Rayonier Inc (RYN) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the Rayonier second quarter earnings release conference call. [OPERATOR INSTRUCTIONS] At this time for opening remarks and introductions I would like to turn the call over to Senior Vice President, Mr. Hans Vanden Noort. Please go ahead, sir.

Thank you and good afternoon. Welcome to Rayonier's investor teleconference covering second quarter earnings. Our earnings statements and supplemental materials were released this morning and are available on our website at rayonier.com. With us today are Lee Nutter, Chairman, President and CEO, and Tim Brannon, Senior Vice President and head of our Forest Resources and Wood Products businesses. Let me remind you that in these presentations we include forward-looking statements made pursuant of the Safe Harbor provisions of the federal securities laws. Our earnings release as well as our form 10-K filed with the SEC list some of the factors which may cause actual results to differ materially from the forward-looking statements we may make. They're also repeated on page two of our supplemental material. Please familiarize yourselves with them. This conference is being webcast and can be reached through our home page. Let's start the program with opening comments from Lee Nutter. Lee?

Thank you, Hans. I'll make a few comments here. Hans will then take you through the financials and Tim Brannon will review those markets at that business segment. Today I'll discuss Real Estate and Performance Fibers. Second quarter results across the board reflect the strength and balance of our three core businesses where demand and prices remain strong for our high value sale of specialty products and timber. In Real Estate the mix of development versus real properties reflect the transition in our strategy of moving further up the value chain, as well as to some extent the timing of transactions which, as you know, is reflective of the nature of this business. Interest in our higher value properties remains high. The outlook for the second half of the year is good and, as I've indicated on several occasions, it should be much stronger than the first half.

This would be mainly due to stronger operating results in Real Estate and Performance Fibers. As you might surmise for the year, overall results excluding special items are expected to be above 2005. We remain well positioned in our core businesses and this, coupled with our strong balance sheet and cash flow, will enable us to opportunistically grow our timber business and thus further expand our Real Estate subsidiary TerraPointe. With that, let me turn it back over to Hans for review of the financials.

Thank you, Lee. Before we go through our typical discussion of this quarter's earnings compared to prior periods, let us review page three of the supplemental material where we itemize various special items that we believe should be taken into account when analyzing the current periods' earnings. At the top of the page we highlighted the gain on the sale of a portion of our investment in the New Zealand joint venture. This sale, which reduced our ownership to 40% from 49.7%, yielded an after tax gain of 6.5 million or $0.08 per share. Adjusting for this item results in second quarter pro forma earnings of 36.3 million or $0.47 per share and year-to-date pro forma earnings of 59.6 million or $0.77 per share. The bottom half of page three indicates special items in the prior year's periods. The first item is the impairment charge and loss from operations of our MDF business of $0.32 per share, which was sold last year and characterized as a discontinued operation.

The second line item is the impact of IRS audit settlements which contributed $0.10 per share in the second quarter of 2005 and $0.22 per share for the first six months. Adjusting for these items, results in second quarter 2005 pro forma earnings per share of $0.44 and for last year's six month period pro forma earnings per share of $0.77. These pro forma amounts will be the basis for the comparisons on the following pages. With that, let's turn to page four for overall financial highlights. Second quarter results were strong, with sales, operating income, and pro forma earnings all exceeding the comparative periods. Sales of 312 million were 35 million above the prior quarter and 22 million above second quarter 2005, with improved Timber, Real Estate, and Performance Fiber sales driving this increase. Leading Tim will go into the key drivers behind that revenue movement. Operating income of 51 million was approximately 14 million above first quarter 2006 and two million above second quarter 2005. We'll go into more detail on individual segment variances in the following pages.

Pro forma income from continuing operations of $0.47 per share, was $0.17 above the first quarter and $0.03 above the second quarter of 2005. On the bottom half of page four we provide a outline of cash resources and liquidity for the six months ended June 30th. Cash provided by operating activities of 133 million was above last year's amount, mostly due to lower working capital requirements. Cash use for investing activities of 48 million was slightly above last year, as 18 million of increased capital expenditures and 4 million of timber land acquisitions were offset by the 22 million in proceeds from the previously mentioned sale of a portion of our investment in the New Zealand joint venture. Cash use for financing activities up 66 million, was 40 million above 2005, which included an increase in debt of 28 million. Also, current year dividends to date are about 10 million above last year. Adjusted EBITDA of 159 million was 15 million below the prior six month period. All cash available for distribution of 82 million was below last year by 14 million. We'll look at CAD separately a little bit later.

