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 Rule 12b-2 of the Act).  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 June 30, 2006, was approximately $4,175,000,000. 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 20, 2007, there were 105,152,306 shares of Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s definitive proxy statement to be prepared in connection with the 2007 Annual Meeting of Shareholders 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 four business segments:

 

 

Temple-Inland Inc. is a Delaware corporation that was organized in 1983. The following chart presents the ownership structure for our significant subsidiaries at year-end 2006. 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.

 

From our Internet website, http://www.templeinland.com, you may obtain additional information about us including:

 

 

 

 

We will also provide printed copies of any of these documents to any shareholder upon request. In addition, the materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information about the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information that is filed electronically with the SEC.

 

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 revenues by geographic area are contained in Items 6, 7 and 8 of this Annual Report on Form 10-K.

 

Narrative Description of the Business

 

Corrugated Packaging.  Our corrugated packaging segment provided 54 percent of our 2006 consolidated net revenues. Our vertically integrated corrugated packaging operation includes:

 

 

We manufacture containerboard and convert it into a complete line of corrugated packaging. Approximately nine percent of the containerboard we produced in 2006 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 converting facilities. 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 converting facilities 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 packaging 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 over 11,000 corrugated packaging customers with 19,000 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.

 

In August 2006, we sold our Performance Sheets operation, which consisted of a sheet feeder plant in City of Industry, California. This sale was part of our initiatives to improve return on investment by lowering costs, improving operating efficiencies, and increasing asset utilization. We will continue to review operations that do not meet return objectives and determine appropriate courses of action, including possibly consolidating or closing converting facilities and eliminating positions.

 

Forest Products.  Our forest products segment provided 22 percent of our 2006 consolidated net revenues and manages our 1.8 million acres of strategic timberland in Texas, Louisiana, Georgia, and Alabama. 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. Sales of forest products are heavily dependent upon the level of residential housing expenditures, including the repair and remodeling market.

 

We also own a 50 percent interest in Del-Tin Fiber LLC, a joint venture that produces MDF at a facility in El Dorado, Arkansas. In 2006, we acquired our partner’s 50 percent interest in Standard Gypsum LP and integrated those gypsum wallboard operations within our forest products segment.

 

Real Estate.  Our real estate segment provided three percent of our 2006 consolidated net revenues. We operate under the name Forestar Real Estate Group and conduct real estate investment and development activities, including:

 

 

We entitle and develop real estate that we own directly or participate in through over 30 ventures in which we own interests ranging from 25 to 75 percent. Currently, we have projects in eight states and 12 markets encompassing about 237,000 acres, including 196,000 acres of high-value lands located in Georgia, principally near Atlanta, and in Texas. We create the infrastructure and secure entitlements on these lands for single-family residential, commercial, mixed-use, and multi-family housing site development.

 

We sell residential lots primarily to national or regional home builders and, to a lesser extent, to local home builders. We sell land designated for commercial uses to national retail chains and to regional and local commercial developers. Most of our sales are pursuant to contracts that require payment in full at closing. Sales of residential lots are influenced by changing population patterns and other demographics and are largely dependent on the demand for new single-family housing.

 

Financial Services.  Our financial services segment provided 21 percent of our 2006 consolidated net revenues. We provide financial services in the areas of:

 

 

Guaranty Bank is a federally-chartered stock savings bank that conducts our consumer and commercial banking activities through banking centers in Texas and California and lends in diverse geographic markets. Our 100 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 53 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. We are developing the capability to begin acquiring mortgage loans from some of our correspondent mortgage warehouse borrowers. However, we do not expect these activities to begin until second quarter 2007.

 

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. 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 at year-end 2006, Guaranty met or exceeded all of these capital adequacy requirements.

 

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.

 

Other Information.

 

On January 22, 2007, a group affiliated with Carl C. Icahn filed a Schedule 13D stating that they owned 7,201,939 shares of our common stock, representing approximately 6.73 percent of our outstanding shares. On February 16, 2007, Icahn Partners LP, Icahn Partners Master Fund LP, and High River Limited Partnership, all of which are entities affiliated with Carl C. Icahn, provided notice to us that they intend to nominate four named individuals for election to our Board of Directors at the Annual Meeting. The notice stated that these Icahn funds beneficially own 7,201,939 shares of our common stock, representing approximately 6.73 percent of our outstanding shares.

