UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

For the quarterly period ended September 30, 2017

or

For the transition period from             to

Commission File Number 1-32729

POTLATCH CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

(509) 835-1500

(Registrant’s telephone number, including area code)

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act).    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange act).

Yes  ☐    No  ☒

The number of shares of common stock of the registrant outstanding as of October 19, 2017 was 40,610,865.

 

 

 

 

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POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES

Table of Contents

 

 

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Part I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

 

Potlatch Corporation and Consolidated Subsidiaries

Consolidated Statements of Income (Loss)

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Potlatch Corporation and Consolidated Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

See Note 5: Derivative Instruments and Note 7: Pension and Other Postretirement Employee Benefits for additional information. Amortization of prior service credit and amortization of actuarial loss are included in the computation of net periodic cost (benefit).

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Potlatch Corporation and Consolidated Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Potlatch Corporation and Consolidated Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Certain 2016 amounts within cash flows from operating activities have been reclassified to conform to the 2017 presentation. There is no change to previously reported net cash from operating, investing or financing activities.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Notes to Condensed Consolidated Financial Statements

 

NOTE 1. BASIS OF PRESENTATION

For purposes of this report, any reference to “Potlatch,” “the company,” “we,” “us,” and “our” means Potlatch Corporation and all of its wholly-owned subsidiaries, except where the context indicates otherwise.

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission pertaining to interim financial statements; certain disclosures normally provided in accordance with generally accepted accounting principles in the United States have been omitted. This Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on February 17, 2017. We believe that all adjustments necessary for a fair statement of the results of such interim periods have been included and all such adjustments are of a normal recurring nature.

Certain 2016 amounts on the Condensed Consolidated Statements of Cash Flows within cash flows from operating activities have been reclassified to conform to the 2017 presentation. There is no change to previously reported net cash from operating, investing or financing activities.

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which changes several aspects of the accounting for share-based payment award transactions, including accounting for income taxes, diluted shares outstanding, classification of excess tax benefits on the statement of cash flows, forfeitures and minimum statutory tax withholding requirements. We prospectively adopted the provisions of this ASU on January 1, 2017, which include recording the tax effects related to share-based payments through the income statement. As a Real Estate Investment Trust (REIT), we are generally not subject to federal and state corporate income taxes, except through our taxable REIT subsidiaries. Therefore, the adoption of this guidance was not material to our consolidated financial statements. We will continue to estimate forfeitures each period. We consider many factors when estimating expected forfeitures, including types of awards, employee class and historical experience.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU No. 2014-09), which requires an entity to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 also included other guidance, including the presentation of a gain or loss recognized on the sale of a long-lived asset or a nonfinancial asset. Subsequent ASU’s have been issued that provide clarity, technical corrections and improvements to ASU No. 2014-09. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date, which deferred the effective date of ASU No. 2014-09 by one year. ASU No. 2014-09 is effective for us on January 1, 2018. For most of our sales, which consist of logs, manufactured wood products, residual by-products and real estate, we have identified no change to the timing or amount of revenue recognized because our contracts are legally enforceable, the transaction price is fixed and performance is completed at a point in time, typically when risk of loss and title pass. For our other sales, which include stumpage contracts, timber deeds, land use permits, and royalties, we have also identified no change to the timing or amount of revenue recognized. We will have minor refinements to our controls over financial reporting. Our expanded disclosures will disaggregate revenues along the lines of the sales categories mentioned above. The guidance permits a retrospective application of the new standard with certain practical expedients (contracts completed within the same annual reporting period need not be restated and other allowances for contracts with variable consideration) or retrospective application with a cumulative effect adjustment to the beginning balance of retained earnings. Upon adoption of this ASU on January 1, 2018, if there is a difference in the amount of revenue recorded for any of the prior reporting periods presented, while considering the practical expedients, we will restate that period to conform with the ASU. The adoption of this guidance is not expected to have a significant effect on our consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, Compensation – Retirement Benefits (Topic 715), Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires an entity to present service cost within compensation expense and the other components of net benefit cost outside of income from operations. This ASU is effective for us on January 1, 2018. The amendments in this update require retrospective presentation in the income statement. Changes to the capitalized portion of both service cost and the other components of

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net benefit cost within inventory will be applied prospectively. In 2016, net periodic pension and other postretirement employee benefit cost reported within operating income totaled $15.7 million of which $6.5 million represented service cost.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities, which is intended to better portray the economic results of an entity’s risk management activities in its financial statements through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The amendments expand and refine hedge accounting for certain nonfinancial and financial risk components and align the recognition and presentation of the effects in the financial statements, particularly in the areas of measuring hedge ineffectiveness. This ASU is effective for us on January 1, 2019, with early application permitted in any interim period. The presentation and disclosure guidance is required prospectively upon adoption. Our cash flow hedges currently have no ineffectiveness, but in the event they did, as of the beginning of the fiscal year that we adopt this ASU, a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness would be recorded to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings.

