employee benefit plan liabilities are calculated using actuarial estimates and management assumptions. These estimates are based on historical information, along with certain assumptions about future events. Changes in assumptions, as well as changes in actual experience, could cause the estimates to change.
The Company closed enrollment in its pension and postretirement medical plans to salaried employees hired after December 31, 2005. Salaried employees hired after December 31, 2005 are automatically enrolled in the Company’s 401(k) plan and receive an enhanced retirement contribution.
14
The net periodic benefit cost for the Company’s pension and postretirement plans (medical and life insurance) for the three and nine months ended September 30, 2007 and 2006 are shown in the following table:
Components of Net Periodic Benefit Cost
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of losses
Net periodic benefit cost
The Company does not have any required pension plan contributions for 2007; however, the Company made a discretionary contribution of $20 million during the third quarter of 2007. Further contributions are not expected in the fourth quarter of 2007.
14.
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Accumulated Other Comprehensive Income (Loss) was comprised of the following as of September 30, 2007 and December 31, 2006:
Foreign currency translation adjustments
Unrecognized components of employee benefit plans, net of tax
During the nine months ended September 30, 2007, the net foreign currency translation adjustments were due to changes in the New Zealand to U.S. dollar exchange rate. After-tax amortization of unrecognized components of employee pension and postretirement plans of $1.4 million and $3.9 million was recognized during the three and nine months ended September 30, 2007, respectively.
15
15.
SUBSEQUENT EVENT
In October 2007, Rayonier TRS Holdings Inc. issued $300 million of 3.75% Senior Exchangeable Notes due 2012. The notes are guaranteed by Rayonier Inc., are non-callable, and are exchangeable by holders for cash and, in certain circumstances, common stock of Rayonier Inc. The initial exchange rate is 18.24 shares per $1,000 principal based on an exchange price equal to 122% of our stock’s closing price of $44.93 on October 10, 2007. In order to limit potential dilution to Rayonier shareholders, TRS and Rayonier Inc. entered into separate exchangeable note hedge and warrant transactions which will have the effect of increasing the conversion premium from 22% to 40% or to $62.90 per share. We will use a portion of the net proceeds of the offering to repay in full indebtedness outstanding under our revolving credit facility and to repay a $112.5 million note maturing on December 31, 2007.
In connection with this offering, the Company is providing the following condensed consolidating financial information in accordance with SEC Regulation S-X Rule 3-10 Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered. Each entity in the consolidating financial information follows the same accounting policies as described in the consolidated financial statements, except for the use of the equity method of accounting to reflect ownership interests in subsidiaries which are eliminated upon consolidation and the allocation of certain expenses of Rayonier Inc., incurred for the benefit of its subsidiaries.
The following condensed consolidating financial information presents the balance sheets as of September 30, 2007 and December 31, 2006, the statements of income for the three and nine months ended September 30, 2007 and 2006, and the statements of cash flows for the nine months ended September 30, 2007 and 2006 for the parent guarantor (Rayonier Inc.), the issuer (Rayonier TRS Holdings Inc.), the subsidiary non-guarantors and consolidating adjustments.
