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Executives

Eric Cremers - CFO

Mike Covey - CEO

Analysts

Gail Glazerman - UBS

Hanza Mazari - Credit Suisse

Mark Weintraub - Buckingham Research

Steve Chercover - D. A. Davidson

Mike Roxlin - Banc of America

Roger Bugner - Bugner Enterprises

Rich Paoly - APG Investments

Potlatch Corporation (PCH) Q1 2008 Earnings Call April 24, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2008 Potlatch Earnings Call. My name is Alicia and I will be your operator for today. (Operator Instructions)

I would now like to introduce your host for today’s call, Mr. Eric Cremers, Chief Financial Officer. Please proceed.

Eric Cremers

Well, good morning. This is Eric Cremers, CFO for Potlatch and joining me here in Spokane is Mike Covey our Chief Executive Officer. After taking you through our quarterly results Mike is going to provide some comments regarding our outlook.

Before we begin, let me remind you that this call may contain forward-looking statements within the meaning of the U.S. Securities Laws. These statements include statements about the company’s future business prospects and anticipated performance in upcoming quarters. 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 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 our website, www.potlatchcorp.com as part of the webcast for this call. I would now like to discuss our first quarter results.

We reported first quarter 2008 net income from continuing operations of 24 million or $0.61 per fully diluted share as can be seen on page 3 of the slides accompanying this presentation. Included in this net income is an after-tax charge of 1.6 million related to a settlement in principle with the direct purchaser class in the OSB antitrust lawsuit. This compares to net income of 5.8 million or $0.15 per fully diluted share in the first quarter of last year, which included both a 2.8 million pre-tax reorganization charge for our Resource segment as well as a $9.2 million pre-tax cost for planned maintenance on a recovery boiler in Lewiston.

I’d now like to shift gears and talk about or first quarter results broken down by segment. Our Resource segment results for the first quarter of 2008 were much better than the first quarter of 2007. Operating income in the first quarter totaled 17.2 million compared to 13.2 million in the first quarter of last year. Increased fee harvest volume was a significant contributor to the positive comparisons with total company fee harvest volume up 22%. Broken down by region, our northern region fee harvest volume was up 41% versus last year offsetting the 7% decline in the southern region’s fee harvest volume.

The decline in the south was directly related to weather as conditions made it challenging to harvest in certain areas. The two acquisitions we completed last year, one in Wisconsin and one in Central Idaho, were key drivers of incremental fee harvest volume in the north. Also, as we indicated in our last call we deferred some fee volume in the fourth quarter of 2007 for tax reasons and we indicated then that we expected to make up that deferred volume in the first quarter which we did. Pricing has been a positive contributor to the quarter’s earnings in the southern region with pricing up 10% versus Q1 ‘07 due to the strong pulpwood market.

On average, pricing in the northern region was down 9% versus Q1 ‘07 and down 16% versus Q4 ‘07. It is important to note that this drop in pricing is due to both a drop in sawlog prices other than cedar and an unfavorable product mix. We are carefully monitoring pricing and will consider harvest deferrals should prices drop more. Finally, in comparing Q1 of 2008 with Q1 of 2007 it is important to note that we had a $2.8 million pre-tax restructuring charge in Q1 of ‘07.

Our Real Estate segment closed sales totaling 21.1 million during the first quarter resulting in operating earnings of 16.7 million. Included in these results is a portion of a one time sale of nearly 43,000 acres in northern Minnesota for just over $16 million. Excluding this large land sale, we had 28 other real estate transactions at an average price of over $2,200 per acre, well above the $1,500 per acre we achieved last year.

Now I’d like to make a few comments about the large land sale in Minnesota. First, this sale will close in two phases. The first of which amounted to 23,500 acres and is already closed. And the second of which will be 19,300 acres and will close in the second quarter. The average selling price on this non-strategic acreage was relatively low at $370 per acre. But it is important to note that this price per acre was considerably above both our internal and external estimates of value for the property, both from a timber standpoint as well as from a recreational real estate standpoint.

Further, selling this non-strategic piece of real estate will allow us to redeploy the capital to better uses. So we’re quite pleased with this sale and we are excited about the progress we’re making in this nascent business segment.

As you would expect, our Wood Products segment had a challenging first quarter, with operating losses of 10.1 million for the quarter in comparison to operating earnings of 2.8 million in last year’s first quarter. The steep decline in performance was driven by lower lumber shipments and a nearly 16% decrease in average lumber selling prices. While we did see improvements in both plywood and particleboard pricing, it was not enough to offset the weakness in lumber pricing in shipments.