Our debt and debt to capital were comparable to year-end and we ended the quarter with approximately $165 million in cash. Turning to page five we show a comparison of second quarter to first quarter earnings. We begin with $0.30 per share from the first quarter and come down to our second quarter pro forma earnings of $0.47 per share. Our timber operations had a strong quarter with increased volumes and prices in the northwest leading the way. Our Real Estate results were slightly improved, primarily due to increased rural acres sold. Continuing down the page, we can see a $5 million improvement this quarter for our Performance Fibers business unit driven by improved cellulose specialties prices and volumes, net of somewhat higher costs. In corporate and other deposited variance includes lower stock based incentive compensation accruals.

Let's then move to page six to briefly review the year-over-year variances. To begin with last year's second quarter pro forma earnings of $0.44 per share, which excludes the 7.2 million tax benefit that resulted from settling the prior year's tax audits. Overall timber land results were significantly improved the prior year driven by higher prices in the U.S. and increased volumes in the northwest. Real Estate earnings were comparable. Performance Fibers results reflect strength in prices and sales of specialties. However, this improvement was more than offset by increased energy, wood fiber and chemical costs, as well as lower volume resulting primarily from start-up difficulties early in the second quarter from a scheduled maintenance shutdown. Wood Products results were 4 million below prior year due to declining lumber prices. In Corporate and Other we were 2 million favorable with lower stock-based compensation the single largest contributor. Moving below operating income we benefited from lower interest expense from reduced average debt levels and favorable interest income resulting from increased cash balances.

Finally, we were 3 million unfavorable on tax expense excluding like kind exchanges as last year included a benefit from a foreign exchange loss on unrepatriated earnings. These amounts bring us to the current quarter's results of $0.47 per share. The major causal factors for the business units second quarter variances generally apply to the six month period. Additionally, note that Real Estate operating income to date is 5 million below last year. As Lee mentioned, we expect our second half Real Estate sales, particularly of development acres, to be significantly above the first half of the year. Let's now turn to page seven for a brief discussion on cash available for distribution. On this page we reconcile from cash provided by operating activities, which is a GAAP measure, to our metric of cash available for distribution or CAD. We deduct capital expenditures from cash provided by operating activities and then adjust for any equity related cash flows like kind exchange tax benefits and changes in committed cash, to arrive at we consider operationally generated cash available for distribution.

As expected, CAD for the first six months was below the comparable prior year period, primarily due to higher level of capital spending. As we mentioned on last quarter's call, we're investing in a Performance Fibers mills to significantly reduce our fuel oil consumption and expect full year capital expenditures to be approximately 20 million above normal levels. With that, let me turn the conference over to Tim to begin covering markets and operations.

Thanks, Hans. For the northwest on page nine, volumes were up sequentially as well as compared to second quarter 2005. Prices improved compared to the first quarter 2006 and were on a par with the second quarter 2005 as log supply was generally tight in the region due to adverse weather conditions and limited log imports from Canada. For the third quarter, prices are expected to remain steady while volumes are expected to be down sequentially as they typically are in the third quarter. Although they are expected to be above third quarter 2005. For the year, both prices and volumes are expected to be steady with last year. Moving on to the southeast on page 10, as expected volumes were down somewhat sequentially as well as compared to last year's second quarter. Prices eased compared to the first quarter, but were above second quarter 2005 levels. The relatively dry weather so far this year in the southeast has resulted in a slight increase in supply. That, coupled with the recent decline in lumber prices, has put some downward pressure on pine timber prices.

For the third quarter, prices are expected to remain steady. Volumes are expected to be below second quarter, but generally in line with last year's third quarter levels. As noted on the last call, for the year we are still expecting prices to be up on average about 10%, while volumes are expected to be down about 3%. Now, I'll turn the call over to Lee for comments on Real Estate and Performance Fibers.

