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Rayonier, Inc. (NYSE:RYN)

Q4 2009 Earnings Call

January 26, 2010 2:00 pm ET

Executives

Hans E. Vanden Noort – Chief Financial Officer & Senior Vice President

Lee M. Thomas – Chairman of the Board, President and Chief Executive Officer

Paul G. Boynton – Executive Vice President Forest Resources and Real Estate

Charles Margiotta – Senior Vice President Business Development & President of TerraPoint Services, Inc.

Jack M. Kriesel – Senior Vice President Performance Fibers

Analysts

Michael Roxland – Bank of America Merrill Lynch

Peter Ruschmeier – Barclays Capital

Claudia Hueston – J.P. Morgan

Steven Chercover – D. A. Davidson & Co.

Chip Dillon – Credit Suisse

Mark Weintraub – Buckingham Research Group

Operator

Welcome and thank you for joining Rayonier’s fourth quarter 2009 teleconference call. At this time all participants are in a listen only mode. (Operator Instructions) Today’s conference is being recorded. If you have any objections you may disconnect at this time. Now, I will turn the meeting over to Mr. Hans Vanden Noort, CFO.

Hans E. Vanden Noort

Welcome to Rayonier’s investor teleconference covering the fourth quarter earnings. Our earning statements and presentation materials were released this morning and are available on our website at www.Rayonier.com. I’d like to remind you that in these presentations we include forward-looking statements made pursuant to the Safe Harbor provisions of federal securities laws.

Our earnings release as well as our Form 10K filed with the SEC lists some of the factors which may cause actual results to differ materially from the forward-looking statements we may make. They’re also referenced on page two of our presentation material. With that, let’s start our teleconference with opening comments from Lee Thomas Chairman, President and CEO.

Lee M. Thomas

I’ll make a few overall comments before turning it back over to Hans to review our financial results. Then, we’ll ask Paul Boynton in his new role as Executive Vice President Forest Resources and Real Estate to comment on our timber results. As previously announced Tim Brannon our Senior Vice President who headed our forest resources business unit until Paul’s promotion in November will be retiring at the end of March after many years of dedicated service to Rayonier.

Following our review of timber Charlie Margiotta our Senior Vice President of Real Estate will discuss the results of that segment. Joining us today for the first time on this call is Jack Kriesel, recently promoted to Senior Vice President Performance Fibers who will take us through the results of that business.

The difficult economic conditions we faced in 2009 underscored the strategic value of our unique business mix. Strong results in performance fibers fueled by strong worldwide demand for our cellulous specialties products helped to offset the impact of housing market weakness on timber and real estate. Overall, we generated strong operating cash flows that significantly exceeded our dividend with cash available for distribution above last year’s level.

Throughout the challenges of 2009 we focused on preserving value for the future. We deferred harvest of our saw timber and maintained our financial discipline in real estate only selling those non-strategic properties where we could realize attractive returns. Our strong balance sheet conservative leverage and ample liquidity provided us with operating flexibility during the recession and now positions us well for new opportunities going forward. With that, let me turn it over to Hans to review the financials.

Hans E. Vanden Noort

Let’s start no page three with our financial highlights. Overall, we had a solid fourth quarter. Sales totaled $310 million while operating income totaled $121 million and net income was $98 million or $1.21 per share. Note that these results include the benefit of the alternative fuel mixture credit which increased fourth quarter operating income and net income by $64 million which is $0.79 a share. Without this benefit operating income was $57 million and net income was $33 million or $0.42 per share. These pro forma amounts will be used for the comparisons throughout this call.

On the bottom of page three we provided an outline of capital resources and liquidity. Our full year cash flow was strong with adjusted EBITDA of $370 million and cash available for distribution of $230 million. Our debt is now $700 million reflecting the repayment of $122 million of notes at yearend. We ended the quarter with approximately $75 million in cash so on a net debt basis we finished at $625 million.

Let’s now run through the variance analogies. On page four we prepared our sequential quarterly variance analysis. In timber, operating income operating income increased driven by higher other income which consists primarily of recreational licenses that are largely recognized in the fourth quarter. We also have price improvement in both the eastern and western regions.

Real estate income decreased $8 million due primarily to fewer rural acres sold compared to a very strong third quarter. Moving to performance fibers you can see a price decline which was in cellulose specialties. As previously disclosed this reflects the removal of a cost base $95 a ton surcharge from September 2008. Our cost have continued to normalize as indicated here so the surcharge was removed. We also had improved volumes as expected as customer demand was strong. Corporate and other expenses were $5 million above the third quarter which benefited from the receipt of an insurance settlement. Also, incentive compensation costs increased.

Let’s move to page five now and look at the year-over-year variances. In timber the fourth quarter and year-to-date variances last year generally reflect similar drivers of softening prices, lower volumes and a decrease in the mix of saw log volumes versus pulp wood. We were able to offset some of this negative impact through reduced costs.

Moving down to real estate, as expected and previously noted during last quarter’s call a $25 million decrease in fourth quarter real estate results reflect the absence of any significant non-strategic sales. On a year-over-year basis the $24 million decline was driven by lower acre prices in both rural and non-strategic sales reflecting somewhat weaker markets and a geographic mix shift.

