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Potlatch Corporation (NASDAQ:PCH)

Q2 2009 Earnings Call Transcript

July 28, 2009 11:00 am ET

Executives

Eric Cremers - VP and CFO

Michael Covey - Chairman, President and CEO

Analysts

Gail Glazerman - UBS

George Staphos - Banc of America/Merrill Lynch

Mark Weintraub - Buckingham Research

Mike Wakelin [ph] -Banc of America

Chip Dillon - Credit Suisse

Steve Chercover - D.A. Davidson

Peter Ruschmeier - Barclay Capital

John Curran [ph]

Mark Marbart - Ramsey

Operator

Good morning. My name is Sandrel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Potlatch second quarter 2009 earnings conference call, featuring Eric Cremers, Vice President of Finance and Chief Financial Officer; and, Michael Covey, Chairman, President, and Chief Executive Officer for Potlatch Corporation. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you.

And now, I would like to turn the call over to Mr. Eric Cremers for opening remarks. Sir, you may proceed.

Eric Cremers

Thank you, and good morning. And welcome to Potlatch’s investor teleconference covering our second quarter 2009 earnings. Before we begin, let me remind you that this call may contain certain forward-looking statements within the meaning of US Securities Laws. These statements include statements about the company’s future business prospects, anticipated performance in upcoming quarters, harvest levels, and future dividends. These statements are not guarantees of future performance, and the company undertakes no duty to update them. Although these statements reflect management’s expectations today, they are subject to a number of business risks and uncertainties. Actual results may differ materially from those expressed or implied in this call.

For a discussion of certain factors that may cause actual results to differ from the results anticipated, please refer to Potlatch’s recent filings with the SEC. Also, please note that segment information as well as a reconciliation of non-GAAP measures, can be found in the supplemental materials on our Web site, www.potlatchcorp.com, as part of the webcast for this call. I would now like to discuss our second quarter results.

Despite a challenging economy in the second quarter, we made significant strides in several areas. Our balance sheet has now improved as Clearwater Paper completed the refinancing event in the second quarter, effectively retiring the credit sensitive debentures from Potlatch’s balance sheet. Further, we recently entered into a $50 million timber deed sale agreement that we expect to close later in the third quarter that will further bolster earnings and cash flow and help de-lever the balance sheet. Finally, our wood products business improved considerably in the second quarter, which I’ll talk about more in just a minute.

We reported second quarter 2009 net income from continuing operations of $3.7 million or $0.09 per fully diluted share as can be seen on slide three of the slides accompanying this presentation. This compares to net income from continuing operations of $18.9 million or $0.48 per fully diluted share in the second quarter of last year. As a reminder, our financial results have Clearwater Paper operations moved to discontinued operations, including corporate administrative costs directly associated with Clearwater and interest expense for the debt retained by Clearwater.

I’d now like to review our second quarter results broken down by segment. Our resource segment results from the second quarter of 2009 were weaker than the second quarter of 2008. Operating income in the second quarter totaled $4.5 million, compared to $12.2 million in the second quarter of last year. The primary driver behind the negative earnings variance was the planned lower harvest volumes and lower log selling prices, somewhat offset by lower costs.

Slide four highlights volume and pricing trends for the northern region. Saw log feet volumes were down 47% comparing Q2 ’09 to Q2 ’08, as we executed on our previously announced plan to scale back our harvest levels to match the lower demand caused by sawmill curtailments in the region. Saw log pricing in the northern region was down 33% year-over-year, but actually increased 2% sequentially. Pulp wood volumes in the northern region were down 31% year-over-year, and pricing was lower by 7%. Fortunately, as Michael will discuss in a moment, we are now seeing signs of price stability both in the northern and southern regions.

Slide five highlights volume and pricing trends in the southern region. Saw log feet volumes in the second quarter of 2009 increased 18% over the second quarter of 2008, and increased nearly 4% sequentially. Saw log pricing in the southern region is holding up better than the northern region, with prices down 9% year-over-year and only 4% sequentially. Pulp wood volumes in the southern region were up 1% year-over-year, while pricing fell 6%.

Next, I’d like to review our real estate business. As shown on slide six, our real estate segment closed sales totaling $4.7 million during the second quarter resulting in operating earnings of $1.5 million. In total, we have 38 real estate transactions in the quarter, coincidentally, the same as in Q1.