NOTE 3. EARNINGS PER SHARE

The following table reconciles the number of shares used in calculating basic and diluted earnings per share:

 

 

For the three months ended September 30, 2017, there were no stock based awards that were anti-dilutive. For the nine months ended September 30, 2017, there were 167 stock-based awards that were excluded from the calculation of diluted earnings per share because they were anti-dilutive. For the three months ended September 30, 2016, there were 12,139 stock-based awards that were excluded from the calculation of diluted earnings per share because they were anti-dilutive. For the nine months ended September 30, 2016, no dilutive potential shares were included in the computation of diluted net income (loss) per share due to the net loss. Anti-dilutive stock-based awards could be dilutive in future periods.

NOTE 4. CERTAIN BALANCE SHEET COMPONENTS

INVENTORIES

 

PROPERTY, PLANT AND EQUIPMENT

 

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TIMBER AND TIMBERLANDS

 

In the nine months ended September 30, 2017, we purchased approximately $22.0 million of timber and timberlands adjacent to our current operations in northern Idaho, Arkansas and Alabama.

 

On April 21, 2016, we sold approximately 172,000 acres of timberlands located in central Idaho for $114 million. The company purchased the property in 2007 and 2008 for the purpose of growing and harvesting timber and selling rural recreation parcels. The sale freed up capital without having to wait for the rural recreation real estate market in central Idaho to recover. We recorded a loss of $48.5 million before taxes in our Real Estate segment in the second quarter of 2016. Historical earnings generated by the property were positive, but not material.

NOTE 5. DERIVATIVE INSTRUMENTS

From time to time, we enter into derivative financial instruments to manage certain cash flow and fair value risks.

Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset or liability to a particular risk, such as interest rate risk, are considered fair value hedges. We have five fair value interest rate swaps to convert interest payments on fixed-rate debt to variable-rate 3-month LIBOR plus a spread.

Derivatives designated and qualifying as a hedge of the exposure to variability in the cash flows of a specific asset or liability that is attributable to a particular risk, such as interest rate risk, are considered cash flow hedges. We have one interest rate swap to convert variable-rate debt, comprised of 3-month LIBOR plus a spread, to fixed-rate debt. Our cash flow hedge is expected to be highly effective in achieving offsetting cash flows attributable to the hedged interest rate risk through the term of the hedge. Therefore, changes in the fair value of the interest rate swap are recorded as a component of other comprehensive income and will be recognized in earnings when the hedged interest rate affects earnings. The amounts paid or received on this interest rate hedge will be recognized as adjustments to interest expense. As of September 30, 2017, the amount of net losses expected to be reclassified into earnings in the next 12 months is $0.1 million.

Derivatives not designated as hedges are not speculative and are used to manage our exposure to interest rate movements, commodity price movements or other identified risks, but do not meet the strict hedge accounting requirements. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly into income. In April 2017, we entered into a lumber price swap to fix the price on a total of 36 million board feet (mmbf) of southern yellow pine with an effective date of July 1, 2017 and a termination date of December 31, 2017. Under the contract, cash settlement on 6 mmbf occurs monthly.

The following table presents the gross fair values of derivative instruments on our Condensed Consolidated Balance Sheets:

 

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The following table details the effect of derivatives on our Consolidated Statements of Income (Loss):

 

 

NOTE 6. FINANCIAL INSTRUMENTS

The following table presents the estimated fair values of our financial instruments:

 

 

 

For cash and cash equivalents and any revolving line of credit borrowings, the carrying amount approximates fair value due to the short-term nature of these financial instruments.

The fair value of interest rate and lumber price swaps are determined using discounted cash flow analysis on the expected cash flows of each derivative. The analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate and commodity price forward curves.

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The fair value of our long-term debt is estimated based upon quoted market prices for similar debt issues or estimated based on average market prices for comparable debt when there is no quoted market price.

The contract value of our COLI, the amount at which it could be redeemed, is used to estimate fair value because market prices are not readily available.

