UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

 

 

For the quarterly period ended September 30, 2016

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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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 21, 2016 was 40,518,533.

 

 

 

 

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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 (Dollars in thousands, except per share amounts)

 

 

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 (Dollars in thousands)

 

 

See Note 7: Derivative Instruments and Note 9: 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 (Dollars in thousands)

 

 

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 (Dollars in thousands)

 

 

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, 2015, as filed with the Securities and Exchange Commission on February 12, 2016. 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.

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases, which, among other things, requires lessees to recognize most leases on the balance sheet. We have operating leases covering office space, equipment, land and vehicles expiring at various dates through 2028, which would require a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, to be recognized in the statement of financial position. Lease costs would generally continue to be recognized on a straight-line basis. We expect our right-of-use asset and lease liability will approximate our current future minimum lease payments required under our operating leases, which were $9.6 million at December 31, 2015. The ASU is effective for us on January 1, 2019.

In March 2016, the FASB issued 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. This ASU is effective for us on January 1, 2017. The adoption of this guidance is not expected to have a significant effect on our consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable recognition threshold for credit impairments. The new guidance broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. The guidance provides no specified method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. This ASU is effective for us on January 1, 2020. Our credit loss estimates are reflected in our allowance for doubtful accounts on accounts receivables, which had a balance of $0.4 million at December 31, 2015. The adoption of this guidance is not expected to have a significant effect on our consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, which reduces diversity in practice where the FASB was either unclear or did not provide specific guidance for classifying cash payments and receipts in the statement of cash flows for eight specific transactions. The ASU currently applies to our proceeds from the settlement of corporate-owned life insurance policies, which require cash proceeds received from the settlement of corporate-owned life insurance policies to be classified as cash inflows from investing activities. This ASU is effective for us retrospectively on January 1, 2018, with early adoption permitted. We report our cash flow activity consistent with the new ASU and, therefore, the adoption of this guidance will have no effect on our consolidated financial statements.

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In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which reduces the complexity in the accounting standards by allowing the recognition of current and deferred income taxes for an intra-entity asset transfer, other than inventory, when the transfer occurs. Historically, recognition of the income tax consequence was not recognized until the asset was sold to an outside party. This amendment should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. There are no new disclosure requirements. This ASU is effective for us on January 1, 2018. Early option is permitted in the first interim period of 2017.  We are currently evaluating the impact of this ASU on our consolidated financial statements, which includes assessing the timing of certain asset sales to outside parties.

NOTE 3. EARNINGS PER SHARE

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

 

 

No dilutive potential shares were included in the computation of diluted net loss per share for the first nine months of 2016 due to the net loss. For the three months ended September 30, 2016 and 2015, there were 12,139 and 36 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 there were 139,216 anti-dilutive stock-based awards. For the nine months ended September 30, 2015, there were no anti-dilutive stock-based awards. Anti-dilutive stock-based awards could be dilutive in future periods.

We repurchased 169,625 shares of common stock during the second quarter at an average price of $35.08 per share totaling $6.0 million. The shares were retired and the excess repurchase price over par was allocated to accumulated deficit.

NOTE 4. CERTAIN BALANCE SHEET COMPONENTS

INVENTORIES

 

PROPERTY, PLANT AND EQUIPMENT

 

 

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NOTE 5. LOSS ON SALE OF CENTRAL IDAHO TIMBER AND TIMBERLANDS

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 recreational parcels.  In the recession of 2008 the central Idaho rural recreational real estate market collapsed and has not recovered. The sale freed up capital without having to wait for the rural recreational 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 6. DEBT

In February 2016, we amended our term loan agreement to provide an additional loan in the amount of $27.5 million. This additional tranche refinanced $27.5 million of long-term debt that matured in December 2015 and February 2016. The new debt matures in 2026 and carries a rate equal to 3-month LIBOR plus 2.15% per annum.    

In June 2016, we repaid $42.6 million of revenue bonds.  The bonds carried a rate of 5.9% and had a maturity date in 2026.

In August 2016, we refinanced $65.7 million of revenue bonds at a rate of 2.75%. The original bonds, which carried a rate of 6.0%, were extinguished and a new debt obligation was simultaneously issued. The principal balance and maturity date in 2024 remain unchanged.

NOTE 7. 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, 2016, the amount of net losses expected to be reclassified into earnings in the next 12 months is $0.2 million.