Given the weakness in the lumber business, we announced the permanent closure of our Prescott, Arkansas lumber mill on March 27th. It was a difficult but necessary decision to permanently close the facility. We estimate, the total pre-tax cost of the closure to range from 19 to $21 million. We recorded as discontinued operations a $19 million charge for asset impairment and employee termination costs in the first quarter, 17 million of which is a non-cash cost. Any remaining costs will be recognized during the balance of the year as discontinued operations.

The Pulp and Paperboard segment had operating earnings of $11 million during the first quarter of 2008, versus an operating loss of $6 million for the first quarter of last year. There are three major drivers to our improved performance when comparing the quarters. First, excellent production and shipments, second, continued favorable pricing environment, offset by higher fiber, energy and chemical costs, and third, planned down time at our Lewiston, Idaho facility, which cost 9.2 million in last year’s first quarter. We now anticipate planned down time for maintenance at our two mills in the third and fourth quarters at a cost of $15 million and $3 million, respectively. In addition, early in this second quarter we took down time at our Idaho mill to perform maintenance on a recovery boiler which cost 1.5 million and resulted in lost production of roughly 5000 tons of pulp.

Consumer Products reported first quarter 2008 operating income of $3.3 million versus 4.8 million in last year’s first quarter. Although pricing and shipments were up 2% and 8%, respectively, it was not enough to offset the higher pulp, freight and energy costs we experienced in Q1. We announced price increases that recently went into effect that should help offset these higher costs over the remainder of the year.

Eliminations had a $1 million positive impact on operating income during the first quarter compared to a negative impact of 1.3 million last quarter, and a positive impact of $4.9 million in last year’s first quarter. The main driver for the positive elimination entering the first quarter compared to the fourth quarter was the seasonal log inventory decrease, we typically go through this time of year in Idaho as it gets more challenging to harvest during the winter months, and therefore we typically begin reducing inventory in the first and second quarters and start building it back up again in the second half of the year. The lower positive impact in the first quarter of 2008 compared with the first quarter 2007 was due to lower volume decrease in 2008.

Corporate administration, including interest expense, totaled 22.7 million for the quarter compared to 22.2 million in the fourth quarter and 18.5 million in last year’s first quarter. The first quarter of 2008 expense includes $2.7 million for the OSB antitrust settlement with the direct purchaser class, as well as higher compensation expense and legal costs. Interest expense totaled 8.5 million in the first quarter of 2008 compared to 7.6 million in last year’s first quarter. Our interest expense has increased as we utilize our revolver for the recent central Idaho acquisition.

EBITDA totaled $47 million in the first quarter versus 26.8 million in last year’s first quarter. Funds from continuing operations or FFO for the quarter totaled $46.3 million versus 24.6 million a year ago. The company paid a normal distribution of $20.1 million during the quarter compared to 19.1 million in the first quarter of 2007.

In our last webcast we indicated that we expected capital spending for 2008 to be in the 50 to $60 million range. We now expect it to be at the bottom end of that range for the year, primarily driven by lower capital spending in our Wood Products division. Pages 4, 5 and 6 provide additional detail by segment for the variances I have described. I would now like to turn the discussion over to Mike to provide some additional comments about our operations and markets.

Mike Covey

Thank you, Eric. We were pleased with the performance of our resource and real estate businesses during the quarter. However, there are several key cost pressures on our manufacturing businesses which we did not fully anticipate at the time of our last earnings call in January. Energy cost both for natural gas and diesel fuel have significantly increased. Our pulp based businesses are large users of natural gas and fuel cost impacted multiple segments.

Especially log hauling cost and the cost of outbound shipments in our tissue business. With fiber for our pulp mills continues to escalate in cost largely due to the shortage of residual chips caused by saw mill curtailments in the west. Residual wood chip prices at our Idaho mill have increased by 7% since this time last year. Similarly at our Arkansas mill chip prices have increased 11% year-over-year. We did not anticipate the depth of the downturn in our lumber business. The benchmark Random Lengths Composite Lumber Index has fallen by 14% over last year while log costs has declined only modestly about 6 to 9%.

In addition the margin squeeze caused by rising cost for energy, labor and most maintenance parts and supplies has resulted in most of our wood product facilities operating at a loss. At this time we do not anticipate the permanent closure of additional plants. And we believe that most of our log customers who purchase fee volume from our resource segment to operate their mills will continue operations as well. Most of our log customers have made purchasing commitments for the second quarter and into the third quarter at prices that approximate first quarter levels. For this reason we do not anticipate deferring harvest volume in the second quarter, although; the second quarter is seasonally our lowest quarter for harvesting activity due to spring break-up conditions throughout Idaho, Minnesota, and Wisconsin as well as spring rains in the south.