In performance fibers the fourth quarter benefitted from significantly lower input and transportation costs in the absence of a $4 million loss on fuel oil hedges recorded last year. For the year, cellulose specialty prices increases more than offset declines in fluff prices and slightly higher costs. Corporate and other expense in the fourth quarter was $3 million unfavorable to fourth quarter last year largely due to the previously noted incentive compensation accruals. However, on a full year basis we were still $2 million favorably to last year.

Let’s move now to page six. On this page we reconcile cash provided by operating activities which is the GAAP measure to our non-GAAP metric of cash available for distribution. As you can see our cash flow remains strong with CAD of $230 million well above last year and our dividend payout represented only 69% of CAD.

On page seven we prepared a debt maturity schedule. We have no significant maturities in 2010. Our $250 million revolving credit facility has $235 million of remaining capacity which is available at an interest rate of LIBOR plus 40 bips. This facility does not expire until August 2011. All-in-all we believe our solid balance sheet, conservative credit profile and strong and consistent cash generation provides significant liquidity which positions us well to take advantage of future growth opportunities.

With that let me turn the conference over to Paul Boynton to cover forest resources.

Paul G. Boynton

On page nine you’ll notice that prices for our western timber increased 10% in the fourth quarter over third quarter and well above the 2009 low point in the second quarter and our market supply has tightened due to reduced availability of accessible stumpage and continued export demand. We are currently seeing prices 10% to 15% above fourth quarter as supplies of saw logs are tight. While these prices may ease back we’re optimistic for improved year-over-year prices. We continue to preserve long term value by holding much of our higher value saw timber off the market as we wait for housing markets to recover and therefore plan comparable volume to 2009.

In the east on page 10, prices improved 5% in the fourth quarter over the year’s low point in the third quarter. Pulp wood demand remains strong while pine saw timber markets were weak but stable. We continue our emphasis on pulp wood harvest and thinning with pulp wood representing 80% of our pulp wood harvest compared with a more normal 50% mix.

First quarter prices have escalated 15% to 20% over fourth quarter due to the low supply of pulp wood resulting in part from recent wet weather across the south. However, prices may moderate as the year progress. 2010 pine harvest volume is forecasted to be somewhat below that of 2009 as thinnings return to more normal levels. Overall, operating income should be above 2009.

With that, let me turn it over to Charlie Margiotta to review our real estate business.

Charles Margiotta

Considering the challenging economic conditions, we are pleased with the real estate results for 2009. Page 11 shows our land sales and acres. Rural acres sold in 2009 were comparable to 2008. The fourth quarter development sales of almost 600 acres consisted of some remnant parcels that we have had in inventory in southeast Georgia. Our view for 2010 is that rural acres sold will be well above 2009. We expect steady to improving demand from both rural buyers and conservation groups.

Page 12 details the development and rural per acre prices. The relatively weak development prices was mostly driven by the mix of acres which as indicated was effectively scattered inventory parcels. Rural prices were steady in the fourth quarter however, for the year they were down due to geographic mix and market conditions. For 2010 prices are expected to be flat year-over-year.

Page 13 highlights our non-strategic timber land sales program. Full year 2009 acres sold were above the prior year, however timber land prices were approximately 15% below the 2008 peak. We believe that timber land prices have now stabilized. For 2010 we expect to sell somewhat less non-strategic acres at comparable prices to 2009. Overall, in 2010 the real estate segment should generate operating income and cash flows above the 2009 results.

With that, let me turn it over to Jack to review performance fibers.

Jack M. Kriesel

Performance fiber’s results were strong for the fourth quarter as well as for the full year 2009. On page 14 you’ll see the next selling prices of our two performance fibers product lines. As mentioned previously the cost returning to normal levels we removed 2008 surcharge that was built in to our 2009 price increases.

As a result cellulose specialty prices declined $51 per ton or 4% from the previous quarter. This is higher than previously advised due largely to product mix in Q4. Compared to the same quarter prior year Q4 prices were up 2%. As we look at the full year cellulose specialty year-over-year annual price increase averaged about 12%. Looking at absorbent materials pricing which consists principally of fluff pulp, prices increased $20 per ton or 3% sequentially due to strong demand. However, prices remain $122 per ton or 16% below same quarter prior year.

Moving on to page 15 and looking at volumes, you can see our fourth quarter cellulose specialty sales were up 19,000 tons or 15% sequentially as demand for the year normalized after customer destocking in the first half of 2009. 2009 cellulose specialty sales volume was about 1% lower than prior year, in line with our prior guidance.

Absorbent materials volume of 72,000 tons increased 6% from the prior quarter and 2009 sales volume was up 6% above prior year consistent with the increase production and strong demand. In summary, results were strong in 2009 primarily due to increased cellulose specialty pricing offset by lower absorbent material pricing and somewhat higher manufacturing costs.

As we look in to 2010, we expect to see more normal input costs however, continued wet weather could push up fiber costs in the first half of the year. We are seeing continued solid demand for our cellulose specialty fibers and building on 2009 performance we expect 2010 sales volume to be above 2009 while cellulose specialty prices should average about 3% higher than fourth quarter 2009. We continue to make good progress on our cellulose specialty customer contract extensions going in to 2013 which will provide us long term business stability. In our absorbent materials business annual volumes are expected to be similar to 2009 and prices slightly above 2009 due to favorable market dynamics.