NOTE 7. PENSION AND OTHER POSTRETIREMENT EMPLOYEE BENEFITS

The following tables detail the components of net periodic cost (benefit) of our pension plans and other postretirement employee benefits (OPEB):

 

 

During the nine months ended September 30, 2017 and 2016, we paid non-qualified supplemental pension benefits of $1.2 million and $1.3 million and OPEB benefits of $2.6 million and $2.6 million, respectively. During the nine months ended September 30, 2017 and 2016, we made voluntary contributions to our qualified pension plans of $5.3 million and $1.3 million, respectively.

The following tables detail the pension and OPEB changes in accumulated other comprehensive loss on our Condensed Consolidated Balance Sheets, net of tax:

 

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NOTE 8. COMPONENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS

The following table details the changes in our accumulated other comprehensive loss (AOCL) on our Condensed Consolidated Balance Sheets for the nine months ended September 30, 2017, net of tax.

 

Amounts in parenthesis indicate credits.

See Note 5: Derivative Instruments and Note 7: Pension and Other Postretirement Employee Benefits for additional information.

NOTE 9. EQUITY-BASED COMPENSATION

As of September 30, 2017, we had two stock incentive plans under which performance shares, restricted stock units (RSUs) and deferred compensation stock equivalent units were outstanding. These plans have received shareholder approval. We were originally authorized to issue up to 1.6 million shares and 1.0 million shares under our 2005 Stock Incentive Plan and 2014 Stock Incentive Plan, respectively. At September 30, 2017, approximately 1.0 million shares were authorized for future use. We issue new shares of common stock to settle performance shares, restricted stock units and deferred compensation stock equivalent units.

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The following table details equity-based compensation expense and the related income tax benefit:

 

 

PERFORMANCE SHARES

The following table presents the key inputs used in the Monte Carlo simulation to calculate the fair value of the performance share awards in 2017 and 2016:

 

 

The following table summarizes outstanding performance share awards as of September 30, 2017, and changes during the nine months ended September 30, 2017:

 

 

As of September 30, 2017, there was $4.9 million of unrecognized compensation cost related to unvested performance share awards, which is expected to be recognized over a weighted-average period of 1.3 years.

RESTRICTED STOCK UNITS

The following table summarizes outstanding RSU awards as of September 30, 2017, and changes during the nine months ended September 30, 2017:

 

 

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The fair value of each RSU equaled our common share price on the date of grant. The total fair value of RSU awards that vested during the nine months ended September 30, 2017 was de minimis. As of September 30, 2017, there was $1.4 million of total unrecognized compensation cost related to unvested RSU awards, which is expected to be recognized over a weighted-average period of 1.2 years.

DEFERRED COMPENSATION STOCK EQUIVALENT UNITS

A long-term incentive award is granted annually to our directors and payable upon a director's separation from service. Directors may also elect to defer their quarterly retainers, which may be payable in the form of stock. All stock unit equivalent accounts are credited with dividend equivalents. As of September 30, 2017, there were 137,606 shares outstanding that will be distributed in the future to directors as common stock.  

Issuance of restricted stock units awarded to certain officers and select employees may also be deferred.  All stock unit equivalent accounts are credited with dividend equivalents.  As of September 30, 2017, there were 73,478 RSUs which had vested, but issuance of the related stock had been deferred.

NOTE 10. INCOME TAXES

As a real estate investment trust (REIT), we generally are not subject to federal and state corporate income taxes on income of the REIT that we distribute to our shareholders. We conduct certain activities through our taxable REIT subsidiaries (TRS), which are subject to corporate level federal and state income taxes. These taxable activities are principally comprised of our wood products manufacturing operations and certain real estate investments. Therefore, income tax expense or benefit is primarily due to income or loss of the TRS, as well as permanent book versus tax differences.