16
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
Three Months Ended
September 30, 2007
Cost of sales
Selling and generalexpenses
Other operating (income)expense, net
Equity in income (loss) of NewZealand joint venture
OPERATING (LOSS)INCOME
Interest, dividends andmiscellaneous income(expense), net
Equity in income fromsubsidiaries
INCOME BEFORE INCOMETAXES
September 30, 2006
Equity in (loss) income ofNew Zealand joint venture
Interest, dividends andmiscellaneous income, net
Income tax benefit(provision)
17
Cost of sales (includes $10.1 million fire loss charge)
Other operating income, net
Equity in income of New Zealandjoint venture
OPERATING (LOSS)INCOME BEFORE GAINON SALE OFNEW ZEALANDTIMBER ASSETS
Gain on sale of New Zealandtimber assets
18
CONDENSED CONSOLIDATING BALANCE SHEETS
Accounts receivable, less allowancefor doubtful accounts
Intercompany interest receivable
TIMBER, TIMBERLANDS ANDLOGGING ROADS, NETOF DEPLETION AND AMORTIZATION
PROPERTY, PLANTAND EQUIPMENT, NET
INVESTMENT IN SUBSIDIARIES
INTERCOMPANY/NOTES RECEIVABLE
TOTAL ASSETS
LIABILITIES ANDSHAREHOLDERS’ EQUITY
Current liabilities for dispositionsand discontinued operations
NON-CURRENT LIABILITIESFOR DISPOSITIONS ANDDISCONTINUED OPERATIONS
PENSION AND OTHERPOSTRETIREMENT BENEFITS
INTERCOMPANY PAYABLES
TOTAL LIABILITIES
TOTAL SHAREHOLDERS’ EQUITY
TOTAL LIABILITIES ANDSHAREHOLDERS' EQUITY
19
TIMBER, TIMBERLANDS AND LOGGINGROADS, NET OF DEPLETION ANDAMORTIZATION
PROPERTY, PLANT AND EQUIPMENT, NET
LIABILITIES AND SHAREHOLDERS’EQUITY
Payable to Parent
Current liabilities for dispositions anddiscontinued operations
DEFERRED INCOME TAXES
NON-CURRENT LIABILITIES FORDISPOSITIONS AND DISCONTINUEDOPERATIONS
PENSION AND OTHER POSTRETIREMENTBENEFITS
INTERCOMPANY PAYABLE
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
20
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Equity in income from investments insubsidiaries
Non-cash stock-based incentive compensationexpense
Deferred income tax (expense) benefit
Dividends from investments in subsidiaries
Decrease in accounts payable
Decrease in other current assets
Increase (decrease) in accrued liabilities
Change in intercompany accounts
Expenditures for dispositions and discontinuedoperations
CASH PROVIDED BY OPERATINGACTIVITIES
Proceeds from sale of timberlands
Distributions to parent
21
Decrease (increase) in accounts receivable
Increase (decrease) in accounts payable
Increase in other current assets
Increase (decrease) in other non-current liabilities
Decrease (increase) in other non-current assets
Proceeds from sale of New Zealand timber assets
22
Safe Harbor
Except for historical information, the statements made in this Quarterly Report are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. These forward-looking statements, which include statements regarding anticipated earnings, revenues, volumes, pricing, costs and other statements relating to Rayonier’s financial and operational performance, in some cases are identified by the use of words such as “may,” “will,” “should,” “expect,” “estimate,” “believe,” “anticipate” and other similar language. The following important factors, among others, could cause actual results to differ materially from those expressed in the forward-looking statements contained in this release: the cyclical and competitive nature of the forest products and real estate industries; fluctuations in demand for, or supply of, our performance fibers products, timber, wood products or real estate and entry of new competitors into these markets; changes in energy and raw material prices, particularly for our performance fibers and wood products businesses; changes in global market trends and world events, including those that could impact customer demand; changes in environmental laws and regulations, including laws regarding air emissions and water discharges, remediation of contaminated sites, delineation of wetlands, timber harvesting, and endangered species, that may restrict or adversely impact our ability to conduct our business; the lengthy, uncertain and costly process associated with the ownership or development of real estate, especially in Florida, which also may be affected by changes in law, policy and other political factors beyond our control; changes unexpected delays in the entry into or closing of real estate transactions; adverse weather conditions, including natural disasters, affecting our timberland and the production, distribution and availability of raw materials such as wood, energy and chemicals; our ability to identify and complete timberland and higher value real estate acquisitions; the geographic concentration of a significant portion of our timberlands; changes in key management and personnel; interest rate and currency movements; our capacity to incur additional debt; changes in import and export controls or taxes; our ability to continue to qualify as a REIT and to fund distributions using cash generated through our taxable REIT subsidiaries; the ability to complete like-kind-exchanges of timberlands and real estate; changes in tax laws that could reduce the benefits associated with REIT status; and additional factors described in the company’s most recent Form 10-K on file with the Securities and Exchange Commission. Rayonier assumes no obligation to update these statements except as may be required by law.
Critical Accounting Policies and Use of Estimates
The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect our assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information we believe are reasonable. Actual results may differ from these estimates under different conditions. For a full description of our critical accounting policies, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2006 Annual Report on Form 10-K.