Slide seven highlights our real estate sales by product type. And as you can see, we sold nearly 3,000 acres of rural recreational real estate in the quarter, up from the 2,000 acres we sold in Q1.

Slide eight highlights price trends for our real estate business broken down by product type. The second quarter is generally a slow quarter for our real estate business. So in fact, we are encouraged by these results. Furthermore, our real estate business continues to be relatively stable, and while demand for HBU property is relatively soft, the demand for rural recreational real estate and non-strategic timber land remains relatively firm.

Our wood products business showed considerable improvement in second quarter, with an operating loss of just $3 million compared to an $11.2 million operating loss in Q1. Similarly, EBITDA improved over $8 million, in comparing Q2 to Q1.

Slide nine highlights price and volume trends in the lumber part of our wood products business. And as you can see, lumber prices in volumes improved quarter-over-quarter. Our improved results in the segment were a direct result of both higher selling prices and lower costs. Note that beginning this quarter, we will no longer disclose price and volume data for our panel business due to competitive concerns.

Returning to slide three of the presentation, eliminations and adjustments had a $4.3 million positive impact on operating income during the second quarter, compared to positive impact of $1.6 million in the last year’s second quarter, and a $750,000 positive impact in the first quarter of this year. As is typical in the first half of the year, it gets very challenging to harvest in the northern region during the winter months. And therefore, we typically reduce inventories in the first half of the year, and then start building them back up again in the second half of the year. As the inventory level is reduced, the profit associated with that inventory shows up as a positive elimination. The larger positive impact in this year’s second quarter versus last year, was due to a greater inventory decrease in 2009.

Corporate administration, including interest expense, totaled $11.6 million for the second quarter, compared to $10.8 million in the first quarter, and $10.9 million in last year’s second quarter. Interest expense, net of interest income, totaled $4.9 million in the second quarter of 2009, compared to $5.3 million in last year’s second quarter, and $4.8 million in the first quarter. Our weighted average interest rate at the end of the second quarter was 5.9%.

We booked a $7.9 million tax benefit in the quarter, largely due to nearly $5.8 million of tax benefits associated with renewable electricity generation. This tax credit, referred to as a renewable electricity production credit, is attributable to electricity we generated and sold from renewable energy sources in 2005 to 2009, at our manufacturing facilities. The credit is currently set to expire at the end of 2009, unless Congress elects to extend the credit. We estimate that we will generate an additional $200,000 of tax credits for the remainder of 2009.

EBITDA totaled $7.2 million in the second quarter versus $29.8 million in last year’s second quarter, and $47.7 million in the first quarter of 2009. Funds from continuing operations for the second quarter totaled $10.3 million versus $26.7 million a year ago, and $40.5 million in the first quarter. The company paid a cash distribution of $0.51 per share during the second quarter for a total of $20.3 million.

Next, I’d like to make a few comments about our balance sheet and liquidity. Prior to Potlatch’s spin-off of Clearwater Paper in December of 2008, Clearwater agreed to make all remaining payments due to holders of the credit-sensitive debentures. During the second quarter, Clearwater completed a $150 million high yield offering and deposited $106 million of cash with the credit-sensitive debentures trust fee, which is an amount sufficient to satisfy all remaining principal and future interest due on the credit-sensitive debentures. Until the December 1st, 2009 maturity date of the debentures, the funds deposited with the indenture trustee will be reflected on Potlatch’s balance sheet as restricted cash. And the credit-sensitive debentures will continue to be shown as current installments on long term debt.

Clearwater’s refinancing event is very important to Potlatch for two reasons. First, Potlatch has now received an amendment to its revolving credit facility and we will no longer need to include the credit-sensitive debt, when calculating our leverage ratios for purposes of complying with the credit test. Second, our liquidity has now improved $100 million, as our amended credit agreement no longer requires us to satisfy the $100 million of revolver capacity in case Clearwater couldn’t refinance.

As a result, our balance sheet is in great shape with debt-to-capital for our credit agreement now at just 52%, and our interest coverage ratio, or EBITDA divided by interest expense, at a healthy 4.8 times. And with the timber deed transaction that Mike will talk about in just a minute, our leverage ratios are anticipated to improve even more in the third quarter. I would now like to turn the discussion over to Mike, to provide some additional comments about our recent timber deed transaction, as well as our outlook.