NOTE 11. COMMITMENTS AND CONTINGENCIES

In January 2007, the Environmental Protection Agency (EPA) notified us that we are a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and the Clean Water Act for cleanup of a site known as Avery Landing in northern Idaho. We own a portion of the land at the Avery Landing site, which we acquired in 1980 from the Milwaukee Railroad. The land we own at the site and adjacent properties were contaminated with petroleum as a result of the Milwaukee Railroad's operations at the site prior to 1980. On July 5, 2011, the EPA issued an Action Memorandum for the Avery Landing Site selecting contaminant extraction and off-site disposal as the remedial alternative. On May 23, 2012, we signed a consent order with the EPA pursuant to which we agreed to provide $1.75 million in funding for EPA cleanup on a portion of our property (including the adjacent riverbank owned by the Idaho Department of Lands). The EPA cleanup was completed in October 2012. On April 4, 2013, the EPA issued a unilateral administrative order requiring us to remediate the portion of the Avery Landing site that we own. Our remediation was completed in October 2013. In 2016, the EPA confirmed that Potlatch had completed the cleanup and subsequent monitoring required by the unilateral order. On September 25, 2015, the EPA sent us a letter asserting that the EPA and the Department of Transportation (the current owner of a portion of the adjacent property remediated by the EPA) (DOT) had incurred $9.8 million in unreimbursed response costs associated with the site and that we were liable for such costs. We executed a tolling agreement with the EPA and DOT suspending the statute of limitations on the claim until September 2016 in order to facilitate negotiations of a final settlement and release. In September 2016, the parties agreed to extend the tolling agreement through October 6, 2016. The tolling agreement was further extended through February 22, 2017; in January 2017, the tolling agreement was extended through May 22, 2017; in May 2017 the tolling agreement was extended through September 22, 2017, a further extension to October 23, 2017 was executed in September and an extension to December 31, 2017 was executed in October. Settlement negotiations continue. If settlement efforts prove to be unsuccessful, we believe we have meritorious defenses to this claim and we intend to defend ourselves vigorously. We accrued $0.2 million for this matter in the first quarter of 2016, an additional $0.8 million for this matter in the second quarter of 2016 and an additional $5.0 million in the third quarter of 2017. We have reserved all of our rights to seek reimbursement for the costs of remediation from all parties potentially responsible. We do not expect to make any further accruals in respect of this claim. 

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NOTE 12. SEGMENT INFORMATION

The following table summarizes information by business segment:

 

 

 

 

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NOTE 13. SUBSEQUENT EVENT

On October 22, 2017, Potlatch and Deltic Timber Corporation (Deltic) entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which Deltic will merge with and into a wholly-owned subsidiary of Potlatch. The combined company will be named PotlatchDeltic Corporation. Under the terms of the Merger Agreement, Deltic shareholders will receive 1.80 shares of Potlatch common shares for each share of Deltic common stock at the closing date. Deltic owns approximately 530,000 acres of timberland, operates two sawmills and a medium density fiberboard plant and is engaged in real estate development primarily in Arkansas and north Louisiana.

 

Because the exchange ratio was fixed at the time of the merger agreement and the market value of our common stock will continue to fluctuate, the total value of the consideration exchanged will not be determinable until the closing date. The number of shares to be issued with respect to Deltic stock awards will not be determinable until the closing of the transaction.

 

We have estimated the total consideration expected to be issued to Deltic shareholders in the merger to be approximately 22 million shares of our common stock based on the 1.80 exchange ratio and the number of shares of Deltic common stock issued and outstanding as of October 20, 2017.

 

Subsequent to the completion of the transaction, as part of the REIT conversion process, Deltic’s earnings and profits will be distributed to shareholders of the combined company through a dividend consisting of 80% stock and 20% cash.

 

The merger agreement has been approved by both companies' board of directors. The closing of the merger is subject to approval by the shareholders of Deltic and Potlatch, receipt of certain regulatory approvals and other conditions specified in the merger agreement. The merger is expected to close in the first half of 2018.

 

In addition, on October 22, 2017, Potlatch’s Board of Directors authorized an increase to the annual dividend from $1.50 per share to $1.60 per share, or $0.40 per share on a quarterly basis, commencing December 29, 2017.

 

 

 

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Information

This report contains, in addition to historical information, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including without limitation, fair value of hedging instruments and swaps, expected return on pension assets, recognition of compensation costs relating to our performance shares and RSUs, expectation of no further accruals relating to the Avery Landing matter, the pending merger with Deltic Timber Corporation (Deltic), the amount of Deltic’s earnings and profits, 2017 capital spending and similar matters. Words such as “anticipate,” “expect,” “will,” “intend,” “plan,” “target,” “project,” “believe,” “seek,” “schedule,” “estimate,” “could,” “can,” “may” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements reflect our current views regarding future events based on estimates and assumptions and are therefore subject to known and unknown risks and uncertainties and are not guarantees of future performance. Our actual results of operations could differ materially from our historical results or those expressed or implied by forward-looking statements contained in this report. Important factors that could cause or contribute to such differences include, but are not limited to, the following: 

For a discussion of some of the factors that may affect our business, results and prospects, and a nonexclusive listing of forward-looking statements, refer to “Cautionary Statement Regarding Forward-Looking Information” on page 1 and “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.

Forward-looking statements contained in this report present our views only as of the date of this report. Except as required under applicable law, we do not intend to issue updates concerning any future revisions of our views to reflect events or circumstances occurring after the date of this report.

