UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

Commission File Number 001-08634

 

Temple-Inland Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

1300 MoPac Expressway South

Austin, Texas 78746

(Address of principal executive offices, including Zip code)

 

Registrant’s telephone number, including area code: (512) 434-5800

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes o     No þ

 

The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing sales price of the Common Stock on the New York Stock Exchange on July 1, 2005, was approximately $3,696,000,000. For purposes of this computation, all officers, directors, and five percent beneficial owners of the registrant (as indicated in Item 12) are deemed to be affiliates. Such determination should not be deemed an admission that such directors, officers, or five percent beneficial owners are, in fact, affiliates of the registrant.

 

As of February 28, 2006, there were 110,857,380 shares of Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s definitive proxy statement to be prepared in connection with the Annual Meeting of Shareholders to be held May 5, 2006, are incorporated by reference into Part III of this report.

 

 

TABLE OF CONTENTS

 

 

Introduction

 

Temple-Inland Inc. is a holding company that, through its subsidiaries, operates three business segments:

 

 

Beginning in first quarter 2006, we will classify into a fourth business segment our real estate operations that are currently included within our forest products and financial services segments.

 

Temple-Inland Inc. is a Delaware corporation that was organized in 1983. The following chart presents the ownership structure for our significant subsidiaries as of the end of 2005. It does not contain all our subsidiaries, many of which are dormant or immaterial entities. A list of our subsidiaries is filed as an exhibit to this annual report on Form 10-K. All subsidiaries shown are 100 percent owned by their immediate parent company listed in the chart.

 

 

Our principal executive offices are located at 1300 MoPac Expressway South, Austin, Texas 78746. Our telephone number is (512) 434-5800. Additional information about us may be obtained from our Internet website, the address of which is http://www.templeinland.com.

 

We provide access through the website to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, including amendments to these reports, and other documents as soon as reasonably practicable after we file them with the Securities and Exchange Commission (or SEC). In addition, beneficial ownership reports filed by officers, directors, and principal security holders under Section 16(a) of the Securities Exchange Act of 1934, as amended (or the Exchange Act), are also available through our website. Our website also contains a corporate governance section that includes our

 

 

 

We will also provide printed copies of any of these documents to any shareholder upon request.

 

Financial Information

 

Our results of operations, including information regarding our principal business segments, are shown in the financial statements and the notes thereto contained in Item 8 of this Annual Report on Form 10-K. Certain statistical information required by Securities Act Industry Guide 3 and revenues and unit sales by product line and geographic area are contained in Items 6 and 8 of this Annual Report on Form 10-K.

 

Narrative Description of the Business

 

Corrugated Packaging.  Our corrugated packaging segment provided 58 percent of our consolidated net revenues for 2005. Our vertically integrated corrugated packaging operation includes:

 

 

We manufacture containerboard and convert it into a complete line of corrugated packaging. Approximately eight percent of the containerboard we produced in 2005 was sold in the domestic and export markets. We converted the remaining internal production, in combination with external containerboard we purchased, into corrugated containers at our box plants. While we have the capacity to convert more containerboard than we produce, we routinely buy and sell various grades of containerboard depending on our product mix.

 

Our nationwide network of box plants produces a wide range of products from commodity brown boxes to intricate die cut containers that can be printed with multi-color graphics. Even though the corrugated box business is characterized by commodity pricing, each order for each customer is a custom order. Our corrugated packaging is sold to a variety of customers in the food, paper, glass containers, chemical, appliance, and plastics industries, among others.

 

We also manufacture bulk containers constructed of multi-wall corrugated board for extra strength, which are used for bulk shipments of various materials.

 

We serve about 8,400 corrugated packaging customers with approximately 13,000 shipping destinations. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our corrugated packaging segment.

 

Sales of corrugated packaging track changing population patterns and other demographics. Historically, there has been a correlation between the demand for corrugated packaging and orders for nondurable goods.

 

We also own a 50 percent interest in Premier Boxboard Limited LLC, a joint venture that produces light-weight gypsum facing paper and corrugating medium at a mill in Newport, Indiana.

 

During 2005, we closed converting facilities in Antioch, California; Newark, Delaware; Atlanta, Georgia; and Louisville, Kentucky, as we continued efforts to improve our asset utilization and enhance return on investment from corrugated packaging. These closures were part of our initiatives, announced in November 2003, to lower costs and improve profitability from corrugated packaging. We will continue to consolidate converting facilities, eliminate positions, and improve asset utilization as part of these initiatives.

 

Forest Products.  Our forest products segment provided 21 percent of our consolidated net revenues for 2005 and manages our forest resources of approximately two million acres of timberland in Texas, Louisiana, Georgia, and Alabama (including our approximately 203,000 acres of high-value land principally located near Atlanta, Georgia). We manufacture a wide range of building products, including:

 

 

Our timberland is an important source of wood fiber used in manufacturing both forest products and corrugated packaging.

 

We sell forest products throughout the continental United States, with the majority of sales occurring in the southern United States. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our forest products segment. Most of our products are sold by account managers and representatives to distributors, retailers, and original equipment manufacturers. The forest products business is heavily dependent upon the level of residential housing expenditures, including the repair and remodeling market.

 

At the end of 2005, we owned a 50 percent interest in each of two joint ventures: Del-Tin Fiber LLC, which produces MDF at a facility in Arkansas; and Standard Gypsum LP, which produces gypsum wallboard at a plant and related quarry in Texas and a plant in Tennessee. In early 2006, we purchased our partner’s interest in Standard Gypsum, which is now a wholly-owned operation.

 

We have designated approximately 203,000 acres of our timberland principally located near Atlanta, Georgia, as high-value with the potential for real estate development. We are creating the infrastructure and securing entitlements on this high-value land that will allow us over time to realize value from these lands through sale, joint venture, or development. Beginning in first quarter 2006, these assets and activities will be reclassified into a fourth operating segment, Real Estate, that will also include real estate operations that are currently included within our financial services segment.