Michael Covey

Thank you, Eric, and good morning. As Eric just mentioned, we entered into a binding agreement with FIA, an Atlanta-based TIMO, to sell a 50,708-acre timber deed in Arkansas. The transaction is valued at $50.2 million, or approximately $990 per acre, and is expected to close in the third quarter. Proceeds from the sale will be used to pay down our revolver.

The deed conveys to FIA ownership of the timber that is currently growing on the property, not the land itself. The land parcels in the deed were carefully selected to include prime plantations between ages one and ten, with an average age of just under seven years. The term of the deed cannot exceed 30 years and when harvesting on a parcel is complete, full ownership reverts to Potlatch and we will reforest each site. In total, this transaction represents less than 1% of our current merchantable inventory, and is expected to lower our total harvest volume over the next 30 years, just 3% to 4%.

The timber deed structure is unique in many respects. First, since the deed is similar to a stumpage sale, the proceeds are treated as good REIT income. And we are not subject to a built-in gains tax, since we retained title to the land. Second, due to the young age of the trees, we are giving up very little cash flow for literally the next twenty years. Third, our models indicate that the valuation of almost $1,000 per acre for the timber only, reflects saw log pricing that is significantly higher than the current market. This is another example of how the private market can and does look thru the current dismal housing market to favorably value an attractive asset class such as timber.

Finally, the sale of these trees will have no impact on our ability to increase our harvest levels to approximately 5 million tons, once the market for timber improves, since we don’t plan to fully harvest the trees we’re selling in the deed for 20-plus years anyway. The harvest increase to 5 million tons, which is approximately 30% higher than today’s harvest level, coupled with stronger prices for timber, is expected to result in a significant increase in our cash flow, and more than support our current dividend of $0.51 per share, per quarter.

Our Board of Directors has used our dividend policy each quarter and carefully weighs the fact that we are not currently earning our dividend from core operations against our significant longer term prospects. Thus far, the Board has concluded that maintaining our current dividend through this difficult economic period is prudent, given our ability to increase harvest levels substantially, going forward.

As we expected, our funds available for distribution in the second quarter fell short of the dividend. As always, we will continue to monitor improvements in the economy and our markets, review our dividend policy each quarter, and execute strategic transactions like the timber deed within the best interest of our shareholders, going forward.

We are cautiously optimistic that our worst markets are behind us. Our decision in May to defer 500,000 tons of our planed 2009 saw log harvest, coupled with some improvement in the lumber market, appear to have arrested the decline in log prices in our key markets. We have contracts in place for the majority of our remaining timber harvest for 2009, at prices at or above levels we realized late in the second quarter. We are encouraged by the recent new home sales dated, driven mostly by the west and mid-west markets.

As we discussed last quarter, we expect to see a turnaround in our wood products manufacturing business during the second quarter. June was our best month this year, and our best since June of 2008. We have significantly reduced costs and improved productivity steadily since early spring, following extensive market related down time. These improvements coupled with better markets provided positive cash returns and positive operating earnings last month.

We don't foresee significant additional cost reductions. And lumber and panel prices have recently given back some of the gains realized in May and June. To the balance of 2009, we expect this business to be at or near cash flow break even.

Our real estate business continues at a pace of 30 to 40 transactions per quarter, with no discernable change in pricing for rural recreational land tracts. We expect this trend in the volume of business to continue for the balance of a year.

Sandrel, that concludes our prepared remarks, and we'll now take questions from call participants.

Question-and-Answer Session

Operator

(Operator instructions) We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Gail Glazerman with UBS.

Gail Glazerman - UBS

Hey. Good morning.

Eric Cremers

Good morning.

Gail Glazerman - UBS

Just a few questions. Starting on the dividend and the comments, last quarter you were quite specific saying that you wouldn’t really give in to liquidity to support the dividend. But since then, you’ve obviously had a couple of positive liquidity events. I was just wondering if you could your perspective on that?

Michael Covey

Gail, this is Mike. I think clearly we have to see a pathway to fully earn the dividend from operations, as we look for the housing recovery to take place. We’ve said that we would use our -- access or revolver as needed, on a quarterly basis. But not on a long term basis. And I don’t think that philosophy has changed from our Board at all. We continue to believe we’ve got a terrific harvest profile going forward. And as we look for a housing recovery, hopefully at this point sometime next year, we think we are on our way out of this.

Gail Glazerman - UBS

Okay. And on the timber deed transaction, just a few questions there. Why the deed versus selling outright? Was that a discussion on this piece of land? Just to start with that.

