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Potlatch Corporation (NASDAQ:PCH)

Q3 2012 Earnings Call

October 22, 2012 12:00 p.m. ET

Executives

Michael Covey - Chairman, President and CEO

Eric Cremers - EVP and CFO

Analysts

Michael Roxland - Bank of America Merrill Lynch

Gail Glazerman – UBS

Chip Dillon - Vertical Research

Steve Chercover - D. A. Davidson

Joshua Barber - Stifel Nicolaus

Albert Sebastian - Prospect Advisors

Operator

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Potlatch third quarter 2012 earnings conference call featuring Eric Cremers, Executive Vice President and Chief Financial Officer; and Michael Covey, Chairman, President, and Chief Executive Officer for Potlatch Corporation. (Operator Instructions)

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

Eric Cremers

Thank you and good morning. Welcome to Potlatch's investor teleconference covering our third quarter 2012 earnings.

Before we begin, let me remind you that this call may contain forward-looking statements with regard to our business and operations. Please review the warning statements in our press release, on the presentation slides, and in our filings with the SEC concerning the risks associated with these forward-looking statements. Also please note that segment information as well as a reconciliation of non-GAAP measures can be found on our website, www.potlatchcorp.com, as part of the webcast for this call.

I would now like to turn the call over to Mike Covey, our Chairman and CEO, who will make some introductory remarks, and then I'll review our third quarter results in more detail. Mike?

Michael Covey

Thanks. Good morning. We’re very pleased to announce third quarter results that exceeded our expectations giving us two strong back-to-back quarters in our lumber and plywood business. In our resources business, we again realized higher sawlog prices compared to the previous quarter as well as substantially increased harvest volume caused by normal seasonality.

Our woods products segment continued to build upon what was an exceptionally strong performance in the second quarter and has exceeded our outlook from the beginning of year. Throughout the year, favorable trends in the wood products demand and pricing have prompted to increase production levels at our mills, primarily through increased operating hours in order to take advantage of improved market conditions.

Though our real estate segment results were weaker as compared to prior quarters, we continued to experience a steady level of demand for rural recreational and HBU real estate. In reviewing our consolidated results both our quarterly and year-to-date performance have been much stronger than we originally anticipated.

Given our recent operational gains as well as meaningful turnaround in the housing industry, we maintain a very optimistic outlook over both the near and long-term. In the near term, we expect continued strength in wood products pricing for a variety of reasons. Demand for wood products is higher driven by higher levels of housing starts and improving outlook for both commercial and industrial markets as well as repair and remodel markets.

At the same time there is diminished manufacturing capacity in the industry to meet higher demand as roughly 10 billion board feet or 15% of the industry has been permanently shut down in North America over the past few years. Combined with relatively low inventory levels both at mills and throughout the various distribution channels, industry conditions remain very favorable for further potential pricing gains.

Over the long-term we believe a variety of factors can work in concert to create very favorable market conditions for both our wood products and our resource segments. First, we expect Chinese demand for North American fiber to remain relatively firm, and second, we expect reduced Canadian lumber production due to the mountain pine beetle and the lower allowable cut in the Eastern Canadian provinces. Additionally – and most importantly we expect increased domestic demand for wood products as the U.S. housing market continues to improve.

Though both near and long-term market conditions appear promising, we have not altered our near-term harvest plans. As we have discussed throughout the year, we remain committed to our intentional decision to defer a portion of our timber harvest activities and plan to harvest 3.5 million tons this year which is significantly below sustainable levels. We believe it is most beneficial to our shareholders to exercise patience and preserve our timber value directly on the stock, allowing our trees to continue to grow and further increase in value while awaiting even better market conditions that we believe are in the not-too-distant future.

We’re encouraged by the continued improvements in the wood products industry and have already begun to see higher lumber prices translate into higher sawlog prices, particularly in our northern region. Undoubtedly pronounced continued improvements in the wood products industry, capacity utilization and profitability will ultimately lead to higher sawlog prices and thus higher profits in our resource. Once the sawlog market recovery is clearly evidenced, we will respond by raising our harvest levels which will increase our cash flows considerably from the trough levels that are at today.