Segment Information
We operate in four reportable business segments as defined by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131): Timber, Real Estate, Performance Fibers, and Wood Products. Timber sales include all activities that relate to the harvesting of timber. Real Estate sales include the sale of all properties, including timberlands and those designated for higher and better use (HBU). In 2006, the Real Estate segment entered into two participation agreements with two developers as part of our strategy to move up the real estate value chain and, in the future, the Real Estate segment may also include revenue generated from properties with entitlements and infrastructure improvements. The assets of the Real Estate segment include HBU property held by TerraPointe LLC (TerraPointe), the Company’s wholly-owned real estate development subsidiary, and timberlands under contract to be sold, as previously reported in the Timber segment. Allocations of depletion expense and non-cash costs of land sold are recorded when the Real Estate segment sells an asset from the Timber segment. The Performance Fibers segment includes two major product lines, Cellulose Specialties and Absorbent Materials. The Wood Products segment is comprised of lumber operations. Our remaining operations include purchasing, harvesting and selling timber acquired from third parties (log trading) and trading wood products. As permitted by SFAS 131, these operations are combined and reported in an “Other” category. Sales between operating segments are made based on fair market value and intercompany profit or loss is eliminated in consolidation. We evaluate financial performance based on the operating income of the segments.
Due to the Company’s 2006 timberland acquisitions in five new states (Oklahoma, Arkansas, Texas, Louisiana, and New York), the Company has renamed its Timber segment regions from Southern and Northwestern to Eastern and Western, respectively. The Eastern region represents the Company’s operations in Florida, Georgia, Alabama, Oklahoma, Arkansas, Texas, Louisiana, and New York, while the Western region represents the Company's operations in Washington.
23
Operating income (loss), as stated in the following table and as presented in the Consolidated Statements of Income and Comprehensive Income, is equal to segment income (loss). The income (loss) items below “Operating income” in the Consolidated Statements of Income and Comprehensive Income are not allocated to segments. These items, which include interest, miscellaneous income (expense) and income tax (expense) benefit, are not considered by management to be part of segment operations.
Results of Operations, Three and Nine Months Ended September 30, 2007 Compared to Three and Nine Months Ended September 30, 2006.
Financial Information (in millions)
Sales
Development
Rural
Total Real Estate
Cellulose Specialties
Absorbent Materials
Total Performance Fibers
Other operations
Intersegment Eliminations
Total Sales
Operating Income (Loss)
Corporate and other expenses / eliminations
Total Operating Income
Interest Expense
Interest / Other income
Net Income
Diluted Earnings Per Share
For the nine months ended September 30, 2007, Timber segment operating income includes the $10.1 million fire loss charge. For the nine months ended September 30, 2006, Timber segment operating income reflects the $7.8 million gain on sale of New Zealand timber assets.
24
Overall Timber sales for the three and nine months ended September 30, 2007 increased from the prior year periods due to higher pulpwood and salvage timber volumes in the Eastern region partly offset by reduced sawlog volumes in the Western region and lower Eastern region pine prices.
The Eastern region’s volumes increased 62 percent and 30 percent, respectively, for the three and nine months ended September 30, 2007 primarily due to our 2006 timberland acquisitions, sales of salvage timber from the second quarter forest fires and strong market demand for pulpwood. Average pine prices declined for the three and nine months by 28 percent and 16 percent, respectively, due to the sales of salvage timber and the downturn in the housing market.
The Western region’s volumes decreased slightly for the three and nine months ended September 30, 2007, respectively, as a result of the slowdown in the housing market.
Sales (in millions)
Three months ended September 30,
Nine months ended September 30,
Operating income for the Timber segment was below prior year periods primarily due to lower average prices and reduced margins due to sales mix in the Eastern region.
Operating Income (in millions)
*
For the nine months ended September 30, 2007, operating income includes the $10.1 million fire loss. In addition, 2006 operating income included the $7.8 million gain on sale of New Zealand timber assets.
Our real estate holdings in the Southeast have been segregated into two groups: development properties and rural properties. Development properties are predominantly located in the eleven coastal counties between Savannah, GA and Daytona Beach, FL, while the rural properties essentially include the balance of our ownership in the Southeast. Our Northwest U.S. real estate sales comprise the Other category.
During the three month periods ended September 30, sales and operating income increased primarily as a result of 3,100 acres of rural property sold in west central Florida for $46.6 million. For the nine month periods, sales and operating income improved primarily due to increased rural prices in 2007, while development prices and volumes declined. In 2007, we shifted our focus from sales of development lands to entitling activities.