 

Raw Materials

 

Our main raw material is virgin wood fiber. We own or lease about 1.8 million acres of strategic timberland located in Texas, Louisiana, Georgia, and Alabama. In 2006, wood fiber required for our corrugated packaging and forest products segments was supplied from these lands and as a by-product of our solid wood operations to the extent shown below:

 

 

The balance of our virgin wood fiber requirements 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 wood fiber, but each mill is also able to use recycled fiber for up to 15 percent of its wood fiber requirements. The Ontario, California, and Maysville, Kentucky, mills use only recycled fiber. The mill at New Johnsonville, Tennessee, uses a combination of virgin wood and recycled fiber.

 

In 2006, recycled fiber represented approximately 34 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 used by our converting facilities. 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 market prices. 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 our Cumberland City plant. Synthetic gypsum acquired pursuant to this agreement supplies all the synthetic gypsum required by our Cumberland City and West Memphis plants. Our 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. We hedge very little of our raw material needs.

 

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 75 percent of our energy requirements in 2006 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. It is likely that prices of natural gas will continue to fluctuate in the future. We hedge very little of our energy costs.

 

Employees

 

We have approximately 15,500 employees. Approximately 5,400 of our employees in our manufacturing segments 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 our principal collective bargaining agreements:

 

 

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 $4 million in 2006. 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, excluding expenditures related to the Maximum Achievable Control Technology (or MACT) programs and landfill closures discussed below, will be $5 million in 2007, $10 million in 2008, and $5 million in 2009. The estimated expenditures could be significantly higher if more stringent laws and regulations are implemented.

 

The U.S. Environmental Protection Agency (or EPA) has issued extensive regulations governing air and water emissions from the forest products industry. Compliance with these MACT regulations will be required at certain intervals through 2008.

 

We spent approximately $11 million 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.

 

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 13 boilers at 11 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, $2 million of which was incurred in 2006.

 

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 12 forest products facilities affected by the regulation. These are now being evaluated to determine appropriate compliance measures. Capital expenditures to comply with PCWP MACT are estimated at $7 million.

 

We use company-owned landfills for disposal of non-hazardous waste at three containerboard mills and two forest products facilities. We also have three additional sites that we are remediating. Based on third-party cost estimates, we expect to spend, on an undiscounted basis, $37 million over the next 25 years to ensure proper closure of these landfills and remediation of these three additional sites.

 

At one of these sites, we continue to work with environmental consultants and the Louisiana Department of Environmental Quality (DEQ) to investigate the source of contaminated water discovered in a manhole adjacent to our facility in Bogalusa, Louisiana. Phase II of the investigation process, which involved drilling more and deeper test wells in the affected area, is complete. Our investigation report, including remediation recommendations, was provided to the Louisiana DEQ in September 2006, and a conceptual plan has been approved by that agency. We are currently working on a final remediation plan for submission to the Louisiana DEQ. We estimate that we will incur remediation expenses of about $4 million, for which we have established a reserve, and capital costs of about $6 million in connection with this project.

 

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 our competitors are also subject to these regulations.

 

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 five 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 five 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 over 1,350 box plants in the United States. Our box plants accounted for approximately 12 percent of total industry shipments in 2006, 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 forest products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of forest products.

 

In our real estate markets, we compete with numerous regional and local developers for the acquisition of land suitable for development. We also compete with some of our national and regional home builder customers who develop real estate for their own use in home building operations. The real estate industry is a highly competitive business, and a number of entities with which we compete are larger and have greater resources.

 

Our savings bank competes with commercial banks, savings and loan associations, mortgage banks, and other lenders. We also compete 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 are larger and have greater resources.

 

Executive Officers of the Registrant

 

The names, ages, and titles of our executive officers are:

 

 

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 managing our timberland.

 

Bart J. Doney became Group Vice President in February 2000. Mr. Doney has served as an officer of our corrugated packaging segment since 1990.

 

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 has served as an officer of our corrugated packaging segment since 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.

 

Troy L. Hester was named Principal Accounting Officer in August 2006. Mr. Hester has been with Temple-Inland for seven years and has served in various capacities including Controller-Financial Services, Vice President Accounting Center, and was named Corporate Controller in May 2006. Before joining Temple-Inland, Mr. Hester was deputy controller for a large regional bank and prior to that worked with an international accounting firm.