Michael Covey

It was a discussion point. One of the most attractive reasons for the timber deed for us in this environment was it’s treated as good REIT income, and we don't have a tax effect. Had we had a sales transaction and sold the land with it, we would have had to execute a light kind exchange to defer the tax or elect to pay taxes. And we didn't think that either of those options was attractive.

Gail Glazerman - UBS

Okay. The land sold, was that mainly core timberland or could you give a little sense of the characteristics, other than the age class?

Michael Covey

Well, they said that the age class average is between age one and age ten in the maximum. They’re individual tracts throughout our southern Arkansas ownership. All of that would be considered core timberland. On average, it averages seven years of age. But there is no real estate or any other higher quality aspects to the land -- to the timber.

And reminder, we did not sell the land. We own the land. We continue to collect hunting revenue from it, from leases. We’ll continue to have mineral rights. All those things will continue to be enjoyed by the company.

Gail Glazerman - UBS

Okay. And last question, on the electricity tax credit, if I'm not mistaken there's some provisions pending in front of Congress that might actually give you credit, not only for electricity that you're selling, but potentially electricity they are consuming. Is that something that would qualify under this assuming it goes forward? Is that something you're tracking?

Eric Cremers

Yes. That's exactly what the benefits that we received in this quarter.

Gail Glazerman - UBS

Okay. If that was first stuff that you used, and not that you felt externally?

Eric Cremers

Yes. It used to be you only got the net credit for the two. But now you get -- additionally, you get credit for the stuff that you're producing, consuming on-site as well.

Gail Glazerman - UBS

Okay. I didn't realize that changed. But this is something that is potential going to be permanent, though? Under current--?

Eric Cremers

Yes. Hopefully, we'll see. I guess Congress is still debating it now.

Gail Glazerman - UBS

Okay. Thank you.

Eric Cremers

Thanks.

Operator

Thank you. Your next question comes from the line of George Staphos with Banc of America/Merrill Lynch.

George Staphos - Banc of America/Merrill Lynch

Thanks. Hi, guys. Good morning. Just following on the question on land sales in terms of characteristics, if you could point to one or two, the HBU that you're selling or the development lands that you're selling or rural, bearing a common trace? Could you give us a bit more color on what you sold during the quarter?

Eric Cremers

The second quarter, George, was very similar first quarter at 38 transactions. And it was spread pretty consistently around our different regions. We had about 30 transactions in both the first and second quarters in the Lake States. And Arkansas, we had 45 each of the quarters. And then Idaho, we had just a handful in each of the two quarters. But it's typical for us that our rural sales tend to be -- they tend to be skewed more towards rural that it does HBU. With about, I don’t know -- I’m just glancing at some data here, but maybe a third of the transactions, maybe a little bit less, will be in HBU and the rest being rural.

George Staphos - Banc of America/Merrill Lynch

Where there any outliers, Eric in terms of the transaction that might have skewed the averages that you saw in the quarter? Was it pretty evenly distributed in terms of value that you got per acre?

Eric Cremers

There's always a pretty wide distribution of pricing that we get on the real estate. It's so site specific. I would say the basis of the land that we sold in this most recent quarter was on the high side, in comparison into a typical quarter. By just glancing at some data, we had some HBU sales that were high as $4,000 an acre. And some HBU sales were as low as $1,300 an acre. So there's just a distribution curve. And that seems to be typical each quarter.

Michael Convey

You might also look to slide eight in our presentation materials, George. In the second quarter our better quality HBU sites averaged about $2,200 an acre and the rural recreation real estate was about half of that at $1,100. As you look at the slide, it's been pretty typical.

George Staphos - Banc of America/Merrill Lynch

Right, Mike. I was trying to get more of the change in value relative to geography, but this helpful as well. You mentioned that there has been no discernable trend into the third quarter and realizing the land values are lumpy and transactions are lumpy, would you say that you've seen stabilization in terms of returns being demanded by investors who are -- it's too hard to say for sure what might transpire the couple of three quarters?

Michael Convey

I think it's early to say. The characters of most of our land purchasers tend not to be financial investors, as much as they do adjacent land owners, and people are just looking for rural property for personal use and enjoyment rather than investor's. So I think it would be premature for us to say that there is some kind of investor expectation that has changed.

George Staphos - Banc of America/Merrill Lynch

Let me turn it over. I'll be back. Thanks.

Michael Convey

Thanks.