25
For the three and nine months ended September 30, 2007, cellulose specialty sales improved by approximately $17 million and $43 million, respectively. Market demand for cellulose specialties resulted in average price increases of 7 percent and 10 percent, for the three and nine month periods, respectively. Volumes improved due to the timing of customer orders and fewer scheduled maintenance days.
Due to heavy demand in the fluff pulp market, sales prices for absorbent materials increased 12 percent and 11 percent, for the three and nine month periods ended September 30, 2007, respectively. Volume increased in the three month period primarily due to the timing of customer orders. For the nine month period, volume declined as a result of increased scheduled maintenance days. The result of these changes is an overall increase in absorbent material sales of $8 million and $5 million for the three and nine month periods, respectively.
26
Operating income in 2007 improved by $22 million and $54 million for the three and nine month periods ending September 30, 2007, respectively, primarily due to price increases and lower costs.
Sales decreased compared to the prior year periods due to lower prices and volume. The 4 and 19 percent decline in lumber prices for the three and nine months ended September 30, 2007 resulted primarily from reduced demand in the housing market.
For the nine months ended September 30, 2007, operating income decreased compared to the prior year period due to lower prices and volume partially offset by lower wood costs. For the quarter, operating results improved primarily due to lower wood costs.
Operating Income/Loss (in millions)
Total Operating (Loss)/Income
Total Operating Income/(Loss)
Sales of $15 million and $65 million for the third quarter and year-to-date periods, respectively, were $17 million and $34 million below the prior year periods reflecting the impact of the closure of our International Wood Products trading business in February 2007. Operating income was essentially the same comparing the three month periods, but lower comparing the nine month periods, primarily due to the absence of coal royalties.
Corporate and Other Expenses / Eliminations
Corporate and Other Expenses of $9 million and $26 million for the three and nine months ended September 30, 2007, respectively, were $2 million higher than the prior year periods due to higher stock-based and other incentive compensation.
Other Income / Expense
Interest expense increased for the three and nine months ended September 30, 2007 compared to the prior year periods due to higher average debt levels and $2.3 million of interest accrued related to uncertain tax positions.
Interest/Other income declined by $2 million and $3 million for the three and nine month periods in 2007, primarily due to lower average cash balances.
27
The Company's effective tax rate before discrete items was 9.7 percent and 14.5 percent, and 14.2 percent and 14.6 percent in the three and nine months ended September 30, 2007 and 2006, respectively. The rates decreased principally due to higher REIT income in 2007. Including discrete items, the effective tax rate was 9.6 percent and 15.2 percent, and 4.8 percent and 9.4 percent for the three and nine months ended months ended September 30, 2007 and 2006, respectively. The 2007 discrete items included a net $5.5 million charge relating to the 2003 and 2004 IRS audits, a $3.6 million benefit from reducing a valuation allowance relating to Georgia income tax credits and a favorable $2.0 million return to accrual adjustment. The 2006 discrete items included a favorable adjustment for prior year IRS audit settlements. See Note 4 - Income Taxes for additional information regarding the provision for income taxes.
Outlook
We expect 2007 earnings to be between $2.25 and $2.32 per share, excluding special items.
Liquidity and Capital Resources
Cash Flows
Operating Activities
Operating cash flows increased $41 million to $264 million during the nine months ended September 30, 2007. The increase was as a result of higher net income adjusted for non-cash items (primarily depreciation, depletion and amortization, the non-cash costs of real estate sold and stock-based incentive compensation expense).
Investing Activities
Investing cash outflows were $16 million below prior year as a result of lower capital expenditures and purchases of real estate partially offset by the absence of proceeds from the sale of a portion of our New Zealand joint venture. Strategic acquisitions in 2007 included the purchase of wood chipping facilities and timberlands ($12 million), while the prior year consisted of timberland purchases ($9 million).
Financing Activities
Financing cash flows of $129 million were $27 million above prior year. Discretionary debt repayments of $39 million were made in the current year compared to $2 million of required repayments in 2006. Dividend payments were up $4 million primarily as a result of a 6.4 percent increase in the third quarter 2007 dividend to $0.50 per common share up from $0.47 per common share. The debt repayments and increase in dividends more than offset the increase in proceeds from issuing common shares and excess tax benefits from stock-based compensation.