Thank you, Tim. I'll briefly discuss those two items and then move on to our outlook to some extent for the third quarter and to some extent for the balance of the year. As always, as we all know, much can happen between now and the end of the year, so please keep that in mind. For Real Estate, before I go into these operating details, let me remind you that by the nature and structure of this core business, there is likely to be variability quarter to quarter, as well as year-to-year, and second quarter is a good example of this phenomenon on the development as well as rural side were sales of rural acres were up while the sale of development acres were down. The sale of fewer development acres in the second quarter was a function of timing and not markets. Second quarter results were comparable to both first quarter as well as second quarter 2005. Third quarter results are expected to be well above second quarter as well as third quarter of 2005.

For the year, all else being equal, we're expecting operating results from Real Estate sales to be considerably above that of last year. Also both recent data and anecdotal evidence suggest a slow-down in housing and to some extent development activities. Frankly, as I noted on the last call, we have not felt any direct negative impact on our Florida-Georgia coastal development properties or on the rural side of the TerraPointe business. Due to land entitlements taking several years in our region, especially in Florida, most successful developers realize that attractive land is required throughout a housing cycle. Turning to pages 11 and 12, you see the segment results which generally are based on geography and markets. Development properties are located primarily in the 11 coastal counties between Savannah, Georgia, and Daytona Beach, Florida. Rural properties lie basically throughout the balance of our ownership in the southeast. Overall, we continue to see good demand for both of our development and rural properties.

Also, we continue to have discussions with various parties about joint participation opportunities on several strategic parcels. Development sales on page 11 for the second quarter consisted of one small commercial property transaction. However, as you can see, the four-quarter rolling weighted average has continued to move up. Also, as we discussed on prior calls, a large majority of the development contracts are scheduled to close in the third and fourth quarters. Obviously I can't give specific guidance on future closings or negotiations in progress, however, we continue to be positive about our development sales program for the second half of this year. Along with direct sales we continue to make progress on contracts with developers in which Rayonier will participate in post-entitlement value creation. Rural sales on page 12 for the second quarter consists of approximately 24 separate transactions which included approximately 4300 acres of lower-quality, scattered, non-strategic parcels located in north central Florida.

These properties were sold to multiple buyers by an auction at prices well above their value as timber lands. The market for rural properties seems to have little correlation to housing starts. Looking out, it's difficult to predict to what extent softening housing markets will have on Real Estate business. And while we're not immune to those factors, the location of our higher value properties in northeast Florida and coastal Georgia, where much of the development is for primary home buyers and where job and population growth is positive, the demand for our development property is solid. Moving on to Performance Fibers. Business that continues to perform well with strong demand for our sale of specialties as we manage through rising energy and raw material costs. On page 13 you can see the sequential pickup on our cellulose specialties prices, which includes an energy surcharge implemented on a majority of our sales specialties business. Fluff prices, albeit to a lesser extent, were also up compared to first quarter and down slightly from second quarter of last year.

I expect third quarter fluff prices to be up and slightly below last year's third quarter. I happen to believe there is more upside near term for fluff prices than we are projecting. Overall pricing in Performance Fiber's business segment for the third quarter is to be up slightly from the second quarter levels you see here. On page 14 you can see the second quarter increase in cellulose specialties volume partially offset by a slight commensurate decrease in absorbent materials volume. As you may be aware, cellulose specialties represents approximately 65% of our sales volume, but 75% of our revenue. On July 13th we announced that we had secured long-term contracts with the world's largest manufacturers of acetate based products into 2011 for nearly 80% of our high value cellulose specialty production representing almost 2 million tons and over $2 billion in annual revenue at today's prices. This is the first time in this business we have contracted for such a high percentage and within terms that are advantages to both Rayonier and these very large and long-term customers. Let's go back to Tim now for a quick look at our lumber operations.

Thanks, Lee. Turning to lumber on page 15, we have seen market prices decline across the board in recent weeks. In this relatively small part of Rayonier's overall business, you can see that prices were down in the second quarter, while lumber volumes were up. For the third quarter, prices are expected to weaken further, while volumes should remain steady. For the year, volumes should be up about 6% while average prices are expected to be down as much as 15% from the strong 2005 levels. Now, let me turn the call back to Hans.