 

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.

 

C. Morris Davis became General Counsel in May 2006. Mr. Davis joined Temple-Inland after 39 years with the law firm of McGinnis, Lochridge & Kilgore in Austin, where he served seven years as the firm’s managing partner.

 

J. Bradley Johnston became Chief Administrative Officer in February 2005. Prior to that, Mr. Johnston served as General Counsel from August 2002 through May 2006, 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.

 

The business segments in which we operate are highly competitive.

 

All of the business segments 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.

 

In our real estate markets, we compete with numerous regional and local developers for the acquisition of land suitable for development. We also compete with some of our national and regional home builder customers who develop real estate for their own use in home building operations. The real estate industry is a highly competitive business, and a number of entities with which we compete are larger and have greater resources.

 

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; and with insurance agencies in our insurance activities many of which are larger and have greater resources.

 

The profitability of our corrugated packaging and forest products segments is affected by changes in raw material and other costs.

 

Virgin wood fiber and recycled fiber are the principal raw materials we use to manufacture corrugated packaging and certain of our forest products. 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.

 

Our profitability is also sensitive to changes in the prices of energy and transportation. 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 corrugated packaging 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 periodically experiences substantial overcapacity. 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 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, cash flows, and results of operations.

 

Downward changes in demand for housing in the market regions where we operate could decrease our profitability, especially in our forest products and real estate segments.

 

The residential homebuilding industry is sensitive to changes in economic conditions. Adverse changes in these conditions generally, or in the market regions where we operate, could decrease demand for new homes in these areas. Decline in housing demand could have a negative effect on the pricing and demand for many of our forest products, particularly lumber and gypsum wallboard, and negatively affect our real estate development and investment activities, either of which could result in a decrease in our revenues and earnings.

 

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.

 

Changes in interest rates affect our financial services segment’s profitability.

 

Changes in interest rates are not predictable or controllable. Changes in interest rates affect our financial services net interest margin and demand for loans and other financial services products. The majority of Guaranty’s assets and liabilities are monetary in nature and are affected by changes in interest rates. Like most financial institutions, changes in interest rates 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 interest margin 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 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 profitability of our financial services segment could decrease.

 

Our loan customers may fail to repay their loans according to the terms, 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 and energy loans, which represent about one-half of our loans, generally expose a lender to greater risk of loss than single-family 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. Although the majority of our energy 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. 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 one single-family mortgage loan.

 

Approximately one-half of our single-family residential loans 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.

 

We may not succeed in our plan to acquire mortgage loans from some of our correspondent mortgage warehouse borrowers.

 

We are developing the capability to begin acquiring mortgage loans from some of our correspondent mortgage warehouse borrowers. The correspondent mortgage business is very competitive, and the current interest rate environment is not generally conducive to significant production of adjustable-rate mortgages, which we generally hold. We do not expect our correspondent lending activities to result in significant acquisitions of loans until late second quarter 2007.

 

Our single-family loan portfolio may continue to decline if market conditions inhibit our ability to acquire as many loans as we expect from our correspondent lending activities. This inability to acquire loans could result in a decrease in total loans, which would result in lower net interest income. It is also possible that in order to maintain our qualified thrift lender status, we could be forced to buy securities or other qualifying assets at times when the terms might not be attractive.

 

None.

 

 

We own and operate manufacturing facilities throughout the United States, four converting plants in Mexico, and one in Puerto Rico. We believe our manufacturing facilities are suitable for their purposes and adequate for our business. Additional information about selected facilities by business segment follows:

 

Containerboard Mills

 

 

 

 

Converting Facilities*

 

 

 

 

 

Additionally, we own a graphics resource center in Indianapolis, Indiana, that has a 100² preprint press. We lease 32 warehouses located throughout much of the United States.

 

Forest Products

 

 

 

 

 

 

 

 

Timber and Timberland*
(In acres)

 

 

 

 

Primarily 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 primarily consists of lease and royalty payments, and was approximately $35 million in 2006.