Cash and cash equivalents totaled $92 million and $40 million as of September 30, 2007 and December 31, 2006, respectively, and consisted primarily of marketable securities with maturities at date of acquisition of 90 days or less. At September 30, 2007, debt was $622 million, $37 million below the December 31, 2006 balance of $659 million. Our debt-to-capital ratio at September 30, 2007 was 38.7 percent, a favorable decrease from the December 31, 2006 ratio of 41.7 percent. We have $113 million of installment notes that mature on December 31, 2007, which we intend to refinance with proceeds from the $300 million Senior Exchangeable Notes offering issued by Rayonier TRS Holdings Inc. in October. See Liquidity Facilitiesfor additional information regarding the debt offering.
We made a $20 million discretionary pension contribution during the first nine months of 2007 compared to $12 million during the comparable 2006 period. No additional contributions are expected during the fourth quarter of 2007. Income tax payments totaled $10 million during the nine months ended September 30, 2007 compared to $23 million in 2006. Full year 2007 income tax payments, net of refunds, of $28 million are expected, approximately $11 million below 2006 primarily due to refunds received in the third quarter related to prior year tax audit settlements. Capital expenditures are expected to range from $92 to $95 million in 2007. Pre-tax spending for environmental costs related to dispositions and discontinued operations was $7 million for the nine months ended September 30, 2007; full year expenditures of $10 million are anticipated.
28
Liquidity Performance Indicators
The discussion below is presented to enhance the reader’s understanding of our ability to generate cash, our liquidity and ability to satisfy rating agency and creditor requirements. This information includes two measures of financial results: Earnings before Interest, Taxes, Depreciation, Depletion and Amortization (EBITDA), and Adjusted Cash Available for Distribution (Adjusted CAD). These measures are not defined by Generally Accepted Accounting Principles (GAAP) and the discussion of EBITDA and Adjusted CAD is not intended to conflict with or change any of the GAAP disclosures. We consider these measures to be important to estimate the enterprise and shareholder values of Rayonier as a whole and of its core segments, and for allocating capital resources. In addition, analysts, investors and creditors use these measures when analyzing our financial condition and cash generating ability. EBITDA is defined by the Securities and Exchange Commission (SEC); however, Adjusted CAD as defined may not be comparable to similarly titled measures reported by other companies.
EBITDA is a non-GAAP measure of our operating cash generating capacity. For the nine months ended September 30, 2007, EBITDA was $328 million, $67 million above the prior year period reflecting higher operating income generated from both the Performance Fibers and Real Estate segments. Below is a reconciliation of Cash Provided by Operating Activities to EBITDA for the respective periods (in millions of dollars):
Cash Provided by Operating Activities
Non-cash cost basis of real estate sold
Income tax expense
Interest expense, net
Working capital decreases
Other balance sheet changes
EBITDA
A non-cash expense impacting the economics of our Real Estate business is the non-cash cost basis of real estate sold. EBITDA plus the non-cash cost basis of real estate sold for the three and nine months ended September 30, 2007 and 2006 totaled $133.7 million and $104.5 million, and $335.6 million and $271.5 million, respectively.
Adjusted CAD is a non-GAAP measure of cash generated during a period that is available for dividend distribution, repurchasing our common shares, debt reduction and for strategic acquisitions net of associated financing (e.g. realizing like-kind exchange benefits). We define Cash Available for Distribution (CAD) as Cash Provided by Operating Activities less capital spending, adjusted for equity based compensation amounts, the tax benefits associated with certain strategic acquisitions, the change in committed cash and other items which include the proceeds from matured energy forward contracts and the change in capital expenditures purchased on account. Committed cash represents outstanding checks that have been drawn on our zero balance bank accounts but have not been paid. In compliance with SEC requirements for non-GAAP measures, we also reduce CAD by mandatory debt repayments resulting in the measure entitled “Adjusted CAD.”