 

Financial Services.  Our financial services segment provided 21 percent of our consolidated net revenues for 2005. We provide financial services in the areas of:

 

 

Guaranty is a federally-chartered stock savings bank that conducts its business through banking centers in Texas and California and lends in diverse geographic markets. Our 98 Texas banking centers are concentrated in the metropolitan areas of Houston, Dallas/Fort Worth, San Antonio, and Austin, as well as the central and eastern regions of the state. Our 51 California banking centers are concentrated in Southern California and the Central Valley. We provide deposit products to the general public, invest in single-family adjustable-rate mortgages and mortgage-backed securities, lend money for the construction of real estate projects and the financing of business operations, and provide a variety of other financial products and services to consumers and businesses.

 

Our primary financial services revenues are interest earned on loans and securities, as well as fees received in connection with loans and deposit services. Our major financial services expenses are interest paid on consumer deposits and other borrowings and personnel costs. Like other financial institutions, this business segment is significantly influenced by general economic conditions; the monetary, fiscal, and regulatory policies of the federal government; and the policies of financial institution regulatory authorities. Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for mortgage financing and for other types of loans as well as market conditions. We primarily seek assets with interest rates that adjust periodically rather than assets with long-term fixed rates.

 

Guaranty is required to maintain minimum capital levels in accordance with regulations of the Office of Thrift Supervision (or OTS) established to ensure capital adequacy of savings institutions. We believe that as of year-end 2005, Guaranty met or exceeded all of these capital adequacy requirements. To remain in the lowest tier of Federal Deposit Insurance Corporation insurance premiums, Guaranty must meet a leverage capital ratio of at least five percent of adjusted total assets. At year-end 2005, the leverage capital ratio was 6.94 percent of adjusted total assets.

 

As we previously disclosed, in 2004 the OTS and Guaranty entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist for Affirmative Relief (or Consent Order) related to findings and required corrective actions associated with Guaranty’s mortgage origination activities. Under the Consent Order, Guaranty agreed, among other things, to take certain actions primarily related to its repositioned mortgage origination activities, including strengthening its regulatory compliance controls and management,

enhancing its suspicious activity reporting and regulatory training programs, and implementing improved risk assessment and loan application register programs. Guaranty has implemented the corrective actions required by the Consent Order. Additionally, we further repositioned our mortgage origination activities in 2005, substantially reducing the volume of activity to which the corrective actions apply. The Consent Order remains in effect, but has had no significant ongoing impact on the operations of Guaranty or its ability to pay dividends to the parent company. We have not incurred any significant financial loss as a result of this matter and have no reason to believe that the matters addressed in the Consent Order will have a significant effect on Guaranty’s long-term operations or cash flows. We will originate mortgage loans through certain retail channels, including the retail branches of Guaranty, and we will continue to restructure our mortgage origination capabilities.

 

Through subsidiaries of Guaranty, we act as agent in the sale of commercial and personal lines of property, casualty, life, and group health insurance products. We also administer the marketing and distribution of several mortgage-related personal life, accident, and health insurance programs. In addition, we sell annuities primarily to customers of Guaranty.

 

We are involved in the development of over 60 residential subdivisions in Texas, California, Colorado, Florida, Georgia, Missouri, Tennessee, and Utah. We also own, either directly or through joint venture interests, three commercial properties. Beginning in first quarter 2006, most of these assets and activities will be reclassified into a fourth operating segment, Real Estate, that will also include real estate operations that are currently included within our forest products segment.

 

Raw Materials

 

Our main raw material resource is wood fiber. We own or lease approximately two million acres of timberland located in Texas, Louisiana, Georgia, and Alabama. In 2005, wood fiber required for our corrugated packaging and forest products operations was supplied from these lands and as a by-product of our solid wood operations to the extent shown below:

 

 

The balance of our wood fiber requirements for these operations was purchased from numerous landowners and other timber owners, as well as other producers of wood by-products.

 

Linerboard and corrugating medium are the principal materials used to make corrugated boxes. Our mills at Rome, Georgia and Bogalusa, Louisiana, only manufacture linerboard. Our Ontario, California; Maysville, Kentucky; and Orange, Texas, mills are traditionally linerboard mills, but can also manufacture corrugating medium. Our New Johnsonville, Tennessee, mill only manufactures corrugating medium. The principal raw material used by the Rome, Georgia; Orange, Texas; and Bogalusa, Louisiana, mills is virgin fiber, but each mill is also able to use recycled fiber for up to 15 percent of its raw material requirements. The Ontario, California, and Maysville, Kentucky, mills use only recycled fiber. The mill at New Johnsonville, Tennessee, uses a combination of virgin and recycled fiber. In 2005, recycled fiber represented approximately 36 percent of the total fiber needs of our containerboard operations. The price of recycled fiber fluctuates due to normal supply and demand for the raw material and for the finished product. We purchase recycled fiber on the open market from numerous suppliers. Price fluctuations reflect the competitiveness of these markets. We generally produce more linerboard and less corrugating medium than is converted at our box plants. The deficit of corrugating medium is filled through open market purchases and/or trades, and we sell any excess linerboard in the open market.

 

We obtain gypsum for our wallboard operations in Fletcher, Oklahoma, from one outside source through a long-term purchase contract. At our gypsum wallboard plants in West Memphis, Arkansas, and Cumberland City, Tennessee, synthetic gypsum is used as a raw material. Synthetic gypsum is a by-product of coal-burning electrical power plants. We have a long-term supply agreement for synthetic gypsum produced at a Tennessee Valley Authority electrical plant located adjacent to the Cumberland City plant. Synthetic gypsum acquired pursuant to this agreement supplies all the synthetic gypsum required by the Cumberland City plant and our

West Memphis plant. The gypsum wallboard plant in McQueeney, Texas, primarily uses gypsum obtained from its own quarry and gypsum acquired from the same source that supplies the Fletcher, Oklahoma, plant.

 

We believe the sources outlined above will be sufficient to supply our raw material needs for the foreseeable future.

 

Energy

 

Electricity and steam requirements at our manufacturing facilities are either supplied by a local utility or generated internally through the use of a variety of fuels, including natural gas, fuel oil, coal, wood bark, and other waste products resulting from the manufacturing process. By utilizing these waste products and other wood by-products as a biomass fuel to generate electricity and steam, we were able to generate approximately 72 percent of our energy requirements during 2005 at our mills in Rome, Georgia; Bogalusa, Louisiana; and Orange, Texas. In some cases where natural gas or fuel oil is used, our facilities possess a dual capacity enabling the use of either fuel as a source of energy.