Results of Operations

Our business is organized into three business segments: Resource, Wood Products and Real Estate. Our Resource segment supplies our Wood Products segment with a portion of its wood fiber needs. These intersegment revenues are based on prevailing market prices and typically represent a significant portion of the Resource segment’s total revenues. Our other segments generally do not generate intersegment revenues.

In our discussions of consolidated results of operations, our revenues are reported after elimination of intersegment revenues. In our discussion by business segment, each segment's revenues are presented before the elimination of intersegment revenues.

The operating results of our Resource, Wood Products and Real Estate business segments have been and will continue to be influenced by a variety of factors, including cyclical fluctuations in the forest products industry, changes in timber prices and in harvest levels from our timberlands, weather conditions, competition, timberland valuations, demand for our

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non-strategic timberland for higher and better use purposes, changes in lumber prices, the efficiency and level of capacity utilization of our wood products manufacturing operations, changes in our principal expenses such as log costs, asset or business acquisitions or dispositions and other factors.

Overview

Increased lumber demand coupled with duties on Canadian exports to the United States and reduced lumber and plywood production due to wildfires in the western United States and Canada pushed lumber prices higher, which contributed to our strong results in our Wood Products and Resource segments.

In the nine months ended September 30, 2017, we purchased approximately $22.0 million of timber and timberlands adjacent to our current operations. In April 2016, we sold approximately 172,000 acres of non-strategic timberlands located in central Idaho for $114 million in our Real Estate segment.

Consolidated Results

The following table sets forth changes in our Consolidated Statements of Income (Loss). Our Business Segment Results provide a more detailed discussion of our segments.

 

 

*   Percentage change not meaningful.

 

Revenues

 

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Revenues increased $16.4 million primarily due to higher lumber prices and increased lumber shipments. Harvest volumes declined in the third quarter of 2017, compared with 2016, due to wet weather late in the quarter, which contributed to unfavorable hauling conditions in the Northern region. Lower Northern region harvest volumes were more than offset by higher sawlog prices.

 

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Revenues increased $59.9 million primarily due to higher lumber prices and increased lumber shipments. Lower harvest volumes in both regions were more than offset by higher Northern region sawlog prices. Harvest volumes declined in the first nine months of 2017, compared with the same time in 2016 where we experienced a relatively mild winter and dry spring, as well as due to the sale of central Idaho timberlands in the second quarter of 2016.

Cost of goods sold

 

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Cost of goods sold increased 2% due to higher lumber shipments.

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Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Cost of goods sold increased 1% due to higher lumber shipments, partially offset by lower harvest volumes due to less favorable hauling conditions in 2017 and the sale of central Idaho timberlands in the second quarter of 2016.

Selling, general and administrative expenses

Three months ended September 30, 2017 compared with three months ended September 30, 2016

The 13% increase in selling, general and administrative expenses was the result of higher accrued annual incentive compensation expense and higher workers’ compensation expense. Workers’ compensation expense can fluctuate based on the timing of claims.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

The 8% increase in selling, general and administrative expenses was the result of higher accrued annual incentive compensation expense and workers’ compensation expenses, partially offset by lower pension expense in 2017 resulting from updated mortality tables.

Environmental charges for Avery Landing

 

During the third quarter of 2017, we accrued $5.0 million related to Avery Landing, compared with $1.0 million recorded in the first half of 2016. See Note 11: Commitments and Contingencies for a more detailed discussion of Avery Landing.

Lumber price swap

In April 2017, we entered into a lumber price swap to fix the price on a total of 36 million board feet (mmbf) of southern yellow pine with an effective date of July 1, 2017 and a termination date of December 31, 2017. Under the contract, beginning in July, cash settlement on 6 mmbf occurs each month. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly into income. At June 30, 2017, the estimated fair value of the contract was $3.3 million, which was recognized as an unrealized gain in the Consolidated Statement of Income (Loss). During the third quarter of 2017, we realized $1.0 million in total monthly settlements. At September 30, 2017, the estimated fair value on the remaining term of the contract was $0.2 million, resulting in a $2.1 million change that was reflected as a loss on the lumber price swap in the three months ended September 30, 2017.

See Note 5: Derivative Instruments for a more detailed discussion of the lumber price swap.

Loss on sale of central Idaho timber and timberlands

In April 2016, we sold approximately 172,000 acres of non-strategic timberlands located in central Idaho for $114 million, less selling costs of $2.5 million. This divestiture resulted in a $48.5 million loss before income taxes.