29
Adjusted CAD for the nine months ended September 30, 2007 was $216 million, $72 million above the prior year period. The increase is due to higher cash earnings (due mostly to the Performance Fibers and Real Estate segments) and lower capital spending and working capital requirements. The Adjusted Cash Available for Distribution generated in the current period is not necessarily indicative of amounts that may be generated in future periods. Below is a reconciliation of Cash Provided by Operating Activities to Adjusted CAD (in millions of dollars):
Cash provided by Operating Activities
Capital spending
Decrease in committed cash
Equity-based compensation adjustments
LKE tax benefits
Cash Available for Distribution
Mandatory debt repayments
Adjusted Cash Available for Distribution
Primarily 2006 interest paid in 2007 and previously reflected as a reduction in 2006 Adjusted CAD.
Liquidity Facilities
In October 2007, Rayonier TRS Holdings Inc. issued $300 million of 3.75% Senior Exchangeable Notes due 2012. The notes are guaranteed by Rayonier Inc., are non-callable, and are exchangeable by holders for cash and, in certain circumstances, common stock of Rayonier Inc. The initial exchange rate is 18.24 shares per $1,000 principal based on an exchange price equal to 122% of our stock's closing price of $44.93 on October 10, 2007. In order to limit potential dilution to Rayonier shareholders, TRS and Rayonier Inc. entered into separate exchangeable note hedge and warrant transactions which will have the effect of increasing the conversion premium from 22% to 40% or to $62.90 per share. We will use a portion of the net proceeds of the offering to repay in full indebtedness outstanding under our revolving credit facility and to repay a $112.5 million note maturing on December 31, 2007. See Note 15 – Subsequent Event for additional information regarding the debt offering.
In August 2006, we entered into a $250 million unsecured revolving credit facility to replace the previous facility which was scheduled to expire in November 2006. This facility includes an accordion feature which allows additional borrowing above $250 million, in $25 million increments, up to an aggregate $100 million, provided no default exists. The facility expires in August 2011. At September 30, 2007, the available borrowing capacity was $178 million (excluding the accordion feature), primarily due to borrowings to purchase timberlands in the fourth quarter of 2006, and $7 million attributable to previously issued standby letters of credit.
The credit facility requires us to meet certain covenants, including ratios based on the facility’s definition of EBITDA (Covenant EBITDA). Covenant EBITDA consists of earnings before the cumulative effect of accounting changes and any provision for dispositions, income taxes, interest expense, depreciation, depletion, amortization and the non-cash cost basis of real estate sold. A dividend restriction covenant limits the sum of dividends in any period of four fiscal quarters to 90 percent of Covenant Funds From Operations (Covenant FFO) plus the aggregate amount of dividends permitted under Covenant FFO in excess of the amount of dividends paid during the prior four fiscal quarters. Covenant FFO is defined as Consolidated Net Income, excluding gains or losses from debt restructuring and investments in marketable securities, plus depletion, depreciation and amortization and the non-cash cost basis of real estate sold. Under a covenant relating to $485 million of installment notes, Rayonier Forest Resources, L.P. (RFR), a wholly-owned REIT subsidiary, may not incur additional debt unless, at the time of incurrence and after presenting the pro forma effects relating to the receipt and application of the proceeds of such debt, RFR meets or exceeds a minimum ratio of cash flow to fixed charges.
In addition to the financial covenants listed above, the installment notes and credit facility include customary covenants that limit the incurrence of debt, the disposition of assets, and the making of certain payments between RFR and Rayonier among others. An asset sales covenant in the RFR installment note-related agreements requires us, subject to certain exceptions, to either reinvest cumulative timberland sales proceeds in excess of $100 million (the “excess proceeds”) in timberland-related investments and activities or, once the amount of excess proceeds not reinvested exceeds $50 million, to make an offer to the note holders to prepay the notes ratably in the amount of the excess proceeds. During September 2007, the excess proceeds exceeded $50 million and as a result, $84 million was offered to the note holders in October 2007. The note holders have until November 26, 2007 to respond and management believes their decision will not materially affect the liquidity of the Company. At December 31, 2006, the excess proceeds were approximately $10 million.
30
In May 2007, we completed a Form S-3 universal registration statement to offer debt securities, preferred stock, common stock, warrants and guarantees of Rayonier Inc., debt securities and guarantees of Rayonier TRS Holdings Inc. and debt securities and guarantees of Rayonier Forest Resources, L.P.