 

The natural gas needed to run our natural gas fueled power boilers, package boilers, and turbines is acquired pursuant to a multiple vendor solicitation process that provides for the purchase of gas, primarily on a firm basis with a few operations on an interruptible basis, at rates favorable to spot market rates. Natural gas prices continued to rise during 2005 with some fairly dramatic spikes related to hurricanes and other natural disasters. It is likely that prices of natural gas will continue to fluctuate in the future. We hedge very little of our energy costs.

 

In an effort to reduce our exposure to changing prices of natural gas, we recently completed capital projects at our Bogalusa, Rome, and Orange mills that will modify existing boilers to allow us to increase significantly the use of wood bark and waste fuel for steam generation. These projects, which cost approximately $42 million, have enabled us to reduce our natural gas usage and should continue to produce benefits in 2006.

 

Employees

 

We have approximately 15,500 employees. Approximately 5,325 of our employees are covered by collective bargaining agreements. These agreements generally run for a term of three to six years and have varying expiration dates. The following table summarizes certain information about collective bargaining agreements that cover a significant number of employees:

 

 

We have additional collective bargaining agreements with employees at various other manufacturing facilities. These agreements each cover a relatively small number of employees and are negotiated on an individual basis at each such facility.

 

We consider our relations with our employees to be good.

 

Environmental Protection

 

We are committed to protecting the health and welfare of our employees, the public, and the environment and strive to maintain compliance with all state and federal environmental regulations in a manner that is also cost effective. When we construct new facilities or modernize existing facilities, we generally use state of the art technology for air and water emissions. This forward-looking approach is intended to minimize the effect that changing regulations have on capital expenditures for environmental compliance.

 

Our operations are subject to federal, state, and local provisions regulating discharges into the environment and otherwise related to the protection of the environment. Compliance with these provisions, primarily the Federal Clean Air Act, Clean Water Act, Comprehensive Environmental Response, Compensation and Liability Act of 1980 (or CERCLA), as amended by the Superfund Amendments and Reauthorization Act of 1986 (or SARA), and Resource Conservation and Recovery Act (or RCRA), requires us to invest substantial funds to modify facilities to assure compliance with applicable environmental regulations. Capital expenditures directly related to environmental compliance totaled $5 million in 2005. This amount does not include capital expenditures for environmental control facilities made as a part of major mill modernizations and expansions or capital expenditures made for another purpose that have an indirect benefit on environmental compliance.

 

Future expenditures for environmental control facilities will depend on new laws and regulations and other changes in legal requirements and agency interpretations thereof, as well as technological advances. We expect the prominence of environmental regulation and compliance to continue for the foreseeable future. Given these uncertainties, we currently estimate that capital expenditures for environmental purposes during the period 2006 through 2008 will average $8 million each year, excluding expenditures related to the Maximum Achievable Control Technology (or MACT) programs and landfill closures discussed below. The estimated expenditures could be significantly higher if more stringent laws and regulations are implemented.

 

On April 15,1998, the U.S. Environmental Protection Agency (or EPA) issued extensive regulations governing air and water emissions from the pulp and paper industry (or Cluster Rule). Compliance with the MACT phases of the Cluster Rule will be required at certain intervals through 2008.

 

We estimate we will spend approximately $10 million, $7 million of which was spent in 2005, to meet the requirements of the second phase of MACT I, which covers Hazardous Air Pollutant (or HAP) emissions from High Volume Low Concentration sources at three containerboard mills. We do not anticipate any difficulty meeting the compliance deadline of April 2006.

 

On September 13, 2004, EPA published the Boiler MACT. This regulation affects industrial boilers and process heaters burning all fuel types with the exception of small gas-fired units. However, large existing gas-fired units and liquid fuel (oil) fired units need only submit an initial notification. Affected units with emission standards include new gas-fired and liquid fuel units and all large solid fuel units at major sources for HAPs. Compliance methods vary from verification by testing that the affected unit does not emit a regulated amount of HAPs to adding additional control equipment. Compliance is required by September 2007. We have 12 boilers at ten containerboard and forest products facilities that are now being evaluated to determine appropriate compliance measures and costs. We estimate capital expenditures to comply with the Boiler MACT standards to be $3 million.

The Plywood and Composite Wood Panel (or PCWP) MACT standards were published July 30, 2004, and also limit emissions of HAPs. The rule offers several options for compliance including emission control device performance, production based emission limits, emission averaging, and a low risk subcategory. The initial notices of applicability were filed prior to the January 26, 2005 deadline, with PCWP MACT compliance required by October 1, 2008. We have nine forest products facilities affected by the regulation. These are now being evaluated to determine appropriate compliance measures. Capital expenditures are estimated at $12 million.

 

We use company-owned landfills for disposal of non-hazardous waste at three containerboard mills and two forest products facilities. We also have two additional sites that we are remediating. Based on third-party cost estimates, we expect to spend, on an undiscounted basis, $28 million over the next 25 years to ensure proper closure of these landfills and remediation of these two additional sites.

 

In addition to these capital expenditures, we spend a significant amount on ongoing maintenance costs to continue compliance with environmental regulations. We do not believe, however, that these capital expenditures or maintenance costs will have a material adverse effect on our earnings. In addition, expenditures for environmental compliance should not have a material effect on our competitive position, because other companies are also subject to these regulations.

 

As previously disclosed, we are working with an environmental consulting firm and the Louisiana Department of Environmental Quality to investigate the source of contaminated water discovered in a manhole adjacent to our facilities in Bogalusa, Louisiana, and develop a remediation plan. At this time, we are not able to predict whether we will be subject to any monetary sanctions arising out of this matter or the amount of any such monetary sanctions. Based on the latest, but limited, information we have, we believe it is probable that we will incur remediation costs in connection with this matter, but we are not able to predict the extent of remediation that may be required. We have established an initial reserve of $4 million for the continued investigation of this matter and related remediation costs. Of this amount, $3 million applies to the chemical business, which is included in discontinued operations. As our investigation continues, our estimate of remediation costs could change, which would result in future adjustments to the reserve established for this matter. We currently have no reason to believe that this matter will have a material effect on our financial position or long-term results of operations or cash flows.