 

Real Estate

 

We own directly or participate in through joint ventures over 80 real estate projects in eight states and 12 markets encompassing about 237,000 acres. We classify our real estate as undeveloped; in the entitlement process; or entitled, developed and under development. At year-end 2006, we held about 196,000 acres of undeveloped land; about 26,000 acres in the entitlement process; and about 15,000 acres of entitled, developed or under development land.

 

Other

 

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 2006, property and equipment having a net book value of $2 million were subject to liens in connection with $15 million of debt.

 

General

 

We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. 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. A summary of our more significant legal matters is set forth below.

 

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. 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. We and the other defendants have entered into various settlement agreements that resolved the class action and the majority of the opt-out claims. Our payments under the settlement agreements have totaled $13 million. The first trial of any of the remaining claims is presently scheduled for first quarter 2008.

 

We participated in a mediation conference in November 2006 to discuss possible settlement of the remaining claims, which was not productive. The plaintiffs allege that our sales that serve as a basis for the remaining claims were approximately $1.6 billion. Our sales used as the basis for settling the class action claims, however, were approximately $750 million. Settlements in the case have ranged from 0.2 percent of sales to 7 percent of sales. We have established a reserve for the remaining cases of $13 million. While this reserve remains below the amounts for which some defendants have settled their cases, in light of our view of the different facts of our case compared with other settling defendants and the settlements we have negotiated throughout this case, we believe our reserve for this matter is appropriate.

 

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 11 lawsuits seeking damages for various personal injuries allegedly caused by either exposure to the released gas or fears of exposure. These 11 lawsuits have been consolidated under Louisiana state rules for purpose of discovery. We are vigorously defending against these allegations.

 

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.

 

Indiana Environmental Matter

 

On July 22, 2002, a delivery driver for a chemical supply company overfilled a storage tank for caustic soda at our converting facility in Tipton, Indiana. The excess caustic soda drained through an overflow pipe into the city sewer system, resulting in a temporary shutdown of the city wastewater treatment plant and killing approximately 2,000 fish in a local creek. We removed the fish, assisted in restoring operations at the wastewater treatment plant, and took other measures to assure no ongoing effect to human health or the environment. The incident was investigated in 2002 by the U.S. Environmental Protection Agency and the Indiana Department of Natural Resources, with our cooperation. In early 2007, we entered into a plea

agreement with the U.S. attorney and the EPA in which we agreed to plead guilty to three misdemeanor offenses and agreed to pay monetary sanctions of $600,000 ($150,000 of which will only be paid if we do not satisfactorily complete a one year probation period).

 

Other

 

We were the defendant in a lawsuit in California Superior Court in which a former supplier alleged claims for breach of contract, fraudulent misrepresentation, intentional interference with a business opportunity, misappropriation of trade secrets, and other matters. The plaintiff sued to recover actual and punitive damages. The fraud and intentional interference claims were dismissed in response to our motions for summary judgment. In February 2007, we settled the remaining claims. The settlement required us to increase our reserves for this matter by $2 million as of year end. At the end of 2006, we are also defending three class action claims in California state court alleging violations of that state’s on-duty meal break laws. We settled one of these cases in February 2007 and the remaining cases are currently pending. While we continue to defend these lawsuits and have established reserves that we believe are adequate, we do not anticipate that the outcome in any or all of these cases should have a material adverse effect on our financial position or long-term results of operations or cash flows.

 

 

We did not submit any matter to a vote of our shareholders in fourth quarter 2006.

 

 

 

Market Information

 

Our Common Stock is traded on the New York Stock Exchange. The high and low sales prices for our Common Stock and dividends paid in each quarter in the two most recent years were:

 

 

 

 

Shareholders

 

Our stock transfer records indicated that as of February 20, 2007, there were approximately 4,800 holders of record of our Common Stock.

 

Dividend Policy

 

As indicated above, we paid quarterly dividends during each of the two most recent years in the amounts shown. On February 2, 2007, the Board of Directors declared a quarterly dividend on our Common Stock of $0.28 per share payable on March 15, 2007, to shareholders of record on March 1, 2007. 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⁾

 

 

 

 

Performance Graph

 

We composed an index of our peers consisting of Abitibi-Consolidated Inc., Bowater Inc., Caraustar Industries, Inc., Domtar Inc., International Paper Company, Longview Fibre Company, MeadWestvaco Corporation, Packaging Corporation of America, Smurfit-Stone Container Corporation, and Weyerhaeuser Corporation (Peer Index). During the five preceding years, our cumulative total stockholder return compared to the Standard & Poor’s 500 Stock Index and to the Peer Index was as shown in the following table:

 

 

Assumes $100 invested on the last trading day in fiscal year 2001
*Total return assumes reinvestment of dividends

 

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,” “likely,” “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, the allowance for loan losses. 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 sale of our third-party mortgage servicing portfolio in 2004, accounting for mortgage servicing rights is no longer considered a critical accounting estimate.