I’d now like to turn the call over to Eric to discuss the quarterly results and then we will take questions.

Eric Cremers

Thanks Mike. As shown on page 3 of the slide accompanying this presentation, we reported third quarter 2012 net income of $18.6 million or $0.46 per diluted share. This compares to net income of $25.6 million or $0.63 per diluted share for the third quarter of 2011 and net income of $5.1 million or $0.13 per diluted share for the second quarter this year. As a reminder, in the third quarter of last year we closed on the third and final phase of a large land sale in Northern Idaho which produced revenues of over $9 million in that quarter.

I’d now like to review our third-quarter 2012 results broken down by segment. Slide 4 charts operating income and margin trends in our resource segment. Operating income was $23.6 million for the quarter, which compares to 25.6 million in last year’s third quarter and $6.7 million in the prior quarter.

The third quarter is routinely the strongest quarter for our resource segment due to higher harvest volumes, primarily in our northern region caused by better weather that allows for excellent logging conditions during this time of year. Therefore the positive income variance of $16.9 million in Q3 of 2012 versus Q2 of 2012 was largely the result of our harvest volumes more than doubling between the sequential quarters but higher prices were strong contributing factor as well. The $2 million income variant between Q3 2012 and Q3 2011 is directly attributable to our previously announced harvest deferral in 2012 which particularly impacted our southern region harvest volumes.

Page 5 exhibits volume and pricing trends for the northern region of our resource business. Comparing Q3 2012 to the third quarter of last year, sawlog volume decreased by 5% due to the impact of the planned harvest deferral while sawlog prices increased 3% year-over-year primarily due to improved demand. Comparing Q3 2012 to Q2 2012 sawlog harvest volume increased almost threefold, which again is due to the improved logging conditions in the third quarter. Sawlog prices increased 10% over Q2 driven by improved lumber pricing since approximately 65% of our sawlog harvest volume in the northern region is tied to lumber index which have been strong each of the past two quarters.

Looking at pulpwood, harvest volumes in the northern region are flat comparing the third quarter of 2012 to last year’s third quarter while prices were up 4%. Year-over-year increases in pulpwood harvest volume and pricing experienced in our Idaho regions were offset by decreased pulpwood demand and pricing in the Lake States region, which was precipitated by unusually favorable logging conditions in the second quarter that shifted portion of our pulpwood harvest in Lake States region into the second quarter of this year instead of the third quarter.

Comparing Q3 of 2012 to Q2 of 2012 northern pulpwood harvest volumes are up considerably which is related to typical seasonality. However prices declined 6% due to an oversupply of pulpwood in the markets.

Page 6 displays volume and pricing trends in the southern region of our resource business. Comparing Q3 2012 to the prior year’s third quarter, sawlog harvest volume was reduced by 35% in accordance with our planned harvest deferral while sawlog prices increased 4%. The price increase is the result of a product mix shift between the quarters that included an increase of hardwood saw timber in Q3 of this year to capture better hardwood sawlog pricing. Fine sawlog prices remained relatively flat in the region.

And looking at the variance between the second and third quarters of 2012, harvest volumes increased 17% due to typical seasonality while sawlog prices increased 9%, which again was due to the product mix shift that included a greater proportion of hardwood sawlogs in the third quarter than the second quarter in order to take advantage of attractive hardwood pricing.

Moving to pulpwood in the southern region, our harvest volume declined 14% comparing Q3 2012 to last year’s third quarter again related to our harvest deferral. Prices increased 12% between the quarters due partially to product mix as well as stronger pricing in general on both soft and hard pulpwood in the current quarter.

Comparing consecutive quarters of 2012 pulpwood harvest volume and prices increased 29% and 3% respectively. The increased volume is attributed to typical seasonality while the increase in pricing was generated by a shift in product mix toward hardwood pulpwood during the third quarter.