 

Our facilities are periodically inspected by environmental authorities. We are required to file with these authorities periodic reports on the discharge of pollutants. Occasionally, one or more of these facilities may operate in violation of applicable pollution control standards, which could subject the company to fines or penalties. We believe that any fines or penalties that may be imposed as a result of these violations will not have a material adverse effect on our earnings or competitive position. No assurance can be given, however, that any fines levied in the future for any such violations will not be material.

 

Under CERCLA, liability for the cleanup of a Superfund site may be imposed on waste generators, site owners and operators, and others regardless of fault or the legality of the original waste disposal activity. While joint and several liability is authorized under CERCLA, as a practical matter, the cost of cleanup is generally allocated among the many waste generators. We are named as a potentially responsible party in four proceedings relating to the cleanup of hazardous waste sites under CERCLA and similar state laws, excluding sites for which our records disclose no involvement or for which our potential liability has been finally determined. In all but one of these sites, we are either designated as a de minimus potentially responsible party or believe our financial exposure is insignificant. We have conducted investigations of all four sites, and currently estimate that the remediation costs to be allocated to us are about $2 million and should not have a material effect on our earnings or competitive position. There can be no assurance that we will not be named as a potentially responsible party at additional Superfund sites in the future or that the costs associated with the remediation of those sites would not be material.

 

Competition

 

We operate in highly competitive industries. The commodity nature of our manufactured products gives us little control over market pricing or market demand for our products. The level of competition in a given product or market may be affected by economic factors, including interest rates, housing starts, home repair and remodeling activities, and the strength of the dollar, as well as other market factors including supply and demand for these products, geographic location and the operating efficiencies of competitors. Our competitive

position is influenced by varying factors depending on the characteristics of the products involved. The primary factors are product quality and performance, price, service, and product innovation.

 

The corrugated packaging industry is highly competitive with approximately 1,400 box plants in the United States. Our box plants accounted for approximately 13.5 percent of total industry shipments during 2005, making us the third largest producer of corrugated packaging in the United States. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and metals.

 

In building products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of building products.

 

Our savings bank competes with commercial banks, savings and loan associations, mortgage banks, and other lenders. We also compete with real estate investment and development companies in our real estate activities and with insurance agencies in our property, casualty, life, and health insurance activities. The financial services industry is a highly competitive business, and a number of entities with which we compete have greater resources.

 

Executive Officers of the Registrant

 

Set forth below are the names, ages, and titles of the persons who serve as executive officers of the Company:

 

 

Kenneth M. Jastrow, II became Chairman of the Board and Chief Executive Officer on January 1, 2000. Mr. Jastrow previously served in various capacities since 1991, including President, Chief Operating Officer, Chief Financial Officer, and Group Vice President.

 

Doyle R. Simons was named Executive Vice President in February 2005 following his service as Chief Administrative Officer since November 2003. Mr. Simons served as Vice President, Administration from November 2000 to November 2003 and Director of Investor Relations from 1994 through 2003.

 

J. Patrick Maley III became Executive Vice President — Paper in November 2004 following his appointment as Group Vice President in May 2003. Prior to joining the Company, Mr. Maley served in various capacities from 1992 to 2003 at International Paper, including director of manufacturing for the containerboard and kraft division, mill manager of the Androscoggin coated paper mill in Jay, Maine; staff manufacturing services director of the containerboard and kraft division; and segment general manager of the container business.

 

James M. DeCosmo became Group Vice President in May 2005. Mr. DeCosmo joined Temple-Inland in 1999 as Director of Forest Management for the eastern region forest operations and in November 2000 was promoted to Vice President, Forest for our forest products segment with responsibility for our two million acres of timberland.

Bart J. Doney became Group Vice President in February 2000. Mr. Doney has served as Executive Vice President of our corrugated packaging segment since June 1998, Senior Vice President from 1996 until 1998, and Vice President, Sales and Administration, Containerboard Division from 1990 to 1996.

 

Kenneth R. Dubuque became Group Vice President in February 2000. In October 1998, Mr. Dubuque was named President and Chief Executive Officer of Guaranty. From 1996 until 1998, Mr. Dubuque served as Executive Vice President and Manager — International Trust and Investment of Mellon Bank Corporation. From 1991 until 1996, he served as Chairman, President and Chief Executive Officer of the Maryland, Virginia, and Washington, D.C., operating subsidiary of Mellon Bank Corporation.

 

Jack C. Sweeny became Group Vice President in May 1996. Since November 1982, Mr. Sweeny has served in various capacities in our forest products segment.

 

Dennis J. Vesci became Group Vice President in August 2005. Mr. Vesci previously served as Senior Vice President of Sales and Marketing for our corrugated packaging segment since November 1998.

 

Randall D. Levy became Chief Financial Officer in May 1999. Mr. Levy joined Guaranty in 1989 serving in various capacities, including Treasurer and most recently as Chief Operating Officer from 1994 through 1999.

 

Louis R. Brill became Vice President and Controller in December 1999 and was named Chief Accounting Officer in May 2000. Before joining us in 1999, Mr. Brill was a partner of Ernst & Young LLP for 25 years.

 

Scott Smith became Chief Information Officer in February 2000. Prior to that, Mr. Smith was Treasurer of Guaranty from November 1993 to December 1999 and Chief Information Officer of our financial services segment from August 1995 to June 1999. Mr. Smith also served in various capacities at Guaranty since 1999, including Chief Financial Officer from June 2001 until December 2002.

 

J. Bradley Johnston became General Counsel in August 2002 and was also named Chief Administrative Officer in February 2005. Prior to that, Mr. Johnston served as General Counsel of Guaranty from January 1995 through May 1999, as General Counsel of our financial services segment from May 1997 through July 2002 and Chief Administrative Officer of our financial services segment and Guaranty from May 1999 through July 2002.

 

Leslie K. O’Neal was named Vice President in August 2002 and became Secretary in February 2000 after serving as Assistant Secretary since 1995. Ms. O’Neal also serves as Assistant General Counsel, a position she has held since 1985.

 

David W. Turpin became Treasurer in June 1991.

 

The Board of Directors annually elects officers to serve until their successors have been elected and have qualified or as otherwise provided in our Bylaws.