Interest expense, net

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Interest expense decreased due to the 2016 repayment of $42.6 million in Minnesota revenue bonds and the refinancing of $65.7 million in Idaho revenue bonds, as well as the 2017 repayment of $5.0 million of matured borrowings.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Interest expense decreased due to the 2016 repayment of $42.6 million in Minnesota revenue bonds and the refinancing of $65.7 million in Idaho revenue bonds, as well as the 2017 repayment of $5.0 million of matured borrowings.

Income tax provision

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Income taxes are primarily due to income or loss from our taxable REIT subsidiaries (TRS). For the third quarter of 2017, the income tax provision of $2.8 million was the result of the TRS’s income before income tax of $8.8 million,

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partially offset by permanent book versus tax differences. For the third quarter of 2016, the income tax provision of $3.6 million was the result of the TRS’s income before income tax of $10.9 million, partially offset by discrete tax items.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

For the first nine months of 2017, the income tax provision of $14.0 million was the result of the TRS’s income before income tax of $40.4 million, partially offset by permanent book versus tax differences. For the first nine months of 2016, the income tax benefit of $8.7 million was the result of the TRS’s loss before income tax of $22.3 million, partially offset by discrete tax items.

Business Segment Results

Resource Segment

 

 

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Revenues

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Resource segment revenues increased 10% in the third quarter of 2017, compared with the same period last year, primarily due to higher Northern region sawlog prices, which included higher cedar prices. Total harvest volumes decreased 3% due to late quarter unfavorable hauling conditions in the Northern region. While not a reduction in harvest volumes compared with the same time last year, the Southern region was also affected by wet weather caused by hurricane activity. Northern region pulpwood sales were down nearly 50% due to trucking shortages.

Southern sawlog and pulpwood prices decreased 4% and 3%, respectively, due primarily to the oversupply of logs and high pulp mill inventories. While not a primary factor in the third quarter, prices can also fluctuate based on the mix of sawlog size and volume and the mix of hardwood and softwood.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Resource segment revenues increased 7% in the first nine months of 2017, compared with the same period last year, primarily due to higher Northern region sawlog prices, including higher cedar prices and a greater mix of cedar. Total harvest volumes decreased 5% due to a seasonally wet spring in both regions and wet weather late in the third quarter, which contributed to unfavorable hauling conditions in Idaho, compared with more favorable hauling conditions in 2016. The decrease in 2017 volumes was also the result of the sale of central Idaho timberlands in the second quarter of 2016.

Southern sawlog and pulpwood prices decreased 2% and 6%, respectively, due to the oversupply of logs and high pulp mill inventories. While not a primary factor in the first nine months of 2017, prices can also fluctuate based on the mix of sawlog size and volume and the mix of hardwood and softwood.

Cost of Goods Sold

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Decreased harvest volumes resulted in lower depletion and amortization. The 2% increase in logging and hauling was due to a higher proportion of steep-slope logging in the Northern region, compared with the same time last year.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Lower harvest volumes resulted in less logging and hauling and lower depletion and amortization, partially offset by a higher proportion of steep-slope logging and increased costs for spring road repair in the Northern region. Other expenses in 2016 included a higher number of acres fertilized in our Southern region.

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Wood Products Segment

 

 

Revenues

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Revenues increased 19% due to higher lumber shipments and higher lumber sales prices.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Revenues increased 20% due to higher lumber shipments and higher lumber sales prices.

Cost of Goods Sold

Three months ended September 30, 2017 compared with three months ended September 30, 2016

Cost of goods sold fluctuated based on the following factors:

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

Cost of goods sold fluctuated based on the following factors:

Lumber price swap - See Consolidated Results and Note 5: Derivative Instruments for a more detailed discussion of the lumber price swap.

 

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Real Estate Segment

 

 

 

 

Three months ended September 30, 2017 compared with three months ended September 30, 2016

During the third quarter of 2017, we sold 2,026 acres, with about 80% of the acres comprised of Minnesota real estate. During the third quarter of 2016, we sold 6,292 acres, which included large rural recreational sales in Minnesota. The average price per acre fluctuates based on both the geographic area of the real estate and product mix.

Nine months ended September 30, 2017 compared with nine months ended September 30, 2016

During the first nine months of 2017, we sold 14,000 acres, which included a large conservation sale in Alabama. We sold 15,295 acres in the first nine months of 2016, which also included a large conservation sale in Alabama, in addition to the sale of central Idaho timberlands. The average price per acre fluctuates based on both the geographic area of the real estate and product mix.