Deteriorating log prices continue to be the largest risk factor to our earnings outlook for the remainder of 2008. While sawlog prices remain under pressure, pulp log pricing is very strong and continues to improve in some areas. This is largely due to the strength of the pulp and paper market and the decline and availability of residual wood chips from saw mills. Importantly for Potlatch approximately 20% of our sawlog sales in Idaho are cedar which continues to sell at record prices and shows no sign of weakness. Land sales from our Real Estate segment are still expected to be 20 to 30% higher than 2007. After setting aside the non-strategic land sale that we initiated in Minnesota in the first quarter and will complete next month. Prices and demand for rural recreational real estate in Idaho and the Lake States appear to be strong with little evidence that prices have softened. We will be able to better gauge that as we get into the more active summer season.

Eric commented on the major maintenance outages in our Pulp and Paperboard segment which made quarter-to-quarter comparisons of performance difficult to track. Looking at the past 12 months of division level EBITDA from both of our paper mills it was $92 million compared to 52 million in the prior 12 months period. During the last 12 months we’ve seen significant improvements in results from the Idaho mill despite rising cost for wood chips, energy and chemicals. Both the Lewiston, Idaho and Cypress Bend, Arkansas mills continue to improve production and quality which has allowed us to gain market share in the high end folding carton and commercial print market while scaling back production in lower margin grades.

Market pulp sales during the last quarter were roughly 20,000 tons compared to 30,000 tons in Q4 2007 when we had large shipments to Asia. Market pulp sales are limited by a very small capacity pulp dryer and pulp production constraints at the facility.

We have announced price increases on cup stock which affects approximately 90,000 tons of production from our Idaho mill. This increase if accepted by our customers will result in additional earnings of about $1.3 million for the balance of 2008. The full effect will not be seen until next year due to annual contracts for cup stock. Markets in all three grades we produce, commercial print, cup stock and liquid packaging remain in strong demand and we have solid backlogs at both mills. Further the weak dollar continues to create demand for our products outside the U.S. helping to keep the U.S. market tight. Unfortunately we expect these market opportunities will be partially offset by rising cost for wood chips, pulp wood, energy and chemicals.

As we mentioned on the last quarterly earnings call our consumer products segment continues to improve shipments, productivity and tissue output from each of our four tissue machines. Rising pulp costs and energy however continue to eat away at price increases that were implemented this last month. It will take at least a full quarter for our customers to work through inventory stocks and reorder tissue products at the higher prices that went into effect April 7th. At this time we expect 2008 operating results to be in line with our 2007 performance which is down from the modest improvement we expected at the start of the year.

Now I’d like to turn to our announcement last week that our Board has authorized us to evaluate a potential tax-free spin-off of the company’s pulp based businesses. Such a spin-off would create two stand-alone publicly traded entities: a pure play timber REIT and pulp based manufacturing company that will include our consumer products facilities in Lewiston, Idaho, Las Vegas, Nevada, and Elwood, Illinois and our pulp and paperboard facilities in Lewiston, Idaho and Cypress Bend, Arkansas. These businesses, plus our wood products facility in Lewiston, which would be included in this spin-off since it shares the same site and many plant services, had combined revenues of $1.2 billion in 2007.

We believe the spin-off may have several benefits. Among other things, it would allow management to focus more intently on our core business of timberland management and the sale of rural recreational real estate. These businesses are fundamentally different from the pulp based businesses and have earning streams that are far less volatile. Importantly, the spin off company could focus on managing and growing the manufacturing business without the restrictions posed under REIT rules.

There are a number of critical work streams to complete and evaluate prior to seeking approval from our Board of Directors to move ahead with the spin-off. Should we decide to pursue it, we believe the spin-off could be completed in the fourth quarter of 2008, assuming the following gating items are complete. This includes the receipt of an IRS ruling that a spin-off would be tax free to shareholders and the company, its contingent on obtaining SEC approval after the company files a Form 10, and finally we need to retain a CEO, a Board of Directors and other key management positions.

Many of the questions asked by investors and analysts last week, following our announcement, revolved around the capital structure of both the proposed spin-off company and Potlatch. It is far too early in the process to speculate or answer questions related to any of the issues around the capital structure that either company would have in the event of a spin-off. As we hit milestones in our evaluation process, we will share additional information with analysts and investors.

It is important to note that our Board carefully considered a wide range of alternatives before announcing that we would explore a spin-off. Based on initial market reaction and the feedback from investors and analysts, we are confident that the initial spin-off evaluation makes sense. Given the Board’s fiduciary obligation, we will continue to carefully evaluate all of our available alternatives to maximize shareholder value as we move through the process. We believe the evaluation of a tax-free spin-off of the pulp based businesses is the right step to take at this time.

Thank you for your interest this morning and, Alicia, we will now take questions from participants on the call.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from the line of Gail Glazerman with UBS. Please proceed.