The following table presents the gross fair values of our interest rate contracts designated as hedging 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):

 

¹ Realized gain and losses on interest rate contracts consist of net cash received or paid and interest accruals on the interest rate swaps during the periods. Net cash received or paid is included in the supplemental cash flow information within interest, net of amounts capitalized in the Condensed Consolidated Statements of Cash Flows.

NOTE 8. FINANCIAL INSTRUMENTS

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

 

 

For cash and short-term investments and 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 the interest rate swaps were determined by discounting 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 forward curves.

The fair value of our long-term debt is estimated based upon the quoted market prices for the same or 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 as a practical expedient to estimate fair value because market prices are not readily available.

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NOTE 9. 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, 2016, we made a qualified pension plan contribution of $1.3 million. During the nine months ended September 30, 2016 and 2015, we paid non-qualified supplemental pension benefits of $1.3 million and $1.4 million and OPEB benefits of $2.6 million and $2.9 million, respectively.

The following tables detail the pension and OPEB changes in accumulated other comprehensive loss (AOCL):

 

¹ Amortization of prior service credit (cost) and amortization of actuarial loss are included in the computation of net periodic cost (benefit).

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¹ Amortization of prior service credit (cost) and amortization of actuarial loss are included in the computation of net periodic cost (benefit).

NOTE 10. EQUITY-BASED COMPENSATION

As of September 30, 2016, 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, 2016, approximately 1.1 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.

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 2016 and 2015:

 

 

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The following table summarizes outstanding performance share awards as of September 30, 2016, and changes during the nine months ended September 30, 2016:

 

 

As of September 30, 2016, there was $4.3 million of unrecognized compensation cost related to unvested performance share awards, which is expected to be recognized over a weighted-average period of 1.4 years.

RESTRICTED STOCK UNITS

The following table summarizes outstanding RSU awards as of September 30, 2016, and changes during the nine months ended September 30, 2016:

 

 

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, 2016 was $0.2 million. As of September 30, 2016, there was $1.6 million of total unrecognized compensation cost related to unvested RSU awards, which is expected to be recognized over a weighted-average period of 1.7 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 is typically payable in the form of stock. All stock unit equivalent accounts are credited with dividend equivalents. As of September 30, 2016, there were 150,063 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, 2016, there were 71,483 RSUs which had vested, but issuance of the related stock had been deferred.

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NOTE 11. 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.

At September 30, 2016 $11.0 million was classified as taxes receivable within Receivables, net on the Condensed Consolidated Balance Sheet. At December 31, 2015, we classified the 2015 tax loss of $5.5 million as a deferred tax asset with the intention of carrying the loss forward into 2016. As a result of the loss on sale of central Idaho timberlands in the second quarter of 2016, we reclassified the $5.5 million loss carryforward to a loss carryback, resulting in a tax receivable at September 30, 2016. In addition, we expect to use $4.0 million in tax benefits in the fourth quarter of 2016 and receive $1.5 million in tax refunds.

Unrecognized tax benefits represent potential future obligations to taxing authorities if uncertain tax positions we have taken on previously filed tax returns are not sustained. During the third quarter of 2016, we recorded $850,000 in unrecognized tax benefits related to certain federal and state tax credit studies that were completed in the third quarter of 2016.

NOTE 12. 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. 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 $9.6 million in unreimbursed response costs associated with the site and that we were liable for such costs. We believe we have meritorious defenses to this claim and we intend to defend ourselves vigorously. We have reserved all of our rights to seek reimbursement for the costs of remediation from all parties potentially responsible. 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 has been further extended through February 22, 2017 and settlement negotiations continue. We accrued $0.2 million for this matter in the first quarter of 2016 and an additional $0.8 million for this matter in the second quarter of 2016. 

 

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NOTE 13. SEGMENT INFORMATION

The following table summarizes information by business segment:

 

 

¹ In the second quarter of 2016, we sold approximately 172,000 acres of timberlands located in central Idaho for $114 million at a loss of $48.5 million before taxes. 

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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, effectiveness of the cash flow hedge, recognition of compensation costs relating to our performance shares and RSUs, real estate demand and pricing, log prices, lumber demand and prices, business conditions for our business segments, Resource segment results, Wood Products segment results, Real Estate segment results, 2016 capital spending, stock repurchase, expected harvest levels in 2016 and beyond, 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. For a nonexclusive listing of forward-looking statements and potential factors affecting our business, 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, 2015.

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 represent a 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, competition, timberland valuations, demand for our 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 dispositions or acquisitions and other factors.