Moving on to our real estate business, page 7 displays our revenues for the segment. Our real estate segment produced $0.4 million in revenues for the third quarter which compares to $8.7 million of revenue in the second quarter of 2012 and $14.8 million in last year’s third quarter. This $6.3 million revenue variance between the second and third quarter of 2012 was caused by timing differences as well as real estate transactions can be lumpy making sequential quarterly comparisons challenging.

Comparing third quarter 2012 with last year’s third quarter, the variance was primarily related to the third and final phase of a sequential Idaho real estate sale that accounted for over $9 million of revenues.

Slide 8 presents operating income trends in our real estate segment which generated operating income of $1.3 million during the quarter which compares to $9.9 million in last year’s third quarter and $6.7 million in the second quarter.

Page 9 highlights our real estate acres sold by product type. We continue to see a relatively consistent level of demand for our rural recreational and HBU properties. For the quarter we closed 28 transactions, which is consistent with our expected range of close-ins each quarter.

Page 10 highlights price trends for our real estate business summarized by product type. Overall our average sale prices continue to be firm and fluctuations during the current quarter can be attributed to product mix differences.

Page 11 charts operating income and margin trends for our wood products segment. The performance of our wood products segment again surpassed our expectations both from the beginning of the year as well as the beginning of the third quarter and achieving operating income of $15.2 million for the quarter, compared to $2.9 million in last year’s third quarter and $11.7 million in the second quarter 2012.

Page 12 highlights our wood products segment’s lumber price and volume trends. The strong lumber prices experienced during the second quarter of 2012 were sustained well into the third quarter. Consequently lumber prices finished the quarter up 1% from the prior quarter and up 21% comparing the third quarter to last year's third quarter.

Shipments were consistent comparing the second and third quarters of this year, but increased 4% over the prior year third quarter. In light of the robust wood products demand and solid pricing environment over the past several months, we continue to run our sawmills as well as our plywood mills with increased operating hours to capitalize on favorable market conditions. We continuously evaluate options for increasing production by adding incremental overtime, productivity enhancements and even modest capital expenditures in order to take advantage of the high operating margins.

Looking back to page 3 of our supplemental materials, corporate administration costs totaled $10.6 million for the quarter, compared to $9.2 million last quarter and $5 million in last year’s third quarter. The year over year variance was primarily caused by a $1.6 million increase in pension expense related to our legacy pension plans and a $2.6 million increase in non-cash mark-to-market adjustments associated with our deferred compensation plans, which are tied to our stock price.

Similarly the variance between the second and third quarter of 2012 is attribute primarily to an increase of non-cash mark-to-market adjustments of $1.4 million associated with our deferred compensation plans due to a 17% increase in our stock price during the quarter. The decrease in our book tax provision compared to the prior quarter is a result of lower net earnings generated by our taxable REIT subsidiary during the third quarter. We expect our book tax provision to be approximately 31% of net income before taxes in Q4, driven by wood products and real estate earnings in our TRS.

At a result of our strong operating performance for the quarter and year-to-date, we have a solid balance sheet with $62 million in cash and short-term investments nearly as much as at the start of the year, despite retiring $22 million of debt thus far this year. We have more than ample liquidity given our cash position coupled with our completely undrawn $150 million revolver.

Furthermore our net debt to enterprise value is just 16%, a relatively low level. Still further, our funds available for distribution or FAD year-to-date is approximately $38 million or $0.93 per share which demonstrates our ability to earn our dividend directly from our business operations.

Next, I would like to make a few comments about the outlook for each of our three segments. Our resource segment remains on track for a total harvest of 3.5 million tons for the year, leaving us with about 850,000 tons yet to harvest in the fourth quarter. We expect modest price declines in both sawlog and pulpwood prices in both regions in Q4 and expect logging and hauling costs to remain relatively stable.

Regarding the outlook for our wood products segment in Q4, we expect modest seasonal weakness during the quarter as building activity slows. Thus we anticipate a modest softening in lumber prices for the quarter, perhaps 20 bucks for 30 bucks per thousand board feet but expect plywood prices to remain relatively firm.