Gail Glazerman - UBS

Hi, good morning. I was wondering if you could talk a little bit more about real estate, the sale in Minnesota. And I just want to also know just what that does to your overall strategy, and just to confirm, so you’re still looking for 20 to 30% sales growth in real estate, excluding the Minnesota sale? I just wanted to confirm that.

Mike Covey

Gail, that’s correct. When we originally did our company-wide stratification in 2006 of land that we felt was suitable for higher and better use opportunities or was non-strategic, this 40,000 -- a portion of this 40,000 acre piece was identified in Minnesota due to its very low productivity from a timber perspective. A very small percentage of the land base we felt was suitable for any recreational real estate or HBU outcome in the future.

So this is the most northern -- northeastern part of our Minnesota ownership, so we’ve had our eye on it for disposition for some time. And we had discussions with an investor, a local investor in Minnesota who values the property different than we do, and I don’t think this value is indicative of certainly the rest of our ownership in Minnesota or the rest of the company as Eric mentioned. I think we had 28 real estate transactions in the quarter which were at prices about 25% higher than what we executed last year, and that’s in line with what our guidance was at the start of the year.

Eric Cremers

Yes, Gail, just to give you a feel for it -- this is Eric, I mean those other transactions we had in Minnesota, they were done around $1,600 an acre. So to Mike’s point about this acreage was dramatically different than our other real estate transactions in the state, I think that pricing points that out.

Gail Glazerman - UBS

Okay. And I mean going into the year I think you were guiding towards about 18 to 22,000 acres of sales. Does that also still hold, including Minnesota, or has that gone down?

Eric Cremers

No, I think our forecast at the start of the year is -- it still holds. Just pretend that that Minnesota transaction didn’t happen, and we told you last quarter is consistent with what we’re thinking for the rest of the year.

Gail Glazerman - UBS

Okay. And can you talk a little bit, I mean we talked about land sales, maybe talk a little bit about your opportunity to acquire land, what you’re seeing in the market, what type of opportunities are out there? Or pricing levels, given what you’re seeing in your land are, I guess, just too much of a hindrance?

Mike Covey

Well the -- this is Mike, the timberland landscape across the country continues to be very competitive with, I think still, an awful lot of capital attracted to this asset class, particularly has an inflation edge. And I think the fundamental understanding of the value of timberland is better and better understood every year. So it’s still a very competitive landscape. There is not a lot of property on the market and what there is tends to have a lot of bidders, particularly from TIMOs.

Gail Glazerman - UBS

Okay. And finally, just switching gears. If you can talk a little bit about the northern sawlog markets? I guess prices came off pretty sharply on a sequential basis, I am just wondering how that is starting to stabilize or if it’s still kind of in the second quarter coming off?

Mike Covey

Well, this should give a little more color. Our northern region is made up of both the Lake States and Idaho, two very different market areas. Pricing in the Lake States actually is quite stable. Pricing in Idaho, particularly for pulp logs, continues to increase as it does around the country. As I mentioned, pricing for cedar actually has gone up year-over-year and it continues to be very, very strong. For mixed sawlogs that service the dimension lumber and stud lumber customers that we sell logs to, those prices did come off a bit. And we expect that those prices are going to remain under pressure.

In the second quarter of this year we don’t have a lot of harvesting activity planned in Idaho. It’s just seasonally our lowest, and the Lake States, it’s seasonally a very low, slow period because of spring break-up. So, as Eric mentioned, we’re going to evaluate these prices closely as we come out of the second quarter, get into June and July when logging starts to commence more actively and evaluate what, if any, deferrals we ought to consider. A lot of the volume for the second quarter, and a portion of that in the third quarter, has already been sold to customers at prices we think are attractive. But we’re going to have to watch the markets closely.

Gail Glazerman - UBS

Okay. Thank you very much.

Mike Covey

Your welcome.

Operator

Your next question comes from the line of Hanza Mazari with Credit Suisse. Please proceed.

Hanza Mazari - Credit Suisse

Thank you. Just a couple of questions. You talked a little bit about the next steps in executing your spend. Could you give us a sense of timing? When do you expect the IRS ruling? When you expect to file the Form 10? And when you expect to give an update on your executive search process?

Eric Cremers

Hey, good morning. This is Eric. I think with regard to the outlook, our public statement is that we hope to get it completed by the end of the year. We still think we’re on track to make that happen sometime in the fourth quarter. The key gating items are the Form 10 and the IRS ruling and we are in discussions now with the IRS and we expect to get that letter ruling some time over the next couple quarters. It’s not a simple process, in some cases they will expedite their ruling but in other cases they won’t. So, it’s too early to predict exactly when we are going to get that ruling from the IRS.

The Form 10, we hope to have filed some time in the mid to late summer and part of the timing that’s going to drive that is getting in place, the senior management team or at least the CEO, before we make that filing and our search is just now underway for the new CEO so that’s going to take us a couple of months, I would expect.