 

New Accounting Pronouncements and Change in Method of Accounting for Defined Benefit and Postretirement Plans

 

In the last three years, we adopted a number of new accounting pronouncements, including in 2006, Statement of Financial Accounting Standard (SFAS) No. 123 (Revised December 2004) — Share-Based Payment and SFAS No. 158 — Accounting for Defined Benefit and Postretirement Plans. In addition, there are four new accounting pronouncements that we will be required to adopt in 2007 and 2008, 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 2006, 2005, and 2004

 

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 four key strategies are:

 

 

Actions we took in 2006 to implement our key strategies included:

 

 

A summary of our consolidated results follows:

 

 

In 2006, significant items affecting income from continuing operations included:

 

 

In 2005, significant items affecting income from continuing operations included:

 

 

In 2004, significant items affecting income from continuing operations included:

 

 

Business Segments

 

We currently manage our operations through four 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.

 

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 re-start expenses at our Bogalusa, Louisiana and Orange, Texas linerboard mills.

 

Fluctuations in product pricing, which includes freight and is net of discounts, and shipments are set forth below:

 

 

 

 

In 2006, corrugated packaging and linerboard prices improved reflecting price increases implemented in late 2005 and in 2006. Pricing for corrugated packaging increased in 2005 reflecting price increases implemented in the second half of 2004. We are currently attempting to implement an additional price increase, which could result in an upward trend in prices in 2007.

 

Our corrugated packaging shipments decreased primarily due to the sale of Performance Sheets in August 2006. Linerboard sales and shipments to third parties increased slightly in 2006 due to increased mill production. Linerboard shipments and sales were down in 2005 and 2004 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.

 

Costs and expenses were up one percent in 2006 compared with 2005 and up two percent in 2005 compared with 2004. Higher raw material and freight costs 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 2007. The decrease in depreciation in 2006 and 2004 was principally due to the closure of converting facilities.

 

Information about our converting facilities and mills follows:

 

 

Forest Products

 

We own or lease 1.8 million acres of strategic timberland in Texas, Louisiana, Georgia, and Alabama. We grow timber, cut the timber and convert it into products. 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 hunting, mineral, and recreational leases of our timberland. We also own a 50 percent interest in an MDF joint venture.

 

In January 2006, we purchased our partner’s 50 percent interest in Standard Gypsum LP, a joint venture that produced gypsum wallboard. Results of operations have been consolidated since the date of purchase.

 

A summary of our forest products results follows:

 

 

 

 

Fluctuation in product pricing, which includes freight and is net of discounts, and shipments are set forth below:

 

Pricing for gypsum wallboard, particleboard, and MDF improved compared with 2005. However, pricing for lumber was down and demand and pricing for all products moderated in the last half of 2006 due to declines in the housing industry. It is likely that this trend will continue in 2007.

 

Gypsum wallboard shipments for 2006 were positively impacted by the acquisition of Standard Gypsum LP in January 2006. On a pro forma basis, to reflect the acquisition of Standard Gypsum, shipments were down three percent compared with 2005.

 

Comparisons of MDF are affected by the sale of our Pembroke MDF facility in second quarter 2005.

 

Segment operating income also includes:

 

 

The operating results from the 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 2007.

 

In 2005, we sold about 7,000 acres of timber and timberland to a joint venture in which our real estate segment 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.

 

Costs and expenses were up 13 percent in 2006 compared with 2005 and up six percent in 2005 compared with 2004. The increase in cost in 2006 is primarily attributable to the acquisition of Standard Gypsum LP in January 2006, partially offset by lower wood fiber costs and cost reductions attributable to the sale of our Pembroke MDF facility in June 2005.

 

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, 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 2007.

 

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