Production and shipments will be slightly lower due to typical seasonality. Lastly, in real estate we expect a very strong fourth quarter and expect to sell 7000 to 8000 acres in the quarter, generating revenues of approximately $18 million. For the quarter we expect land-basis to be approximately 25% to 30% of segment revenues.

As you may have read in mid-September, we announced the sale of approximately 2000 acre HBU parcels located along the Mississippi River northeast of Brainerd Minnesota. The parcel has 2.7 miles of river frontage and is ideal for numerous outdoor activities. We have long been exploring options for this parcel and the pending sale is the result of more than a year as collaboration among Potlatch, the Minnesota Office of The Trust for Public Land, the Lessard-Sams Outdoor Heritage Council, Minnesota’s Department of Natural Resources and Crow Wing County.

The parcel is being purchased for $11 million by the Minnesota Department of Natural Resources for conservation purposes. We are pleased with the resulting transaction that is beneficial, not only for our shareholders, but also for the citizens of Minnesota.

To summarize, our solid financial foundation has us well-positioned for the stronger log and lumber markets over the next couple of years. We are optimistic that our harvest deferral strategy will well reward shareholders as the housing market continues its inevitable march higher.

Stephanie, I would now like to open up the call to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Roxland with Bank of America Merrill Lynch.

Michael Roxland - Bank of America Merrill Lynch

Just a quick question, your lumber prices have recently firmed again after the hiding for a number of weeks. Can you give us a little color of what’s driving that pricing stability which seems to be occurring a little brilliant than you guys had expected given the comments in your press release point to December as the month which seems like prices, low prices to actually begin a recovery.

Eric Cremers

Yeah good morning Michael. It’s Eric. Just as a reminder, lot of capacity has come out of the industry not just on the mill side but also on the dealer network. I think I heard somewhere that 25% to 30% of the dealer yards in the country are – have shut down now. I think a lot of people are looking at next year and seeing very firm demand in 2013. Most people believe housing starts again are going to improve 20% to 25%. So in that kind of an environment pricing is likely or expected to move higher next year.

So the question is, do you want to enter the season with low levels of inventory and have to buy next year, or would you rather start buying some now before prices take another run next year? And I think I have seen some forecasts that have the lumber composites up another 10% in pricing next year. So I think it’s just people buying in advance of next year’s building season.

Michael Roxland - Bank of America Merrill Lynch

It’s just assumption based on what’s occurring in the market right now, so even in relative to your guidance there would be additional upside to your lumber business given what we’ve seen with lumber pricing at present?

Eric Cremers

Yeah I think that’s correct.

Michael Roxland - Bank of America Merrill Lynch

And just last question, I think on the last call, you mentioned – I mean on this call you mentioned that you’re putting up some additional shifts at some of your mills but specifically on the last call, you mentioned – you put on additional shifts but not at all of your mills. So has that changed at all given the better housing backdrop and how do since you added additional shifts at all your mills, and can you also talk to some of the productivity initiatives that you made or are going to make at some of your mills to increase the output?

Michael Covey

This is Michael, Mike. We have not added shifts at any of our mills probably in the last 20 months or so. We began running all of our mills at what we would consider full to ship capacity into 2010. Incremental output comes from adding over time hours of various mills and adding it there to schedule but not incremental shifts. So that answers your first question.

In terms of productivity opportunities and enhancements, we’ve made couple of modest capital investments each of, two examples, both about $600,000 that combined will result in lumber production increases in the order of 10 to 15 million board feet in future years just due to higher throughput levels with this modest capital expenditures a while. So that’s a couple of examples. Now I think the big picture is there is a -- according to FEA data there is around 750 mills operating in North America with about 64 billion board feet of capacity, 55 mills are idled right now completely. And I think real question becomes what if any circumstances caused any of those 55 mills to start production again, that probably represents around 6 billion board feet of capacity. But at the same time as we said in our call script, there has been over 10 billion board feet taken out of the industry permanently due to fires or closures or other things. And I think all those things make for what we – coupled with increased demand and rising housing starts, we think creates a pretty favourable environment going forward for the next few years.