Hanza Mazari - Credit Suisse

Okay, thanks. And the cost inflation you guys are facing across your businesses, do you have any hedges in place there?

Eric Cremers

We have forward bought some energy, unfortunately not nearly enough or not nearly as much as we’d have liked. We try to buy forward roughly half of our natural gas usage and we’re not at that level today and we’re at prices that are above where we were last year. So, we have a little bit of gas bought forward but not as much as we’d like.

Hanza Mazari - Credit Suisse

Is it fair to say on your paperboard business that you guys are pretty much maxing out on exports, or is there any additional room to push through more tonnage on the export side?

Mike Covey

Well, this is Mike, I think if we were to exit some domestic markets and switch them to export markets, that’s something that we’d consider on a pretty consistent basis. But many of the contracts on our paperboard business, both for cup stock and other items are longer term contracts, which makes flipping markets problematic; we can’t just do it on a whim. We produce as much market pulp as we possibly can and we don’t have contracts for that, we are exporting most of that but we cannot make a meaningful switch on the amount of export at this time.

Hanza Mazari - Credit Suisse

Okay, and just one more question. Your land sales markets seems to be holding up pretty well, are you seeing any slowdown in any of your markets in terms of pace of land sales, transaction activity?

Mike Covey

No, we’ve not. And our real estate business is relatively small, but the evidence that we would have would be if we’ve had any sales that didn’t move from contract to closing. That has not happened; we still see a lot of interest in broker, enquiries to brokers for property that is listed. But the caveat that I will add and I think we’ve mentioned is the most active period for our real estate business is in the summer season and we’re just approaching that. But so far, the markets in Idaho and the Lake States where we have the most activity on things, Wisconsin and Minnesota both, interest and demand still appears strong.

Hanza Mazari - Credit Suisse

Thank you very much

Mike Covey

You’re welcome.

Operator

The next question comes from the line of Mark Weintraub with Buckingham Research. Please proceed.

Mark Weintraub - Buckingham Research

Thank you. First, I realize that the harvest is going to be closely monitored, but as a starting point should we still be using what you’d referenced in your 10-K as a 4.2 to 4.4 million tons? Is that a good starting point to be at?

Mike Covey

Yeah, Mark, this is Mike. That is a good starting point. And part of the reason for that. You can’t lose track of, given the size of our company particularly, is over the last two years, over the last actually 18 months, we’ve grown the land base by 18%. So a lot of the harvesting activity is driven by much more timber under management.

Mark Weintraub - Buckingham Research

Okay. Also on the gating issues for the spin, are there any precedents for getting the letter from the IRS on the type of action that you’re taking? And how, if for whatever reason if the IRS didn’t want to give you a letter but was certainly not saying that there would be a problem either, would that be a limiting factor or not?

Mike Covey

Well, there’s certainly been a number of tax-free spin-offs that have been done by a number of entities, particularly C Corps, there’s not as many examples in the REIT field, but I don’t think that we’re on the cutting edge here at all. I think what we’re asking for is a fairly straight forward process and application. If the IRS for some reason did not consider it or the timing wasn’t satisfactory, there are alternatives we could consider and get opinions of counsel as to whether or not this would be a tax-free event for shareholders outside of a private letter ruling. But we’re not expecting that to happen.

Mark Weintraub - Buckingham Research

Understood. So this should, even though you mentioned it couple of times it’s not really a high priority potential issue in your view?

Eric Cremers

It’s a very high priority from -- it’s a critical gating item but we really don’t expect any problems with it. We have a very strong case for our business purpose for doing it and early indication is that the IRS will agree.

Mark Weintraub - Buckingham Research

Okay. And then just on the Minnesota sales, I guess I’m just looking at the presentation you had made a couple of years ago and you had indicated 50 to 60,000 acres in Minnesota with markup values of 450 per acre above timberland values. And I guess I’m just trying to foot the, what actually you got on these properties, and if I remember rightly, those were mark-up values as opposed to actual transaction values. Is it that you have a lot of very valuable non-core Minnesota lands? Or how should I be thinking about that?

And, more importantly, if you were to update that table, which you had given maybe a year back or whatever, would there be significant changes for the mark-up values you’d be placing on the HBU or the non-core lands that you’d identified in the 250 to 300,000 acres in total?

Mike Covey

Well the table that you are referring, and I don’t have it in front of me, but it was prepared and distributed in December of 2006 when we ruled out our stratification plan. As I mentioned, a portion of this property that we sold in Minnesota, we had identified at that period in time, as I also stated, we knew it was the lowest value property that we had. So was it specifically called out with an estimate of the value that we eventually sold it for now? Probably not, but I don’t think that should cloud the overall, our overall estimates.