 

In the second quarter of 2016, we sold approximately 172,000 acres of timberlands located in central Idaho for $114 million, resulting in a loss of $48.5 million before tax. The company purchased the property in 2007 and 2008 for the purpose of growing and harvesting timber and selling rural recreation parcels. The sale freed up capital without having to wait for the rural recreation real estate market in central Idaho to recover.

Liquidity and Capital Resources

Overview

As of September 30, 2017, our cash and cash equivalents were $116.8 million, an increase of $34.2 million from December 31, 2016. The increase in cash and cash equivalents was primarily the result of net income, partially offset by

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cash dividends to stockholders. Long-term debt was reduced $5.0 million and we had no borrowings outstanding under our revolving line of credit.

Net Cash from Operations

Net cash provided from operating activities was $129.3 million for the first nine months of 2017, compared with $74.4 million in the first nine months of 2016. This $54.9 million increase in net cash provided by operating activities was primarily attributable to $53.8 million additional cash received from customers. All of our business segments had increased revenue and income. A more detailed discussion of segment revenues and income is located in our Business Segment Results.

In addition to the increases in customer receipts in 2017 from 2016, cash provided by operating activities included:

Net Cash Flows from Investing Activities

Net cash used in investing activities was $43.2 million for the nine months ended September 30, 2017, compared with $96.1 million provided in 2016.  

Net Cash Flows from Financing Activities

Net cash used in financing activities was $52.0 million and $105.6 million for the nine months ended September 30, 2017 and 2016, respectively.

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Credit and Term Loan Agreements

As of September 30, 2017, approximately $0.9 million of capacity under our credit agreement was utilized by outstanding letters of credit, resulting in $249.1 million available for additional borrowings.

The following table sets forth the financial covenants in the credit and term loan agreements and our status with respect to these covenants as of September 30, 2017:

 

The terms of our senior notes limit our ability and the ability of any subsidiary guarantors to enter into restricted transactions, which include the ability to borrow money, pay dividends, redeem or repurchase capital stock, enter into sale and leaseback transactions and create liens. However, such restricted transactions are permitted if the balance of our cumulative Funds Available for Distribution (FAD) and a FAD basket amount provide sufficient funds to cover such restricted payments. At September 30, 2017, our cumulative FAD was $240.6 million and the FAD basket was $90.1 million.

The pending merger with Deltic, as disclosed in Note 13. Subsequent Event is not considered a restricted transaction under any of our borrowing agreements.

Contractual Obligations

There have been no material changes to our contractual obligations in the nine months ended September 30, 2017 outside the ordinary course of business.

Off-Balance Sheet Arrangements

We currently are not a party to off-balance sheet arrangements that would require disclosure under this section.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposures to market risk have not changed materially since December 31, 2016. For quantitative and qualitative disclosures about market risk, see Item 7A – “Quantitative and Qualitative Disclosure about Market Risk” in our 2016 Annual Report on Form 10-K.

Quantitative Information about Market Risks

The table below provides information about our outstanding long-term debt, weighted-average interest rates and interest rate swaps as of September 30, 2017. For debt obligations, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted-average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted-average variable rates are based on implied forward rates in the yield curve.

 

In April 2017, we entered into a commodity swap contract to fix the price on 36 million board feet (mmbf) of southern yellow pine with an effective date of July 1, 2017 and a termination date of December 31, 2017. Under the contract, cash settlement on 6 mmbf occurs monthly.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the Exchange Act)), under the supervision and with the participation of management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of September 30, 2017. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that this information is accumulated and communicated to management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on the evaluation, the CEO and CFO have concluded that these disclosure controls and procedures were effective as of September 30, 2017.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

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Internal Control over Financial Reporting

In the three months ended September 30, 2017, there were no changes in our internal control over financial reporting that occurred that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Other than the environmental proceeding described in Note 11: Commitments and Contingencies in the Notes to Condensed Consolidated Financial Statements, which is incorporated herein by reference, we believe there is no pending or threatened litigation that could have a material adverse effect on our financial position, operations or liquidity.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors previously disclosed in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, except the following:

Our Pending Merger with Deltic Timber Corporation

On October 22, 2017, Potlatch and Deltic entered into a Merger Agreement pursuant to which Deltic will merge with and into a wholly-owned subsidiary of Potlatch (“Merger Sub”) with Merger Sub continuing as the surviving corporation. If the merger is not completed, our businesses may be adversely affected and we may be subject to various risks without realizing any of the benefits of having the merger completed, including the following:

A delay in completing the merger, which is subject to a number of conditions, some of which are outside our control, may reduce or eliminate the expected benefits from the merger.