Operator

Your next question comes from the line of Gail Glazerman with UBS.

Gail Glazerman – UBS

In terms of your contracts that are tying your lost rates to the lumber price, can you just remind us kind of how long a months ago and it seems like it’s been a bit more favourable for you perhaps than your customers. Is there any kind of times of rethinking on that end or are they still pretty extended?

Eric Cremers

Yeah, Gail, we have really two contracts covering 65% of our northern sawlog volume. One goes out three years in length and one is with our own mill. So it’s perpetuity more or less. And the one that’s out three years is renewed on an annual basis putting it another year. But we have three years yet to run on it and both parties seem to be happy with the way it’s working.

Gail Glazerman – UBS

Okay. And let me just maybe some general color on what sawlog prices would be doing were you not tied to the lumber price, would they have been stable in the quarter still up a bit?

Eric Cremers

No, interestingly we have done some analysis and what we found is that pricing for non-index customers are relatively comparable to index customers.

Gail Glazerman – UBS

Is there something going on specifically in Idaho that would explain that because western prices were down and that was kind of the driver of helping you get prices last year, southern prices are pretty flat. Is there something specific about the Idaho market you think that would support sawlog pricing that we’re not seeing elsewhere?

Michael Covey

Well, I mean one factor that we’re a bit insulated from here in the inland west is the effect of the export log market. And I think log exports are down this year from the Pacific Northwest to China and other markets and that’s probably created a little bit weakness in that market that we haven’t felt this great here.

And I think the other thing is we have a number of customers here, producers that are outstanding lumber producers that run their mills at their full capacity as well.

Gail Glazerman – UBS

And really the south is not your biggest market but can you give us some perspective there, you shouldn’t have that export drag that you have in the west and yet even with kind of the improved housing activity, there is really no sign of sawlog prices turning there. Any perspectives on what is keeping that down and what you think is the change – start to see traction in sawlog prices in the south?

Michael Covey

Well, I will make a couple of comments. There has been – there is an awful lot of timberland ownership at TIMOs and REITs throughout the south as well as private landowners. I think across-the-board there has been an awful lot of preferred harvest creating an abundance of supply available to respond to market improvements. That’s one factor.

There has been I think various closures depending on what market areas that have further added to the weakness in log pricing. But I also think while maybe the south has been a tough place to be in terms of the log market in the last couple of years, it’s also the area that we think is going to have the most upside going forward. The south is well positioned to respond to increased lumber production and plywood production as the economy improves and most of that response is going to come from the U.S. south which we think long term will be terrific for log prices.

Eric Cremers

Yeah, in that same light, Gail, I’ve read a couple of industry studies here over the past few weeks and one has southern yellow pine stumped its prices up over 100% over the next few years and the other study has them up by over 30% over the next few years. So the south is really setting itself up to be super competitive here over the next few years.

Gail Glazerman – UBS

And those studies, when do they start seeing that kick-in, is that a 2013 event or further out?

Eric Cremers

Yes, ’13 and ’14.

Operator

Your next question comes from the line of Chip Dillon with Vertical Research.

Chip Dillon - Vertical Research

First question is to deal with the corporate expense number. I noticed it was quite elevated in the third quarter. How should we see that? I'm not counting the interest portion in the fourth and kind of what would be a good run rate? With this recovery we’re seeing certainly in the wood side, let’s say continuous wood products side, the earnings carry over next year to higher level, would we expect to see this year's corporate expense to be repeated all things being equal next year?

Eric Cremers

Chip, this is Eric. So one of the big drivers of that variance was this non-cash mark to market and deferred comp plans. And that’s really tied to our stock-price. So part of what drives that corporate expense number really is driven by what changes in the stock-price, and there is roughly 265,000 shares in a deferred comp plan. So depending upon how the stock-price moves quarter to quarter year-over-year that's going to drive that corporate expense line item.