Overview

Monthly U.S. housing starts have been up and down while the do-it-yourself market has been strong. The South continues to experience excess sawlog supply. The Canadian dollar has strengthened about 5% against the U.S. dollar during 2016, which benefits lumber manufacturers located in the United States by reversing some of Canada’s competitive advantage. The one-year standstill period that followed the softwood lumber agreement expiration ended October 12, 2016 and the terms and timing of a new agreement are uncertain.

All three of our business segments contributed to our solid results for the three and nine months ended September 30, 2016. Our 2015 capital projects at each of our lumber mills have resulted in improved lumber recovery, better grade yield and increased production. The Real Estate segment sold approximately 172,000 acres of non-strategic timberlands located in central Idaho for $114 million in the second quarter of 2016.

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The central Idaho sale freed up capital for the repayment of $42.6 million of long-term debt and a common stock repurchase program. We also refinanced $65.7 million of tax exempt bonds which reduced the interest rate from 6.0% to 2.75%.

Consolidated Results

The following table sets forth changes in our Consolidated Statements of Income (Loss):

 

* Percentage change not meaningful.

 

Revenues

Our Business Segment Results provide a more detailed discussion of our segments.

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Revenues were flat due to offsetting factors. Harvest volumes were 20% lower than the same time last year offset by a 13% increase in lumber shipments and a 10% increase in lumber sale prices.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Revenues increased 1% due to a 10% increase in lumber shipments, partially offset by lower lumber sales prices of 2% and a decrease in harvest volumes of 5%.

Cost of goods sold

Our Business Segment Results provide a more detailed discussion of our segments.

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Cost of goods sold decreased 10% primarily due to lower logging and hauling and depletion on reduced harvest volumes. Lower fiber and manufacturing costs for lumber and a decrease in the average land basis of real estate sold due to geographic mix also contributed to the decrease in cost of sales.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Cost of goods sold decreased 2% primarily due to lower log and haul and depletion on reduced harvest volumes and lower fiber costs in the Lake States, partially offset by an increase in the average land basis of real estate sold due to geographic mix.

Selling, general and administrative expenses

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Selling, general and administrative expenses increased $2.2 million primarily due to higher annual employee incentive plan costs, which were reduced in the third quarter of 2015.

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Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Selling, general and administrative expenses increased $4.7 million primarily due to higher annual employee incentive plan costs compared with no annual employee incentive costs in 2015 and a $1.0 million expense related to Avery Landing.

 

See Note 12: Commitments and Contingencies for a more detailed discussion of Avery Landing.

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. This divestiture freed up capital without having to wait for the rural recreational real estate market in central Idaho to recover, resulting in a $48.5 million loss before income taxes.

Interest expense, net

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Interest expense decreased due to the repayment of $42.6 million in Minnesota revenue bonds and the refinance of $65.7 million in Idaho revenue bonds, partially offset by unamortized debt issuance costs that were expensed in connection with the revenue bond refinance.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Interest expense decreased due primarily to a $2.2 million patronage dividend received in the first quarter of 2016. The patronage dividend was higher in 2016, as compared with 2015, as a result of the debt used to fund the acquisition of timberlands in Alabama and Mississippi in December 2014. Interest expense also decreased due to the repayment of $42.6 million in Minnesota revenue bonds and the refinance of $65.7 million in Idaho revenue bonds, partially offset by unamortized debt issuance costs that were expensed in connection with the revenue bond refinance.

Income tax provision

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Income taxes are primarily due to income or loss from our taxable REIT subsidiaries (TRS). For the three months ended September 30, 2016, the income tax provision of $3.6 million is the result of the TRS’s income before income tax of $10.9 million, partially offset by permanent book versus tax differences. For the three months ended September 30, 2015, the income tax benefit of $2.4 million was the result of the TRS’s loss before income taxes of $5.9 million. In addition, during the third quarter of 2016, we recorded $850,000 in unrecognized tax benefits related to certain federal and state tax credits.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

For the first nine months of 2016, the income tax benefit of $8.7 million is the result of the TRS’s loss before income tax of $22.3 million, discrete tax items and permanent book versus tax differences. For the first nine months of 2015, the income tax benefit of $3.5 million was the result of the TRS’s loss before income tax of $8.5 million and permanent book versus tax differences.