Operator

Thank you. Your next question comes from the line of Mark Weintraub with Buckingham Research

Mark Weintraub - Buckingham Research

Thank you. On the timber deed transaction, what's the profit that you're going to book on that?

Eric Cremers

Well, the book value of that property is around $7 million. So it should be in the low forties.

Mark Weintraub - Buckingham Research

What was the limiting factor on the size or the amount of acreage that you choice to include in the transaction? Because certainly, it seems like a win-win, as much as you are getting very good values and FIA is obviously eager to be putting some of its money to work. So what were the limiting factors that defy the transaction you've mutually decided upon?

Michael Convey

We've been in discussions with FIA about this for sometime. They have raised their funds at specifically targeted at high growth plantations in the south, another in the west and other high growth areas. They have a fund that they needed to invest geographically, so they could not concentrate all of it in one state or one geography, that was one limiting factor.

We felt that $50 million was a meaningful size for both parties. The 50,000 acres just kind of fell out naturally, and so that Arkansas is to what we easily had that we could identify that average --with an average age class of seven years, which was the desire of FIA. We do have more that would have fit, but I think that we just felt that $50million was decent size transaction for both parties.

Mark Weintraub - Buckingham Research

Thanks. And would you potentially have acreage in other regions that would fit the types of criteria that FIA would be looking for? Is there something that -- and obviously, I understand that nothing is being announced or anything like that, but is this something that they could be looked into in your -- the lake states or in the Idaho type areas, or is it really an Arkansas situation where it would have made sense?

Michael Convey

Well, in the case of this specific fund that FIA raised, it really made sense where we had faster growth plantations. And that was really the south for us timber growth rate in Idaho for the most part and are either slower or longer term. And in the lake states, the growth rate just started attractive in this kind of a fund.

Mark Weintraub - Buckingham Research

And then this lastly, if markets, housing markets and stumpage market continue to be in the depressed state in the year ahead, what might be some of the levers that you would be most likely to think about pulling to continue generate the near term cash needs until business gets better, and then harvest levels can kick up, and et cetera.

Michael Convey

As Eric mentioned we've taken some significant steps with the completion of the financing to Clearwater Paper. And removal of this limitation on our credit agreement, we've got lots of liquidity, which is to use that in the near term. I think secondly, we've said for several quarters, Mark, that we believed in this in this market that we're timber sellers. We are not buyers, and that we continue to think there's a demand for non-strategic timber assets for us. And we would continue to sell if we think pricing is favorable. So that goes for those of you -- are things that we look to.

Eric Cremers

And then there are some other things we might look into with our balance sheet as well, Mark. You look at this most recent quarter, our receivables went up about $10 million of the RIS. So it's a tax refund of about $10 million now, which we'll get over the next month or two. So there is an opportunity there. We've also got Prescott, the facility that we closed. It's been written off. It's not operating, but there were folks that approached us who are interested in buying it. So there are some other things that we can do to generate cash and the centrum period as well that won't impact floor operations.

Mark Weintraub - Buckingham Research

Terrific, one very quick one too. So would you be expecting to build log tax this quarter and said that we would have a negative elimination either this quarter or next quarter? How does that play out?

Eric Cremers

We do typically build in the back after the year. I think you'll see a smaller elimination in this coming quarter.

Mark Weintraub - Buckingham Research

Okay. Thank you.

Operator

Thank you. Your next question comes from the line of Mike Wakelin [ph] with Banc of America

Mike Wakelin -Banc of America

Thanks very much everybody. Last quarter in the press release and even on the call, you mentioned that you were seeing soft HBU sales. From the press release, it sounded though that interest in HBU has picked up, even if just a little bit. Are you currently seeing any improvement in HBU interests?

Michael Convey

No. And I think, to be candid, I don't think so. It's been steady, we had thirty some transactions that -- I think 38 transactions in the last two quarters in a row. But we certainly don't sense that there's all of a sudden renewed interest in HBU or development type of property. I'd consider it to be steady state.

Mike Wakelin -Banc of America

And then you mentioned that you are targeting your goal of five million tons in terms of -- when you tend to harvest. What type of housing starts do you think you need to see to get to the harvest level?

Eric Cremers

That's a tough question. The answer is so dependent upon your specific manufacturing base in the region, but it's probably up around a million starts, something like that.

Michael Convey

It's difficult to answer because there's been so much change in capacity, and it's unknown what's going to happen with Canada, about RMB, and currency issues. There are just lots of moving targets that affect that. But clearly, we need activity that's roughly double or more than what it's at today.