Now we did see particularly strong hit in the third quarter because our stock really ran here in the third quarter. But I think if you look out over the next couple of quarters I would expect it to moderate and that corporate expense line to look more like – maybe somewhere between the first and second quarter this year, maybe around 8.5 million something like that going forward. And the pension expense variance will continue to be felt going forward.

Chip Dillon - Vertical Research

So again, the 8.5 million is sort of what you would expect it to be if the stock is unchanged, is that right? Is that sort of the base to use and then the stock changes on top of that?

Eric Cremers

That’s correct.

Chip Dillon - Vertical Research

And then I am struggling a little bit with the tax rate. First of all, you said 850,000 tons more or less is the harvest for the fourth quarter right?

Eric Cremers

That’s correct.

Chip Dillon - Vertical Research

And then when we look at the tax rate for the fourth quarter you mentioned it would be darn close to a Sea Corp rate and I know seasonally the wood products earnings I am guessing will back off a bit like they always do. And so therefore you’re going to gain certainly a lot more income with the land sale and with the harvest level being at that level of 850,000 ton level, I just have a hard time of seeing why that would still generate such a high tax rate. Is there some catch-up in there and can you shed some light on that?

Eric Cremers

It’s not due to catch-up. The way to think of it is in the fourth quarter, we’re going to have a pretty good quarter in our wood products business of course. Our real estate businesses is going to perform exceptionally well. Lot of these land sale transactions we’re talking about or happening out of our TRS, so you have to take that into consideration.

And then if you look at the REIT side of the business, it’s just the log harvesting and side of it. And if you look at the income that gets generated by the REIT, roughly half of our corporate expenses are in the REIT and half are in the TRS. While the same thing is true for interest expense roughly half is in the REIT and half is in the TRS. So the income that the REIT is going to make in the fourth quarter is going to have to be used to pay half corporate and half interest expense. So that’s why the effective rate is relatively high in the fourth quarter.

Chip Dillon - Vertical Research

And looking at the guidance, I think you gave us a land sales with conservation transaction which I think is like $11 million. You’re saying maybe the segment might book 18 million in the quarter. Did I get that right?

Eric Cremers

Yeah you got that right.

Chip Dillon - Vertical Research

And then lastly, I know it’s quite volatile and I don’t want to pin you down but given that I think you’re not involved with hedges, do you think the wood products segment could see double digits in the fourth quarter despite the seasonality or would that be strong?

Eric Cremers

Wood products double-digits in terms of EBIT earnings – yeah, I think it’s possible. If you look at it, we produced about 160 million board feet a quarter, let’s say prices declined 30 bucks a thousand, 30 times that is about 4.8 million something like that off of today's earnings all else being equal.

Chip Dillon - Vertical Research

One last thing, I know that it's not apples to apples. If you get back and look at ’02, ’03, ’04 period, when you saw the Canadians really pumping a lot of lumber into the U.S. I guess trying to make a point, we certainly don't see any sign of that I would supposed now, and it just seems to me that your margin here in the last quarter in the wood products business was within a few – not that far from what you saw back in that period. In fact, it was higher than what you saw back over the – even at the last peak and I am sure part of that is tied to the fact that – well it has to be tied to your cost experience. And if you could just talk a little bit about how your system, I know you might not have been there then but how your system you feel is different than that was back in the run-up to the last housing peak?

Michael Covey

I can’t even remember back that far, Chip. But I think the cost curve I think has come down across the industries substantially. One of the big differences today I think compared to several years ago is, the log cost for us in the Lake States and the U.S. south are quite low relative to where they’d normally be and that certainly helped drive margins even in this strong lumber market. The margins I think were even better now because of lower log cost particularly in the U.S. south and the Lake States for Potlatch. The Idaho log costs are probably more normalized.

But you also, I think to your point, Canadians has 35% of the share of the U.S. market ten years ago, pretty soft with lumber agreement days and today that number is 25% or something like that. China market didn't exist, the Pine Beatle wasn’t around the market, it’s just a really different phenomenon today than it was back then, and I think these margins that we have today are going to improve in the next few years. Even with rising log costs, I think we’re going to see lumber prices over the next few years to be very favourable.