As Eric mentioned, the transactions just this last quarter in Minnesota for the rest of the property we sold were I think at $1,600 an acre. Overall, I think our HBU program was around $2,200 an acre in the quarter when we true in the activity from all the states, which I think is very much in line with the estimates that we prepared in ‘06. And I think, more importantly, I think last year’s program ended up at about $1,500 an acre in total, and we expected this year 25 to 30% increase in prices, because the character of the property that we are going to sell this year had a larger HBU component and I think we are right on track with that today, Mark.

Mark Weintraub - Buckingham Research

Okay, great. So 1,600 you had referenced from Minnesota that was actually other non-core lands as opposed to HBU?

Eric Cremers

Well, there’s some HBU in that mix, Mark. If you look at the total acreage that we sold outside of that one large Minnesota transaction in the quarter, was around 5,500 acres, and of that acreage, 1,800 of it across the company is what we would consider HBU, with the rest being this rural recreational type real estate. The rural recreational stuff sold for around 2,000 an acre, and then our total acreage sold for 2,200 an acre. The HBU actually went for 2,800 an acre.

Mark Weintraub - Buckingham Research

Okay, great. So the bottom line that there is, at this point if anything you feel as good or better about the values of your HBU and non-core program than you did in December of ‘06? Would that be a fair....

Mike Covey

Yes. I think, yes, not only do we think we feel as good or better about the values, we’re building a team that attracted I think a number of people that are going to extract a lot of value from this, and I think, furthermore we’re probably identifying more land than maybe we initially thought. Certainly the property that we purchased in central Idaho has a much higher component of HBU and that was not discussed at all in the December rollout in ‘06 that we -- that you’re referencing.

Mark Weintraub - Buckingham Research

Okay. And then...

Mike Covey

We didn’t own that then.

Mark Weintraub - Buckingham Research

Fair enough. And then one last quick follow up. Conceptually, when you are thinking about the cash flows from your business, and you’ve obviously gotten your ongoing harvest cash flows, and then you have referenced that you also think about your land sale. Do you include non-core land sales in the thought process that you use or do you kind of view this as kind of separate one-time stuff that you don’t really include in that thought process when you start thinking about dividends and things like that?

Mike Covey

Well, certainly when we did the assessment of -- that you referred to in ‘06 of land that would be sold over time, which was identified as, I think between -- around 18% of our ownership, 250 to 300,000 acres at the time. A portion of that we identified and consider as non-core, and we said all of it was going to be sold over a decade.

So I think the non-core pieces of it, such as the one we just sold in Minnesota, are definitely part of the, if you think about in terms of the decade of cash flows, we expected to sell those properties over a 10 year period. And then in addition, we were able to redeploy this Minnesota sale in a 10-31 exchange, and do this on a tax-free basis, so I think that’s all part of our strategy.

Mark Weintraub - Buckingham Research

Okay. Thank you.

Mike Covey

You’re welcome.

Operator

Your next question comes from the line of Steve Chercover with D.A. Davidson. Please proceed.

Steve Chercover - D. A. Davidson

Thanks. Good morning, Eric and Mike.

Eric Cremers

Good morning, Steve.

Steve Chercover - D. A. Davidson

First question, I believe you said you incorporated the 2.7 million OSB settlement into first quarter corporate expense, so that goes away. But can you quantify what kind of expense we might see associated with your analysis of the spin-off, whether it’s recruiting CEOs or just paying investment banks?

Eric Cremers

Well, that’s a good question, Steve. We’re still getting our arms around what those numbers might look like. It’s a little bit early, but certainly there’s going to be some accounting work that has to be done to get the financial statements ready for the Form 10. There will be some recruiting costs. There’s going to be a fair bit of legal costs as we get that Form 10 prepared and get the letter ruling from the IRS. I’d hesitate to guess, but it’s probably less than 5 million over the next couple of quarters, excluding banker fees.

Steve Chercover - D. A. Davidson

Will you -- yes, good. I was glad, hoping it wasn’t going to be the kind of numbers that were, although I don’t remember them precisely associated with original transition into REIT. So will you break those out as we go through the quarters with the kind of discreet spending on advices?

Eric Cremers

Yeah, yeah. We’ll break that out for you.

Steve Chercover - D. A. Davidson

Great. Secondly, can you quantify the magnitude of the tissue price increase either in percentage terms or dollars per ton?

Mike Covey

Well I think the public announcement and the comments that we’ve made Steve were in the range of, kind of 4 to 7%. Obviously not all that, at least, not all of that we anticipated would be successful. There’ll be some promotions that have to go against that. So the net price increase on products may be is two to five, when it’s all said and done. And it was not on every single tissue product that we make. As you know, we follow, kind of, and compete with many of the large brands and some of our pricing is predicated on what they do and how our merchants accept that. So it was not across the board.