Thanks, Tim. Before we close with our guidance, let us turn to page 16 where we've included a chart on the projected tax characteristics of this year's dividends. As you can see, we currently expect 100% of the dividend to be characterized as capital gain. The results from a planned intercompany sale of Real Estate, the REIT to our taxable REIT subsidiary generating significant gain at the REIT, although this is eliminated in consolidation for financial reporting purposes. In 2005, as you may recall, about 79% of the dividend was characterized as capital gain with the remainder a return of capital. With that, let's turn to page 17 to review earnings trends. At this point we're focusing on the third quarter and full-year 2006. Based on current market conditions, we expect third quarter earnings to be above second quarter's pro former earnings of $0.47 per share. On a sequential basis the increase is driven primarily by anticipated improvement in Real Estate and particularly stronger development sales in Performance Fibers, offsetting our normal third quarter Timber decline.

On a full year basis, we expect pro forma earnings to be above our 2005 pro forma EPS of $1.57 per share driven primarily by improved Real Estate and Performance Fibers results in the second half of the year. Before I close, I'd like to share a few key statistics that are relevant to some of you in maintaining your forecast models for Rayonier. First, for full year 2006, we expect depletion, depreciation and amortization, and the non-cash cost basis of land sold to range from 140 to $145 million. Capital expenditures, excluding acquisitions, are expected to total about 107 million, well above our typical 85 to 90 million target level. This increase reflects the Performance Fibers projects noted earlier which will significantly reduce our oil consumption. With respect to our investment in New Zealand, for the year we expect break-even results from the joint venture. However, because of the way the joint venture is structured we expect to realize cash flow in the 4 to 5 million range, in addition to the 22 million realized on the sell down of our interest to 40%. With that, let me turn back to Lee for some summary comments.

I will conclude here by saying that we are well positioned and expect third quarter results, as we've said earlier, to be up sequentially as well as compared to third quarter 2005, excluding special items, primarily due to the timing of Real Estate transactions. For the year, we expect earnings to be above 2005. As you might surmise, second half of '06 is expected to be much stronger than the first half. Again, mainly due to higher Real Estate operating results, particularly from transactions involving our high-valued development properties and stronger Performance Fibers results. Our portfolio of businesses combined with a strong cash flow, balance sheet, and tax efficient restructure, allows us to very aggressively pursue timber land purchase opportunities. Acquisitions of which do two things for us, they obviously increase the size of our timber land base, but of equal importance they allow us to very significantly reduce the tax on our higher and better use timber lands by moving it down to a Real Estate subsidiary. With that, let's go back to Hans.

Thank you, Lee. With that, I'd like to close the formal part of the presentation and turn the teleconference back to the conference operator for questions from the audience.

[OPERATOR INSTRUCTIONS] We'll go first to Chip Dillon with Citigroup.

Yes, good afternoon. I got several. I might have just missed this but you all were good enough to give us some of your expectations for the full year change in price and volumes and I got the southeast Timber, but what was the northeast? Did you give that--northwest, I'm sorry?

In terms of the northwest the volumes basically are expected to be pretty much on par year-over-year and we're anticipating that in terms of price, again, reasonably flat, looking at year-over-year.

Okay. And, now, but the southeast obviously we got to see some comeback from where prices are now to get to that 10%. Is that right?

The pricing level that we have been experiencing in the southeast, it certainly has been stronger in the first half than we have experienced last year. So we're expecting not to be harder this year than last. Am I answering your question?

Maybe it is in the packet somewhere. Are you up 10% year-over-year so far in price in the southeast?

Anticipating that we would be about 10% above year-over-year.

Right. But are you there--are you already at that rate so far in the first half versus the first half of '05? In other words, do you have to go up further to get to that, or not?

No, we're already there. We're already meeting that price level.

And then as you have--in fact, one thing that might help you and I just wanted to ask, there is several OSB plants going in, I know, in South Carolina and Georgia, three in particular that start up in the next 12 to 15 months. And maybe in some of the other parts of the south, are you all talking to those people about increasing your -- assuming or even establishing a relationship with these people to supply them?

Chip, as I think you know, of course, we -- our timber is sold on a stumpage basis in the southeast and we would certainly expect that the advent of these new mills and the expansions that are coming on are certainly going to be good news for us going into the future. We expect that demand will be up, yes.