Operator

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

Steve Chercover - D. A. Davidson

I just want to try and correlate what Mike said of improving lumber margins with what I understood would be implication of the transfer prices of your logs, because I thought sooner or later the margins that you are earning in wood products would transfer over to resource segment. And that was beneficial because it’s tax efficient. Am I wrong that you expect lumber to get better still?

Eric Cremers

No, I think what you said is exactly true. Eventually those higher lumber prices, Steve, they will translate into higher log prices. They are already doing it in our northern region. I think what we’re really talking about is over the longer term the price trends are very favorable for the resource business but it may not materialize this quarter per se.

Steve Chercover - D. A. Davidson

Okay. So in a rising lumber market, the mills continue to be very very well but as lumber prices stabilize, ultimately the log prices by formula are bit up and the earnings will then accrue to the resource, right?

Michael Covey

Yeah in general, that’s the case. Sure.

Eric Cremers

Now today in the south it’s little bit different dynamic, right, because they are not indexed in the south. Lumber prices have really run in the south but it hasn't translated into higher log prices. But most industry prognosticators feel like log prices are going to be moving up a lot over the next four to five years, maybe not next quarter but over the next several years.

Steve Chercover - D. A. Davidson

So I don’t know if you feel comfortable answering this or not, but looks like you are on track to have 40 odd million dollars in operating earnings for wood products this year. And do you think it could be similar next year?

Eric Cremers

It’s hard to talk about next year, we haven’t announced our plans. But I think it is easily doable for at least that may be even more next year. Lumber prices – I think last forecast I saw was roughly 10% higher composite random lengths lumber price next year. So lumber prices are going to run 10%. Most cost factors for most mills especially in the south are going to stay subdued. That’s just going to mean more margin for lumber manufacturers.

Steve Chercover - D. A. Davidson

Okay and then switching gears since there’s such a lead time between when you actually get the conversation deals done and when you start formulating them, can you just discuss whether you have any material – conservation deals you are working on currently?

Michael Covey

No. The answer is we’re not going to kind of pre-announce the conservation things, we are working on those, to you point, the negotiations take a long time. The Mississippi North was a property that we just announced, was a very special place and a unique place in the Potlatch ownership. But we also have others that are attractive and they do take time and conservation organizations. And the source of conservation funding is very unpredictable. You can't really count until you close the deal. As you know, a lot of the funding for conservation deals has come through land and water conservation funding. Who knows what Congress is going to do with that.

So we don’t have any that are on the drawing board to close in 2013 at this point, but longer-term we do have others.

Operator

Your next question comes from the line of Joshua Barber with Stifel Nicolaus.

Joshua Barber - Stifel Nicolaus

I am wondering if you could talk about your future harvests so that your plans haven’t changed the whole lot, but it clearly sounds like there is a lot of positive things going on both in your markets and obviously in the market at large. Can you talk about where that could possibly go in 2013 and 2014 if the trends that we’re seeing continue?

Michael Covey

Well, we are not – we will give guidance on our harvest activity – the plans for 2013 during our first quarter earnings call in late January, early February. But I think it’s safe to say and we have been clear that we took a major decision to defer a lot of harvest during this downturn and we’ve got significant upside potential as markets recover . And if these trends continue, we will start bringing it back to market over the next few years.

Joshua Barber - Stifel Nicolaus

And Mike, you guys talked a little bit before about how much supply you’re still on the frontline – in the lumber world of capacity, more specifically at what point do you think that what we are seeing in lumber prices today start to translate again to what we saw from plywood early in this quarter and there will be some announcements that start having a pretty decent impact on pricing? And where are we in your mind at least in terms of the supply relative to where the market is and where the market is probably going to go in the next six-months?