Mike Wakelin -Banc of America

And so it still could be a couple of years away.

Michael Convey

I don't know when that's going to happen.

Eric Cremers

I think mostly we're talking about starts being up in the 89,000 range next year and then moving up to the million -- 1.2 million in the following year. So it can be towards the back half of next year, or maybe into 2011.

Mike Wakelin -Banc of America

The last question. Obviously, you and your competitors are deferring harvest with the hopes that pricing will either stabilize or even improve later on. How do you think all that extra harvest is going to impact an eventual recovery?

Eric Cremers

The way I think of it, everybody talks about all this harvest for all that we’re going through. And people have to remember that there was over-harvesting, if you will, going back to the 2006-2007 time frame for a very, very robust housing market. In the not too distant future, you’re going to start to feel the effects, as Mike mentioned from that mountain pine beetle, that’s going to impact supply quite a bit.

If you just look at the North American market, I’ve heard estimates that British Colombia is anywhere from 5% to 15% of North American volume. So that alone can have a very meaningful impact. Much more so than what we’re talking about from the various deferrals that have taken place. I think it’s too early to say that the volume getting deferred now has got a meaningful impact -- meaningfully impact prices in the near term.

Michael Covey

I also think, particularly in the US South, most of the timberland is owned by non-industrial private land owners, small individuals. I think it’s unknown what their practices are currently. The TIMOs and financial owners of timberland like ourselves and others don’t collectively own that much timber.

Mike Wakelin -Banc of America

Got you. Thanks, very much.

Michael Covey

You’re welcome.

Operator

Thank you. You’re next question comes from the line of Chip Dillon with Credit Suisse.

Chip Dillon - Credit Suisse

Hey. Good morning. Let me just verify on the deed sale. I think you said -- just so I get this right that it only counts for 1% of the current merchantable timber, but it would basically offset about 3% to 4% of your otherwise harvest levels based on your current ownership to the next 30 years. Is that right?

Michael Covey

Yes. If you add up what our planed harvest was going to be over the next 30 years before this transaction versus -- now, after this transaction. The total cumulative harvest level has come down about 3% or 4%.

Chip Dillon - Credit Suisse

But most of that is kind of back and loaded. So you might say, obviously like 1% or something early years, and maybe upper single digits for the later years. Is that right?

Eric Cremers

Well, yes. There’s certainly smoothing things you can do with your harvest profile curve. But those 30 years captures the full harvest cycle.

Chip Dillon - Credit Suisse

Got you.

Michael Covey

To be clear, the trees, on average, are seven years old today. They range between age one and age ten. Technically, there is almost no merchantable inventory. The small amount that there is, which is kind of associated to mature trees that happen to be on an isolated tract or two, so nearly no indeterminable -- no impact.

Chip Dillon - Credit Suisse

Got you. And when we look at that transaction across the years, in the south or in north Arkansas in particular, is it fair to say -- I know no two transactions are alike. But, if you’re sort of cutting and operating for -- I’m sorry, involving and operating ongoing forest situation, I would imagine the average age as opposed to seven years in your case, is what? Maybe 12 or 13, just because I understand that the typical rotation in the south is 25 years?

Eric Cremers

Yes. I can’t talk to what the average of a typical transaction is. But we did take a close look at comparing this transaction to the sale that we had in the first quarter for $1,750 an acre. And that acreage, roughly 50% of it -- 52% was 15 years or less. Whereas as we mentioned, this timber deed is -- the average age is under seven years.

The stocking levels are what the real driver of this. The difference in values between the two, the transaction we had in the first quarter was stocked about four to five times the stocking level of what -- in this timber deed. Roughly 50 tons per acre is what got sold in the first quarter, whereas this is just around 10 tons per acre.

So it’s that age in stocking difference is what really drives the valuation difference between the first quarter transaction and this timber deed. There is also the effect of the land, which has got an impact as well. We gave away title -- we sold title to land in the transaction in the first quarter. Whereas obviously in this one, where this timber deed we are retaining. We are retaining title to land.

Chip Dillon - Credit Suisse

Got you. And so, when you say $50 a ton for the other one, that includes the land that is, did you say, embedded in that? Or was that trying to strip that out?

Eric Cremers

No. That was roughly 50 tons per acre.

Chip Dillon - Credit Suisse

Fifty tons per acre. I’m sorry. Yes. Got you, okay.