The covenants listed below, which are the most significant financial covenants in effect as of September 30, 2007, are calculated on a trailing 12-month basis:
Covenant EBITDA to consolidated interest expense should not be less than
Total debt to Covenant EBITDA should not exceed
RFR cash flow available for fixed charges to RFR fixed charges should not be less than
Dividends paid should not exceed 90 percent of Covenant FFO
Contractual Financial Obligations and Off-Balance Sheet Arrangements
No material changes to guarantees or financial instruments such as letters of credit and surety bonds occurred during the first nine months of 2007. See Note 10 - Guarantees, for details on the letters of credit, surety bonds and total guarantees outstanding as of September 30, 2007.
Segment EBITDA
EBITDA is also used for evaluating segment cash return on investment, allocating resources and for valuation purposes. EBITDA by segment is a critical valuation measure used by the Chief Operating Decision Maker, existing shareholders and potential shareholders to measure how management is performing relative to the assets with which they have been entrusted. EBITDA by segment for the three and nine months ended September 30, 2007 and 2006 was as follows (millions of dollars):
31
The following tables reconcile Cash Provided by Operating Activities by segment to EBITDA by segment:
Three Months Ended September 30, 2007
Cash provided by operating activities
Less: Non-cash cost basis of real estate sold
Add: Income tax expense
Interest, net
Working capital (decreases) increases
Three Months Ended September 30, 2006
Nine Months Ended September 30, 2007
Nine Months Ended September 30, 2006
Add: Gain on sale of New Zealand timber assets
32
The following tables provide sales volumes by segment:
Western U.S., in millions of board feet
Eastern U.S., in thousands of short green tons
Acres sold
Northwest U.S.
Sales Volume
Cellulose specialties, in thousands ofmetric tons
Absorbent materials, in thousands ofmetric tons
Production as a percent of capacity
Lumber
Sales volume, in millions of board feet
The following tables provide sales by geographic location:
Geographical Data (Non-U.S.)
New Zealand
Operating income (loss)
Western U.S.
Eastern U.S.
Operating income
Eastern U.S. *
New Zealand **
Operating income for the nine months ended September 30, 2007 includes the $10.1 million forest fire loss.
**
Operating income for the nine months ended September 30, 2006 includes a $7.8 million gain from the sale of New Zealand timber assets.
33
Market Risk
We are exposed to various market risks, including changes in interest rates, commodity prices and foreign exchange rates. Our objective is to minimize the economic impact of these market risks. We use derivatives in accordance with policies and procedures approved by the Finance Committee of the Board of Directors; derivatives are managed by a senior executive committee whose responsibilities include initiating, managing and monitoring resulting exposures. We do not enter into financial instruments for trading or speculative purposes.
Cyclical pricing of commodity market paper pulp ultimately influences Performance Fibers prices, particularly in the Absorbent Materials product line. However, since we are a non-integrated producer of specialized Performance Fibers for non-papermaking end uses, our high-value product mix tends to lag (on both the upturn and downturn) commodity paper pulp prices with peaks and valleys that are less severe.
The fair market value of our long-term fixed interest rate debt is subject to interest rate risk; however, we intend to hold most of our debt until maturity. We periodically enter into interest rate swap agreements to manage exposure to interest rate changes. These swaps involve the exchange of fixed and variable interest rate payments without exchanging principal amounts. At September 30, 2007, we had two interest rate swap agreements, both maturing in December 2007, which resulted in a liability with a fair market value of $0.5 million. Generally, the fair market value of fixed-interest rate debt will increase as interest rates fall and decrease as interest rates rise.
We periodically enter into commodity forward contracts to fix some of our fuel oil and natural gas costs; however, at September 30, 2007, there were no outstanding commodity forward contracts for fuel oil or natural gas. The forward contracts partially mitigate the risk of a change in Performance Fibers margins resulting from an increase or decrease in these energy costs. We do not enter into commodity forwards for trading or speculative purposes. The net amounts paid or received under the contracts are recognized as an adjustment to fuel oil or natural gas expense. Our natural gas and fuel oil contracts do not qualify for hedge accounting and as such mark-to-market adjustments are recorded in “Other operating income, net.” See Note 9 – Financial Instruments for gains and losses recognized from such contracts.
Primarily all of our revenues and expenses are U.S. dollar-denominated. However, the JV is subject to the risks of foreign currency fluctuations (See Note 7 – Joint Venture Investment for additional information on the JV). At September 30, 2007, there were no outstanding forward foreign currency contracts to purchase New Zealand dollars.