In summary, we’re anticipating another strong year in performance fibers business. Now, let me turn it back over to Hans.

Hans E. Vanden Noort

Before we run through some of the typical statistics for 2010 I’d like to provide an update on a couple of items. First, in New Zealand Phaunos Timber Fund has agreed to invest $167 million New Zealand dollars to become the largest shareholder in the Matariki joint venture. The investment would be for newly issued capital by Matariki and would be used entirely to pay down a portion of the outstanding $367 million New Zealand dollar debt facility.

This investment will result in a reduction in our ownership interest from 40% to 26%. Rayonier New Zealand will continue to serve as manager of the joint venture. We expect to record a gain of about $11 million or $0.14 per share upon closing which we expect sometime in the first quarter here after New Zealand government approval.

Turning now to the alternative fuel mixture credit, we are claiming it as a refundable income tax credit and have applied $20 million against our 2009 estimated tax payments. In 2010 we expect to offset another $15 million of estimated taxes. The remaining credit of about $180 million will be received as a refund around July 2010 after filing our 2009 tax return. We plan to use these proceeds for strategic growth initiatives, increased investment in our performance fibers mills and higher pension contributions.

Now, I’d like to provide some key statistics to assist you in developing your 2010 model. We expect depreciation, depletion and amortization of $147 million and a non-cash cost basis of land sold of $9 million or approximately $156 million in total. This is about $10 million below 2009 driven primarily by lower depletion.

Capital expenditures excluding acquisitions are expected to total about $140 million versus $92 million in 2009. This significant one year increase for 2010 is effectively being funded by the alternative fuel credit and will be invested primarily in performance fibers on cost reduction and efficiency projects, as well as additional environmental projects. We expect interest expense net of interest income of about $50 million slightly below 2009.

Finally, our effective tax rate is expected to range between 18% and 20% versus 22% in 2009 when you exclude the alternative fuel impact. This decrease reflects our expectations of an increase in the mix of income from our REIT businesses. When you put all these elements together with the alternative fuel refund we anticipate very strong cash flow despite the need to defer the harvest of our highest value saw timber.

We expect EBITDA to be slightly above 2009 however, cash available for distribution should be well above 2009 and in the $320 to $340 million range reflecting the alternative fuel refund net of the higher cap ex and pension contributions. Finally, we expect pro forma earnings per share to be 10% to 20% above 2009 excluding the gains from the alternative fuel credit in 2009 and the gain on the New Zealand joint venture transaction in 2010.

Now, let me turn it back to Lee for some summary comments.

Lee M. Thomas

We’re optimistic that the economic recovery is indeed taking root and that liquidity has returned to the capital markets. We expect to see a gradual improvement in housing but recognize that a full recovery will take several more years. Although we’re encouraged by recent timber price improvements, we will continue to preserve value for the future by holding all saw timber harvest. We will remain focused on upgrading and growing timber land holdings in 2010.

With our strong balance sheet we’ll seek acquisitions that meet our strategic and financial criteria while remaining disciplined sellers of non-strategic timber land. We’re actively participating in the emerging biomass sector and are seeing increased interest by customers fueled by public policy in Europe and the US which emphasized the role that biomass will play as a carbon neutral renewable energy source.

Overall, we see tremendous value in our timber lands based on improving near term markets and strong long term fundamentals. The relatively modest decline of around 15% in timber land values provides evidence that investors are also looking through this cyclical downturn when valuing these assets.

In real estate we expect continued interest in our rural conversation and non-strategic timber land properties. We hope to make significant progress in entitling several of our development properties positioning us well for an eventual housing market recovery along our coastal properties of Georgia and Florida. In addition to our substantial timber land portfolio and HBU real estate properties we remain the coastal leader in cellulose specialties products.

We anticipate continued strong demand for these products and for absorbent materials particularly in China contributing to strong performance fibers results comparable to 2009. With our unique business mix, strong balance sheet we have the operating flexibility to manage through the economic challenges that remain while taking advantage of attractive opportunities for growth.

We expect to increase earnings and cash available for distribution in 2010 and remain committed to providing an attractive dividend in creating long term value for our shareholders. 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.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Roxland – Bank of America Merrill Lynch.

Michael Roxland – Bank of America Merrill Lynch

Just quickly could you elaborate on some of the trends that you have seen recently or that have occurred over the last few months or weeks to justify your more positive outlook on the timber and real estate segments?

Lee M. Thomas

Well on the timber side and I’ll let Paul fill you in if he needs to, I think one of the things that we’ve seen is good steady demand. Part of that I think is weather related but part of it is just because I think supply constraints as far as timber is concerned. I also think we’ve seen good steady demand as far as exports are concerned particularly in to Asia from the west coast so overall through the fourth quarter and now leading in to the first quarter we’ve seen steadiness, we’ve seen price improvement as we’ve indicated over and above fourth quarter going now in to the first quarter.