The merger is subject to a number of conditions, some of which are beyond our control, that could prevent, delay or otherwise materially adversely affect its completion. We cannot predict whether and when the conditions will be satisfied. The requirement to obtain certain regulatory approvals could delay the completion of the merger for a significant period of time or prevent it from occurring. A delay in completing the merger could cause the combined company not to realize some or all of the synergies and other benefits that it expects to achieve if the merger is successfully completed within its expected time frame. The Merger Agreement contains certain restrictions on the conduct of our business. If the merger is delayed, these restrictions could adversely affect our ability to execute business strategies or pursue attractive business opportunities. In addition, a delay could cause management to focus on completion of the merger instead of on other opportunities that could be beneficial to the company.

The merger will involve substantial costs, and the combined company may be unable to successfully integrate the businesses of the two companies and realize the anticipated benefits of the merger.

We have incurred and expect to continue to incur substantial costs and expenses relating directly to the merger, including fees and expenses payable to financial and other professional advisors, SEC filing fees, printing and mailing costs and other transaction-related costs, fees and expenses. We expect to incur substantial expenses in connection with the integration of the businesses, policies, procedures, operations, employees, technologies and systems of Deltic with those of Potlatch. There are a large number of systems that must be integrated, including management information, purchasing, accounting and finance, sales, billing, payroll and benefits, fixed asset and lease administration systems and regulatory

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compliance. Expenses related to this integration are by their nature difficult to estimate accurately. These expenses could, particularly in the near term, exceed the savings that we expect to achieve from the realization of economies of scale and cost savings and synergies related to the integration of the businesses. These integration expenses likely will result in significant charges against earnings following the completion of the merger, but the amount and timing of such charges are uncertain.

The merger involves the combination of two independently operated public companies. The merger will require management to devote significant attention and resources to integrating business practices and operations. The combined company may fail to realize some or all of the anticipated benefits of the merger if the integration process takes longer than expected or is more costly than expected.

Uncertainties associated with the merger may adversely affect our business and operations.

Uncertainties associated with the merger could cause customers, suppliers or other entities with whom we have a business relationship to delay or defer decisions, which could negatively impact our revenues, earnings and cash flows. In addition, customers or suppliers may elect to cease doing business with us or the combined company in anticipation of or following the merger, or seek to take advantage of potential uncertainty or disruption resulting from the merger to interfere with relationships with customers, suppliers or employees.

We are dependent on the valuable experience and industry knowledge of our officers and other employees to execute our business plans and successfully conduct operations. Our success after the merger will depend in part upon our ability to retain key personnel. Current and prospective employees may feel uncertain about their roles following the merger, which may materially adversely affect our ability to attract and retain key personnel.

The market price of our common stock may decline in the future as a result of the merger.

The market price of our common stock may decline in the future as a result of the merger for a number of reasons, including our inability to successfully integrate the two companies or our failure to achieve the perceived benefits of the merger, including financial results, as rapidly as or to the extent anticipated by financial or industry analysts. Failure to successfully integrate the two companies could negatively impact our revenues, earnings and cash flows, and could materially adversely affect our ability to pay dividends at historical levels, or at all.

The combined company may incur adverse tax consequences if either Potlatch or Deltic has failed or fails to qualify as a REIT for U.S. federal income tax purposes.

Potlatch has operated in a manner that it believes has allowed it to qualify as a REIT for U.S. federal income tax purposes under the Code. Deltic is a C Corporation. We intend to operate in a manner that allows us to continue to qualify as a REIT after the merger. However, even if we have operated so as to retain our REIT status, if we are unable to convert Deltic to a REIT status in the taxable year that includes the merger, we will face serious tax consequences that could substantially reduce cash available for distribution to our shareholders and significantly impair our ability to expand our business and raise capital.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

On April 26, 2016, the company announced that its Board of Directors had authorized management to repurchase up to $60 million of common stock over a period of 24 months (the “Repurchase Plan”).

No shares were repurchased during the first nine months of 2017. As of September 30, 2017, the maximum dollar values of shares that may yet be purchased under the plan is approximately $54 million. Transaction costs are not counted against authorized funds under the Repurchase Plan.    

We record share repurchases upon trade date, as opposed to the settlement date when cash is disbursed. We record a liability to account for repurchases that have not been settled. There were no unsettled repurchases as of September 30, 2017.

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ITEM 6. EXHIBITS

 

* Incorporated by reference

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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