Eric Cremers

Whereas the deed is just 11 tons per acre.

Chip Dillon - Credit Suisse

Got you, got you. And last question, when you look at, I think you said this in your prepared remarks, but you indicated that obviously, the log prices are depressed, and given the housing market and et cetera. But if you look at what you were -- is there sort of a guess as to what, I know it’s years in the future, but I think you alluded to this, what you’re selling this trees for now up front, I guess per thousand, or per ton, or however you look at it, relative to where prices are either now or where they’ve been?

Eric Cremers

Yes. We also--

Chip Dillon - Credit Suisse

Logs for logs?

Eric Cremers

Yes. Chip, we also did an analysis of what we thought the value of that timber is worth on a present value basis to us. And if we do that analysis, and we assume pricing at where we were about two years ago for saw logs, then net present value is still below what we’re selling this timber deed for.

Chip Dillon - Credit Suisse

Got you. So you’re sort of better off today than you would have been if you’d sold them, if the logs had existed two years ago?

Eric Cremers

That’s correct.

Chip Dillon - Credit Suisse

Got you. Thank you.

Operator

(Operator instructions) And your next question comes from the line of Steve Chercover with D.A. Davidson.

Steve Chercover - D.A. Davidson

Thanks. Good morning. Clearly we’re all quite interested in this timber deed. I have a couple more questions. First of all, was it an unsolicited transaction?

Michael Covey

Good morning, Steve. It’s Mike. Well, as I said before, FIA had raised a fund as part of their normal investor activities. And they approached us with any interests we had in working with them. I’m sure they’ve approached others as well.

Steve Chercover - D.A. Davidson

Okay. And given that the net present value is probably better today than even using saw log prices from two years ago, I see why you’d be amenable to additional deals with a similar nature.

Michael Covey

We’re very happy with them. As I said, I think we've sized it, I think, at $50 million as a comfort level for both parties. But we think there’s other property particularly in the south that suits this.

Steve Chercover - D.A. Davidson

Who has the obligation to reforest it when it’s all said and done?

Michael Covey

Potlatch does.

Steve Chercover - D.A. Davidson

Okay. Does this say anything or do you have any comments on what raw dirt might be down in Arkansas? Assuming the land was suitable for farming thereafter, would it be worth $800 an acre or something?

Eric Cremers

Yes. See, we hear prices for raw dirt down in Arkansas, and it’s $600, $700, $800 an acre kind of range. Our net present value of that dirt down there that we’re eventually going to get the title to is -- because it’s tied up for the next 20 to 30 years, is lower than that. But it’s still a couple of hundred dollars an acre.

Steve Chercover - D.A. Davidson

Okay. I think that covers it. Thanks very much.

Michael Covey

Thank you

Operator

Thank you. Your next question comes from the line of Peter Ruschmeier with Barclay Capital.

Peter Ruschmeier - Barclays Capital

Thanks. Good morning. I have some follow ups as well on that timber deed. I’m curious, from a tax perspective -- I’m not aware that there is a precedent for this type of structure. And I was curious if you could elaborate on that. And if there’s not, I’m curious if there is anything you did specifically to get a comfort level from a tax perspective, that this is in fact good REIT income?

Eric Cremers

No. We researched it, Peter. And it’s good REIT income. It’s considered stumpage sale and we’re retaining title to the dirt. So it’s just like selling timber straight out.

Peter Ruschmeier - Barclays Capital

Okay. That’s helpful. I’m rankly surprised possibly by the valuation of -- that you’re getting here. I was curious if you could share with us, since these lands were fairly recently harvested, certainly with the last --presumably last five years or so. What kinds of cash flows may have come off these lands looking backward? So 50 tons per acre, what kind of cash flow per acre did that generate, looking back to the last couple of years?

Eric Cremers

I don’t have the cash flow model in front of me, Peter. What I can tell you is tell you is that over the next five to six years, there is little to no cash flow coming off that land. We would have run into some pending five to six years out that would have provided a little bit of revenues, but virtually none here in the near term. I’m assuming, looking back it would have been similar.

Peter Ruschmeier - Barclays Capital

Okay. And then maybe a question as well on the energy bill, I’m curious on your thoughts as you’ve looked at the progress of the energy bill. Mike, have you had conversations with energy players and how are you posturing -- I know you’re going for a saw timber rotation. But how much pulp wood might you might be able to free up for that source of demand if it were to evolve?

