##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





Quarterly Report Under Section 13 or 15(d)


of the Securities Exchange Act of 1934





For Quarter Ended September 30, 2002





Commission file number 1-5313





---




POTLATCH CORPORATION


(Exact name of registrant as specified in its charter)





A Delaware Corporation

82-0156045(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)





601 West Riverside Ave., Suite 1100Spokane, Washington

99201(Address of principal executive offices)

(Zip Code)





Registrants telephone number, including area code (509) 835-1500





---




Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ̈





The number of shares of common stock outstanding as of September
30, 2002: 28,513,923 shares of Common Stock, par value $1 per share.





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##### Table of Contents

POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





Index to Form 10-Q





Page NumberPART I.    FINANCIAL INFORMATIONItem 1.    Financial StatementsStatements of Operations for the quarters and nine months ended September 30, 2002 and 2001

2Condensed Balance Sheets at September 30, 2002 and December 31, 2001

3Condensed Statements of Cash Flows for the nine months ended September 30, 2002 and 2001

4Notes to Financial Statements

5-16Item 2.    Managements Discussion and Analysis of Financial Condition and Results of Operations

17-28Item 3.    Quantitative and Qualitative Disclosures About Market Risk

29Item 4.    Disclosure Controls and Procedures

29PART II.    OTHER INFORMATIONItem 6.    Exhibits and Reports on Form 8-K

29SIGNATURES

30OFFICER CERTIFICATIONS

31-32EXHIBIT INDEX

33







1




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##### Table of Contents




PART I





Item 1.    Financial Statements





POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





STATEMENTS OF OPERATIONS


Unaudited (Dollars in thousandsexcept per-share amounts)





Quarter EndedSeptember 30


Nine Months EndedSeptember 302002


2001


2002


2001Net sales

$
324,060


$
337,903


$
975,427


$
985,801Costs and expenses:Depreciation, amortization and cost of fee timber harvested


29,067



30,270



86,795



85,142Materials, labor and other operating expenses


271,910



269,599



823,169



839,812Selling, general and administrative expenses


20,814



22,037



63,761



63,079Restructuring charge






353







4,570321,791



322,259



973,725



992,603Earnings (loss) from operations


2,269



15,644



1,702



(6,802
)Interest expense


(13,984
)


(22,009
)


(48,289
)


(57,377
)Debt extinguishment costs


(9,256
)






(15,154
)


Other income, net


3,950



2,612



9,483



5,142Loss before taxes on income


(17,021
)


(3,753
)


(52,258
)


(59,037
)Provision (benefit) for taxes on income (Note 2)


(6,639
)


(1,464
)


(20,381
)


(23,025
)Loss from continuing operations


(10,382
)


(2,289
)


(31,877
)


(36,012
)Discontinued operations (Note 3):Loss from discontinued operations (including loss on disposal of $0, $0, $254,970 and $0)


(3,361
)


(6,987
)


(275,451
)


(19,239
)Income tax benefit


(1,310
)


(2,725
)


(107,425
)


(7,503
)Net loss

$
(12,433
)

$
(6,551
)

$
(199,903
)

$
(47,748
)Net loss per common share from continuing operations (Note 4):Basic

$
(.36
)

$
(.08
)

$
(1.12
)

$
(1.27
)Diluted


(.36
)


(.08
)


(1.12
)


(1.27
)Net loss per common share:Basic


(.43
)


(.23
)


(7.03
)


(1.69
)Diluted


(.43
)


(.23
)


(7.03
)


(1.69
)Dividends per common share (annual rate)


.60



.60



.60



1.17Average shares outstanding (in thousands):Basic


28,498



28,257



28,431



28,280Diluted


28,498



28,257



28,431



28,280


---

Certain 2001 balances have been conformed to the 2002 presentation.
See Note 1.





The accompanying notes are an integral part of these financial statements.




2




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##### Table of Contents




POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





CONDENSED BALANCE SHEETS


2002 amounts unaudited (Dollars in thousandsexcept per-share amounts)





September 30, 2002

December 31, 2001AssetsCurrent assets:Cash

$
8,769

$
7,475Restricted cash (Note 5)


15,013


98,200Short-term investments


27,624


30,509Receivables, net (Note 6)


127,594


118,632Inventories (Note 7)


141,038


107,713Prepaid expenses


36,341


31,274Assets held for sale (Note 3)


22,287


772,033Total current assets


378,666


1,165,836Land, other than timberlands


8,666


8,668Plant and equipment, at cost less accumulated depreciation


770,628


808,763Timber, timberlands and related logging facilities


397,117


395,668Other assets


118,565


108,211$
1,673,642

$
2,487,146Liabilities and Stockholders EquityCurrent liabilities:Current installments on long-term debt

$
15,607

$
132,603Accounts payable and accrued liabilities


206,994


189,916Early maturing long-term debt (Note 3)





197,000Liabilities related to assets held for sale (Note 3)


208


33,933Total current liabilities


222,809


553,452Long-term debt


640,328


820,522Other long-term obligations


210,629


195,258Deferred taxes


98,656


210,610Stockholders equity


501,220


707,304$
1,673,642

$
2,487,146Stockholders equity per common share

$
17.58

$
24.98Working capital

$
155,857

$
612,384Current ratio


1.7:1


2.1:1


---

Certain 2001 balances have been conformed to the 2002 presentation.
See Note 1.





The accompanying notes are an integral part of these financial statements.




3




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##### Table of Contents




POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





CONDENSED STATEMENTS OF CASH FLOWS


Unaudited (Dollars in thousands)





Nine Months EndedSeptember 302002


2001Cash Flows From Continuing OperationsNet loss

$
(199,903
)

$
(47,748
)Adjustments to reconcile net loss to net operating cash flows:Loss from discontinued operations


12,493



11,736Loss on disposal of discontinued operations


221,223



Depreciation, amortization and cost of fee timber harvested


86,795



85,142Deferred taxes


(111,954
)


(18,828
)Working capital changes


(27,698
)


17,654Debt financing costs write-off


4,570



Other, net


(4,896
)


(2,168
)Net cash provided by (used for) operating activities of continuing operations


(19,370
)


45,788Cash Flows From InvestingDecrease (increase) in restricted cash


83,187



(97,549
)Decrease (increase) in short-term investments


2,876



(46,900
)Additions to investments


(3,491
)


(3,415
)Reductions in investments


1,616



1,558Additions to plant and properties


(37,258
)


(36,610
)Net cash provided by (used for) investing activities of continuing operations


46,930



(182,916
)Cash Flows From FinancingChange in book overdrafts


(2,578
)


(2,031
)Decrease in notes payable






(188,943
)Proceeds from long-term debt






450,000Repayment of long-term debt


(494,190
)


(100,768
)Long-term debt issuance fees






(15,352
)Issuance of treasury stock


5,482



3,524Purchase of treasury stock






(8,349
)Dividends


(12,789
)


(28,868
)Other, net


(4,319
)


(6,531
)Net cash provided by (used for) financing activities of continuing operations


(508,394
)


102,682Cash from continuing operations


(480,834
)


(34,446
)Cash from discontinued operations


482,128



30,692Increase (decrease) in cash


1,294



(3,754
)Balance at beginning of period


7,475



10,657Balance at end of period

$
8,769


$
6,903


---

Net interest payments (net of amounts capitalized) for the nine
months ended September 30, 2002 and 2001 were $52.9 million and $38.8 million, respectively. Net income tax payments (refunds) for the nine months ended September 30, 2002 and 2001 were $(15.9) million and $.4 million, respectively.





Certain 2001 balances have been conformed to the 2002 presentation. See Note 1.





The accompanying notes are an integral part of these financial statements.