Steve Chercover - D. A. Davidson

Sure. Any early indication of those being accepted in the marketplace? I know it’s only a couple of weeks.

Mike Covey

So far, from the three large grocery store chains that are our largest customers, I think it’s been accepted completely and it’s being implemented in their stores today.

Steve Chercover - D. A. Davidson

Good. Okay. Final question. The number of acres that you sold in Minnesota, that’s already reflected in the full 45,000 has been reflected in your recent press releases even though half of it is yet to settle. Is that correct?

Eric Cremers

Yeah. The full acreage -- of that full acreage, the 43,000, only the 23 is closed. The remainder is still yet to close. And we should close that in May.

Steve Chercover - D. A. Davidson

Yeah, I understood that Eric, but I think I calculated that 45,000 sold just by looking at your recent press releases versus the 10-K. And so I just wanted to determine that you’ve already kind of taken that out of your ownership in recent press releases.

Eric Cremers

No. The full amount has not traded hands. I mean I don’t know if there’s a rounding issue there, or what Steve. But only that 23,500 acre figure is closed. Now we did have an additional 5,000 acres above and beyond that Minnesota sale.

Steve Chercover - D. A. Davidson

Understood. Okay, thank you.

Operator

The next question comes from the line of George Staphos with Banc of America. Please proceed.

Mike Roxlin - Banc of America

Hi. This is [Mike Roxlin] in for George. Going back a second for the cost issue, in addition to some of the inflation hedges you’ve set up, what are some of the other measures you’ve taken to offset the rising cost?

Mike Covey

Well, there’s numerous examples of that by product line. As you can imagine one of the largest expenses that we incur is the hauling of logs. From a diesel fuel perspective, we’re taking steps to try to optimize that to get more loaded tons per mile on each load of logs. We’ve taken steps to reduce our natural gas usage. We’ve cut the amount of gas usage per ton of paper production that we make out of our paperboard mills, almost in half, I think, in the last three or four years.

I don’t have exactly the statistic in terms of over the time period. But, I believe it’s over the last four years it’s gone down by 50%. We’re examining the use of alternative fuels where we think that can make sense to get away from fossil fuel inputs that are very expensive. Electricity is another area to a lesser degree than natural gas or diesel. It’s gone up. We’re trying to optimize or minimize the use of that where we can. So, I think it’s, one of the largest cost inputs we have that’s gone up the most is wood chips. Any steps we can take to increase the yield from the input of wood chips to the output of paper production in each of our mills is one of the areas where we have the most leverage. And we’re making improvements in that daily.

Mike Roxlin - Banc of America

What’s your outlook for input cost pressures? Obviously you’ve said, I would assume that you intend that they would remain in the short term elevated. But, longer term what’s your outlook there?

Mike Covey

Well I’m not an economist. I don’t know. I don’t think any of us imagined we’d see diesel fuel prices at over $4 a gallon or natural gas over $10 per therm. I have no idea what to think.

Eric Cremers

On the pulp side, the fiber side, we really need to see a rebound in saw mill activity to get the pulp prices back down again to help out our pulp based businesses. And when that happens it’s kind of dependent upon housing starts and consumer confidence and the like.

Mike Covey

Get our chip prices down.

Eric Cremers

Yeah, to get the chip prices back down, very hard to predict.

Mike Roxlin - Banc of America

Got you, last question, just given the continued weak sawlog markets, why not defer more of the harvest until pricing recovers?

Mike Covey

Well, it’s difficult to make that kind of across the board statement. Every market’s different. As I mentioned, we’re seeing pretty decent markets in the South, especially for pulp wood. And sawlog pricing there has held up relatively well. The Lake States have been pretty flat dimension. Sawlog prices in Idaho have tumbled a bit more. We also balanced that with, as we’ve talked about in the past, we have an older decadent forest, particularly in Idaho and we have an older age class forest in Arkansas.

We think when we run our modeling and try to simulate not only the growth of the forest but the value of the trees and how best to maximize net present value. Almost in all cases it tells us the smartest thing to do is accelerate the harvest, replant the trees, and establish younger thriftier stands. It makes the most financial sense. Obviously there’s a limit to that. And I think that the area we’re going to have to watch the closest is the Idaho sawlogs but I think in Arkansas and in the Lake States we feel that we are in pretty solid ground with our plan today.

Mike Roxlin - Banc of America

But given the weakness in Idaho I mean are you measuring before you’re going to -- you will reevaluate towards the end of the second quarter whether you are going to have any type of deferral.

Mike Covey

Yeah, that’s correct.

Mike Roxlin - Banc of America

Thank you.

Mike Covey

You are welcome.