Michael Covey

Well we continue to be active on -- the industry continues to be active on energy issues through the National Trade Association, the National Alliance of Forest Owners has worked aggressively on the Waxman-Markey Bill and others, and with the Senate as well to makes sure that timber and timber land gets fair treatment in the energy picture for both renewable electricity as well as bio-fuels and say oxy --ethanol opportunities and other things.

We think that --we’ll grow pulp wood or any other kind of a tree, at any size that suits the best market. And that’s what we’re speaking in this bills, is free and open access to any markets. No matter what they are. And we think that currently, with the language out of the Farm Bill that’s been inserted in the latest bill that’s in Congress, we sure feel pretty good about where it’s at.

Peter Ruschmeier - Barclays Capital

And can you share -- how much of your current pulp wood harvest today might be in fact going to those end market energy uses? And how, given your outlook, do you think that’s going to ramp up anytime soon, or based on your conversations? Or do you think it’s really much more of a three to four years out situation?

Michael Covey

We have some pulp wood today going to energy applications in the lake States. But you need one of these facilities to be sited approximate to your land to be able to benefit from that and we really don’t have -- we’re in discussions with energy investors and virtually every region in the country. But I would -- from where we sit today, I would tend to think that until there’s certainty from Congress and bricks and mortar get installed, that we’re still two to three years out from seeing significant market opportunities from this.

Peter Ruschmeier - Barclays Capital

Very helpful. Thanks very much, guys.

Michael Covey

You’re welcome.

Operator

Thank you. Your next question comes from the line of John Curran [ph], private investor.

John Curran

Good morning.

Michael Covey

Good morning.

John Curran

I’m looking at your slide 11, under wood products. You’ve increased your lumber shipments pretty substantially, about 20%, quarter-over-quarter. And your unit price has also increased. You show about a 25% increase in value quarter-to-quarter also. Could you comment on what you see happening in there?

Eric Cremers

You’ve really got two different things happening here. One, is prices have moved up, and you’ve got -- costs have come down significantly. You can’t see cost coming down on that slide, but both log cost and other input cost that have dropped considerably, which is what has allowed a turnaround performance for our wood products business.

Michael Covey

Well also had a number of facilities curtailed in the first quarter, running less that 40 hours per week, per shift. And for the most part we’re back at full capacity at most facilities.

John Curran

Thank you.

Michael Covey

You’re welcome.

Operator

Thank you. (Operator instructions) Thank you. Your next question comes from the line of Mark Marbart with Ramsey.

Mark Marbart - Ramsey

Yes. Just two quick questions on the stocking that you referred to, I guess that refers to the density. That’s my assumption. So the five times, that’s does seem like such a dramatic difference between the sale on the first quarter and the second quarter. Why is that’s so different?

Eric Cremers

Just the age of the trees is dramatically different. In the first quarter, that transaction, the trees were significantly older than what we’re talking about on the timber deed.

Mark Marbart - Ramsey

So that 11 tons per acre in 20 years would be more in line with -- would be a lot higher?

Eric Cremers

Sure. You have biological growth. That’s for sure.

Mark Marbart - Ramsey

Okay. So the 11 tons per acre, if you’re just trying to think about this on a profit per acre when you’re doing the MPV [ph], I mean that’s not the right number to use because that’s not a harvest -- that’s not what you are going to harvest. What would be a number that you would harvest again?

Michael Covey

The tree is on an average now, as we said, are seven rears old. They’re going to be grown until at least, no later than 30 years old in total. And the biological growth of those trees over time could easily be in the 5% to 8% range per year. That’s about as much guidance I think, as we can give on that question.

Mark Marbart - Ramsey

Okay. That is helpful. And then have you ever disclosed the differences in profitability between Arkansas and Idaho or given any guidance on that? With the saw mills shutting down in Idaho and the different train that you have up there, hw are we able to get a little bit closer as to how much less profitable an Idaho dollar is versus an Arkansas dollar

Eric Cremers

We don’t break out our results by region. They’re consolidated into one report at (inaudible).

Mark Marbart - Ramsey

Okay. All right. Thank you.

Operator

Thank you. (Operator instructions) And there are no further questions at this time. I would like to hand over the call back to the floor for any closing remarks.

Michael Covey

We don’t have any additional remarks. Thank you and we’ll talk to you next quarter.

Operator

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may now disconnect.

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Source: Potlatch Corporation Q2 2009 Earnings Call Transcript
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