Okay. Some of this timber that you are selling on the stump, of course, would be pulpwood and not all just saw timber.

That's correct.

That is very helpful. And then it was intriguing, the announcement of a couple weeks ago or about a week ago on the Performance Fibers, it looks like that, if I understand, that does not involve any of the fluff but it's all the dissolving specialty. If that is correct, it would seem to almost account for all your volume. Can you just talk a little bit about how the pricing will be determined on that contract with the Chinese customer?

Well, Chip, it's for basically five customers, the Chinese just happen to be the last one we signed with. It is about 80% of our acetate business, which is very core of our sale specialties. Prices in that business have and will continue to be negotiated on an annual basis. There is some parameters around them that are fairly tight. And this is really, I think, as I said earlier in my comments, this is the first time we've ever been able to put in place five-year contracts with kind of pricing mechanisms that are in there. I think it's good for both sides. I mean, we know where our volume is going to go. They know from where it is going to come from. Of course, they're very large and certainly those five represent probably 80% of the world production of acetate. So it is very good and we're -- it is a nice thing for us to have in place.

What will determine when the price mechanism changes? Is it in the contract itself that if something changes in the world that the price will go up or down?

Yes, there's number of factors, without getting into specifics, that said it, but they're really fairly tight bounds within which they can move. As I said, they negotiated and prices are set on an annual basis.

Okay. So they're set annually. Got you. And does this significantly reduce the number or increases the concentration of your customers?

No, concentration really doesn't change. We've--these five customers have been ours for a very long time. This year Eastman Chemical and Rayonier mark 75 years. The others, some of them dating into the '50's. We've just continued to grow as a supplier to them and of course the market for that product has increased. This is very good. This is the heart of Rayonier's business.

Okay. And then I guess the last question, when you look at the increase in land sales in the second half, in the last few years, obviously your basis as a proportion of the land sales has been pretty low, like 25%, give or take. And would you agree that the number, I think--I don't think you've given a specific guidance in the past this year, but something in the 120ish range with maybe the basis only being 25% or so, is that consistent with what you think would likely happen if things come together as you think?

Hans, do you want to take that?

I don't think we want to get in too many specifics on these sales amounts, per se, but I would say on the basis running 20% is not a--is a pretty good estimate.

Okay. Are there any other costs? I guess there is a few. And then there is some cash costs in there, too, right?

Yes, but they are relatively small.

So your EBIT margin will be between maybe 75 and 80%, then?

That is not a bad range.

We'll go next to Mark Weintraub with Buckingham Research.

Let me just follow up if I could on Chip's questions. I had meant to mention earlier, I know we talk often about the sale of some of our higher and better use properties. Sometimes what we don't do is describe what we're doing on the acquisition side and within the last 12 months, I suppose give or take a little bit, we have purchased or in the process of purchasing this year about $45 million in higher and better-use properties. So we are not just a seller. Some of these properties are strategic and sit in the middle of some of our other holdings and some of them are properties that we have rights of first refusal on and we feel they certainly have good value over time. So I guess, Mark, excuse me for interrupting, go ahead.

Maybe I'll just follow up on that. Can you hear me, by the way?

Yes, sir.

Have you spent much of that 45 million, yet, or are those projects that you have in process?

We spent some of it. Some of it is under hard contract. And some of it is in the final stages of negotiation. It's pretty well committed.

Okay. And first I just want to go back to the Performance Fibers and then back in development. Your costs in Performance Fibers have gone up quite a bit for obvious reasons in the last couple of years. Do you see much opportunity here to really start driving the earnings by reducing the cost side of the equation? Can you talk through that a bit?

Well, I think, Mark, as Hans indicated, we have been, and by the end of this year, we will have spent quite a bit of money on energy reduction projects. The big one, as we mentioned before I think, was a $30 million new boilered [Fernindana], which will reduce the consumption there by probably 180,000 barrels of oil a year, not an insignificant number in today's world. Also some capital investments at the Jesup mill to reduce energy at that one, although it is not one big piece. The big thing that's been, and I'll ask Tim to comment on it, the other big thing that has hit us pretty hard is the cost of hardwood fiber. Some of that is due to weather over the last period in which we've had, the last couple years, a lot of rain that pushed the base price up underneath it. But, Tim, do you want to comment on both fluff as well as pine prices at the mill?