 

 

All of the industries in which we operate are highly competitive and are affected to varying degrees by supply and demand factors and economic conditions, including changes in interest rates, new housing starts, home repair and remodeling activities, loan collateral values (particularly real estate), and the strength of the U.S. dollar. Given the commodity nature of our manufactured products, we have little control over market pricing or market demand. No single company is dominant in any of our industries.

 

Our corrugated packaging competitors include large, vertically-integrated paperboard and packaging products companies and numerous smaller companies. Because these products are globally traded commodities, the industries in which we compete are particularly sensitive to price fluctuations as well as other factors, including innovation, design, quality, and service, with varying emphasis on these factors depending on the product line. To the extent that one or more of our competitors become more successful with respect to any key competitive factor, our business could be materially adversely affected. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and various types of metal.

 

In the forest products markets, our forest products segment competes with many companies that are substantially larger and have greater resources in the manufacturing of forest products.

The financial services industry is also a highly competitive business, and a number of entities with which we compete are substantially larger and have greater resources than we do. Our financial services segment competes with commercial banks, savings and loan associations, mortgage banks, and other lenders in our savings bank activities; with real estate investment and development companies in our real estate activities; and with insurance agencies in our insurance activities.

 

Our manufacturing segments are affected by the cost of certain raw materials and energy.

 

Virgin wood fiber and recycled fiber are the principal raw materials we use to manufacture corrugated packaging. The portion of our virgin fiber requirements that do not come from our timberland or that are not produced as a by-product from our forest products operations are purchased in highly competitive, price sensitive markets. The price for these materials has historically fluctuated on a cyclical basis and has often depended on a variety of factors over which we have no control, including environmental and conservation regulations, natural disasters, the price and level of imported timber and the continuation of any applicable tariffs, and weather. In addition, the increase in demand for products manufactured, in whole or in part, from recycled fiber, including old corrugated containers, has caused an occasional tightness in the supply of recycled fiber. It may also cause a significant increase in the cost of such fiber used in the manufacture of recycled containerboard and related products. Such costs are likely to continue to fluctuate. While we have not experienced any significant difficulty in obtaining wood fiber and recycled fiber in economic proximity to our mills, this may not continue to be the case for any or all of our mills.

 

The cost of producing our products is also sensitive to the price of energy. While we have attempted to contain energy costs through internal generation and in some instances the use of by-products from our manufacturing processes as fuel, no assurance can be given that such efforts will be successful in the future or that energy prices will not rise to levels that would have a material adverse effect on our results of operations. We hedge very little of our energy needs.

 

The corrugated packaging and forest products industries are cyclical in nature and experience periods of overcapacity.

 

The operating results of our paper and forest products segments reflect each such industry’s general cyclical pattern. While the cycles of each industry do not necessarily coincide, demand and prices in each tend to drop substantially in an economic downturn. The forest products industry is further influenced by the residential construction and remodeling markets. Further, each industry has had substantial overcapacity for several years. Both industries are capital intensive, which leads to high fixed costs and generally results in continued production as long as prices are sufficient to cover marginal costs. These conditions have contributed to substantial price competition and volatility in these industries, even when demand is strong. Any increased production by our competitors could further depress prices for our products. From time to time, we have closed certain of our facilities or have taken downtime based on prevailing market demand for our products and may continue to do so, reducing our total production levels. Certain of our competitors have also temporarily closed or reduced production at their facilities, but can reopen and/or increase production capacity at any time, which could exacerbate the overcapacity in these industries and depress prices.

 

Our manufacturing activities are subject to environmental regulations and liabilities that could have a negative effect on our operating results.

 

Our manufacturing operations are subject to federal, state, and local provisions regulating the discharge of materials into the environment and otherwise related to the protection of the environment. Compliance with these provisions has required us to invest substantial funds to modify facilities to ensure compliance with applicable environmental regulations. In other sections of this Annual Report on Form 10-K, we provide certain estimates of expenditures we expect to make for environmental compliance in the next few years. However, we could incur additional significant expenditures due to changes in law or the discovery of new information, and such expenditures could have a material adverse effect on our financial condition and results of operations.

 

Our financial services segment operates in a highly regulated environment and may be adversely affected by changes in federal and local laws and regulations.

 

Our financial services segment is subject to regulation, supervision, and examination by federal and state banking authorities. The regulations enforced by these authorities are intended to protect customers and federal

deposit insurance funds, not creditors, stockholders, or other security holders. Regulations affecting banks and financial services companies are continuously changing, and any change in applicable regulations or federal or state legislation could have a negative effect on our financial services segment. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by federal savings banks and their holding companies (including the power to appoint a conservator or receiver for the bank) or to require changes in various aspects of their operation at any time, including restrictions on the payment of dividends to the parent company. Any exercise of such regulatory discretion could have a negative effect on our financial condition or the results of our operations.

 

We previously disclosed that our savings bank subsidiary, Guaranty Bank, agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist for Affirmative Relief with its banking regulator, the OTS, on December 22, 2004. Under this consent order, Guaranty agreed, among other things, to take certain actions primarily related to its repositioned mortgage origination activities, including strengthening its regulatory compliance controls and management, enhancing its suspicious activity reporting and regulatory training programs, and implementing improved risk assessment and loan application register programs. The consent order remains in effect and the OTS continues to evaluate Guaranty’s compliance. Any failure by Guaranty to meet the requirements of the consent order in a timely fashion, or any additional requirements imposed or supervisory actions taken by the OTS, could have a material adverse effect on our financial condition or the results of our operations.

 

Fluctuations in interest rates could reduce our financial services segment’s profitability.

 

Fluctuations in interest rates are not predictable or controllable. The majority of Guaranty’s assets and liabilities are monetary in nature and may be adversely affected by changes in interest rates. Like most financial institutions, changes in interest rates can affect our net interest income as well as the value of our assets and liabilities. A significant change in the general level of interest rates may adversely affect our net yield on interest-earning assets because our interest-bearing assets and liabilities do not reprice in tandem. In addition, periodic and lifetime caps may limit interest rate changes on our mortgage-backed securities and loans that pay interest at adjustable rates.

 

Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest rates will likely affect our net interest income and our overall results.

 

If our allowance for loan losses is not sufficient to cover actual loan losses, the income from our financial services segment could decrease.