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Business Segment Results

Resource Segment

¹ Intersegment fiber revenues, which are not eliminated above, were $17.8 million and $18.5 million for the three months ended September 30, 2016 and 2015 and $41.7 million and $41.0 million for the nine months ended September 30, 2016 and 2015, respectively.

 

² Sawlog and pulpwood sales prices are on a delivered basis, which includes contracted logging and hauling costs.

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Revenues

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Resource segment revenues decreased 16% in the third quarter of 2016, compared with the same period last year.

Volumes in our Northern region decreased 23% resulting from harvest volumes that were pulled forward into the second quarter due to favorable spring hauling conditions. We also moderated the third quarter harvest volumes due to high mill log inventories that resulted from the strong second quarter production and salvage wood from timberlands that burned in 2015. These harvest volume and scheduling changes temporarily impacted logging contractor availability during the quarter. The 10% increase in sawlog prices included higher pricing and cedar mix.

Harvest volumes in our Southern region decreased 18% in the third quarter of 2016 due to abnormally wet conditions. Southern sawlog prices were constant with last year while pulpwood prices were 9% lower due to certain pulp mill outages and high inventories. Stumpage prices fluctuate based on the mix of pulpwood and sawlog volumes and the mix of hardwood and softwood.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Resource segment revenues decreased 6% in the first nine months of 2016, compared with the same period last year.

Harvest volumes in our Northern region decreased 10% in the first nine months of 2016, compared with the same period last year. Harvest plans are set on a dimensional basis in the North. Lower tons were due to an increase in the log diameter that achieved dimensional harvest plans. Harvest volumes also decreased due to the sale of approximately 172,000 acres of central Idaho timberlands in the second quarter of 2016. The 2% increase in sawlog prices included higher pricing and cedar mix.

Harvest volumes in our Southern region were constant with last year. Southern sawlog and pulpwood prices were down 2% and 6% respectively, due to smaller log size and high inventories at pulpwood mills. Stumpage prices fluctuate based on the mix of pulpwood and sawlog volumes and the mix of hardwood and softwood.

Cost of Goods Sold

Three months ended September 30, 2016 compared with three months ended September 30, 2015

The decrease in harvest volumes resulted in lower logging, hauling and depletion expense. Lower diesel prices resulted in slightly lower hauling rates.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

The decrease in harvest volumes resulted in lower logging, hauling and depletion expense. Lower diesel prices resulted in slightly lower hauling rates. Other expenses were slightly higher due to an increase in the number of acres fertilized, largely in our Southern region.

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Wood Products Segment

* Percentage change not meaningful.

 

¹ Intersegment fiber costs were $17.8 million and $18.5 million for the three months ended September 30 in 2016 and 2015 and $41.7 million and $41.0 million for the nine months ended September 30 in 2016 and 2015, which are not eliminated above.

 

Revenues

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Revenues were $14.8 million higher due to higher lumber shipments and higher lumber sales prices. The increase in lumber prices included an increase in premium grade lumber resulting from the 2015 capital projects.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Revenues were $15.5 million higher due to higher lumber shipments, partially offset by lower lumber sales prices.

Cost of Goods Sold

Three months ended September 30, 2016 compared with three months ended September 30, 2015

Cost of goods sold fluctuated based on the following factors:

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

Cost of goods sold fluctuated based on the following factors:

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Real Estate Segment

* Percentage change not meaningful.

 

 

Three months ended September 30, 2016 compared with three months ended September 30, 2015

During the third quarter of 2016 we sold an additional 1,757 acres, as compared with the same time last year. The average price per acre fluctuates based on the geographic area of the real estate. The average land basis per acre sold was higher in the prior year largely due to an HBU sale in the South.

Nine months ended September 30, 2016 compared with nine months ended September 30, 2015

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 recreational parcels.  In the recession of 2008, the central Idaho rural recreational real estate market collapsed and has not recovered. The sale freed up capital without having to wait for the rural recreational real estate market in central Idaho to recover.

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Excluding the sale of central Idaho timberlands, in the first nine months of 2016 we sold an additional 4,467 acres, as compared with the same time last year, at a lower weighted average sales price. The average sales price per acre was higher in the prior year largely due to the sale of two commercial real estate sites included in HBU, as well as geographic mix.  

Liquidity and Capital Resources

Overview

At September 30, 2016, our financial highlights included:

Net Cash from Operations

Net cash provided from operating activities was:

Net cash from operations increased $19.3 million for the nine months ended September 30, 2016, compared with the same period last year, primarily due to:

Net Cash Flows from Investing Activities

Net cash provided from investing activities was $56.0 million for the nine months ended September 30, 2016, compared with $9.7 million used in 2015. Short-term investments increased $40.1 million in the first nine months of 2016 primarily due to the proceeds of $111.5 million from the sale of approximately 172,000 acres of timberlands located in central Idaho, compared with a decrease of $26.3 million in the first nine months of 2015 primarily due to lower lumber shipments and prices.

Capital spending for property, plant and equipment and timber reforestation and roads during the first nine months of 2016 was $12.7 million lower than the same period in 2015. During the first nine months of 2015, we completed large capital project installations at each of our four lumber mills. Capital spending for property, plant and equipment and timber reforestation and roads is expected to be $19 million in 2016, compared with $32.7 million in 2015.

Net Cash Flows from Financing Activities

Net cash used in financing activities was $105.6 million and $48.7 million for the nine months ended September 30, 2016 and 2015, respectively. Net cash used in financing activities in 2016 was primarily attributable to the $42.6 million repayment of Minnesota revenue bonds (see Credit and Term Loan Agreements below), $45.6 million of dividends to stockholders and $6.0 million in the repurchase of common stock. In 2015, net cash used in financing activities was primarily attributable to dividend payments to stockholders of $45.8 million.

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Credit and Term Loan Agreements

In February 2016, we amended our term loan agreement to provide an additional loan in the amount of $27.5 million. This additional tranche refinanced $27.5 million of long-term debt that matured in December 2015 and February 2016. The new debt matures in 2026 and carries a rate equal to 3-month LIBOR plus 2.15% per annum. At September 30, 2016, our term loan debt includes nine tranches totaling $349.5 million.

In June 2016, we repaid $42.6 million of Minnesota revenue bonds.  The bonds carried a rate of 5.9% and had a maturity date in 2026.

During the third quarter of 2016, we refinanced $65.7 million of Idaho revenue bonds at a rate of 2.75%. The bonds previously carried a rate of 6.0%. The maturity date in 2024 remains unchanged.

As of September 30, 2016, approximately $1.2 million of capacity under our credit agreement was utilized by outstanding letters of credit, resulting in $248.8 million available for additional borrowings under our credit agreement.

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, 2016:

 

¹ Acres sold under the credit and term loan agreements were 209,103 and 16,059, respectively, at September 30, 2016.  The term loan agreement allows for an exclusion of up to 250,000 acres sold in the fiscal years ending December 31, 2016 and December 31, 2017.

Senior Notes

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, 2016, our cumulative FAD was $205.8 million and the FAD basket was $90.1 million.

Sale of Central Idaho Timberlands

On April 21, 2016, we sold approximately 172,000 acres of timberlands located in central Idaho for $114 million. Net cash received was $111.5 million.

As a result of this sale, we have updated the number of non-core timberlands to be approximately 220,000 acres. This includes approximately 55,000 acres of HBU property, 55,000 acres of non-strategic timberland and 110,000 acres of rural recreational real estate property.

In addition, we have updated our harvest level to range between 3.8 million and 4.6 million tons each year over the next several years, depending on market conditions and other factors, assuming no significant timberland acquisitions or dispositions. Based on our current projections, which are based on constant timberland holdings, and that take into consideration such factors as market conditions, the ages of our timber stands and recent timberland sales and acquisitions, we expect to harvest approximately 4.2 million tons in 2016.

Contractual Obligations

Other than changes to our long-term debt as disclosed in Note 6: Debt, there have been no material changes to our contractual obligations in the nine months ended September 30, 2016 outside the ordinary course of business.

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Off-Balance Sheet Arrangements

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposures to market risk have not changed materially since December 31, 2015. For quantitative and qualitative disclosures about market risk, see Item 7A – “Quantitative and Qualitative Disclosure about Market Risk” in our 2015 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, 2016. 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.

 

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, 2016. 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, 2016.

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, 2016, 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 12: 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, 2015.

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”).

During the second quarter of 2016, we repurchased 169,625 shares of common stock for $6.0 million (including transaction costs).  No shares were repurchased in the third quarter of 2016. Transaction costs are not counted against authorized funds under the Repurchase Plan.  All purchases were made in open-market transactions.

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, 2016.

ITEM 6. EXHIBITS

Exhibits are listed in the Exhibit Index.

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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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POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES

EXHIBIT INDEX

 

* Incorporated by reference

 

 

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