Yes, Lee, certainly. First on hardwood, as you mentioned we had back several years ago kind of a confluence of things, weather, certainly, very wet wether that hit us. And then realizing that we were going to just simply have to go further afield to get hardwood. We have been somewhat fortunate in 2006, early part of 2006, it has been a bit dry in the southeast and that has enabled some of the producers to increase their supply. But I have to say that as we go out, getting substantial reductions in hardwood costs is going to be very difficult for us. In terms of pine, we have seen some increase in costs in pine chips in 2006. Pine has been at relatively low levels for the past several years and we're seeing a bit of a pickup, I think in part because some of the pulp mills in our area have switched from some furnish of hardwood back over to pine. So that's increased the demand somewhat. As Chip indicated earlier, I think there has been increase in the volume of OSB, and that has taken some of the pine volume as well. So we have been seeing a gradual increase, not an alarming increase, but certainly an increase in pine values over 2006.

Okay. And so when you put this altogether, is it fair, in your mind, to think that the Performance Fibers business is going to tend to be much more steady in its earning -- it has been pretty stable the last two or three years, but before that there was some more volatility. As you look forward, do you see it really in a 50 to $65 million range or are there things that you can do to potentially move the dial?

Well, Mark, rather than sort of give you what the numbers are going to be, we certainly feel the second half is going to be better than the first half. Part of what contributed to the weak, very weak performance in the first half was the disastrous start-up of two mills, the two mills after the shut downs in March. So that hit the costs and hit them pretty badly. I, looking at prices that we've put in place, looking at some of the other fundamentals of the business, I would be very disappointed if the results for '07 weren't, I'll say, significantly above what we've seen this year. We are in a pretty good -- we are in an awfully good position with that business.

Okay. Great. And then you referenced that you were going to have a much bigger second half of the year in the development side, as well, and I recognize you don't want to give us the specifics, but give us a sense of what type of properties, obviously coastal county properties, but what type of ventures are these and how long have they been in process? Obviously, Terra Pointe has not been in existance that long. Just give us a bit of a background for what is going on here.

Probably what we're looking at in the second half, about 40% of what we'll expect to sell will be under joint participation agreements. I think it's probably fair to say it's been about six months, we've been in discussion and rather than name the companies, of course, I just would tell you they're very reputable and they're very reputable companies.

Can you give a sense as to what type of structure that joint participation agreements are likely to take?

Well, there is a couple of forms, Mark. Kind of depending upon how much value we pull out at the beginning and how much we leave in, that's a couple of them. One of them is, as I believe, is one where we own some property adjacent to some the developer already owns and so it becomes structured a little differently. But that's just to give you some general description. Maybe kind of depending we may have Charlie Margiotta here at the end of the third quarter and he can talk to you about Terra Pointe and the Real Estate business.

And then just lastly, right at the end of your prepared remarks, Lee, you threw in the notion that buying timber lands gives you the ability to move down property to their Real Estate subsidiaries, is this because you can take advantage of like-kind exchanges? Can you just flush out what you were referring to when you made that comment?

I think you pretty much answered it. What we are really looking at is 1031s, in which you very simplistically buy timber land down in the TRS. Then you take that value and you assign that value, if you will, to the higher and better use properties. You trade down into TRS and you end up with what amounts to very low cost timber bases, then is pushed up into the REIT. Of course, there is no tax up at the REIT. So other than the tax -- well it very much minimizes the tax you would otherwise pay.

Okay. Sorry, Lee.

I was just going to say it is a very efficient way of dealing with taxes that otherwise would be very high, as you can imagine, I think as somebody mentioned just a minute ago. Cost basis in this holdings is very low.

And then lastly, one of your peers, Plumb Creek yesterday -- it's been buying back stock and it basically said that it felt that it was able to buy its own timber lands less expensively than that what's out there in the market. Can you kind of update us on your philosophy on share repurchase?