 

Our loan customers may fail to repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. Such loan losses could have a material adverse effect on our operating results. We make various assumptions, estimates, and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we rely on a number of factors, including our own experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio and adjustments may be necessary that would have a material adverse effect on our operating results.

 

We face risks related to the composition of our financial services segment’s loan portfolio.

 

Commercial real estate, multi-family, and commercial business loans, which represent about one-third of our loan portfolio, generally expose a lender to greater risk of loss than one- to four-family residential mortgage loans because such loans involve larger loan balances to single borrowers or groups of related borrowers. The repayment of commercial business loans often depends on the successful operations and income streams of the borrowers. Many of Guaranty’s commercial real estate or multi-family borrowers have more than one loan outstanding with Guaranty. Consequently, an adverse development with respect to one loan, credit relationship, or geographic market can expose Guaranty to a significantly greater risk of loss compared to an adverse development with respect to a single one- to four-family residential mortgage loan.

Additionally, Guaranty’s commercial business portfolio includes approximately $700 million in loans to companies that operate in the energy sector. Although the majority of these loans are collateralized by oil and gas reserves, significant changes in energy prices or unsuccessful hedge programs by Guaranty’s borrowers could affect collateral values.

 

Approximately one-half of our one- to four-family residential loan portfolio consists of loans in the state of California. We would be adversely affected by a reduction in the value of real estate located in California that serves as collateral for our loans. We may be forced to increase our allowances for loan losses and may suffer additional loan losses as a result of any such reduction in collateral values. The adverse impact from a reduction in real estate values in California may be greater for Guaranty than that suffered by other financial institutions with a more geographically diverse loan portfolio.

 

None.

 

We own and operate manufacturing facilities throughout the United States, four converting plants in Mexico, and a box plant in Puerto Rico. In 2005, we sold our MDF facility in Canada. Additional descriptions of selected properties are set forth in the following charts:

 

Containerboard Mills

 

 

 

 

Corrugated Packaging Plants*

 

 

 

 

 

Additionally, we own a graphics resource center in Indianapolis, Indiana, that has a 100² preprint press, and a fulfillment center in Gettysburg, Pennsylvania. We lease 50 warehouses located throughout much of the United States.

 

Forest Products

 

 

 

 

 

 

 

Timber and Timberland*
(In acres)

 

 

 

 

We believe our plants, mills, and manufacturing facilities are suitable for their purposes and adequate for our business.

 

We further classify our timberland as either strategic timberland, non-strategic timberland, or high-value land with real estate development potential. At year-end 2005, we held 20,000 acres of non-strategic land, which will be sold over time, 203,000 acres of high-value land, and 1.8 million acres of strategic timberland. The 1.8 million acres of strategic timberland are important to our converting operations and play a key role in our competitiveness and ability to meet environmental certification requirements relating to sound forest management techniques and chain of custody. We are creating the infrastructure and securing entitlements on the 203,000 acres of high-value land that will allow us over time to realize value from these lands through sale, joint venture, or development.

 

In connection with our timber holdings, we also own mineral rights on 388,000 acres in Texas and Louisiana and 351,000 acres in Alabama and Georgia. Revenue from our mineral rights consists solely of lease and royalty payments, and was approximately $30 million in 2005.

 

We also own certain office buildings, including approximately 445,000 square feet of office space in Austin, Texas, and 150,000 square feet of space in Diboll, Texas.

 

At year-end 2005, property and equipment having a net book value of $5 million were subject to liens in connection with $45 million of debt.

 

General

 

We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. A summary of our more significant legal matters is set forth below. We believe that adequate reserves have been established for any probable losses and that the outcome of any of these proceedings should not have a material adverse effect on our financial position or long-term results of operations or cash flows. It is possible, however, that charges related to these matters could be significant to results of operations or cash flows in any single accounting period.

 

Antitrust Litigation

 

On May 14, 1999, we and eight other linerboard manufacturers were named as defendants in a consolidated class action complaint that alleged a civil violation of Section 1 of the Sherman Act. We executed a settlement agreement on April 11, 2003, with the representatives of the class, which received final approval by the trial court. We paid a total of $8 million into escrow to fulfill the terms of the class action settlement.

 

Twelve individual complaints containing allegations similar to those in the class action have been filed by certain opt-out plaintiffs and over 3,000 of their named subsidiaries against the original defendants in the class action. In July 2005, we entered into a settlement agreement with five of the opt-out plaintiffs and their subsidiaries that resulted in our paying $5 million to these plaintiffs. In December 2005, the other defendants in the remaining opt-out cases settled with the majority of the plaintiff groups in those cases. Discovery on the

remaining cases is ongoing with trial set for 2007. In 2005, we increased our reserve for this matter by $13 million.

 

Bogalusa Litigation

 

On October 15, 2003, a release of nitrogen dioxide and nitrogen oxide took place at our linerboard mill in Bogalusa, Louisiana. The mill followed appropriate protocols for handling this type of event, notifying the Louisiana Department of Environmental Quality, the U.S. Environmental Protection Agency and local law enforcement officials. The federal and state environmental agencies have analyzed the reports we prepared and have not indicated that they will take any action against us.

 

To date, we have been served with seven lawsuits seeking damages for various personal injuries allegedly caused by either exposure to the released gas or fears of exposure. These seven lawsuits have been consolidated into a cumulative case under Louisiana state rules. We intend to vigorously defend against these allegations.

 

Tax-exempt bonds

 

The Internal Revenue Service (or IRS) has announced that it is targeting for examination the tax-exempt status of solid waste disposal bonds issued to finance capital expenditures that involve paper, pulpwood, and sawdust. Over the years, we have financed about $250 million of capital expenditures using tax-exempt solid waste disposal bonds, including $85 million of capital expenditures of joint ventures in which we held a 50% interest. Currently, $41 million of these bonds are outstanding and included in long-term debt on our balance sheet.

 

The IRS is examining five of these solid waste disposal bond issues aggregating $134 million: $30 million City of Maysville, Kentucky bonds issued in 1992, $21 million City of Hope, Arkansas bonds issued in 1994, $8 million Waxahachie Industrial Development Authority bonds issued in 1998, $46 million Industrial Development Board of Stewart County, Tennessee bonds issued in 1999 through our Standard Gypsum joint venture, and $29 million Union County, Arkansas bonds issued in 1997 through our Del-Tin joint venture. All of these issues were previously redeemed except for the City of Maysville bonds, which are outstanding.