So that’s kind of the timber side. As far as real estate is concerned as we indicated last year, we saw good steady demand for our rural properties as well as for our non-strategic properties. We’ve seen a good steady I think pricing format over the course of the last quarter or so and continued interest in both our rural and non-strategic and we also have seen a limited amount of property coming on the market particularly on the non-strategic area so from a supply point of view there is a limited amount of property available. We continue to hear from investors of additional money being available as far as [TMOS] are concerned so we think there is stability in pricing and we see good steadiness as far as pricing is concerned. Charlie or Tim do you want to add to that?

Charles Margiotta

I think the term steady is absolutely right. We saw timber land prices move off the peak but since then they have been very steady and very solid.

Michael Roxland – Bank of America Merrill Lynch

I guess the traffic has held up in terms of investor interest for all of your lands? That’s the sense that I’m getting from your commentary.

Lee M. Thomas

I think that is true, don’t you Charlie? I think we’ve seen it across the country?

Charles Margiotta

I think there’s a fairly broad mix of buyers out there. I can’t quote the number of [TMOS] for instance but it continues to grow so there’s a fairly large group of buyers. But, on the rural side because of our geographic diversity we tend to have strong markets in some states and so we’ve had solid steady demand.

Lee M. Thomas

I think also we have seen just a continuing interest on the conservation side. I mean, that’s something we’ve been for a long time but we continue to see interest in those kinds of pieces of our property that have conservation value.

Michael Roxland – Bank of America Merrill Lynch

Then just on the performance fibers business, I know you mentioned that cost have normalized but if you look at caustic soda that’s risen from around $175 a ton in 3Q to about $215 to $220 currently and from our understanding there are additional price increases on the table for the next couple of months. I know that in the past you guys have mentioned that the caustic contracts are fairly flexible which benefits you when prices fall but will likely hurt you when prices rise especially in this type of environment. Any way for you to comment on the contracts and what you’re seeing as the trend thus far in 1Q in respect to caustic?

Jack M. Kriesel

When we look at caustic and our contracts, certainly we’re not going to get in to the specifics of them but we do have favorable contracts with our suppliers and I guess the good thing out there is that with foreign imports, when prices start getting too high the foreign imports start coming in and that keeps people in check in terms of what the pricing can be and we certainly saw that this last year. So when we’re looking out in to 2010 on caustic pricing we see it remaining pretty well flat for the year. If the housing market starts to pick up there will be more chlorine produced and therefore more caustic produced and that may apply some pressure downwards on that.

Michael Roxland – Bank of America Merrill Lynch

So it is predicated on a housing rebound which should produce obviously as a byproduct being caustic soda and given increased supply prices should be relatively steady for the year?

Jack M. Kriesel

That is correct.

Lee M. Thomas

And that is pretty well what we’re looking at now but things can always change but the chlorine production is a big factor on whether caustic is available or not.

Operator

Your next question comes from Peter Ruschmeier – Barclays Capital.

Peter Ruschmeier – Barclays Capital

A couple of questions maybe for Paul Boynton, I was hoping Paul you could elaborate on the source of the export log strength maybe by product if it is a particular type of species or particular type of log and maybe by region? I guess related to that as you think about your northwest exposure are you doing anything differently to prepare for shipping more volumes in the future off the export market?

Paul G. Boynton

Most of that obviously going in to dimensional lumber in to Asia primarily China and Korea. We see it as steady, we don’t see a huge surge in it so we’ll continue to be active in that market, we don’t see any dramatic push up in volume that we’re trying to achieve but we’ll just stay again, just kind of a steady supplier to that marketplace.

Lee M. Thomas

You know one of the other things I would add on to that is kind of to show the way that market has changed not so much off the west coast but out of New Zealand is the fact that China now I think is probably our largest customer out of New Zealand where as three years ago we were probably shipping very little in to China. I think it is a result of them really making changes because of what was going on with the Russian log imports. But China and to some extent we’re beginning to see India come on as well. But, all of that is really related to New Zealand more than it is northwest.

Peter Ruschmeier – Barclays Capital

So Lee those logs from New Zealand would also be going in to dimensional lumber converting in to lumber?

Lee M. Thomas

That is correct.

Peter Ruschmeier – Barclays Capital

Coming back if we could to the pulp business I’m curious if Jack could comment or elaborate on the outlook for potentially rising fiber cost in the first half of the year? How much fiber cost escalation have you already incurred or how much more might you expect to incur?

Jack M. Kriesel

We have seen some increases already and also tight supply particularly from the hardwood side of the business. Your guess is as good as mine when we look at the weather going forward but we expect to see some impact in the first half of this year in our overall fiber costs.

Paul G. Boynton

If I could add to that, we will be seeing courses as the warmer seasons come around we’ll start seeing kind of a drain off a lot of that so it should help improve the harvest and the opportunity to mitigate some of the rises as the year goes on.

Charles Margiotta

Just to add another part to that, unfortunately we have a very broad footprint in terms of our procurement and so our guys out there do a very good job on getting us the needed timber or chips when we need it.

Peter Ruschmeier – Barclays Capital

Then maybe just finishing up, maybe a question for Hans, I want to make sure I heard you correctly in terms of your earnings outlook. I believe you said 10% to 20% above ’09 levels. I want to make sure we’re looking at the right base, is that off $1.50 level? Then related to that, your CAD obviously as you mentioned is way above your dividend and so above and beyond the increase in cap ex you cited, how should we think about your priorities for free cash flow?