Well, I think what they say is right. It is the old adage the cheapest place to buy timber is on Wall Street. That is as if you don't have 1031 opportunities. I think it is fair to say the percentage of higher and better use real properties that we have, could likely be above theirs and using a vehicle for 1031s is a better use of our money. Certainly without answering the question, I'm sure you're going to ask, we do have a number in mind at which the better-spent money is on buy-backs. But right now the best opportunity is for us is to make timber land acquisitions, which will be cash accretive, with the trade down of the HBU, which also allows us to build the TerraPointe business more quickly than we otherwise could if we just brought in shares.

We'll go next to Christopher Chun with Deutsche Bank.

Good afternoon. On Performance Fibers, again, if I'm remembering correctly, I think you guided last time that earnings would be up year-over-year in '06 in Performance Fibers. Is that right and does that still hold true?

Yes.

Okay. And then on the timber side, I was a bit surprised, pleasantly surprised, to see that volumes and stumpage prices rose quarter over quarter in the northwest because we've been hearing that some of the lumber producers there have been suffering a margin squeeze with the roll-back in lumber prices. Can you comment a little bit about that?

Sure, this is Tim. In the northwest, it has been kind of an interesting situation. I do believe that you're probably right in that, I think the saw mills have been squeezed. What's been occurring, though, is that there was wet weather in the spring that curtailed some of the harvest in some of the areas, not so much on Rayonier timber lands because we have quite good access to our timber. And so as a result some of the producers were able to continue to harvest or harvest on our properties where they couldn't on some others. So that gave us a bit of an advantage and helped us with the volume. The other thing I think that was major impact was that there is a relatively low rate of imports coming in from Canada right now. And so as a result those saw mills that wanted to continue to run needed the volume and fortunately were able to come and get it from us, and so I think we've benefited from that in the second quarter.

Okay. Great. And then on the Real Estate side, in terms of your rural acres, you had pretty good volume this time and still a pretty good price, but it was down a bit quarter over quarter. Can you comment on whether that was due just to where they were located or whether you're seeing any weakness sequentially in terms of buyer interest?

No, we're not seeing a reduction in buyer interest. Let me say here, I think the rural properties that we have been selling and will continue to sell, generally are not development kind of properties. They tend to be for uses other than that, broad range from somebody just wanting a little bit of property, somebody wanting to own something next to farm maybe they own goes into conservation, it goes for recreational uses. So but anyway, back to your first question, we had some property that was in north central Florida, quite poor quality, if you will for building particularly, timber lands, lot of wet property on it, swamps. It just was not good for growing timber and it wasn't really good for development. Just cases where it went, it was sold by auction, I think as I said, went to a wide range of people, but it certainly we were quite happy with the prices. I should add that. It was just not something you wanted to hold for timber land.

Finally, Lee, it seems like this rural acreage, which as you say, is much of which is not things that you really want to hold for timber land purposes is still actually fetching, per acre, values that exceed timber land. Have you quantified how many acres there might be in this category that might create more value for you?

Well, we've never stepped back and done that as such. Obviously with 1.6 million acres we own down here in the southeast, even after allowing for our estimate of about 200,000 acres of HBU here along these 95 corridor, there is plenty. As I'm sure you're aware, there is one very large land owner in the state of Florida that has indicated that none of their property is timber land, it is all worth more. I'm not quite sure I'm ready to say that. But there continues to be a lot of interest in rural properties in this area, along with HBU properties. Often we sort of get painted with the Florida brush that housing is overbuilt, development is overstretched, and I think you have to differentiate northeast Florida and southeast Georgia. It tends to be a residential area, and not kind of a second home. That applies to these rural properties that are out there. Somebody is just looking for, I think, as I said, sort of recreational, different kind of use than housing.

Right. Thanks a lot for your help.

We'll go next to Frank Dunau with Adage Capital.

I got just a few questions. If you look at your guidance coming out of the last quarter, and this quarter you were supposed to be somewhat below last year and you came in somewhat above. I was just trying to figures out what the variance was in your own projection.

We were a little stronger in northwest Timber and little bit in Performance Fibers.

Then I also noticed in the guidance you left out the word somewhat for the year. What am I supposed to read into that?

Well, I think I was on Bloomberg this morning, I was sort of asked the question as to what -- they knew what consensus was for the year and my comment was we are very comfortable with consensus. That may not help you much, but that is as far as I would like to go.