Operator

The next question comes from the line of [Roger Bugner with Bugner Enterprises], please proceed.

Roger Bugner - Bugner Enterprises

Mike, in the comments at the beginning you made a comment on Consumer Products, what the volume increase was, and we missed that, could you repeat that?

Mike Covey

I don’t recall a comment about a volume increase in Consumer Products.

Eric Cremers

We talked about pricing in shipments, pricing was up 2% and shipments were up 8%.

Roger Bugner - Bugner Enterprises

That’s what I was looking for shipments. Thank you. That’s all.

Operator

The next question comes from the line of [Richard Paoly with APG Investments], please proceed.

Rich Paoly - APG Investments

Hi guys, it’s Rich Paoly just to follow-up on an earlier question, could you remind me the proportion of the cut and haul costs that are borne by you versus by the purchaser. Because if I recall correctly regionally there’s different methodologies, can you just remind us how that works and then you know what the trends has been on I guess the cut and haul guys, they’re probably getting squeezed also. Is that right, the contract, contract workers.

Mike Covey

I assume your question is related to our Resource segment...

Rich Paoly - APG Investments

Yeah, yeah.

Mike Covey

When you say hauling? Well, the company pays both a logging cost to a contractor to cut the tree down and load it on to a truck and we also pay a hauling cost then to deliver it to a location, to a mill location. So we bear 100% of the cost. Typically we index the cost of the what we pay a contractor to do that based on the price of fuel. So that the contractor doesn’t bore the entire risk and expense of a rising fuel market, we obviously try to make it fair but there is no question that our contractors have been squeezed as well.

As they operate heavy machinery and the logging equipment is very fuel intensive. It’s not only the cost of fuel but the cost of tires and hoses and many of the other things that come from petroleum products has risen as well. So they are squeezed, we are squeezed, and I think most of our customers would feel that without a rise in the price of wood products which most of them sell they don’t have the ability to pay any more for it. So it’s truly a margin squeeze.

Rich Paoly - APG Investments

Okay. So you guys don’t do any, any contract work where it’s just still on a stumpage basis and then the buyer bears that cost. Is there any and is there any chance of that trend changes given the environment?

Mike Covey

We do a small amount of that where we would sell those stumpage sale. And the contractor would have, or the purchaser would have typically 12 months to 18 months or something to cut and remove the timber and they take the market risk on price and cost. We do a little bit of that but not very much. We feel we can add more value by maintaining the ability to merchandize and cut the tree into its component log segments to maximize value where we can sell a pulp log to a pulp customer, saw log to a saw log customer. We typically think we get more value then letting somebody else do that.

Rich Paoly - APG Investments

Okay. And then just a follow up question also. Are the lumber businesses being spun off also I guess sort of the lumber manufacturing where it is just the I guess the pulp and tissue type businesses?

Mike Covey

No, primarily. It’s the pulp based businesses that I mentioned which is tissue and paperboard. Included in that is one, excuse me...

Rich Paoly - APG Investments

That was not me.

Mike Covey

Okay. One saw mill in Lewiston, Idaho where -- the saw mill in Lewiston, Idaho is on the same site and complex as our large paperboard facility and consumer products facility where it shares power and services and air permits and chip supplies and so on. So that one is a included in the spin off but the rest are not considered at this time.

Rich Paoly - APG Investments

Okay. And the just one last question. Could you perhaps walk through the I guess the big picture. Why does it make more sense to spin of this business versus to sell it to an operator who eventually could gain economies of scale like combining, do what they do, especially when you have to go out and find the Board Of Directors, find management and sort of I am presuming that you would need certain approval at anyway to sell the business but maybe just short of that, it seems like that analysis has been done and why that’s been concluded in that fashion?

Mike Covey

Well first of all, the decision to spin it has not been made, we’re evaluating it and our Board has considered a number of alternatives before arriving at the decision to evaluate the spinoff. One of the considerations in the spinoff, pending approval by the IRS obviously, is that there is a possibility that this can be a tax-free event for the company and the shareholders, which is also a very compelling advantage to spinoff versus the sale of a business.

Rich Paoly - APG Investments

And there was no way the structure will potentially de-structure any type of tax advantaged sale?

Mike Covey

As we’ve looked at it, this alternative makes the most sense right now to evaluate.

Rich Paoly - APG Investments

Okay. Great. Thank you.

Mike Covey

You’re welcome.

Operator

We have no additional questions at this time. I’d like to go ahead and turn the call back over to management for closing remarks.

Mike Covey

Thank you and thanks for your participation and we’ll talk to you in the next quarter.

Operator

Ladies and gentlemen, this does conclude your conference call. You may now disconnect. Have a great day.

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Source: Potlatch Corporation Q1 2008 Earnings Call Transcript
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