Hans E. Vanden Noort

First of all the 10% to 20% is off the $1.50 base, it’s off the pro forma $1.50 for 2009 so that’s where we see it today. As far as the second question I think really what we’re looking at for the additional CAD is just looking for some strategic growth initiatives and so we continue to look at opportunities. I think it’s fair to say that we’re starting to become more aggressive at looking at those versus the same time last year for example. So that’s where our outlook will be.

Peter Ruschmeier – Barclays Capital

Is there a particular size that you see? Are there opportunities in the 5,000 to 10,000 acre tracts or the 50,000 to 100,000 acre tracts? Is there anything that you happen to be noticing in the marketplace along with those lines?

Lee M. Thomas

Most of what’s coming on the market these days or at least for the last few months has been smaller sizes as opposed to larger sizes and by that I mean under the 50,000 acre tract. You see more in the 10,000 to 15,000 to 20,000 acre tracts that are coming on the market.

Operator

Your next question comes from Claudia Hueston – J.P. Morgan.

Claudia Hueston – J.P. Morgan

I was hoping you could just elaborate on the capital that you’re spending in the performance fibers business in 2010? How much are you allocating towards these projects and sort of how should we think about the benefits there?

Lee M. Thomas

Let me let Jack comment on some of that but first I think you ought to think about kind of an average run rate in performance fibers of capital if you looked back would probably be in the $100 to $105 million range – I’m sorry total company with performance fibers being a substantial part of that. This past year we reduced capital both in performance fibers as well as other parts of the company down to that $91 to $92 million figure. So, I would think it is off the $100 million to $105 million base would be a more normal so you’re taking $35 to $40 million and most all of that is going to go in to performance fibers. Jack, do you want to talk about where some of that is going?

Jack M. Kriesel

On a year-to-year basis we typically invest about $50 to $60 million in performance fibers so we’re looking at roughly about $40 million incremental investment. There’s a number of projects both from a cost improvement and overall effectiveness of our operations standpoint and also an environmental. Environmental makes up a big chuck of that incremental capital of about $18 million and I think we’ve talked a little bit in the past about that project being a [collar] reduction project.

But, we’re also investing in both of our facilities and our recovery boilers in a significant way to improve the efficiency and from a custodial standpoint as well as a couple of projects in cost improvement. An example of that would be a large chlorine dioxide tank which is our primary bleaching agent. That type of a project we’d invest somewhere around $3 million and has a very good return in a relatively short period of time.

Lee M. Thomas

So we’ve got several projects like that. They are not large but they are very good return projects that we’re going to invest in.

Claudia Hueston – J.P. Morgan

Then Hans, can you just quantify the year-over-year change in pension expense? If you said it I just missed it and I’m sorry if I did.

Hans E. Vanden Noort

Actually, I didn’t say it. Pension expense we’re looking at about $14 million in 2010 versus expense of about $11 million in 2009. But what I was referencing more was the actual cash contributions to the plans and we contributed about $9 million to the plans in ’09 and we’ll have to see what happens there with the markets and the pension assets but we would expect at this point to significantly increase the contributions in to the plans in 2010.

Lee M. Thomas

But Hans that will be later in the year that we’d take a look at so we can give guidance as we go along depending on how it looks, right?

Hans E. Vanden Noort

Right.

Operator

Your next question comes from Steven Chercover – D. A. Davidson & Co.

Steven Chercover – D. A. Davidson & Co.

A couple of my questions have been somewhat answered but I wanted to drill on the dividend a bit more since the coverage is so good. Can you maybe articulate just what the policy is in terms of a dividend policy?

Lee M. Thomas

Well, as we’ve talked in the past we take a look at that dividend, our board does on a pretty ongoing basis and at least once a year takes a thorough look at it in terms of its return. It’s an important part of the value proposition we have for our investors and they feel that 4.5% to 5% kind of return is something that’s important to our investors. We over the last 18 months as you know have not increased the dividend as we’ve gone through this particular recession. The board will take another look at it this year and they always look at it as a way to provide a return versus other options that we have. But, they’ll take a hard look at it.

They also I would say Steve, look at it not just in terms of the immediate situation but they look at various scenarios on terms of what does the next year or two look like as far as the future is concerned and how do they want to use the cash that is available to us that we generate and have. So that’s a long answer but it’s a variety of factors that come to play as the board takes a look at it. But again, it’s an important part of the value of Rayonier and they always pay attention to it.

Steven Chercover – D. A. Davidson & Co.

I guess it appears at this stage strategic growth might actually be a higher priority?

Lee M. Thomas

I would say strategic growth is a higher priority.

Steven Chercover – D. A. Davidson & Co.

My second question is just on performance fibers, do you automatically seek a price increase in the vicinity of 10% as the calendar flips over?

Lee M. Thomas

No, we don’t automatically seek a 10% pricing increase. We go through a negotiation each year as you know, generally our customers are on a longer term volume contract and we take a look at our costs, we take a look at market conditions and work through a price adjustment with our customers each year. Jack, I don’t know if you want to add to that or not?

Jack M. Kriesel

That covers it.