For a full description of our market risk, please refer to Item 7,Management Discussion and Analysis of Financial Condition and Results of Operations, in the 2006 Annual Report on Form 10-K.
Rayonier management is responsible for establishing and maintaining adequate disclosure controls and procedures. Disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(c) and 15d-15(c) of the Securities Exchange Act of 1934 (the “Exchange Act”)), are designed with the objective of ensuring that information required to be disclosed by the Company in reports filed under the Exchange Act, such as this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Because of the inherent limitations in all control systems, no control evaluation can provide absolute assurance that all control exceptions and instances of fraud have been prevented or detected on a timely basis. Even systems determined to be effective can provide only reasonable assurance that their objectives are achieved.
Based on an evaluation as of the end of the period covered by this quarterly report on Form 10-Q, our management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the design and operation of the disclosure controls and procedures were effective as of September 30, 2007.
In the quarter ended September 30, 2007, based upon the evaluation required by paragraph (d) of SEC Rules 13a – 15 and 15d – 15, there were no changes in our internal controls over financial reporting that would materially affect or are reasonably likely to materially affect our internal control over financial reporting.
34
PART II. OTHER INFORMATION
See Notes 11 and 12 of the Notes to Condensed Consolidated Financial Statements set forth in Part I of this Report, which are hereby incorporated by reference.
There were no material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2006. For a full description of these risk factors, please refer to Item 1A – Risk Factors, in the 2006 Annual Report on Form 10-K.
The Company is authorized, through its Common Share repurchase program, to repurchase 2,449,749 and 2,444,227 shares as of September 30, 2007 and December 31, 2006, respectively. There were no shares repurchased during the three months ended September 30, 2007.
Not applicable.
No matter was submitted to a vote of security holders of Rayonier during the third quarter of 2007.
4.1
Purchase Agreement dated as of October 10, 2007 among Rayonier TRS Holdings Inc., Rayonier Inc. and Credit Suisse Securities (USA) LLC, as representative of the several purchasers named therein
Incorporated by reference fromthe registrant’s October 17, 2007Form 8-K.
4.2
Indenture related to the 3.75% Senior Exchangeable Notes due 2012, dated as of October 16, 2007, among Rayonier TRS Holdings Inc., as issuer, Rayonier Inc., as guarantor, and The Bank of New York Trust Company, N.A., as trustee.
4.3
Registration Rights Agreement, dated October 16, 2007 among Rayonier TRS Holdings Inc., Rayonier Inc. and Credit Suisse Securities (USA) LLC, as representative of the several purchasers named herein.
4.4
Convertible Bond Hedge Transaction Confirmation, dated October 10, 2007 between Credit Suisse Capital LLC, as dealer, represented by Credit Suisse Securities (USA) LLC, as agent, and Rayonier TRS Holdings Inc.
4.5
Convertible Bond Hedge Transaction Confirmation, dated October 10, 2007 between JP Morgan Chase Bank, National Association, London Branch and Rayonier TRS Holdings Inc.
4.6
Issuer Warrant Transaction Confirmation dated October 10, 2007 between Credit Suisse Capital LLC, as dealer, represented by Credit Suisse Securities (USA) LLC ,as agent, and Rayonier Inc.
4.7
Issuer Warrant Transaction Confirmation dated October 10, 2007 between JP Morgan Chase Bank, National Association, London Branch, as dealer, and Rayonier Inc.
Incorporated by reference fromthe registrant’s October 17, 2007 Form 8-K
35
4.8
Issuer Warrant Transaction Amendment dated October 15, 2007 between Rayonier Inc. and Credit Suisse Capital LLC, as dealer, represented by Credit Suisse Securities (USA) LLC, as agent.
4.9
Issuer Warrant Transaction Amendment dated October 15, 2007 between Rayonier Inc. and JP Morgan Chase Bank, National Association, London Branch, as dealer.
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
Filed Herewith
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
Certification pursuant to Section 906 of the Sarbanes-Oxley Act
36
SIGNATURE
Pursuant to the requirements of Section 13 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.
By:
/s/ HANS E. VANDEN NOORT
Hans E. Vanden Noort
Senior Vice President andChief Financial Officer
October 26, 2007
37