I never knew what you meant referring to it by somewhat, so now I know.

We have those same kind of debates here. Somewhat, some, significant, substantial. You're welcome to come and help us any time we're writing earnings releases.

I looked it up in the dictionary and it didn't help me.

Yes, sir.

We'll go next to Peter Ruschmeier with Lehman Brothers.

Thanks, good afternoon. I checked my Thesaurus and I couldn't find it, either. Couple questions maybe just to come back. If I look at your net debt position now, from a market capital perspective or from enterprise perspective, it is about 11% if I did my math right. I'm curious on what you think your debt capacity is and if you could just remind us to walk through the financial criteria you used to evaluate opportunities? Should we really think about Rayonier looking at one-off small types of opportunities, or is there anything philosophically that prevents you from using more of your debt capacity to work towards a larger transaction and, if so, what kind of criteria? That is the nature of the question.

Let me start on the first part of it and maybe Hans needs to add to it. I think our net debt position, if you take it, was slightly below 400 million, to about 28 or 27% debt to total capital at that level. Obviously I think we're underleveraged. We have looked at a number of timber acquisitions, both small and large, and as we looked at them and the prices just got beyond where we were comfortable, any acquisition you're going to see us make after considering the benefits of 1031, or 1033, will be cash accretive. As to how far we're willing to go, I'm certainly willing under the right situation to leverage the company up over 50%. We're not going to compromise investment grade, but we're certainly ready to take a fair amount more on the balance sheet. I think year under utilizing our equity today.

That's very helpful. Just a clarification on your CapEx project at Fernindana, the savings of 180 thousand barrels of oil, if I'm doing my math right, is $13 million a year, is that right? Is that about a two-year payback of that investment? And when does that factored in? Is that during the fourth quarter?

Let me start backwards on it. No, we're not really looking at it to come up until in the first quarter. We'll begin some debugging in the fourth quarter but they won't see any impact on that until the second quarter. On oil, I'm not quite sure what the number was you used. You might have been using crude at the $75. Really what we're using is number 6, which is pretty close to diesel, which is last time I looked painfully it is about $55 a barrel. So it does have a very high payback, if you will. Unfortunately, since we put the PAR in the payback has even gotten better and the returns higher. But, believe me, we're very anxious to get that up and going.

Okay. That's all I had. Congratulations on the quarter.

Thank you.

[OPERATOR INSTRUCTIONS] We'll go next to Steve Chercover with D.A. Davidson.

Just a couple follow-ons. With respect to the 45 million in HBU that you are doing, will that cover any 1031 obligations that you have in the current year? Or do you still have to do more?

Well, we'll be evaluating it, whether it goes directly into our TRS or some of it perhaps will come into the REIT, but we will have additional unsolicited sales from the REIT that we'll have to consider when we do close those acquisitions.

Switching gear to Performance Fibers, with effectively 80% of your volumes committed to your large customers, if you get incremental orders, is there any capital required to ramp up production out of fluff and into specialties, because I assume it is still the objective to maximize, to make sure that every drop of pulp that you make is specialty, if possible.

You're certainly right about the latter part. What we're really talking about, within the specialty cellulose segment, by far the largest piece that is acetate. What I think I said or meant to say at least was that about 80% of that acetate is tied up under those long-term contracts. What we can do, of course, as we have orders or demand for the balance of that acetate and some of the other cellulose specialties product, you are always looking at moving up the chain, where you move up the higher value business. As you go across you move up, I guess, for two reasons. One, of course, you want to get a long-term contract on it. You want price stability which increases your return. As far as any major move, shift-up in the mix between cellulose specialties, which I think is about 26% of our mix, I mean--about 64% of our mix, and the balance being fluff, to make a major shift or to enrich that mix, it takes perhaps $200 million in capital investment to make it a quantum step. So we'll continue to make small ones, amount of capital is very modest. It is more in operations than it is in capital expenditures.

Thank you.

And that is all the questions we have. I'll turn it back over to Hans Vanden Noort for any additional or closing remarks.

We have no additional remarks. We'd like to thank everybody for joining us. And please contact Parag Bhansali with any followup questions. Thank you.

This does conclude today's conference call. You may disconnect at this time. Thank you for participating.