 

These audits are all in the early stages of examination, with the exception of the City of Hope bonds, for which the IRS has issued a preliminary adverse determination, which we are appealing, and the Waxahachie Industrial Development Authority bonds, which the IRS has concluded without adjustment due to the fact that the bonds were redeemed in 2000. In connection with the routine examination of our consolidated tax returns for the 2001 — 2003 audit cycle, the IRS has proposed an after tax adjustment of $3 million due to the disallowance of the interest deductions we took for interest paid on these bonds during those years.

 

Asbestos

 

We are a defendant in various lawsuits involving alleged workplace exposure to asbestos. These cases involve exposure to asbestos in premises owned or operated by us. We do not manufacture any products that contain asbestos and all our cases in this area are limited to workplace exposure claims. Historically, our aggregate annual settlements related to asbestos claims have been approximately $1 million. We have experienced an increase in the number of asbestos claims asserted against us, and these claims are on the rise generally in the United States against owners or operators of premises allegedly containing asbestos.

 

Other Litigation

 

In 1988, we formed Guaranty (then known as Guaranty Federal Savings Bank) to acquire substantially all the assets and deposit liabilities of three thrift institutions from the Federal Savings and Loan Insurance Corporation, as receiver of those institutions. In connection with the acquisition, the government entered into an assistance agreement with us in which various tax benefits were promised. In 1993, Congress enacted narrowly targeted legislation to eliminate a portion of the promised tax benefits. We filed suit against the United States in the U.S. Court of Federal Claims alleging, among other things, that the 1993 legislation breached our contract and that we are entitled to monetary damages. This lawsuit is currently in the discovery and motion stage and, if it were to go to trial, we would not expect to resolve it for several years. We, however, are currently in settlement negotiations with the government that we hope will lead to a more timely resolution of this matter.

 

We did not submit any matter to a vote of our shareholders during the fourth quarter of our fiscal year ended December 31, 2005.

 

 

Market Information

 

Our Common Stock is traded on the New York Stock Exchange and The Pacific Exchange. The table below sets forth the high and low sales price for our Common Stock during each fiscal quarter in the two most recent fiscal years.

 

 

 

The amounts in this table have been adjusted to reflect our two-for-one stock split effected on April 1, 2005.

 

 

Shareholders

 

Our stock transfer records indicated that as of February 28, 2006, there were approximately 5,000 holders of record of our Common Stock.

 

Dividend Policy

 

As indicated above, we paid quarterly dividends during each of the two most recent fiscal years in the amounts shown. On February 3, 2006, the Board of Directors declared a quarterly dividend on our Common Stock of $0.25 per share payable on March 15, 2006, to shareholders of record on March 1, 2006. The Board periodically reviews the dividend policy, and the declaration of dividends will necessarily depend upon our earnings and financial requirements and other factors within the discretion of the Board.

 

Issuer Purchases of Equity Securities⁽¹⁾

 

 

 

Other

 

See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for disclosure regarding securities authorized for issuance under equity compensation plans.

 

 

 

 

 

 

 

 

 

 

 

Forward-Looking Statements

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements” within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as “believe,” “anticipate,” “could,” “estimate,” “intend,” “may,” “plan,” “expect,” and similar expressions, including references to assumptions. These statements reflect management’s current views with respect to future events and are subject to risk and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:

 

 

 

Our actual results, performance, or achievement probably will differ from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. In view of these uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. We expressly disclaim any obligation to publicly revise any forward-looking statements contained in this report to reflect the occurrence of events after the date of this report.

 

Non-GAAP Financial Measure

 

Return on investment (ROI) is an important internal measure for us because it is a key component of our evaluation of overall performance and the performance of our business segments. Studies have shown that there is a direct correlation between shareholder value and ROI and that shareholder value is created when ROI exceeds the cost of capital. ROI allows us to evaluate our performance on a consistent basis as the amount we earn relative to the amount invested in our business segments. A significant portion of senior management’s compensation is based on achieving ROI targets.

 

In evaluating overall performance, we define ROI as operating income, adjusted for significant unusual items, divided by parent company total assets, less certain assets and certain current liabilities. In evaluating segment performance, we define ROI as segment operating income divided by segment assets less segment current liabilities. We do not believe there is a comparable GAAP financial measure to our definition of ROI. The reconciliation of our ROI calculation to amounts reported under GAAP is included in a later section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Despite its importance to us, ROI is a non-GAAP financial measure that has no standardized definition and as a result may not be comparable with other companies’ measures using the same or similar terms. Also there may be limits in the usefulness of ROI to investors. As a result, we encourage you to read our consolidated financial statements in their entirety and not to rely on any single financial measure.

 

Accounting Policies

 

Critical Accounting Estimates

 

In preparing our financial statements, we follow generally accepted accounting principles, which in many cases require us to make assumptions, estimates and judgments that affect the amounts reported. Our significant accounting policies are included in Note 1 to the Consolidated Financial Statements and Note A to the Parent Company and Financial Services Summarized Financial Statements. Many of these principles are relatively straightforward. There are, however, a few accounting policies that are critical because they are important in determining our financial condition and results, and they are difficult for us to apply. Within the parent company, they include asset impairments and pension accounting, and within financial services, they include the allowance for loan losses and, through 2004, mortgage servicing rights. The difficulty in applying these policies arises from the assumptions, estimates and judgments that we have to make currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations, as well as our intentions. As the difficulty increases, the level of precision decreases, meaning actual results can, and probably will, be different from those currently estimated. We base our assumptions, estimates and

judgments on a combination of historical experiences and other factors that we believe are reasonable. We have discussed the selection and disclosure of these critical accounting estimates with our Audit Committee.

 

 

As a result of the 2004 sale of our third party mortgage servicing portfolio, accounting for mortgage servicing rights is no longer considered a critical accounting estimate.

 

New Accounting Pronouncements and Change in Method of Accounting for Certain Inventories

 

In the last three years, we adopted a number of new accounting pronouncements, and in 2005, we changed our method of accounting for our corrugated packaging inventories and retrospectively applied the new method to prior year financial statements. In addition there are three new accounting pronouncements that we will be required to adopt in 2006, none of which we expect to have a significant effect on our financial position, results of operations or cash flows. Please read Note 1 to the Consolidated Financial Statements for additional information.