Eric Cremers

It’s really hard to say, Josh. We haven’t seen a lot of mill restarts frankly since this recovery began. And I think a lot of people in the industry are really skittish. Industry has been through some really tough times and I think most people are looking at bringing on supply very incrementally along with demand. If you look at supply it’s up 6-7% year-to-date and that's consistent with demand being higher plus 6% or 7% year-to-date. I think people are just being really, really cautious and I think the industry has been through some rough times and credit part of the analysis here, because thinking of mill regoing again you’ve got to build working capital and find the crews and what not. I think it’s a lot harder than most people realize. So I think it will be slow to be come back to market.

Joshua Barber - Stifel Nicolaus

Last question, are you seeing any issues in the past quarter or so – and quarter to date both on the logging and on the lumber side, in terms of contractors and trucking?

Eric Cremers

Well we’re seeing a little bit of cost pressure on the logging and hauling side. I think we said at the start of the year we expect our costs to be a little bit higher for the year. And I think so far this year our full-year outlook is logging and hauling costs up $0.50 a ton in the south and up above $0.95 a ton in the north. So we are seeing a little bit of cost pressure but it appears to be manageable.

Michael Covey

And I don’t think that -- we don’t anticipate that if we did decide to raise harvest levels next year, that we would have any barriers or constraints due to lack of logging contractor capacity. We have a core contracting force that’s capable of managing more output.

Operator

Your next question comes from the line of Albert Sebastian - Prospect Advisors

Albert Sebastian - Prospect Advisors

Most of my questions have been answered but just a quick one. I guess for modelling purposes, we should assume a 160 to 165 million board feet is – for lumber production is essentially a full capacity?

Eric Cremers

For the fourth quarter, 160 million might be a good number.

Albert Sebastian - Prospect Advisors

So in terms of your ability to other than that the small debottlenecking projects you announced, that’s essentially the maximum output you could produce over a sustained period?

Eric Cremers

Where we stand today, that’s correct.

Operator

Your next question is a follow-up from Chip Dillon with Vertical Research.

Chip Dillon - Vertical Research

I might have missed this. And I know it’s too early you’re going to tell us in earlier than a year, but did you think you can comment about what your harvest could be next year, it could have – I mean would it make sense to maybe that it would start with the four in terms of millions of tons?

Michael Covey

No, we did not say that. We didn’t say yes and we didn’t say no. We didn’t give any guidance about that. As you know, we have deferred about a million tons of harvest, currently at about 3.5 million tons and we have said our sustainable level to manage is around 4.5 million tons. So we’re down about a million and we will give guidance in February, in late January on next year’s plans.

Chip Dillon - Vertical Research

And I guess to be realistic, that’s only prudent, because a) you want to see how the market develops and b) I think there are probably some specific areas like Arkansas I guess where you have to sort of see what the local interest on the ground is, is that fair?

Michael Covey

Yes, that’s fair.

Chip Dillon - Vertical Research

And then secondly, as we see the numbers move up in wood products, and let’s say this recovery continues, does it be hoof you all assuming there is not a change in the near term in the land that -- transaction offers for you to behave a bias toward maybe slowing down your pace of the sales of timberlands or should we continue to see them at the rate that we've seen in recent years? I know it’s been lumpy.

Michael Covey

Well, we’ve said at the start of this year, Chip, that we only plan to sell about 20,000 to 25,000 acres of land, and that's what we’re on pace to do almost all of that this year, get back all of that this year is rural recreational land and HBU sales. We only have about 15,000 acres of non-strategic timberland that we’ve identified the start of this year that we plan to sell, and we haven’t sold any of that.

So the large land sales, the non-strategic land sales that we did in the last three years are largely behind us. Going forward it will be the 25 or 30 transactions a quarter of small deals. That’s what we will do over the next several years.

Chip Dillon - Vertical Research

And so that roughly adds up like in the 10 to 15,000 per year range, is that a good kind of guess that’d be at?

Michael Covey

This year we said 20 to 25,000, we also said it will be little less next year. So we will give more guidance on that in January.

Operator

At this time there are no additional questions. I will turn it back over to management for closing remarks.

Michael Covey

Well, thank you all for joining us. We will speak to you in our first earnings call at the start of the year. Thank you.

Operator

Thank you. This concludes today’s conference. You may now disconnect.

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