Steven Chercover – D. A. Davidson & Co.

Are there any emerging competitors in performance fibers or is the landscape pretty much unchanged?

Lee M. Thomas

Well, it is pretty much unchanged given the discussion we’ve had over the last several years. As you know, the largest addition has been the addition of the mill in Brazil that started up this past year. Now, one of the things that is occurring in the marketplace is some of our competitors produce both commodity viscose as well as some specialties. Our production is all in the specialty side of things so commodity viscose prices are quite high and so many of the viscose producers are actually emphasizing that commodity viscose production as opposed to looking at specialty.

So I don’t think there are any new entrants that I know of, Jack or Paul, other than the ones we’ve talked about for quite a long while. You’ve got that new Brazilian capacity that has come on the market starting last year but again, I think probably a good bit of that capacity is directed towards that commodity business.

Operator

Your next question comes from Chip Dillon – Credit Suisse.

Chip Dillon – Credit Suisse

Just a couple of housekeeping items, I know that you had a line in your last few 10Qs about the New Zealand business and you didn’t have that in your press release. Is that just because it is so small or will the transaction no longer be required to be reported that way?

Hans E. Vanden Noort

Well the transaction hasn’t closed yet Chip so once we receive the New Zealand government approval the transaction should close here in the first quarter. Then, we’ll go ahead and record the impact of that transaction.

Chip Dillon – Credit Suisse

But I mean on an ongoing basis you normally report a small equity loss and I didn’t know if that would continue or not?

Hans E. Vanden Noort

Yes, that will continue we’ll just be at 26% versus the current 40% rate.

Chip Dillon – Credit Suisse

Then I know that the EBITDA you have on the slides for real estate was about $88 million in ’09 and the EBIT was about $30 million so there is a difference of $58 million and the non-cash basis was about $7, does that mean the depletion that is allocated to real estate was about $50 million?

Hans E. Vanden Noort

You’re talking about the full year Chip?

Chip Dillon – Credit Suisse

Yes.

Hans E. Vanden Noort

The depletion is probably about $24 million and we have other costs in the organization with respect to the personnel, with respect to some of the ongoing entitlement type of things we are doing in our development side as well. So you’re ’09 you have about $8 million of non-cash land, you have depletion about $24 and the rest are just other cost.

Chip Dillon – Credit Suisse

Thinking about the cash you have down in the TRS from the black liquor credits and the refund next year, just so I understand this obviously that will keep you from paying taxes to the extent of the credit in that TRS. Are you therefore free to up that cash in to the REIT to the extent that income doesn’t consist of more than I think a third or a fourth of the total income in the REIT? Is that the way to think about it?

Hans E. Vanden Noort

That’s exactly the way to think about it. We’ll look at what the full year REIT income is and then we can dividend up to the extent that we don’t trip that. That typically for us has ranged from $35 to $40 million a year. So some of the cash as we mentioned would be used within cap ex and performance fibers, some of the pensions are actually in TRS pension plans, we can dividend some up and then as we find some attractive timber land investment opportunities we could also acquire in the TRS using that cash and then do those internal like kind of exchanges that we’ve done in the past. So there are a couple of different mechanisms to put that cash to work.

Chip Dillon – Credit Suisse

I guess the last question is for you if you’re thinking about just hypothetically the difference between a higher dividend and buying shares I would imagine just given the split that you have seen and I would guess would continue between the dividend counting as either capital gain income or return of capital that that is not really the same struggle that other companies would have if you assume the ’03 tax cuts expire and there’s a big difference between if you will the ordinary tax rate on dividends and the capital gain rate?

Hans E. Vanden Noort

Well I mean as you’ve seen over the years we’ve never had a component of our dividend be ordinary income. This year we were only 77% capital gain the rest return of capital has historically been probably 90% capital gain. So yes, to the extent tax law changes that could certainly have somewhat of an impact but we don’t foresee a scenario going forward where a significant part or any part would be ordinary income.

Operator

Your next question comes from Mark Weintraub – Buckingham Research Group.

Mark Weintraub – Buckingham Research Group

A couple of things, one is there any additional color you can give us on the biomass cost assistance program? How that is playing out and what if any impact you expect it will have on your company?

Lee M. Thomas

Mark it has started and we have proceeded to participate in that program at a variety of levels. It’s still very early. As you know, the Department of Agriculture has not even published rules that people can comment on so we’re working off of guidance that we’ve gotten so it is very difficult to say kind of what we think the impact is going to be. Paul, do you want to comment about that? We have a single point of contact in the company that coordinates that and it is being implemented both in our timber business, our wood procurement business and our mill operations.

Paul G. Boynton

Mark both of our two performance fiber mills are registered as biomass conversion facilities along with our three saw mills. So those have all been registered. Then as Lee noted, in addition we have on the forest resources side all of our business now we’re moving it out as eligible material owners or EMO to the extent we can and to the extent possible. But, it’s a pretty fluid set of rules right now and we’re just going to kind of watch it and make sure we participate to the extent we can.

Lee M. Thomas

I think everybody, well I shouldn’t say everybody but we know we’re being relative conservative in terms of full participation to make sure that we’re not tripping over rules that have yet to be promulgated so we’re taking it step-by-step as we go along and communicating well with the local Department of Agriculture offices to make sure we’re doing this correctly.

Mark Weintraub – Buckingham Research Group

I guess we’ll obviously be revisiting that as the year goes on?

Lee M. Thomas

Yes and hopefully we’ll have a much better feel for it as we finish the first quarter. Hopefully we’ll get some rules out of agriculture and understand better how it affects us.

Mark Weintraub – Buckingham Research Group

This next one I’m struggling to sink it through and was hoping to get some help from you. The good news is that your performance fibers business just keeps doing better and better and it’s just making tremendous amounts of money. As I try and piece through the math on an ongoing basis it gets harder and harder without there being meaningful change to see how you would continue to meet the REIT requirements.

I realize there’s lots of scope in the short term for you to be able to deal with the various issues. Obviously one way is issuing equity at some point and kind of reinvesting that in to good REIT income. Are there other ways if the performance, and I am sure there are, but maybe you could help me understand what are the other ways if performance fibers keeps doing really, really well unless there’s a very, very substantial in the good REIT income generation from the real estate business to kind of keep everything working as a REIT?

Hans E. Vanden Noort

Mark I would say two things, from an asset test perspective it is something that we look at every quarter and go through with our board every quarter. A couple of things, over the last couple of years we’ve basically focused on moving all of our debt out of the REIT and in to the TRS and effectively with the payment of $122 [inaudible] notes we’ve effectively done that. So, remember that the asset test is done on the net assets of the TRS so effectively you have $690 to $700 million of debt in the TRS now and so on a net basis when you compare that versus the 25% limit and then you look at the other side on the timber side for good REIT assets, it’s just the left side of the balance sheet shows the timber value only so when you look at that we have quite a bit of head room still remaining there from an asset test perspective.

On the income test it is important to remember that even if the earnings at performance fibers and our other TRS businesses generate, it’s only counted towards the income test to the extent that those earnings are upstream via a dividend. So this is again, something that we basically back in to what we can dividend up on an annual basis without tripping the test. So at this point we’ve been able to manage that pretty well so I don’t see anything near term really impacting either one of those.

Mark Weintraub – Buckingham Research Group

I guess the point you’re making is that there’s a fair bit of headroom still on the valuation test because eventually if you don’t up REIT the income to meet the income test you would eventually run in to a valuation issue? Am I thinking of this right? I mean again, a long time out.

Hans E. Vanden Noort

It would be a long time out but that’s assuming again that we don’t do something else on the timber lands for increasing the number of acres for example.

Lee M. Thomas

Obviously, the strategy that we’ve got Mark as you know is to grow the size of our timber REIT.

Mark Weintraub – Buckingham Research Group

So in order to do that would you have to issue equity to buy the additional timber land? How do you finance that?

Hans E. Vanden Noort

Basically we’d have to evaluate what our debt capacity is at the time and currently we still have I would say on an entity wide basis a fair amount of debt capacity that we could issue debt from the REIT for example to acquire timber lands and not come anywhere close to affecting our investment grade rating for example. Now, if we came across a large opportunity it may have to be a combination of debt and equity. But, we take the total capital structure in to play but we still have a fair amount of debt capacity.

Mark Weintraub – Buckingham Research Group

The debt though if you were to be using it to acquire timber lands that obviously would have to go in to the REIT and wouldn’t be able to go on the TRS?

Hans E. Vanden Noort

If we were constrained at the limit of the TRS, that’s right.

Operator

Your next question comes from Chip Dillon – Credit Suisse.

Chip Dillon – Credit Suisse

I hate to beat a dead horse here but I was looking at the wrong column, you had somewhere – my printer just doesn’t quite get your columns right, you had $101 million in real estate sales in ’09 and $56.1 million in operating income and of course you had as I mentioned EBITDA of about $88 million so there’s a difference between those of about $32. You said $8 million was the basis so that would mean about $24 million would be the depletion?

Hans E. Vanden Noort

Yes, that’s right.

Chip Dillon – Credit Suisse

Then the other question I had is as we think about the ownership of timber land in the country and the potential at least for some of the early I guess partnerships for investors be they college endowments or defined benefit plans looking for liquidity to you see any potential or is it even within the realm of possibility to see some of those partnerships either convert to REIT status and if they are big enough try to become independent or possibly seek mergers with other REITs so that way they’re not out there selling land but they instead are if you will creating liquidity for their inside investors for those who need it?

Lee M. Thomas

Well, we haven’t seen any evidence of that at this point. Charlie have you seen anything like that?

Charles Margiotta

No, not really. There are private REITS within [TMOS], there are some of those that are a little hard to track but we haven’t seen I guess you’d describe that as unusually activity, we haven’t seen that or heard of that.

Chip Dillon – Credit Suisse

Would that be something you would think about as you think of your business for the next three to five years that could be an opportunity for Rayonier because of your size and scale that you could pretty much grow by offering liquidity to investors who are if you will in more illiquid investments in timber land and who might want the option to be able to have a more diversified portfolio while also gaining liquidity?

Lee M. Thomas

I think it could be. We look at a variety of options, that could be one of the ones that may be available to us to take a look at.

Operator

Your next question comes from Peter Ruschmeier – Barclays Capital.

Peter Ruschmeier – Barclays Capital

I was hoping to come back to Paul Boynton again and follow up on the comment, I want to make sure I understood and heard correctly that the harvest in 2009 I believe did you say was as much as 80% pulp wood?

Paul G. Boynton

In our eastern forest resources, yes.

Peter Ruschmeier – Barclays Capital

In a normal year if there is such a thing you would expect to be roughly 50/50 saw timber pulp wood?

Paul G. Boynton

Right, when the stable housing market and therefore the lumber mills are running, we’d see that far more balanced than what we have right now.

Peter Ruschmeier – Barclays Capital

As you look out in to the future in your crystal ball how long do you think it might take for you to return your harvest and I guess it depends on your assumptions but would you have an expectation that within two years or three years you’d get back to a normal cut or more quickly than that? Do you have a view as you plan your harvest looking out?

Lee M. Thomas

Peter, it really as you said depends on kind of your view of housing and our internal view is we’ve got another couple of years before housing is back to a more normal level. Now, during that period of time we see it gradually improving. We see this year we’ll have a gradual improvement and it will continue next year. So my sense is that you would see us adjust our harvest levels depending on how the overall pricing looks as far as saw logs are concerned. As that housing market comes up depending on demand for saw logs you may see us adjust that percentage. That’s the great thing about timber we’ve got a lot of flexibility there.

Peter Ruschmeier – Barclays Capital

Within that harvest the 80/20 was the pulp wood harvest would you say looking at say over a decade were your pulp wood fittings would you characterize them to be above average? In other words not really sustainable at those levels because part of what I’m trying to understand is your sustainable cut? Where was your cut last year relative to your sustainable cut? I assume that you under harvested your sustainable cut but within that you may have over harvested your pulp wood.

Lee M. Thomas

I think that is correct and I think that is related to thinnings. Now, we talked in the past about the fact that historically we had more a total cut approach as opposed to a thinning approach in the east. So we began a couple of years ago, actually before the downturn in housing with an overall thinning approach as we took a look at net present value of our timber and how we wanted to harvest it. So, we began to modify our overall harvesting regime to more of a thinning approach.

But we had not done that historically so we had a substantial amount of property in the east that was available for thinning which worked out well frankly during the last two years with the housing down turn. But, as Paul said in his opening comments, we’re looking at returning to more of a normalized level of what we consider thinning as a part of our pulp wood and I think that’s part of why we’ve got in there basically an overall volume reduction year-over-year, isn’t it Paul?

Paul G. Boynton

Yes, that’s right. I think to just give you a range as far as ongoing the thinning program can be 15% to 25% kind of range of our harvest in the east if that helps you Pete.

Peter Ruschmeier – Barclays Capital

I guess on a related point as it relates to thinning and pulp wood, I’m curious Lee if you have any thoughts on some of the RPS standards and what inning are we in as to whether we’re going to see any of these boilers see the light of day? How many conversations have you had with potentially new customers that would be using wood in a new way?

Lee M. Thomas

You know the ones that I see as more likely to come on line are the European driven whether it’s pellet plants or whether it is demand for chips, those are the ones that are talking directly with us about contracts. We’ve got contracts with one, we’re talking with more. A substantial amount of chips whether it is to go in to a pellet plant or whether it is to ship directly overseas I think to some extent domestic while we talk to an awful lot of people, is to some extent waiting to see what the kind of overall US policy is going to be as far as incentives are concerned. I think this biomass crop assistance program is an example of the country still being somewhat uncertain as to exactly how it wants to provide incentives there.

So while there’s an awful lot of discussion going on and I can’t tell you how many conversations we’ve had with people who want to talk about supply, because we’ve had a heck of a lot, people who have gotten plans for power plants, etc., the ones that seem to be coming to reality in terms of actually signing contracts are driven more by the European demand because they’ve got a more certain regulatory scheme.

Peter Ruschmeier – Barclays Capital

Recognizing Lee that you don’t want to talk about I’m sure specifics of a customer contract, could you maybe speak more broadly to the types of considerations that are important to you? Presumably some of these customers would want surety of supply for a long period of time but I’m not sure you want to lock yourself in to a 10 year pricing contract so how do you wrestle with those different elements of negotiations?

Lee M. Thomas

Well, they do want surety of supply, that’s because in some cases it’s important for them for their own financing and we look at that as something that’s part of the negotiation process. Obviously we don’t want to get locked in for any long period of time. We actually can deal with the pricing, generally we find that we’re able to discuss an overall market mechanism to adjust pricing so we feel like that’s not a big issue.

The issue is more how much flexibility we have around the total amount of wood volume we would have as far as a particular contract is concerned. We want the flexibility to be able to ensure that we can maintain a diverse set of customers and not end up with just one or two big customers that we’re locked in to. But we’ve found the discussions we’ve been able to have we’re able to work through and are working through most of the issues that are raised.

Operator

At this time there are no further questions.

Hans E. Vanden Noort

Thank you very much. For follow up questions please contact Carl Kraus.

Operator

This does conclude today’s conference. Thank you for your participation. You may now disconnect.

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Source: Rayonier, Inc. Q4 2009 Earnings Call Transcript
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