4




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##### Table of Contents




POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS


Unaudited (Dollars in thousands)





NOTE 1.    GENERAL  The accompanying condensed balance sheets at September 30, 2002, and December 31, 2001, the statements of operations for the quarter and nine months ended September 30, 2002 and
2001, and the condensed statements of cash flows for the nine months ended September 30, 2002 and 2001, have been prepared in conformity with accounting principles generally accepted in the United States of America. We believe that all adjustments
necessary for a fair statement of the results of such interim periods have been included. On March 18, 2002, we announced that we had signed a definitive agreement to sell a majority of the assets of our Printing Papers segment to a domestic
subsidiary of Sappi Limited, and upon completion of the sale in May 2002, we exited the printing papers business. On June 3, 2002, we announced our intention to close our hardwood lumber mill in Warren, Arkansas, and exit the hardwood lumber
business. We sold the facility in August 2002. As a result, the Printing Papers segment and the hardwood lumber mill operations have been classified as discontinued operations and assets held for sale in the financial
statements presented herein. Year 2001 comparative amounts have been reclassified to conform to the 2002 presentation. Except for adjustments to the carrying value of the Printing Papers segment and hardwood lumber mill assets, made in conjunction
with the announcements and pursuant to Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, all adjustments were of a normal recurring nature; there were no other
material nonrecurring adjustments.





NOTE 2.    INCOME TAXES  The provision or benefit for taxes on
income has been computed by applying an estimated annual effective tax rate. This rate was 39 percent for the quarter and nine months ended September 30, 2002 and 2001.





NOTE 3.    DISCONTINUED OPERATIONS  On March 18, 2002, we announced that we had signed a definitive agreement with a domestic subsidiary of Sappi Limited for the sale
of our Cloquet, Minnesota, pulp and printing papers facilities and certain associated assets (Printing Papers segment assets) for $480 million in cash. The sale was completed in May 2002. As a result of the transaction, we recorded an
after-tax charge of $149.8 million in the first quarter of 2002. The charge represents estimated costs associated with the write-down of the carrying value of the assets involved in the sale and closure of the Brainerd facility, as well as other
costs associated with exiting the coated paper business. The charge and year-to-date operating losses of $11.6 million, after tax, are presented as discontinued operations in the Statements of Operations, as required by SFAS No. 144.





In conjunction with the sale, we closed our Brainerd, Minnesota, printing papers mill. In late October we entered into a
memorandum of understanding with a potential buyer for the sale of the Brainerd facility. The sale is subject to several contingencies, including the execution of a definitive agreement.





On June 3, 2002, we announced that we would close our Bradley hardwood mill in Warren, Arkansas, and exit the hardwood lumber business. We sold the facility in August 2002.
An after-tax charge of $5.7 million was recorded for estimated asset write-down and closure costs. The charge and year-to date operating losses of $.9 million, after tax, are presented as discontinued operations in the Statements of Operations, as
required by SFAS No. 144.




5




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







The assets and liabilities of the Printing Papers segment and the
Bradley lumber mill are presented in the Balance Sheets under the captions Assets held for sale and Liabilities related to assets held for sale. The carrying amounts of the major classes of these assets and liabilities are as
follows:








September 30, 2002

December 31, 2001(Dollars in thousands)AssetsCash

$


$
292Receivables, net





40,715Inventories


6,194


76,858Land, other than timberlands


108


374Plant and equipment, net


15,899


653,785Other assets


86


9Total assets held for sale

$
22,287

$
772,033LiabilitiesAccounts payable and accrued liabilities

$
208

$
33,933





Upon consummation of the sale of the Printing Papers segment assets
in May, all outstanding amounts under our bank credit facility became due and payable, including the four-year term loan. Accordingly, amounts outstanding under the four-year term loan at December 31, 2001, of which $2.0 million was due within one
year and $197.0 million was due in 2003 and later years, were classified as current liabilities.





NOTE 4.    LOSS
PER COMMON SHARE  Loss per common share is computed by dividing the net loss and loss from continuing operations by the weighted average number of common shares outstanding in accordance with SFAS No. 128, Earnings Per Share.





The following table reconciles the number of common shares used in the basic and diluted earnings per share
calculations (in thousands):





Quarter Ended September 30

Nine Months Ended September 302002

2001

2002

2001Basic average common shares outstanding

28,498

28,257

28,431

28,280Incremental shares due to common stock options and put options







Diluted average common shares outstanding

28,498

28,257

28,431

28,280





Incremental shares due to common stock options and put options were
not included in the diluted average common shares outstanding totals due to their antidilutive effect as a result of our net loss for the periods presented. The amounts (in thousands) not included for stock options and put options




6




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)




totaled 20 and 0, respectively, for the quarter ended September 30, 2002; 1 and 15, respectively, for the quarter ended September 30, 2001; 25 and 0, respectively, for the nine months ended
September 30, 2002; and 7 and 35, respectively, for the nine months ended September 30, 2001. Stock options to purchase 2,078, 1,984, 2,078 and 1,958 shares (in thousands) of common stock for the quarters ended September 30, 2002 and 2001 and nine
months ended September 30, 2002 and 2001, respectively, were not included in the computation of diluted earnings per share because the exercise prices of the stock options were greater than the average market price of the common shares.





NOTE 5.    RESTRICTED CASH  In June 2001, we entered into a new credit facility. Under the terms of
that financing we placed $96.6 million of the proceeds into an interest-bearing escrow account. The escrow accounts use was restricted to the repayment of our $100 million 6.25% debentures, which occurred on March 15, 2002.





In September 2002, we placed $15.0 million into an interest-bearing escrow account under the terms of an amendment to our
credit agreement. The escrow accounts use is restricted to the repayment of $15 million of our medium-term notes, bearing an interest rate of 9.42%, which mature on April 4, 2003.





NOTE 6.    RECEIVABLES, NET  Included in the Receivables, net balance at September 30, 2002, and December 31, 2001, is approximately $22.3
million due to settlements reached with the Internal Revenue Service for the years 1989 through 1994. The settlements exceed the threshold amount that requires review by the congressional Joint Committee on Taxation, which review is currently in
process.





NOTE 7.    INVENTORIES  Inventories related to continuing operations at the balance sheet
dates consist of:





September 30, 2002

December 31, 2001Raw materials

$
64,559

$
55,443Work in process


491


456Finished goods


75,988


51,814$
141,038

$
107,713




7




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







NOTE 8.    SEGMENT
INFORMATION 





Quarter Ended September 30


Nine Months Ended September 302002


2001


2002


2001(Dollars in thousands)Segment SalesResource

$
106,301


$
131,502


$
314,039


$
304,262Wood productsOriented strand board


47,538



48,395



141,043



128,932Lumber


58,866



70,164



198,149



199,080Plywood


9,265



12,118



28,078



34,671Particleboard


4,051



3,201



11,802



10,903Other


4,573



6,733



15,952



19,693124,293



140,611



395,024



393,279Pulp and paperPaperboard


99,301



103,473



292,236



325,266Tissue


74,705



82,929



237,042



244,945Pulp


4,477



3,289



11,803



10,784178,483



189,691



541,081



580,995409,077



461,804



1,250,144



1,278,536Elimination of intersegment sales


(85,017
)


(123,901
)


(274,717
)


(292,735
)Total consolidated net sales

$
324,060


$
337,903


$
975,427


$
985,801Intersegment sales or transfersResource

$
81,605


$
119,198


$
264,121


$
278,682Wood products


2,723



4,693



9,888



14,023Pulp and paper


689



10



708



30Total

$
85,017


$
123,901


$
274,717


$
292,735Operating Income (Loss)Resource

$
19,742


$
17,860


$
42,269


$
35,730Wood products


(9,126
)


34



(9,389
)


(12,657
)Pulp and paper


2,871



9,973



2,297



(411
)Eliminations and adjustments


309



(1,560
)


664



(694
)13,796



26,307



35,841



21,968Corporate


(30,817
)


(30,060
)


(88,099
)


(81,005
)Consolidated loss from continuing operations before taxes on income

$
(17,021
)

$
(3,753
)

$
(52,258
)

$
(59,037
)


---

Certain 2001 balances have been conformed to the 2002 presentation.




8




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







NOTE 9.    SUBSIDIARY GUARANTORS  A portion of our
outstanding debt is unconditionally guaranteed, on a joint and several basis, by four of our subsidiaries, which are also guarantors, on an unconditional, joint and several basis, of any obligations under our current bank credit facilities.





Consolidating statements of operations for the quarter and nine months ended September 30, 2002 and 2001 are as
follows (unaudited):





For the quarter ended September 30, 2002Parent Company


Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)Net sales

$
324,060


$
265


$
(265
)

$
324,060Costs and expenses:Depreciation, amortization and cost of fee timber harvested


29,048



19







29,067Materials, labor and other operating expenses


272,162



13



(265
)


271,910Selling, general and administrative expenses


20,703



111







20,814321,913



143



(265
)


321,791Earnings from operations


2,147



122







2,269Interest expense


(13,984
)










(13,984
)Debt extinguishment costs


(9,256
)










(9,256
)Other income (expense), net


3,951



(1
)






3,950Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(17,142
)


121







(17,021
)Equity in net income of consolidated subsidiaries


74







(74
)


Provision (benefit) for taxes on income


(6,686
)


47







(6,639
)Earnings (loss) from continuing operations


(10,382
)


74



(74
)


(10,382
)Discontinued operations:Loss from discontinued operations


(3,361
)










(3,361
)Income tax benefit


(1,310
)










(1,310
)Net earnings (loss)

$
(12,433
)

$
74


$
(74
)

$
(12,433
)




9




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







For the quarter ended September 30, 2001Parent Company


Subsidiary Guarantors

Eliminations


Consolidated(Dollars in thousands)Net sales

$
337,903


$
296

$
(296
)

$
337,903Costs and expenses:Depreciation, amortization and cost of fee timber harvested


30,249



21






30,270Materials, labor and other operating expenses


269,778



117


(296
)


269,599Selling, general and administrative expenses


21,936



101






22,037Restructuring charge


353










353322,316



239


(296
)


322,259Earnings from operations


15,587



57






15,644Interest expense


(22,009
)









(22,009
)Other income, net


2,612










2,612Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(3,810
)


57






(3,753
)Equity in net income of consolidated subsidiaries


35






(35
)


Provision (benefit) for taxes on income


(1,486
)


22






(1,464
)Earnings (loss) from continuing operations


(2,289
)


35


(35
)


(2,289
)Discontinued operations:Earnings (loss) from discontinued operations


(6,987
)


223


(223
)


(6,987
)Income tax provision (benefit)


(2,725
)


87


(87
)


(2,725
)Net earnings (loss)

$
(6,551
)

$
171

$
(171
)

$
(6,551
)




10




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







For the nine months ended September 30, 2002Parent Company


Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)Net sales

$
975,427


$
763


$
(763
)

$
975,427Costs and expenses:Depreciation, amortization and cost of fee timber harvested


86,736



59







86,795Materials, labor and other operating expenses


823,762



170



(763
)


823,169Selling, general and administrative expenses


63,445



316







63,761973,943



545



(763
)


973,725Earnings from operations


1,484



218







1,702Interest expense


(48,289
)










(48,289
)Debt extinguishment costs


(15,154
)










(15,154
)Other income (expense), net


9,485



(2
)






9,483Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(52,474
)


216







(52,258
)Equity in net income of consolidated subsidiaries


132







(132
)


Provision (benefit) for taxes on income


(20,465
)


84







(20,381
)Earnings (loss) from continuing operations


(31,877
)


132



(132
)


(31,877
)Discontinued operations:Loss from discontinued operations


(275,451
)


(82
)


82



(275,451
)Income tax benefit


(107,425
)


(32
)


32



(107,425
)Net earnings (loss)

$
(199,903
)

$
82


$
(82
)

$
(199,903
)




11




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







For the nine months ended September 30, 2001Parent Company


Subsidiary Guarantors

Eliminations


Consolidated(Dollars in thousands)Net sales

$
985,801


$
886

$
(886
)

$
985,801Costs and expenses:Depreciation, amortization and cost of fee timber harvested


85,076



66






85,142Materials, labor and other operating expenses


840,475



223


(886
)


839,812Selling, general and administrative expenses


62,790



289






63,079Restructuring charge


4,570










4,570992,911



578


(886
)


992,603Earnings (loss) from operations


(7,110
)


308






(6,802
)Interest expense


(57,377
)









(57,377
)Other income, net


5,142










5,142Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(59,345
)


308






(59,037
)Equity in net income of consolidated subsidiaries


188






(188
)


Provision (benefit) for taxes on income


(23,145
)


120






(23,025
)Earnings (loss) from continuing operations


(36,012
)


188


(188
)


(36,012
)Discontinued operations:Earnings (loss) from discontinued operations


(19,239
)


672


(672
)


(19,239
)Income tax provision (benefit)


(7,503
)


262


(262
)


(7,503
)Net earnings (loss)

$
(47,748
)

$
598

$
(598
)

$
(47,748
)




12




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







Condensed consolidating balance sheets as of September 30, 2002 and
December 31, 2001 are as follows (2002 amounts unaudited):





September 30, 2002Parent Company

Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)AssetsCurrent assets:Cash

$
8,686

$
83


$



$
8,769Restricted cash


15,013










15,013Short-term investments


27,624










27,624Receivables, net


127,374


217



3



127,594Inventories


140,874


164







141,038Prepaid expenses


36,375


(34
)






36,341Assets held for sale


22,287










22,287Total current assets


378,233


430



3



378,666Land, other than timberlands


8,270


396







8,666Plant and equipment, at cost less accumulated depreciation


769,810


818







770,628Timber, timberlands and related logging facilities


397,117










397,117Other assets


119,811






(1,246
)


118,565$
1,673,241

$
1,644


$
(1,243
)

$
1,673,642Liabilities and Stockholders EquityCurrent liabilities:Current installments on long-term debt

$
15,607

$



$



$
15,607Accounts payable and accrued liabilities


206,899


92



3



206,994Liabilities related to assets held for sale


208










208Total current liabilities


222,714


92



3



222,809Intercompany transfers


30,786


(30,786
)






Long-term debt


640,328










640,328Other long-term obligations


210,629










210,629Deferred taxes


98,656










98,656Stockholders equity


470,128


32,338



(1,246
)


501,220$
1,673,241

$
1,644


$
(1,243
)

$
1,673,642




13




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







December 31, 2001Parent Company

Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)AssetsCurrent assets:Cash

$
7,391

$
84


$



$
7,475Restricted cash


98,200










98,200Short-term investments


30,509










30,509Receivables, net


118,509


123







118,632Inventories


107,553


160







107,713Prepaid expenses


31,274










31,274Assets held for sale


770,784


1,249







772,033Total current assets


1,164,220


1,616







1,165,836Land, other than timberlands


8,272


396







8,668Plant and equipment, at cost less accumulated depreciation


807,886


877







808,763Timber, timberlands and related logging facilities


395,668










395,668Other assets


109,457






(1,246
)


108,211$
2,485,503

$
2,889


$
(1,246
)

$
2,487,146Liabilities and Stockholders EquityCurrent liabilities:Current installments on long-term debt

$
132,603

$



$



$
132,603Accounts payable and accrued liabilities


189,823


93







189,916Early maturing long-term debt


197,000










197,000Liabilities related to assets held for sale


34,023


(90
)






33,933Total current liabilities


553,449


3







553,452Intercompany transfers


29,872


(29,872
)






Long-term debt


820,522










820,522Other long-term obligations


195,258










195,258Deferred taxes


210,610










210,610Stockholders equity


675,792


32,758



(1,246
)


707,304$
2,485,503

$
2,889


$
(1,246
)

$
2,487,146




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







Condensed consolidating statements of cash flows for the nine months
ended September 30, 2002 and 2001 are as follows (unaudited):





For the nine months ended September 30, 2002Parent Company


Subsidiary Guarantors


Eliminations

Consolidated(Dollars in thousands)Cash Flows From Continuing OperationsNet earnings (loss)

$
(199,985
)

$
82


$


$
(199,903
)Adjustments to reconcile net earnings (loss) to net operating cash flows:Loss from discontinued operations


12,443



50






12,493Loss on disposal of discontinued operations


221,223










221,223Depreciation, amortization and cost of fee timber harvested


86,736



59






86,795Deferred taxes


(111,954
)









(111,954
)Working capital changes


(27,633
)


(65
)





(27,698
)Other, net


(326
)









(326
)Net cash provided by (used for) operating activities of continuing operations


(19,496
)


126






(19,370
)Cash Flows From InvestingDecrease in restricted cash


83,187










83,187Decrease in short-term investments


2,876










2,876Additions to investments


(3,491
)









(3,491
)Reductions in investments


1,616










1,616Investments and advances from subsidiaries


396



(396
)





Additions to plant and properties


(37,258
)









(37,258
)Net cash provided by (used for) investing activities of continuing operations


47,326



(396
)





46,930Cash Flows From FinancingChange in book overdrafts


(2,578
)









(2,578
)Repayment of long-term debt


(494,190
)









(494,190
)Issuance of treasury stock


5,482










5,482Dividends


(12,789
)









(12,789
)Other, net


(4,319
)









(4,319
)Net cash used for financing activities of continuing operations


(508,394
)









(508,394
)Cash from continuing operations


(480,564
)


(270
)





(480,834
)Cash from discontinued operations


481,859



269






482,128Increase (decrease) in cash


1,295



(1
)





1,294Balance at beginning of period


7,391



84






7,475Balance at end of period

$
8,686


$
83


$


$
8,769




15




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in
thousands)







For the nine months ended September 30, 2001Parent Company


Subsidiary Guarantors


Eliminations

Consolidated(Dollars in thousands)Cash Flows From Continuing OperationsNet earnings (loss)

$
(48,346
)

$
598


$


$
(47,748
)Adjustments to reconcile net earnings (loss) to net operating cash flows:Loss (earnings) from discontinued operations


12,146



(410
)





11,736Depreciation, amortization and cost of fee timber harvested


85,076



66






85,142Deferred taxes


(18,828
)









(18,828
)Working capital changes


17,631



23






17,654Other, net


(2,168
)









(2,168
)Net cash provided by operating activities of continuing operations


45,511



277






45,788Cash Flows From InvestingIncrease in restricted cash


(97,549
)









(97,549
)Increase in short-term investments


(46,900
)









(46,900
)Additions to investments


(3,415
)









(3,415
)Reductions in investments


1,558










1,558Investments and advances from subsidiaries


1,057



(1,057
)





Additions to plant and properties


(36,610
)









(36,610
)Net cash used for investing activities of continuing operations


(181,859
)


(1,057
)





(182,916
)Cash Flows From FinancingChange in book overdrafts


(2,031
)









(2,031
)Decrease in notes payable


(188,943
)









(188,943
)Proceeds from long-term debt


450,000










450,000Repayment of long-term debt


(100,768
)









(100,768
)Long-term debt issuance fees


(15,352
)









(15,352
)Issuance of treasury stock


3,524










3,524Purchase of treasury stock


(8,349
)









(8,349
)Dividends


(28,868
)









(28,868
)Other, net


(6,531
)









(6,531
)Net cash provided by financing activities of continuing operations


102,682










102,682Cash from continuing operations


(33,666
)


(780
)





(34,446
)Cash from discontinued operations


29,950



742






30,692Decrease in cash


(3,716
)


(38
)





(3,754
)Balance at beginning of period


10,526



131






10,657Balance at end of period

$
6,810


$
93


$


$
6,903




16




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##### Table of Contents

|ITEM 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- |  | -------------------------------------------------------------------------------------




Overview





We are a
vertically integrated and diversified forest products company. We own approximately 1.5 million acres of timberland and operate 15 manufacturing facilities, located primarily in Arkansas, Idaho and Minnesota. Our business is organized into three
segments: (i) Resource, which manages our timberlands and supplies wood fiber to our manufacturing segments and third parties; (ii) Wood Products, which manufactures oriented strand board (OSB), plywood, lumber and particleboard, and (iii) Pulp and
Paper, which manufactures bleached paperboard, consumer tissue and bleached softwood market pulp.





In May 2002, we
exited a fourth business segment, Printing Papers, which produced primarily high grade coated printing papers and bleached hardwood market pulp. Our exit from this business was done in conjunction with the sale of our Cloquet, Minnesota, pulp and
printing papers facilities and certain associated assets to a domestic subsidiary of Sappi Limited for $485.5 million in cash, after closing adjustments. We closed our Brainerd, Minnesota, printing papers mill at the same time. In late October we
entered into a memorandum of understanding with a potential buyer for the sale of the Brainerd facility. The sale is subject to several contingencies, including the execution of a definitive agreement. As a result of the sale of the Brainerd
facility and our exit from the printing papers business, we anticipate recording an additional pre-tax charge in the fourth quarter of 2002 in the range of $10 million to $16 million. The sale of the printing papers business reflects a strategic
realignment to focus in particular on our natural resources, wood products and consumer tissue businesses, which we believe have the greatest potential for growth.





This report contains, in addition to historical information, forward-looking statements. These forward-looking statements are based on managements best estimates and
assumptions regarding future events, and are therefore subject to known and unknown risks and uncertainties and are not guarantees of future performance. Our actual results could differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below under Factors Influencing Our Results of Operations.





A certification with respect to this Quarterly Report on Form 10-Q by our Chief Executive Officer and Chief Financial Officer, as required
by Section 906 of the Sarbanes-Oxley Act of 2002, has been submitted to the SEC as additional correspondence accompanying this report.





Critical Accounting Policies





Our principal accounting policies are discussed on pages
30-32 of our Form 10-K for the year ended December 31, 2001. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions
that affect the reported financial position and operating results of the company. Management believes the accounting policies discussed below represent the most complex, difficult and subjective judgments it makes in this regard.




17




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##### Table of Contents




Long-lived assets.    We account for long-lived assets in
accordance with Financial Accounting Standards Board (FASB) Statement No. 144. The statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The test for impairment requires management to estimate future cash flows, which can differ materially from actual future results based upon many factors, including but not limited to changes in economic conditions, environmental
requirements, and capital spending.





Restructuring and other charges.    In 2000 and 2001 we
recorded charges for the restructuring of our salaried workforce, the closure of a manufacturing plant and the reduction of the hourly workforce at another site. We also completed the sale of a majority of our Printing Papers segment assets, and the
corresponding closure of a printing papers facility in May 2002. In June 2002 we announced plans to close a hardwood lumber mill in Warren, Arkansas, which we closed in July. The mill was sold in August 2002. These events require estimates of
liabilities for employee benefits, demolition, environmental clean-up and other costs, which could materially differ from actual costs incurred.





Environmental liabilities.    We record accruals for estimated environmental liabilities in accordance with FASB Statement No. 5. These estimates reflect assumptions and judgments
as to the probable nature, magnitude and timing of required investigation, remediation and monitoring activities. Due to the numerous uncertainties and variables associated with these assumptions and judgments, and changes in governmental
regulations and environmental technologies, our accruals are subject to substantial uncertainties and our actual costs could be materially more or less than the estimated amounts.





Pension and postretirement benefits.    Substantially all of our employees are covered by noncontributory defined benefit pension plans, and certain
salaried and hourly employees are covered by company-sponsored defined benefit retiree health care and life insurance plans. The cost of these plans is accounted for in accordance with FASB Statement Numbers 87, 106 and 132. These Statements require
assumptions regarding discount rates and asset returns and, with respect to the postretirement benefits plans, assumptions regarding medical cost trends. Actual asset returns and medical costs which are more favorable than our assumptions can have
the effect of lowering our expense and cash contributions, and conversely, actual results which are less favorable than our assumptions could increase our expense and cash contributions. Due to our recent exit from the coated printing papers
business and the resulting reduction in the number of salaried and hourly employees, we believe that our costs should decline in the future for pension and postretirement benefits.





Factors Influencing Our Results of Operations





Our
operating results have been and will continue to be influenced by a variety of factors, including the cyclical nature of the forest products industry, competition, the efficiency and level of capacity utilization of our manufacturing operations,
changes in our principal expenses such as wood fiber expenses and energy costs, changes in the production capacity of our manufacturing operations as a result of major capital spending projects and other factors.





Our operating results reflect the general cyclical pattern of the forest products industry. Our wood products are subject to competition
from manufacturers in North and South America. In addition, our pulp-based products, other than tissue products, are globally-traded commodity products. Historical prices for our products have been volatile, and we, like other




18




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##### Table of Contents

participants in the forest products industry, have limited direct influence over the timing and extent of price changes for our products. Product pricing is significantly affected by the
relationship between supply and demand in the forest products industry. Product supply is influenced primarily by fluctuations in available manufacturing capacity. Demand is affected by the state of the economy in general and a variety of other
factors. The demand for our timber resources and wood products is affected by the level of new residential construction activity and, to a lesser extent, home repair and remodeling activity, which are subject to fluctuations due to changes in
economic conditions, interest rates, population growth, weather conditions and other factors. The demand for most of our pulp and paper products is primarily affected by the state of the global economy, in general, and, in particular, the economies
in North America and east Asia.





The markets for our products are highly competitive and companies that have
substantially greater financial resources than we do compete with us in each of our markets. Our competitors are located throughout the world, and variations in exchange rates between the U.S. dollar and other currencies significantly affect our
competitive position compared to our international competitors. In addition, our industry is capital intensive, which leads to high fixed costs and generally results in continued production as long as prices are sufficient to cover variable costs.
These conditions have contributed to substantial price competition, particularly during periods of reduced demand. Some of our competitors are currently lower-cost producers in some of the businesses in which we operate and accordingly these
competitors may be less adversely affected than we are by price decreases.





Energy has become one of our most
volatile operating expenses over the past several years. Substantial price increases commenced in late 2000 and continued in the first half of 2001, before moderating in the second half of 2001. In the first nine months of 2002, energy prices
returned to more normal historical levels, which has had a favorable effect on our results compared to the same period of 2001. In periods of high energy prices, market conditions may prevent us from passing higher energy costs on to our customers
through price increases and therefore could adversely affect our operating results. We have taken steps to reduce our exposure to the volatile spot market for electricity. Our energy costs in future periods will depend principally on our ability to
continue to produce internally a substantial portion of our electricity needs and on changes in market prices for natural gas.





Another significant expense is the cost of wood fiber needed to supply our manufacturing facilities. Our timberlands provided approximately 53% of the log requirements for our sawmill and plywood manufacturing facilities in 2001 and
an average of approximately 62% of those requirements over the past five calendar years. Including the logs used for pulp and OSB, the percentages of our fiber requirements supplied by our timberlands were approximately 28% in 2001 and an average of
approximately 37% over the past five calendar years. Adjusted for our exit from the printing papers and hardwood lumber businesses, the percentage of our fiber requirements supplied by our timberlands was approximately 35% in 2001 and an average of
approximately 42% over the past five years. The percentage of our wood fiber requirements supplied by our timberlands will fluctuate based on a variety of factors, including changes in our timber harvest levels and changes in our manufacturing
capacity. The cost of various types of wood fiber that we purchase in the market has at times fluctuated greatly because of economic or industry conditions. Selling prices of our products have not always increased in response to wood fiber price
increases. On occasion, our results of operations have been and may in the future be adversely affected if we are unable to pass wood fiber price increases through to our customers.




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##### Table of Contents




Finally, changes in our manufacturing capacity primarily as a result of capital
spending programs have significantly affected our results of operations in recent periods. In September 2000, we closed our plywood mill in Jaype, Idaho, as a result of poor plywood markets, lack of adequate raw materials and long-term
transportation concerns. In January 2001, we completed a modernization and expansion of our OSB mill in Cook, Minnesota, resulting in an increase in annual production capacity from 250.0 million square feet to 435.0 million square feet. In May 2002,
we sold a majority of our Printing Papers segment assets to a domestic subsidiary of Sappi Limited and exited the printing papers business. In August 2002, we sold a hardwood sawmill in Arkansas and exited the hardwood lumber business. Each of these
changes has affected our levels of net sales and expenses, as well as the comparability of our operating results from period to period. Additionally, the profitability of our manufacturing segments depends largely on our ability to operate our
manufacturing facilities efficiently and at or near full capacity. Our operating results could be harmed if market demand does not justify operating at these levels or if our operations are inefficient or suffer significant interruption for any
reason.





Results of Operations





As noted above, our business is organized into three reporting segments: Resource; Wood Products; and Pulp and Paper. Sales or transfers between the segments are recorded as intersegment sales based on
prevailing market prices. Because of the role of the Resource segment in supplying our manufacturing segments with wood fiber from both our own timberlands and from outside third parties, intersegment sales represent a significant portion of the
Resource segments total net sales. Intersegment sales represent a substantially lower percentage of net sales for our other segments.





A summary of period-to-period changes in items included in the statements of operations is presented on page 28 of this Form 10-Q. In the period-to-period discussion of our results of operations below,
when we discuss our consolidated net sales, contributions by each of the segments to our net sales are reported after elimination of intersegment sales. In the Discussion of Business Segments sections below, each segments net sales
are set forth before elimination of intersegment sales. Also, in discussing our operating results we refer to net sales realizations, which for each product line are calculated by subtracting freight from net sales and then dividing the result by
the relevant quantities of the product shipped for the period. We believe net sales realizations are helpful in showing trends in the pricing of our products.




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##### Table of Contents




As a result of the sale of a majority of our Printing Papers segment assets and
the sale of the Bradley hardwood sawmill, those operations have been classified as discontinued operations and assets held for sale in the financial statements for the quarter and nine months ended September 30, 2002. Year
2001 comparative amounts in the financial statements have been reclassified to conform to the 2002 presentation. The discussion below addresses our continuing businesses.





Nine Months Ended September 30, 2002, Compared to Nine Months Ended September 30, 2001





Net Sales  Net sales decreased 1%, from $985.8 million for the nine months ended September 30, 2001, to $975.4 million for the same period in 2002. The decline was the result of a decrease
in net sales for the Pulp and Paper segment of $40.6 million. Partially offsetting the decrease in Pulp and Paper segment sales were increases in sales by the Resource segment of $24.3 million and the Wood Products segment of $5.9 million. An
increase in sales to external customers was responsible for the rise in net sales in the Resource segment. Increased shipments of oriented strand board were responsible for the increase in net sales for the Wood Products segment. Lower net sales
realizations for paperboard and consumer tissue products and decreased paperboard shipments caused net sales for the Pulp and Paper segment to decline.





Depreciation, amortization and cost of fee timber harvested  For the nine months ended September 30, 2002, depreciation, amortization and cost of fee timber harvested totaled $86.8
million, an increase of $1.7 million from the prior year period total of $85.1 million. The increase was largely due to higher depletion expense. Depletion expense was $2.7 million higher as a result of activities at our hybrid poplar plantation in
Boardman, Oregon, and increased permit timber harvests in Arkansas.





Materials, labor and other operating
expenses  Materials, labor and other operating expenses decreased $16.6 million, from $839.8 million for the nine months ended September 30, 2001, to $823.2 million for the nine months ended September 30, 2002. A decline of $26.3 million
in energy costs for the first nine months of 2002 compared to 2001 was partially offset by higher wood fiber costs.





Selling, general and administrative expenses  Selling, general and administrative expenses amounted to $63.8 million for the nine months ended September 30, 2002, up slightly from $63.1 million for the same period of
2001.





Restructuring charge  In March 2001 we recorded a $4.2 million pre-tax charge associated with
a workforce reduction plan at our pulp, paperboard and consumer products operations in Idaho. In September 2001, we recorded an additional $.4 million pre-tax charge for final cost determinations for pension and medical benefits.





Interest expense, net of capitalized interest  Interest expense was $48.3 million for the nine months ended
September 30, 2002, a decrease of $9.1 million from the prior year period. The decrease reflects our repayment of $494.2 million of debt during the first nine months of 2002, offset partially by a reduction in the amount of interest capitalized for
major construction projects in 2002.





Debt extinguishment costs  We incurred one-time, pre-tax costs
of $15.2 million for the nine months ended September 30, 2002, related to our early repayment of over $363 million of outstanding debt. These costs included cash fees and premiums of $10.6 million and the non-cash write-off of related debt financing
costs totaling $4.6 million.





Other income, net  For the nine months ended September 30, 2002, other
income was $9.5 million, compared to $5.1 million for the 2001 period. The higher income amount is largely due to increases in gains from the sale of nonstrategic timberland, interest income and recreational fee income.




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##### Table of Contents




Provision (benefit) for taxes on income  For the nine months ended
September 30, 2002, we recorded an income tax benefit from continuing operations of $20.4 million, reflecting our net loss before taxes, based on an estimated tax rate of 39%. For the nine months ended September 30, 2001, we recorded an income tax
benefit from continuing operations of $23.0 million, also reflecting a tax rate of 39%.





Loss from continuing
operations  We recorded a loss from continuing operations of $31.9 million for the nine months ended September 30, 2002, compared to a loss from continuing operations of $36.0 million for the same period in 2001.





Discussion of business segments  The Resource segment reported operating income of $42.3 million for the first nine months of
2002, up from $35.7 million earned in the same period of 2001. Segment net sales increased 3% from $304.3 million for the 2001 period to $314.0 million for the 2002 period. The rise in net sales was due to increased net sales realizations and higher
sales volumes to third parties in Idaho, Minnesota and Arkansas. Resource segment expenses increased 1% to $271.8 million for the first nine months of 2002, compared to $268.5 million for the first nine months of 2001. Increased logging costs were
largely responsible for the increase in expenses.





The Wood Products segment reported an operating loss of $9.4
million for the first nine months of 2002, compared to the $12.7 million loss recorded in the first nine months of 2001. Segment net sales were $395.0 million for the first nine months of 2002, just slightly higher than the $393.3 million recorded
for the 2001 period. Oriented strand board net sales increased $12.1 million, to $141.0 million for the first nine months of 2002 compared to $128.9 million in 2001, due to a 15% increase in shipments. Lumber net sales were down slightly to $198.1
million, from $199.1 million in 2001, as a result of a 2% decline in net sales realizations. Plywood net sales declined $6.6 million, from $34.7 million in 2001 to $28.1 million in 2002. Plywood shipments were down 23%, due in large part to lower
production in 2002 compared to 2001. Production was higher in 2001 due to extra shifts above the normal operating schedule at our St. Maries, Idaho, mill. Segment expenses were slightly lower for the first nine months of 2002, totaling $404.4
million versus $405.9 million in 2001. Small declines in energy and labor costs were partially offset by higher wood fiber costs. Wood fiber costs were slightly higher for the first nine months of 2002, largely due to operating the Cook, Minnesota,
oriented strand board mill for the full nine months in 2002. The mill was shut down for a portion of the first quarter of 2001 to complete a modernization and expansion project.





The Pulp and Paper segment reported operating income for the first nine months of 2002 of $2.3 million, compared to a loss of $.4 million for 2001s first nine months.
Segment net sales decreased to $541.1 million for the first nine months of 2002 from $581.0 million for the 2001 period. The decrease was due largely to lower net sales realizations and decreased shipments for paperboard and consumer tissue
products. Paperboard net sales realizations declined 8% and shipments were 3% below those for the first nine months of 2001. Consumer tissue product net sales realizations and shipments were down 2% and 1%, respectively. Segment expenses were also
lower for the first nine months of 2002, totaling $538.8 million compared to $581.4 million for the first nine months of 2001. Energy expenses were significantly lower for the first nine months of 2002. The decline in paperboard shipments resulted
in reduced cost of sales.




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Our discontinued operations, which consist of our former Printing Papers segment
and our Bradley sawmill in Warren, Arkansas, reported a loss, before taxes, of $20.5 million in 2002s first nine months, compared to a loss, before taxes, of $19.2 million in 2001. The Printing Papers segment operated until mid-May, when a
majority of its assets were sold. The Bradley sawmill was sold in late August. Additionally, during the first nine months of 2002 we recorded losses on the disposal of discontinued operations totaling $255.0 million, before taxes.





Three Months Ended September 30, 2002, Compared to Three Months Ended September 30, 2001





Net Sales  Net sales decreased 4%, to $324.1 million for the three months ended September 30, 2002, from $337.9 million for the same period in 2001. An
increase in Resource segment net sales of $12.4 million was more than offset by declines in net sales for the Wood Products segment of $14.3 million and the Pulp and Paper segment of $11.9 million. Resource segment net sales benefited from increased
sales to third parties in Idaho, Arkansas and Minnesota. A decline in shipments and lower net sales realizations for lumber and a decline in plywood shipments were largely responsible for the decrease in net sales for the Wood Products segment.
Lower net sales realizations for paperboard and consumer tissue products and a decline in consumer tissue product shipments caused net sales for the Pulp and Paper segment to decline.





Depreciation, amortization and cost of fee timber harvested  For the three months ended September 30, 2002, depreciation, amortization and cost of fee timber
harvested totaled $29.1 million, a decrease of $1.2 million from the prior year amount of $30.3 million. Lower permit timber harvests in Minnesota were responsible for the decline.





Materials, labor and other operating expenses  Materials, labor and other operating expenses increased slightly, to $271.9 million for the three months ended
September 30, 2002, from $269.6 million for the three months ended September 30, 2001. Increases in wood fiber and other production costs were mostly offset by lower energy costs of $4.6 million in the third quarter of 2002 compared to 2001.





Selling, general and administrative expenses  Selling, general and administrative expenses were
$20.8 million for the third quarter of 2002, compared to $22.0 million for the same period of 2001. Small decreases in administration and research expenses were responsible for the decline.





Interest expense, net of capitalized interest  Interest expense was $14.0 million for the three months ended September 30, 2002, a decrease from $22.0 million
in the prior year period. The decrease reflects our payment during 2002 of approximately $494 million in debt that was outstanding during the third quarter of 2001.





Debt extinguishment costs  We incurred one-time, pre-tax costs of $9.3 million for the quarter ended September 30, 2002, related to our early repayment of
approximately $118 million of outstanding debt. The costs include cash premiums of $8.6 million and the non-cash write-off of related debt financing costs totaling $.7 million.





Other income, net  For the three months ended September 30, 2002, other income was $4.0 million, compared to $2.6 million for the 2001 period. A greater gain
from the sale of nonstrategic timberlands in the current quarter compared to the 2001 quarter was the primary reason for the increase in income.




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Provision (benefit) for taxes on income  For the three months ended
September 30, 2002, we recorded an income tax benefit from continuing operations of $6.6 million, reflecting our net loss before taxes, based on an estimated tax rate of 39%. For the three months ended September 30, 2001, we recorded a tax benefit
from continuing operations of $1.5 million, also reflecting a tax rate of 39%.





Loss from continuing
operations  We recorded a loss from continuing operations of $10.4 million for the three months ended September 30, 2002, compared to a loss from continuing operations of $2.3 million for the same period in 2001.





Discussion of business segments  The Resource segment reported operating income of $19.7 million for the third quarter of
2002, up from $17.9 million earned in the same period of 2001. Segment net sales decreased 19% from $131.5 million for the 2001 period to $106.3 million for the 2002 period. The decrease in net sales was due to decreased wood fiber sales to our
other operating segments in Arkansas, Idaho and Minnesota. Our other operating segments are currently transitioning to a fiber procurement system where a portion of third party fiber purchases are made directly by each segment. The changes in the
fiber procurement system will likely result in lower intersegment sales for the Resource segment in the future and, consequently, lower fiber purchases by the Resource segment from third parties. Resource segment expenses decreased $27.1 million, to
$86.6 million in the third quarter of 2002, compared to $113.6 million in the third quarter of 2001. Decreased outside fiber purchases were largely responsible for the decrease in expenses.





The Wood Products segment reported an operating loss of $9.1 million for the third quarter of 2002, compared to breakeven results in the third quarter of 2001. Segment net
sales were $124.3 million for the third quarter of 2002, 12% lower than the $140.6 million recorded for the 2001 period. Oriented strand board net sales decreased slightly, to $47.5 million for the third quarter of 2002, compared to $48.4 million in
the 2001 period, due to a 13% decrease in net sales realizations, partially offset by a 10% increase in oriented strand board shipments. Lumber net sales were $58.9 million, down from $70.2 million in 2001. Lumber shipments decreased 13% and net
sales realizations were 3% lower than in the third quarter of 2001. Plywood net sales also declined, to $9.3 million for the third quarter of 2002 from $12.1 million in the third quarter of 2001. The decline reflects the absence of extra production
shifts at our plywood mill in 2001. Segment expenses were lower for the third quarter of 2002, totaling $133.4 million versus $140.6 million in 2001. Lower overall product shipments for the segment were primarily responsible for the decrease.





The Pulp and Paper segment reported operating income for the third quarter of 2002 totaling $2.9 million,
compared to $10.0 million for 2001s third quarter. Segment net sales decreased to $178.5 million for the third quarter of 2002 from $189.7 million for the 2001 period. The decrease was due largely to lower net sales realizations for paperboard
and consumer tissue products. Net sales realizations declined 6% for paperboard and 5% for tissue. Also, a 6% decrease in tissue shipments unfavorably affected results. Segment expenses were lower for the third quarter of 2002, totaling $175.6
million, compared to $179.7 million in the third quarter of 2001, mostly due to the reduced consumer tissue product shipments. Higher wood fiber costs more than offset lower energy expenses, which were approximately $4 million lower than in the
third quarter of 2001.




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##### Table of Contents




Our discontinued operations incurred a loss of $3.4 million, before taxes, for
the third quarter of 2002. The amount includes results for the winding down of manufacturing operations at the Bradley lumber mill, which was sold in August, and costs associated with the Printing Papers segment assets in Brainerd, Minnesota, which
were not a part of the sale of the segments assets to Sappi Limited.





Liquidity and Capital Funding





At September 30, 2002, our financial position included long-term debt of $655.9 million, including current installments on long-term debt
of $15.6 million. Long-term debt (including current installments and early maturing long-term debt) to stockholders equity was 1.31 to 1 at September 30, 2002, compared to 1.63 to 1 at December 31, 2001. Long-term debt at September 30, 2002
(including current installments and early maturing long-term debt) declined $494.2 million from the December 2001 balance. Our debt declined due to normal payments on maturing debt of $131.0 million and the early repayment of $363.4 million of
long-term debt, using a portion of the proceeds from the sale of the Printing Papers segment assets. We will continue to look for opportunities to make further reductions in our long-term debt. Stockholders equity declined $206.1 million,
largely due to a net loss of $199.9 million for the first nine months of 2002.





Payments due on long-term debt
during each of the five years subsequent to December 31, 2002 are as follows:





(Dollars in thousands)2003

$
15,6072004


6072005


1,6082006


2,9582007


6,759





In September 2002, we placed $15.0 million into an interest-bearing escrow account under
the terms of an amendment to our credit agreement. The escrow accounts use is restricted to the repayment of $15 million of our medium-term notes, bearing an interest rate of 9.42%, which mature on April 4, 2003.





We had working capital of $155.9 million at September 30, 2002, a decrease of $456.5 million from December 31, 2001. The decrease was
largely due to a decrease in assets held for sale of $749.7 million, as a result of the sale of Printing Papers segment assets and the Bradley hardwood sawmill. Also reflected in the decrease is the use of $98.2 million in restricted cash to repay
maturing debt. Partially offsetting these decreases to working capital were increases in receivables of $9.0 million and inventories of $33.3 million, combined with decreases in current installments on long-term debt of $117.0 million, early
maturing long-term debt of $197.0 million and liabilities related to assets held for sale of $33.7 million.





Net
cash used for operations for the first nine months of 2002 totaled $19.4 million, compared with cash provided by operations of $45.8 million for the same period in 2001. An increase in cash used for working capital items accounts for a majority of
the unfavorable comparison. As noted above, inventories increased $33.3 million and receivables increased $9.0 million from December 31, 2001. Inventories have increased primarily to assure continued customer service, as labor negotiations continue
at our pulp and paper facilities in Lewiston, Idaho.




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For the nine months ended September 30, 2002, net cash provided by investing was
$46.9 million, compared to cash used for investing of $182.9 million during the nine months ended September 30, 2001. In March 2002 we applied the balance in our restricted cash account to the repayment of current installment debt. In September 2002
we designated $15.0 million as restricted cash for repayment of debt due April 2003. Short-term investments decreased $2.9 million in the first nine months of 2002, due to our continued repayment of long-term debt with proceeds received from the
sale of Printing Papers segment assets. Capital spending totaled $37.3 million in the first nine months of 2002, compared to $36.6 million for the same period in 2001. In September 2002, our board of directors approved $66 million to construct a new
tissue machine adjacent to our existing converting facilities in Las Vegas, Nevada. Spending on this project as of September 30, 2002, totaled $13.5 million. The balance of capital spending through September 30, 2002, was focused on routine general
replacement, safety, forest resource and environmental projects.





Net cash used for financing was $508.4 million
for the nine months ended September 30, 2002, compared to cash provided by financing of $102.7 million during the same period in 2001. The majority of the cash used in the current year was for the repayment of $494.2 million of long-term debt. As
discussed above, we used our restricted cash to repay our $100 million 6.25% debentures, and paid other debt using a portion of the proceeds from asset sales. Our dividend payments declined for the first nine months of 2002, to $12.8 million from
$28.9 million for the same period in 2001, due to a dividend rate cut announced on August 10, 2001.





In connection
with the sale of our Printing Papers segment assets, we were required under the terms of our bank credit facility to use the proceeds to repay approximately $198.5 million under the term loan portion of the credit facility, and all outstanding debt
under our revolving credit line, totaling $33.2 million. We have also used a portion of the proceeds to repay approximately $164.9 million of additional debt.