 

Results of Operations for the Years 2005, 2004 and 2003

 

Summary

 

Our mission is to be the best by consistently exceeding customer expectations, maximizing asset utilization, lowering operating costs and improving efficiency. We are a market-driven, customer-focused company.

 

Our three key strategies are:

 

 

Actions we took in 2005 to implement our key strategies included:

 

 

 

A summary of our consolidated results follows:

 

 

Significant items affecting income from continuing operations included:

 

 

Business Segments

 

We currently manage our operations through three business segments:

 

 

Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in interest rates, new housing starts, home repair and remodeling activities, loan collateral values (particularly real estate), and the strength of the U.S. dollar. Given the commodity nature of our manufactured products, we have little control over market pricing or market demand.

 

As previously announced, beginning first quarter 2006, we will classify into a fourth business segment our real estate operations. As a result, we anticipate transferring into the new real estate segment about $300 million in real estate assets currently included in our financial services segment and about $100 million of high-value timberlands and other assets currently included in our forest products segment.

 

Corrugated Packaging

 

We manufacture linerboard and corrugating medium that we convert into corrugated packaging and sell in the open market. Our corrugated packaging segment revenues are principally derived from the sale of corrugated packaging products and, to a lesser degree, from the sale of linerboard in the domestic and export markets.

 

A summary of our corrugated packaging results follows:

 

 

Hurricanes Katrina and Rita adversely affected 2005 segment operating results by about $10 million principally related to mill production downtime and start-up expenses at our Bogalusa, Louisiana and Orange, Texas linerboard mills.

 

Corrugated packaging pricing, which includes freight and is net of discounts, increased in 2005 compared with 2004, reflecting price increases implemented in the second half of 2004. In second quarter 2005, corrugated packaging prices declined reflecting lower industry volumes. However, in fourth quarter 2005, corrugated packaging prices began to improve as a result of a linerboard price increases driven by capacity closures, stronger industry volumes and lower inventories. In first quarter 2006, we began to implement two corrugated packaging price increases. Our corrugated packaging shipments increased due to market share growth. Linerboard sales and shipments to third parties were down because more of our production was used in our converting facilities, which is consistent with our strategy to convert more of the linerboard we produce in our own converting facilities.

 

 

 

 

About one percentage point of the 2005 and 2004 increase in corrugated packaging shipments is attributable to growth in our converting operations in Mexico.

 

Costs and expenses were up two percent in 2005 compared with 2004 and down two percent in 2004 compared with 2003. Higher volumes and prices for most raw materials were partially offset by lower health care costs and cost reductions attributable to the closure of converting facilities, workforce reductions and

increased mill reliability and efficiency, which resulted in lower maintenance costs and improved raw material yield and energy usage.

 

Fluctuations in our significant cost and expense components included:

 

 

The costs of our outside purchases of wood and recycled fiber, energy, and freight fluctuate based on the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2006.

 

The changes in depreciation in 2005 and 2004 were principally due to the closure of converting facilities, and the change in 2003 was principally due to the facilities we acquired in 2002.

 

Information about our converting facilities and mills follows:

 

 

As a result of Hurricanes Katrina and Rita, our 2005 mill production was adversely affected by about 42,000 tons.

 

Forest Products

 

We own or lease two million acres of timberland in Texas, Louisiana, Georgia, and Alabama. We grow timber, cut the timber and convert it into products. We are creating the infrastructure and securing entitlements necessary for real estate development of our designated high-value timberland in Georgia, principally near Atlanta. We manufacture lumber, gypsum wallboard, particleboard, fiberboard and medium density fiberboard (MDF). Our forest products segment revenues are principally derived from the sales of these products and, to a lesser degree, from sales of fiber and high-value lands. We also owned 50 percent interests in a gypsum wallboard joint venture and an MDF joint venture. In January 2006, we acquired the remaining 50 percent interest in the gypsum wallboard joint venture.

 

A summary of our forest products results follows:

 

 

Hurricane Rita adversely affected 2005 segment operating results by about $1 million principally related to downtime and start-up expenses at four of our Texas and Louisiana lumber converting facilities.

Pricing, which includes freight and is net of discounts, and shipments improved for most product lines due to the continued strength in the housing and repair and remodeling markets. There is some uncertainty as to whether that strength will continue throughout 2006.

 

 

Comparisons of MDF and particleboard shipments are affected by the sale of our Pembroke MDF facility in second quarter 2005, the indefinite closure of our Clarion MDF facility in third quarter 2003 and the subsequent sale of this facility in second quarter 2004, and the indefinite closure of our Mt. Jewett particleboard facility in second quarter 2003.

 

Segment operating income also includes:

 

 

The operating results from the gypsum and MDF joint ventures generally fluctuate in relation to the price and shipment changes noted above. Mineral income is generally derived from leases and royalty interests and fluctuates based on changes in the market prices for energy. It is likely prices will continue to fluctuate in 2006.

 

In 2005, we sold about 7,000 acres of timber and timberland to a joint venture in which one of our financial services subsidiaries owns 50 percent and an unrelated public company owns the other 50 percent. This acreage was sold pursuant to the terms of a long-standing option agreement, which was about to expire. The joint venture intends to hold the land for future development and sale. We recognized about half of the $10 million gain in income in 2005 and anticipate recognizing the remainder in the future as this land is sold.

 

At year-end 2005, our high-value timberland consisted of about 203,000 acres located in Georgia, principally near Atlanta. Information regarding our high-value land sales follows:

 

 

Costs and expenses were up five percent in 2005 compared with 2004 and up three percent in 2004 compared with 2003. Higher volumes and higher prices for most raw materials offset lower health care costs and cost reductions attributable to the sale of our Pembroke MDF facility in June 2005 and our Clarion MDF facility in May 2004.

Fluctuations in our significant cost and expense components included:

 

 

Our goal is to increase use of wood fiber from our timberlands and reduce our reliance on outside purchases. The cost of our outside purchases of fiber and energy, freight, and chemicals fluctuates based on the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2006.

 

Information about our timber harvest and converting and manufacturing facilities follows: