ITEM 1. BUSINESS
General
Potlatch Corporation (the "company"), incorporated in 1903, is an integrated forest products company with substantial timber resources. It is engaged principally in the growing and harvesting of timber and the manufacture and sale of wood products, printing papers and pulp and paper products. Its timberlands and all of its manufacturing facilities are located within the continental United States.
Information relating to the amounts of revenue, operating profit and identifiable assets attributable to each of the company's industry segments for 1997-1999 is included in Note 13 to the financial statements on pages 33- 35 of this report.
This report contains, in addition to historical information, certain forward-looking statements, including without limitation, statements regarding future revenues, costs, manufacturing output, capital expenditures, timber supply and Year 2000 issues. These forward-looking statements are based on management's best estimates and assumptions regarding future events, and are therefore subject to known and unknown risks and uncertainties and are not guarantees of future performance. The company's actual results of operations could differ materially from those expressed or implied by forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, changes in the United States and international economies; changes in worldwide demand for the company's products; changes in worldwide production and production capacity in the forest products industry; competitive pricing pressures for the company's products; unanticipated manufacturing disruptions; impact of Year 2000 issues; and changes in raw material, energy and other costs.
Resource
The principal source of raw material used in the company's operations is wood fiber obtained from its own timberlands and purchased on the open market. The company owns in fee approximately 1.5 million acres of timberland: 500,000 acres in Arkansas, 671,000 acres in Idaho and 338,000 acres in Minnesota. The company also owns and is developing 22,000 acres in Oregon as a hybrid poplar plantation.
In July 1999, the company separated the operations of its timberlands from its wood products manufacturing facilities, creating the Resource Management Group. The primary functions of the group are managing company-owned timberlands and supplying the fiber requirements of the company's manufacturing facilities.
The group generates a majority of its revenues through sales of sawlogs and pulpwood at market prices to the company's manufacturing facilities. A portion of annual revenues is also derived from log sales to third parties, sales of nonstrategic land parcels and receipts from hunting leases. The majority of revenue is derived from trees grown on the company's timberlands.
The amount of timber harvested in any year from company-owned lands varies according to the requirements of sound forest management and the supply of timber available for purchase on the open market. The company intends to manage long-term harvest levels on its timberlands in a manner that ensures sustainable yields, thus providing for a continuous supply of wood fiber in the future. By continually improving forestry and silviculture techniques and other forest management practices, the company has been able to increase the volume of wood fiber produced per acre from its timberlands. In most cases, the cost of timber from company land is substantially below the cost of timber obtained on the open market.
The company's fee lands provided approximately 64 percent of its sawlogs and plywood logs in 1999 and an average of 70 percent over the past five years. Including the raw materials used for pulp, oriented strand board and particleboard, these percentages were 35 percent for 1999 and an average of 43 percent for the past five years. Additional logs are obtained primarily from private landowners and from state and local governments.
At the present time, timber from the company's lands, together with outside purchases, is adequate to support manufacturing operations. For more than a decade, the timber supply from federal lands has been increasingly curtailed, largely due to environmental pressures that are expected to continue for the foreseeable future. Although this trend has had a favorable effect on earnings for the company as a whole, it has had an adverse effect on wood fiber costs. The long-term effect of this trend on company earnings cannot be predicted. The company has been developing additional fiber supplies.
The company assumes substantially all risk of loss from fire and other hazards on the standing timber it owns, as do most owners of timber tracts in the United States.
Wood Products
The company manufactures and markets oriented strand board ("OSB"), lumber, plywood and particleboard. These products are sold through the company's sales offices primarily to wholesalers for nationwide distribution.
To produce these solid wood products, the company owns and operates several manufacturing facilities in Arkansas, Idaho and Minnesota. A description of these facilities is included under Item 2
ITEM 2. PROPERTIES
The principal manufacturing facilities of the company, together with their respective 1999 capacities and production, are as follows:
- -------- (A) 3/8" Basis (B) There are two sawmills in Warren. (C) 3/4" Basis (D) The capacity in 2000 is 468,000 tons.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In February and November 1997, the company received Notices of Violation ("NOVs") from Region 10 of the U.S. Environmental Protection Agency ("EPA"). Both NOVs allege that the company violated the Prevention of Significant Deterioration permit requirements and permit requirements of the Idaho State Implementation Plan by burning tire derived fuel in the company's No. 4 power boiler in Lewiston, Idaho, in quantities which caused sulfur dioxide emissions to exceed permitted amounts
over a five-year period beginning in 1992. Although no specific relief has been requested by the EPA, the NOVs set forth EPA's authority to seek, among other things, penalties of up to $25,000 per day for each violation. The matter has been referred to the United States Department of Justice ("DOJ") to commence an enforcement action against the company. No such action has been filed against the company. The company believes it has defenses to the alleged violations and has held conferences with the EPA and the DOJ for the purpose of presenting information bearing on the alleged violations.
In December 1995, the company filed a complaint against Beloit Corporation in the District Court of the State of Idaho, Nez Perce County. The complaint alleged that a pulp washer system supplied by Beloit Corporation and installed at the company's pulp mill in Lewiston, Idaho, experienced massive defects and deficiencies and failed to meet contract performance requirements and criteria. In June 1997, a jury awarded damages of $95 million to the company. Beloit appealed the case to the Idaho Supreme Court (the "Court"). On April 2, 1999, the Court vacated the judgment and remanded the case to the trial court for a new trial. In its ruling, the Court did not decide the merits of the company's case. On April 23, 1999, the company filed a Petition for Rehearing with the Court, which was denied on June 18, 1999. On June 7, 1999, Beloit Corporation and its parent, Harnischfeger Industries, Inc., filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. As a result, further action on the company's claim against Beloit has been stayed. Subject to the requirements of the Bankruptcy Code, the company intends to continue to pursue its claims against Beloit.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999.
Executive Officers of the Registrant
Information as of March 1, 2000, and for the past five years concerning the executive officers of the company is as follows:
L. Pendleton Siegel (age 57), first elected an officer in 1983, has served as Chairman of the Board and Chief Executive Officer since May 1999. Prior to May 1999, he was President and Chief Operating Officer. Mr. Siegel was elected a director of the company effective November 1997. He is a member of the Finance Committee of the Board of Directors.
Richard L. Paulson (age 58), first elected an officer in 1992, has served as President and Chief Operating Officer since May 1999. From May 1996 through April 1999, he was Vice President, Minnesota Pulp and Paper Division. Prior to May 1996, he was Vice President, Consumer Products Division.
Phillip M. Baker (age 40), first elected an officer in 1999, has served as Vice President, Minnesota Pulp and Paper Division since May 1999. Prior to May 1999, he was an appointed officer and served in the following positions: from December 1997 through April 1999 he was Vice President, Sales and Marketing for the Minnesota Pulp and Paper Division; from October 1997 through November 1997 he was Vice President, Marketing for the Minnesota Pulp and Paper Division. From May 1996 through September 1997 he was Director of Purchasing Services. Prior to May 1996, he was the environmental manager for Pulp-Based Operations.
Michael W. DeGenring (age 47), first elected an officer in 1999, has served as Executive Vice President, Finance and Administration since joining the company in September 1999. In January 2000 he was also elected Chief Financial Officer. Prior to joining the company he was employed by Atlantic Richfield Company (ARCO) as follows: from November 1997 to April 1999 he was Chief Financial
Officer of ARCO Coal Company (a division of ARCO); from August 1996 to October 1997 he served as interim President of ARCO Coal Company; and from August 1995 to August 1996 he was President of ARCO Coal America (a division of ARCO Coal Company). Prior to August 1995, he was Vice President, Finance and Administration for ARCO Coal Company.
Richard K. Kelly (age 52), first elected an officer in 1999, has served as Group Vice President, Wood Products since July 1999. In May 1999 he was elected Vice President, Western Wood Products Division. Prior to May 1999, he was an appointed officer serving as Vice President, Western Wood Products Division.
John R. Olson (age 51), first elected an officer in 1999, has served as Group Vice President, Resource Management since July 1999. In May 1999 he was elected Vice President, Resource Management. From August 1998 through May 1999 he was an appointed officer serving as Vice President, Resource Management. Prior to August 1998, he was Poplar Project Manager.
Charles R. Pottenger (age 60), first elected an officer in 1991, is Group Vice President, Pulp and Paper.
NOTE: The aforementioned officers of the company are elected to hold office until the next annual meeting of the Board of Directors. Each officer holds office until the officer's successor has been duly elected and has qualified or until the earlier of the officer's death, resignation, retirement or removal by the board.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The company's common stock is traded on the New York, Chicago and Pacific Stock Exchanges. Quarterly and yearly price ranges were:
In general, all holders of Potlatch common stock who own shares 48 consecutive calendar months or longer ("long-term holders") are entitled to exercise four votes per share of stock so held, while stockholders who are not long-term holders are entitled to one vote per share. All stockholders are entitled to only one vote per share on matters arising under certain provisions of the company's charter. There were approximately 3,200 common stockholders of record at December 31, 1999.
Quarterly dividend payments per common share for the past two years were:
ITEMS 6, 7 AND 8.
The information called for by Items 6, 7 and 8, inclusive, of Part II of this form is contained in the following sections of this Report at the pages indicated below:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the directors of the company is set forth under the heading "Election of Directors" on pages 3-5 of the company's definitive proxy statement, dated March 29, 2000, for the 2000 annual meeting of stockholders (the "2000 Proxy Statement"), which information is incorporated herein by reference. Information concerning Executive Officers is included in Part I of this report following Item 4 and under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" on page 7 of the 2000 Proxy Statement, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information set forth under the heading "Compensation of Directors and the Named Executive Officers" on pages 8-12 of the 2000 Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of management set forth under the heading "Stock Ownership" on pages 6-7 of the 2000 Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information set forth under the heading "Certain Transactions" on page 12 of the 2000 Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial statements are listed in the Index to Consolidated Financial Statements on page 13 of this Form 10-K. No financial statement schedules are presented because they are either immaterial, not required or the required information is given in the consolidated financial statements.
(b) No reports on Form 8-K were filed for the quarter ended December 31, 1999.
(c) Exhibits are listed in the Exhibit Index on pages 37-38 of this Form 10- K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Potlatch Corporation (Registrant)
/s/ L. Pendleton Siegel By: _________________________________ L. Pendleton Siegel Chairman of the Board and Chief Executive Officer
Date: March 30, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 30, 2000, by the following persons on behalf of the company in the capacities indicated.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following documents are filed as part of this Report:
Potlatch Corporation and Consolidated Subsidiaries
Selected Financial Data (Dollars in thousands--except per-share amounts)
Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity
Liquidity of a company can be measured by several factors. Of major importance are:
. Capability of generating earnings and cash flow
. Maintenance of a sound financial structure
. Access to capital markets
. Maintenance of adequate working capital
In 1999, the company's net cash provided by operations, excluding working capital changes, as presented in the Statements of Cash Flows on page 22, totaled $210.0 million, compared with $201.2 million in 1998 and $193.4 million in 1997.
The company maintains a credit line for general corporate purposes totaling $250.0 million, of which $100.0 million may be used for long-term debt and the balance may be used for short-term debt. At December 31, 1999, the company had $25.0 million outstanding under the short-term portion of the credit line. The remainder of the credit line is used to back the company's commercial paper program. Commercial paper outstanding at December 31, 1999, totaled $96.5 million, all of which was classified as short-term debt.
The ratio of long-term debt to stockholders' equity was .76 to 1 at December 31, 1999, the same level as the ratio at December 31, 1998, and December 31, 1997. In March 1999, the company issued $100.0 million of long-term debt, due March 15, 2002. The proceeds from the issue were used to
repay a like amount of commercial paper that had been classified as long-term debt. Also during the year, $10.0 million of medium-term notes were reclassified from long-term to current due to their maturity in 2000. Stockholders' equity declined $9.9 million, largely due to payment of dividends in excess of earnings and the issuance of put options.
One of the company's stated objectives is to maintain a sound financial structure. In that regard, the company believes that debt ratings within investment grade categories are important for long-term access to capital markets. The company's senior long-term debt is rated BBB+ by Standard & Poors, Baa1 by Moody's and A- by Duff and Phelps. With the company's ability to generate cash flow and its access to capital markets, the company believes it is capable of funding capital expenditures, working capital and other liquidity needs for the foreseeable future.
At December 31, 1999, working capital was $51.8 million, compared with $97.6 million at December 31, 1998, and $106.2 million at December 31, 1997. Working capital decreased a net $45.8 million in 1999. An increase in current liabilities of $54.4 million was partially offset by an increase in current assets of $8.6 million. The increase in current liabilities was primarily due to a $46.5 million increase in notes payable and a $7.6 million increase in accounts payable and accrued liabilities. Notes payable, which consist of borrowings under the company's line of credit and commercial paper issuances, rose during 1999 as the company used these funds along with internally generated resources for capital expenditures and general corporate purposes.
Capital Resources and Funding
Capital expenditures totaled $247.7 million in 1999, compared with $147.0 million in 1998 and $158.5 million in 1997.
Capital spending in the resource segment amounted to $17.4 million in 1999. Approximately half of this total related to development activities at the company's hybrid poplar plantation in Boardman, Oregon. The remaining expenditures were largely for reforestation, fertilization and logging roads on the company's timberlands.
The company spent $26.6 million on capital projects during 1999 in the wood products segment. Most of this amount was spent on the modernization and expansion of the Cook, Minnesota, OSB mill. Completion of the $67 million project at the end of 2000 will increase the plant's capacity by about 80 percent and make it cost-competitive. Most of the remaining expenditures were related to pollution control equipment and smaller projects designed to improve efficiency and product quality at the company's mills in Arkansas, Idaho and Minnesota.
The printing papers segment recorded capital expenditures totaling $181.9 million in 1999. Again this year the most significant portion of the outlays related to the modernization and expansion of the Cloquet, Minnesota, pulp mill. Construction during the year focused on the bleach plant, recausticizing area, pulp dryer and wood room. With the completion of these portions by year end, the pulp mill project is essentially finished. The Cloquet expansion was constructed in phases over several years. This allowed commitments to be made in a financially prudent manner. As of December 31, 1999, the company had spent approximately $530 million on the Cloquet project, which includes $31.8 million of capitalized interest. As various phases were completed they were placed into service and depreciated over the estimated useful lives of the assets, even though in most cases the full benefits of the improvements would not be realized until completion of the entire project. Depreciation on the phases already placed in service totaled $39.5 million as of December 31, 1999. Of this amount, $12.2 million was charged against income in 1999.
Capital spending in the pulp and paper segment totaled $20.9 million. A significant portion of this amount was spent on coater equipment at the Lewiston, Idaho, paperboard mill. The remaining expenditures were largely for environmental, safety and general replacement projects.
Authorized but unexpended appropriations totaled $195.5 million at December 31, 1999. Of that amount, $182.8 million is budgeted to be expended in 2000. Major expenditures will include the modernization and expansion of the oriented strand board plant at Cook and the continued development of the hybrid poplar plantation in Boardman. The 2000 capital program will be funded primarily from internally generated sources.
Historically, the company has spent less on capital expenditures than the annual amount budgeted. In 1999, the company spent $30.7 million less than the $278.4 million budgeted. Spending on projects may be delayed due to acquisition of environmental permits, acquisition of equipment, engineering, weather and other factors.
With the completion of the modernization and expansion of the pulp mill in Cloquet and the oriented strand board plant in Cook (scheduled for startup in December 2000), the company's 15-year program to update its facilities will be substantially completed. As a result, the company believes capital expenditure requirements to maintain and update its facilities after 2000 will be significantly less than in the last 15 years. The projected reduction in required capital expenditures plus the added revenues from the modernized and expanded pulp mill in Cloquet should provide a significant amount of additional cash starting in 2000. The company expects to utilize any such cash for reduction of debt, for high return projects at its existing facilities, for repurchasing shares of its stock and for other capital projects.
In December 1994, the company began a stock repurchase program to purchase up to 1 million shares of its common stock over several years. Through November 1999, the company had acquired a total of 498,800 shares. In December 1999, the company replaced this program with an expanded program to repurchase up to 2 million shares of stock. Purchases of common stock will be made from time to time through open market and privately negotiated transactions at prices deemed appropriate by management, and through the company's put option program.
Environment
The company is subject to extensive federal and state environmental regulations at its operating facilities. The company endeavors to comply with all environmental regulations and regularly monitors its activities for such compliance. Compliance with environmental regulations requires capital expenditures as well as additional operating costs. Capital expenditures specifically designated for environmental compliance totaled approximately $14 million during 1999 and are budgeted to be approximately $22 million in 2000. In addition, the company made expenditures for pollution control facilities as part of major mill modernization and expansions currently under way.
In early 1998 the Environmental Protection Agency published the "Cluster Rule" regulations applicable specifically to the pulp and paper industry. These extensive regulations govern both air and water emissions. The company is currently in the process of making modifications to process equipment and operating procedures in order to comply with the regulations. Based on an analysis of the regulations and the condition of the company's three pulp mills, the company estimates that compliance will require capital expenditures of approximately $15 million in 2000. The company does not expect that such compliance costs will have a material adverse effect on its competitive position.
Results of Operations
Comparison of 1999 with 1998
The company's 1999 consolidated net sales of $1.68 billion were slightly higher than 1998 net sales of $1.57 billion. Net earnings for 1999 were $40.9 million, modestly higher than the $37.2 million earned in 1998. Diluted net earnings per common share for the year were $1.41, compared to $1.28 in 1998.
Strong market conditions during the year for the company's wood products, especially panel products, helped to offset continued weakness in its pulp- based businesses and led to the modestly improved results. The 1999 results include a nonrecurring after tax charge of $4.6 million for expenses related to the termination of efforts to form a timber real estate investment trust.
The resource segment was created in July 1999 when the operations and management of the company's timberlands were separated from the wood products segment. The segment derives its income mainly from the sale of sawlogs and pulpwood at market prices to company manufacturing facilities, and to a lesser extent sales to third parties, hunting lease revenues and land sales. Prior year amounts have been restated to reflect the change. Resource segment operating income of $69.4 million was slightly lower than the $71.3 million earned in 1998. Although sales for the segment increased slightly in 1999 compared to 1998, lower fee harvest in Arkansas and lower market prices for logs in Minnesota were responsible for the earnings decline.
At the present time, timber from the company's own lands, together with outside purchases, is adequate to support manufacturing operations. For more than a decade the timber supply from federal lands has been increasingly curtailed, largely due to environmental pressures that are expected to continue for the foreseeable future. Although this trend has had a favorable effect on earnings for the company as a whole, it has had an adverse effect on wood fiber costs. The long-term effect of this trend on company earnings cannot be predicted. The company has been developing additional fiber supplies.
The wood products segment reported 1999 operating income of $82.9 million, a substantial improvement over the $2.5 million earned in 1998. Significantly higher net sales realizations and increased product shipments for oriented strand board, plywood and particleboard were primarily responsible for the results. Demand for panel products continued to be driven by the strong housing market during the year, and prices reached historic highs before declining by the year's end. Net sales realizations for lumber were also higher in 1999 and, combined with increased product shipments, helped contribute to the favorable results.
The company's printing papers segment incurred an operating loss of $13.8 million in 1999, compared to earnings of $14.2 million in 1998. Weak market conditions existed throughout the year for coated printing papers. Although segment sales were higher than in 1998, net sales realizations were lower in 1999 due to the product mix and continued pricing pressures on all paper grades. Also, segment results were adversely affected by costs associated with the new pulp mill in Cloquet, Minnesota. The mill started up late in the fourth quarter of 1999. The company expects costs to significantly decline once the startup has been completed.
Operating income for the pulp and paper segment was $14.8 million, significantly lower than the $53.4 million earned in 1998. The unfavorable comparison was largely due to lower net sales realizations for paperboard, as prices reached the bottom of the current cycle around midyear, and an unfavorable product mix compared to 1998. The unfavorable product mix was attributable to weak markets for liquid packaging during the first half of 1999. Also, operating problems at the Lewiston, Idaho, paperboard mill during the year resulted in a production decline and higher costs. Paperboard markets began to improve in the second half of 1999. Consumer tissue markets remained steady for the second straight year, with a modest increase in tissue product shipments being offset by a small decline in net sales realizations.
Comparison of 1998 with 1997
The company's 1998 consolidated net sales of $1.57 billion equaled net sales for 1997. Net earnings for 1998 were $37.2 million, slightly higher than the $36.1 million earned in 1997. Diluted net earnings per common share were $1.28, versus $1.24 for 1997.
Competitive market conditions for most of the company's paper and lumber products, due in part to the economic conditions in Asia, continued to adversely affect results in 1998. A rebound in OSB markets from the depressed market conditions in 1997 helped to partially offset the decline in earnings for most of the company's other products.
Operating income for the resource segment was $71.3 million in 1998, versus $88.1 million in 1997. The decline in 1998 was largely due to a decline in market prices for logs in Idaho. Income for 1997 was also positively affected by land sales in Idaho and Minnesota.
The wood products segment reported 1998 operating income of $2.5 million, an improvement over the $40.5 million loss in 1997. Significantly higher net sales realizations and higher product shipments for OSB were primarily responsible for the 1998 results. Demand for OSB, as well as for other panel products, was driven by a robust housing market during 1998. Lumber product shipments were also higher than in 1997, although the benefits were more than offset by lower net sales realizations. While the strong housing market encouraged domestic consumption of lumber products, the decreased demand in Asia created downward pressure on lumber prices.
The company's printing papers segment had operating income of $14.2 million in 1998, substantially below 1997's earnings of $33.4 million. Net sales realizations were lower in 1998, due in part to a less favorable product mix as well as pricing pressures on all paper grades. Shipments also declined during the year, reflecting competitive markets due to worldwide capacity increases. Production was lower at the company's two mills compared to the prior year largely because product mix factors did not allow the facilities to run at optimal levels, resulting in increased production costs.
The pulp and paper segment reported slightly higher operating income of $53.4 million, compared to $51.0 million in 1997. Consumer tissue markets were steady during 1998, and the company increased its product shipments while maintaining net sales realizations comparable to those of 1997. Results in the consumer tissue area were tempered by very competitive conditions in the pulp and paperboard markets. Demand in Asia weakened in 1998 and the company experienced a decline in paperboard shipments and reduced net sales realizations for both pulp and paperboard. Production improvements at the Lewiston, Idaho, pulp mill as a result of the washer replacement project helped reduce costs and partially offset the effects of the unfavorable markets.
Income Taxes
The company's effective tax rates for 1999, 1998 and 1997 were 38.0 percent, 36.0 percent and 34.0 percent, respectively.
Year 2000
The company has completed its comprehensive project to identify and resolve potential Year 2000 problems. The review was divided into two categories: business systems and manufacturing systems. The company's business systems were substantially Year 2000 compliant at December 31, 1998. With respect to the company's manufacturing systems (including both embedded technology and information technology), assessment, remediation and testing continued throughout 1999 to ensure that the systems would function properly on January 1, 2000, and thereafter. To date, no Year 2000 problems have arisen on any of the company's critical manufacturing systems.
The costs incurred to date to conduct the manufacturing systems inventory and other Year 2000 conversion work have not been material to the company's results of operations for any reporting period in which expenditures were made. These costs, including hardware, software, internal personnel and external consultants, were expensed as incurred, except for expenditures relating to
system replacements or upgrades occurring in the normal course of business that were capitalized under company guidelines. Prior to 1998, the company did not separately identify internal costs related to Year 2000 conversion work. The total costs incurred from January 1998 through the conclusion of the Year 2000 project were approximately $4 million, exclusive of normal replacements and upgrades.
To date, the company has not experienced any disruptions in its operations as a result of its suppliers or vendors encountering Year 2000 compliance problems. The company has contingency plans in place for each of its facilities to address both internal and external potential failures, as well as any potential unresolved issues. The contingency plans will remain in place until the risk of any Year 2000 compliance problems has passed.
Market Risks of Financial Instruments
The company's exposure to market risks on its financial instruments is limited to interest rate changes on its variable rate debt and to put option contracts associated with its common stock repurchase program. Changes to market interest rates have had an immaterial impact on the company's total interest expense because the company's debt obligations are predominately fixed-rate. Also, the exposure to put option contracts on the company's common stock is immaterial due to the limited number of such contracts outstanding.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF EARNINGS (Dollars in thousands--except per-share amounts)
- -------- * Includes a nonrecurring charge of $7.5 million ($4.6 million after tax) for expenses related to the termination of efforts to form a timber real estate investment trust.
The accompanying notes and summary of principal accounting policies are an integral part of these financial statements.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
BALANCE SHEETS (Dollars in thousands--except per-share amounts)
The accompanying notes and summary of principal accounting policies are an integral part of these financial statements.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CASH FLOWS (Dollars in thousands)
Net interest paid (net of amounts capitalized) in 1999, 1998 and 1997 was $43.9 million, $49.7 million and $45.7 million, respectively. Net income taxes paid in 1999, 1998 and 1997 were $4.5 million, $4.2 million and $2.8 million, respectively.
The accompanying notes and summary of principal accounting policies are an integral part of these financial statements.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands--except per-share amounts)
The accompanying notes and summary of principal accounting policies are an integral part of these financial statements.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
Consolidation
The financial statements include the accounts of Potlatch Corporation and its subsidiaries after elimination of significant intercompany transactions and accounts. There are no significant unconsolidated subsidiaries.
Potlatch Corporation is an integrated forest products company with substantial timber resources. It is engaged principally in the growing and harvesting of timber and the manufacture and sale of wood products, printing papers and pulp and paper products. Its timberlands and all of its manufacturing facilities are located within the continental United States. The primary market for the company's products is the United States, although it sells a significant amount of paperboard to countries in the Pacific Rim.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.
Inventories
Inventories are stated at the lower of cost or market. The last-in, first- out method is used to determine cost of logs, lumber, plywood, particleboard and chips. The average cost method is used to determine cost of all other inventories.
Earnings Per Common Share
Earnings per common share are computed by dividing net earnings by the weighted average number of common shares outstanding in accordance with Financial Accounting Standards Board Statement No. 128, "Earnings Per Share." The following table reconciles the number of common shares used in the basic and diluted earnings per share calculations:
Stock options to purchase 1,949,725, 1,230,475 and 293,563 shares of common stock for 1999, 1998 and 1997, respectively, were not included in the computation of diluted earnings per share because the exercise prices of the stock options were greater than the average market price of the common shares.
Properties
Property, plant and equipment are valued at cost less accumulated depreciation. Depreciation of buildings, equipment and other depreciable assets is determined using the straight-line and units of
production methods of depreciation. Estimated useful lives range from 30 to 40 years for buildings and structures and 2 to 25 years for equipment.
Timber, timberlands and related logging facilities are valued at cost net of the cost of fee timber harvested and depreciation or amortization. Logging roads and related facilities are amortized over their useful lives or as related timber is removed. Cost of fee timber harvested is determined annually based on the estimated volumes of recoverable timber and related cost.
Major improvements and replacements of property are capitalized. Maintenance, repairs, and minor improvements and replacements are expensed. Upon retirement or other disposition of property, applicable cost and accumulated depreciation or amortization are removed from the accounts. Any gains or losses are included in earnings.
Income Taxes
The provision for taxes on income is based on earnings reported in the financial statements. Deferred income taxes are recorded for the temporary differences between reported earnings and taxable income using current tax laws and rates.
Preoperating and Startup Costs
Preoperating and startup costs are expensed as incurred in compliance with the Accounting Standards Executive Committee Statement of Position 98-5, "Reporting on the Costs of Startup Activities."
Environment
As part of its corporate policy, the company has an ongoing process to monitor, report on and comply with environmental requirements. Based on this ongoing process, accruals for environmental liabilities are established in accordance with Statement of Financial Accounting Standards No. 5.
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Inventories
If the last-in, first-out inventory had been priced at lower of current average cost or market, the values would have been approximately $28.5 million higher at December 31, 1999, and $26.2 million higher at December 31, 1998.
Note 2. Plant and Equipment
Depreciation charged against income amounted to $126.7 million in 1999 ($126.3 million in 1998 and $125.5 million in 1997).
Authorized but unexpended appropriations for capital projects totaled $195.5 million at December 31, 1999. Of that amount, $182.8 million is budgeted to be expended in 2000. Historically, the company has spent less on capital expenditures than the annual amount budgeted and expects that trend to continue in 2000. Spending on projects may be delayed due to acquisition of environmental permits, acquisition of equipment, engineering, weather and other factors.
Note 3. Timber, Timberlands and Related Logging Facilities
Timber, timberlands and related logging facilities are stated at cost, less cost of fee timber harvested and amortization. Cost of fee timber harvested amounted to $21.3 million in 1999 ($21.4 million in 1998 and $19.8 million in 1997). Amortization of logging roads and related facilities amounted to $1.7 million in 1999 ($1.7 million in 1998 and $.7 million in 1997).
Note 4. Other Assets
Note 5. Taxes on Income
Provision for taxes on income is comprised of the following:
The provision for taxes on income differs from the amount computed by applying the statutory federal income tax rate of 35 percent to earnings before taxes on income due to the following:
Principal current and noncurrent deferred tax assets and liabilities at December 31 were:
- -------- (1) Included in Prepaid expenses in the Balance Sheets.
The company's federal income tax returns have been examined and settlements have been reached for all years through 1988. The company believes that adequate provision has been made for likely assessments of additional taxes.
Note 6. Debt
The interest rate payable on the 9.125 percent credit sensitive debentures is subject to adjustment if certain changes in the debt rating of the debentures occur. No such change in the interest rate payable has occurred.
The commercial paper is backed by the company's credit arrangements, enabling it to classify up to $100.0 million of short-term borrowings as long- term debt, which the company chose to do at December 31, 1998. In March 1999, the company issued $100.0 million of long-term debt and used the proceeds to repay a like amount of commercial paper. The balance of commercial paper outstanding at December 31, 1998, totaling $44.9 million, as well as all commercial paper outstanding at December 31, 1999, totaling $96.5 million, was classified as a portion of current notes payable in the Balance Sheets. At December 31, 1999, the weighted average annual interest rate payable on commercial paper was 6.9 percent.
Certain credit agreements have restrictive covenants. At December 31, 1999, the company was in compliance with such covenants. The company does not currently have any covenants in any of its loan agreements which limit the payment of dividends. No significant assets of the company have been pledged, mortgaged or otherwise subjected to liens.
Payments due on long-term debt during each of the five years subsequent to December 31, 1999 are as follows:
At December 31, 1999, the company maintained a credit line of $250.0 million for general corporate purposes. Of that amount, a $150.0 million portion is subject to renewal annually and is available for short-term borrowings. The $100.0 million long-term portion will expire on November 17, 2004. At December 31, 1999, the company had $25.0 million of outstanding indebtedness under the short-term credit line, which is classified as a portion of current notes payable in the Balance Sheets. At December 31, 1999, the weighted average annual interest rate payable for such indebtedness was 6.92 percent.
Note 7. Accounts Payable and Accrued Liabilities
Note 8. Other Long-Term Obligations
Note 9. Put Options
In December 1994 the company began a stock repurchase program to purchase up to 1 million shares of its common stock over several years. Through November 1999, the company had acquired a total of 498,800 shares. In December 1999, the company replaced this program with an expanded program to repurchase up to 2 million shares of stock. Purchases of common stock will be made from time to time through open market and privately negotiated transactions at prices deemed appropriate by management, and through the company's put option program.
In conjunction with the repurchase program, the company issued put options which gave the purchaser the right to sell shares of Potlatch stock to the company at prices ranging from $31.50 to $42.39 per share on specific dates in 1998, 1999, 2000 and 2001. Activity during 1999 and 1998 is summarized as follows:
The company's potential obligations of $10.3 million and $6.8 million at December 31, 1999 and 1998, respectively, are classified as "Put options" in the Balance Sheets and the related offset is recorded in "Common shares in treasury" under Stockholders' equity.
Note 10. Disclosures about Fair Value of Financial Instruments
Estimated fair values of the company's financial instruments are as follows:
For short-term investments, current notes payable and put options, the carrying amount approximates fair value. The fair value of the company's long- term debt is estimated based upon the quoted market prices for the same or similar debt issues. The amount of long-term debt for which there is no quoted market price is immaterial and the carrying amount approximates fair value.
Note 11. Retirement, Savings and Other Postretirement Benefit Plans
Substantially all employees of the company are eligible to participate in 401(k) savings plans and are covered by noncontributory defined benefit pension plans. These include both company-sponsored and multi-employer plans. In 1999, 1998 and 1997 the company made matching 401(k) contributions on behalf of employees of $9.1 million, $8.1 million and $7.9 million, respectively. The company also provides benefits under company-sponsored defined benefit retiree health care and life insurance plans, which cover most salaried and certain hourly employees. Most of the retiree health care plans require retiree contributions and contain other cost sharing features. The retiree life insurance plans are primarily noncontributory.
The change in benefit obligation, change in plan assets, funded status and related balance sheet amounts for company-sponsored benefit plans are as follows:
The projected benefit obligation, accumulated benefit obligation and value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were $26.3 million, $22.2 million and $7.7 million, respectively, at December 31, 1999, and $14.8 million, $12.8 million and zero, respectively, at December 31, 1998.
Net periodic (benefit) costs were:
Weighted average assumptions as of December 31 were:
The health care cost trend rate assumption used in determining the accumulated postretirement benefit obligation is 5.92 percent for 2000. The rate is assumed to decrease incrementally to 5.25 percent in 2001 and remain at that level thereafter. This assumption has a significant effect on the amounts reported. A one percentage point change in the health care cost trend rates would have the following effects:
Hourly employees at two of the company's manufacturing facilities participate in a multi-employer defined benefit pension plan, the Paper Allied-Industrial, Chemical and Energy Workers International Union (PACE) Pension Fund. The company also makes contributions to a trust fund established to provide retiree medical benefits for these employees, which is managed by PACE. Company contributions to these plans in 1999, 1998 and 1997 amounted to $4.7 million, $4.7 million and $4.8 million, respectively.
Note 12. Stock Compensation Plans
The company currently has three fixed stock option plans under which options are issued and outstanding. Options are granted at market value and prior to 1995 may have included a stock appreciation right. Options may also be issued in the form of restricted stock and other share-based awards, none of which were outstanding at December 31, 1999. Options are fully exercisable after two years and expire not later than 10 years from the date of grant. The company was originally authorized to issue up to 1.2 million, 1.5 million and 1.7 million shares under its 1983 Stock Option
Plan, 1989 Stock Incentive Plan and 1995 Stock Incentive Plan, respectively. At December 31, 1999, no shares were available for future use under the 1983 Stock Option Plan and 1989 Stock Incentive Plan, while 96,000 shares were authorized for future use under the 1995 Stock Incentive Plan. Stock option information presented for the year ended December 31, 1999, includes 1.4 million shares reserved for future grants under a plan approved by the board of directors in 1999, which will be submitted to stockholders for approval at the 2000 annual meeting.
The company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock options. Accordingly, no compensation cost has been recognized when options are granted under the plans. Had compensation costs for the plans been determined based on the fair value at the grant dates for option awards under those plans as prescribed by Financial Accounting Standards Board Statement No. 123, the company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
A summary of the status of the company's stock option plans as of December 31, 1999, 1998 and 1997 and changes during those years is presented below:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 4.21, 4.61 and 3.61 percent; stock volatility of .2355, .1945 and .1597; risk free rate of return of 6.28, 5.03 and 6.00 percent; and expected term of 10 years for all grants.
The following table summarizes information about stock options outstanding at December 31, 1999:
Note 13. Segment Information
The company has divided its operations into four reporting segments: resource, wood products, printing papers and pulp and paper, based upon similarities in product lines, manufacturing processes, marketing and management of its businesses. The resource segment manages the company's timberland base and provides wood fiber to the manufacturing segments. The wood products segment produces oriented strand board, lumber, plywood and particleboard. The printing papers segment produces coated printing papers and pulp. The pulp and paper segment produces paperboard, consumer tissue and pulp.
The reporting segments follow the same accounting policies used for the company's consolidated financial statements and described in the summary of significant accounting policies. Management evaluates a segment's performance based upon profit or loss from operations before income taxes. Intersegment sales or transfers are recorded based on prevailing market prices.
Following is a tabulation of business segment information for each of the past three years. Prior year amounts have been reclassified to conform to the 1999 presentation. Corporate information is included to reconcile segment data to the consolidated financial statements.
- -------- (1) Intersegment sales for 1999-1997, which were based on prevailing market prices, consisted primarily of logs, chips, pulp logs and other fiber sales to the wood products, printing papers and pulp and paper segments.
All of the company's manufacturing facilities and all other assets are located within the continental United States. However, the company sells and ships products to many foreign countries. Geographic information regarding the company's net sales is summarized as follows:
Note 14. Other Income (Expense), Net
Note 15. Financial Results by Quarter (Unaudited)
INDEPENDENT AUDITORS' REPORT
The Board of Directors:
We have audited the accompanying balance sheets of Potlatch Corporation and consolidated subsidiaries as of December 31, 1999 and 1998 and the related statements of earnings, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of Potlatch Corporation and consolidated subsidiaries as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles.
KPMG LLP
Portland, Oregon January 26, 2000
POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES
EXHIBIT INDEX
- -------- * Incorporated by reference. /1/ Management compensatory plan or arrangement. /2/ Management contract.