Our current bank credit facility is comprised of a three-year revolving line of credit of up to $200.0 million that expires June 28, 2004, including a $140.0 million subfacility for letters of credit,
usage of which reduces availability under the revolving line of credit. Our obligations under the bank credit facility are secured by our accounts receivable and inventory. As of September 30, 2002, there were no amounts outstanding under the credit
facility. Approximately $89.9 million of the revolving line of credit was used to support outstanding letters of credit. Approximately $55.4 million of these letters of credit provide credit enhancement for a portion of our outstanding floating
interest rate bonds. During the third quarter of 2002, we negotiated an amendment to our bank credit facility, which, among other changes included a revision to certain financial covenants. As of September 30, 2002, we were in compliance with such
covenants. Notification has been made to the Trustees of the floating rate bonds that they will be re-marketed as fixed rate bonds effective in December 2002. We will cancel the related letters of credit under the bank credit facility and reduce its
size correspondingly. An amendment to the facility will be negotiated in the fourth quarter to reflect this change and a corresponding change in our credit requirements.





We believe that our cash, cash flow from operations and available borrowings under our bank credit facility will be sufficient to fund our operations, capital expenditures
and debt service obligations for the next twelve months and for the foreseeable future. We cannot assure, however, that our business will generate sufficient cash flow from operations or that we will remain in compliance with the financial covenants
in the bank credit facility so that future borrowings thereunder will be available to us. This will be dependent upon our future financial performance, which will be affected by general economic, competitive and other factors, including those
discussed under Factors Influencing Our Results of Operations, many of which are beyond our control.




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On September 23, 2002, Standard & Poors Ratings Services announced that
its ratings and outlook on our debt would remain unchanged at BBB- with a negative outlook following the announcement that our board of directors had approved $66 million to construct a new tissue machine adjacent to our existing converting
facilities in Las Vegas, Nevada. During the quarter Fitchs ratings remained unchanged at BBB- rating and a stable outlook. Moodys rating of our debt remained at Baa3 with a negative outlook and we continued to be on CreditWatch. Any
ratings downgrade by Standard & Poors or Moodys will cause the interest rate on our $100 million Credit Sensitive Debentures to increase from 9.425% to at least 12.5%.





It is our practice to periodically review strategic and operational alternatives to improve our operating results and financial position. In this regard, we consider and
plan to continue to consider, among other things, adjustments to our capital expenditures and overall spending, the restructuring of our operations to achieve greater efficiencies, and the disposition of assets that may have greater value to others.
There can be no assurance that we will be successful in implementing any new strategic or operational initiatives or, if implemented, that they will have the effect of improving our operating results and financial position.




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POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





Changes in Statements of Operations


(Dollars in
thousands)





Quarter Ended September 30


Nine Months Ended September 302002


2001


Increase (Decrease)


2002


2001


Increase (Decrease)Net sales

$
324,060


$
337,903


(4
%)

$
975,427


$
985,801


(1
%)Costs and expenses:Depreciation, amortization and cost of fee timber harvested


29,067



30,270


(4
%)


86,795



85,142


2
%Materials, labor and other operating expenses


271,910



269,599


1
%


823,169



839,812


(2
%)Selling, general and administrative expenses


20,814



22,037


(6
%)


63,761



63,079


1
%Restructuring charge






353


*







4,570


*Earnings (loss) from operations


2,269



15,644


(85
%)


1,702



(6,802
)

(125
%)Interest expense


(13,984
)


(22,009
)

(36
%)


(48,289
)


(57,377
)

(16
%)Debt extinguishment costs


(9,256
)





*



(15,154
)





*Other income, net


3,950



2,612


51
%


9,483



5,142


84
%Provision (benefit) for taxes on income


(6,639
)


(1,464
)

353
%


(20,381
)


(23,025
)

(11
%)Loss from continuing operations


(10,382
)


(2,289
)

354
%


(31,877
)


(36,012
)

(11
%)Discontinued operations:Loss from discontinued operations


(3,361
)


(6,987
)

(52
%)


(275,451
)


(19,239
)

1,332
%Income tax benefit


(1,310
)


(2,725
)

(52
%)


(107,425
)


(7,503
)

1,332
%Net loss

$
(12,433
)

$
(6,551
)

90
%

$
(199,903
)

$
(47,748
)

319
%


---

* Not a meaningful figure.




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##### Table of Contents




ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk





Our exposure to market risks on our financial instruments includes interest rate risk on our outstanding variable rate debt under our revenue bonds and our bank credit facility. As of September 30, 2002, we had approximately $54
million of variable rate debt and no credit line debt outstanding. The interest rates applied to these borrowings are adjusted often and therefore react quickly to any movement in the general trend of market interest rates. Interest expense incurred
annually related to our variable rate debt depends upon the amount outstanding during the year and the extent to which interest rates rise or fall. Maturities for the variable rate debt begin in 2007 and extend through 2030.





All of our other long-term debt is fixed-rate and therefore changes in market interest rates do not expose us to risk for these financial
instruments. However, in December 2001 we entered into a fixed-to-variable interest rate swap to hedge a portion of our 10% senior subordinated debentures. The swap has been designed as a fair value hedge and calls for us to pay a variable interest
amount, based on LIBOR rates, and receive a fixed rate payment from a financial institution, calculated on $165.0 million of our 10% senior subordinated debentures. We assume there is no ineffectiveness in the hedge and, accordingly, a fair value
increase or decrease in the swap is offset by a corresponding decrease or increase in the value of the underlying debt instrument.





ITEM 4.    Disclosure Controls and Procedures





Within 90 days prior
to the date of this report, an evaluation was carried out under the supervision and with the participation of Potlatchs management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of Potlatchs disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that Potlatchs disclosure controls and procedures are effective to ensure that information required to be disclosed by Potlatch in reports that it files or submits under the Exchange Act is recorded, summarized
and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of that evaluation, there were no significant changes in Potlatchs internal controls or in other factors that could
significantly affect these controls, including any corrective actions with regard to significant deficiencies or material weaknesses.





PART II





ITEM 6.    Exhibits and Reports on Form 8-K





Exhibits





The exhibit index is located on page 33 of this Form 10-Q.





Reports on Form 8-K





A current report on Form 8-K was filed
on August 13, 2002, announcing that our Chief Executive Officer and our Chief Financial Officer had executed sworn statements in accordance with Order 4-460 and pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934.




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##### Table of Contents




SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





POTLATCH CORPORATION (Registrant)By

/S/    GERALD L. ZUEHLKEGerald L. Zuehlke Vice President, Finance, Chief Financial Officer and
Treasurer (Duly Authorized; Principal Financial Officer)


By

/S/    TERRY L. CARTERTerry L. Carter Controller (Duly Authorized; Principal Accounting Officer)





Date:    November 13, 2002




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##### Table of Contents




CERTIFICATIONS





I, L. Pendleton Siegel, certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Potlatch Corporation;
|-- |  | ---------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




a)  designed
such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
quarterly report is being prepared;





b)  evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c)  presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




a)  all significant deficiencies
in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in
internal controls; and





b)  any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls; and





|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Date: November 13, 2002



/S/    L. PENDLETON SIEGELL. Pendleton Siegel Chief Executive Officer




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##### Table of Contents




CERTIFICATIONS





I, Gerald L. Zuehlke, certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Potlatch Corporation;
|-- |  | ---------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




a)  designed
such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
quarterly report is being prepared;





b)  evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c)  presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




a)  all significant deficiencies
in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in
internal controls; and





b)  any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls; and





|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Date: November 13, 2002



/S/    GERALD L. ZUEHLKEGerald L. Zuehlke Chief Financial Officer




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##### Table of Contents




POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





Exhibit Index





Exhibit





PART
II





(4)

Registrant undertakes to file with the Securities and Exchange Commission, upon request, any instrument with respect to long-term debt.(10)(h)

Potlatch Corporation Benefits Protection Trust Agreement, as amended and restated effective September 20, 2002.(10)(o)(vii)

Fifth Amendment to Credit Agreement and Waiver, dated as of September 9, 2002.(10)(o)(viii)

Consent and Modification dated September 11, 2002.(10)(o)(ix)

Consent and Modification dated September 27, 2002.(10)(o)(x)

Consent dated October 23, 2002.




33