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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



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Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934



For the Quarterly Period Ended September 30, 2004



Commission file number 1-5313



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POTLATCH CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|A Delaware Corporation                                         |  | 82-0156045                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                                        |  |           
|------------------------------------------------------- |  | ----------
|601 West Riverside Ave., Suite 1100 Spokane, 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 ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  x     No ̈



The number of shares of common stock outstanding as of September 30, 2004: 29,720,505 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 Number
|PART I.    FINANCIAL INFORMATION                                                                                                  |  |            
|                                                                                                                                  | 
|Item 1.    Financial Statements                                                                                                   |  |            
|                                                                                                                                  | 
|Consolidated Statements of Operations and Comprehensive Income for the quarters and nine months ended September 30, 2004 and 2003 |  | 2          
|                                                                                                                                  | 
|Consolidated Condensed Balance Sheets at September 30, 2004 and December 31, 2003                                                 |  | 3          
|                                                                                                                                  | 
|Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2004 and 2003                             |  | 4          
|                                                                                                                                  | 
|Notes to Consolidated Financial Statements                                                                                        |  | 5 - 11     
|                                                                                                                                  | 
|Item 2.    Managements Discussion and Analysis of Financial Condition and Results of Operations                                  |  | 11 - 28    
|                                                                                                                                  | 
|Item 3.    Quantitative and Qualitative Disclosures About Market Risk                                                             |  | 29 - 30    
|                                                                                                                                  | 
|Item 4.    Disclosure Controls and Procedures                                                                                     |  | 30 - 31    
|                                                                                                                                  | 
|PART II.    OTHER INFORMATION                                                                                                     |  |            
|                                                                                                                                  | 
|Item 6.    Exhibits                                                                                                               |  | 31         
|                                                                                                                                  | 
|SIGNATURES                                                                                                                        |  | 32         
|                                                                                                                                  | 
|EXHIBIT INDEX                                                                                                                     |  | 33         



1



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##### Table of Contents

PART I



Item 1.    Financial Statements



Potlatch Corporation and Consolidated Subsidiaries



Statements of Operations and Comprehensive Income

Unaudited (Dollars in thousands  except
pershare amounts)



|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ----------------------------- | - | ------- | ---- |  | - | --------- | - |  | - | ------- | -
|                                                                                                              |  | Quarter EndedSeptember 30 |         |   | Nine Months EndedSeptember 30 |  
|                                                                                                              |  | 2004                      |         |   | 2003                          |   |         | 2004 |  |   | 2003      |  
|Net sales                                                                                                     |  | $                         | 370,100 |   |                               | $ | 307,174 |      |  | $ | 1,029,874 |   |  | $ | 895,427 |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Costs and expenses:                                                                                           |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Depreciation, amortization and cost of fee timber harvested                                                   |  |                           | 22,465  |   |                               |   | 21,822  |      |  |   | 66,796    |   |  |   | 65,921  |  
|Materials, labor and other operating expenses                                                                 |  |                           | 275,564 |   |                               |   | 258,748 |      |  |   | 821,738   |   |  |   | 763,571 |  
|Selling, general and administrative expenses                                                                  |  |                           | 20,668  |   |                               |   | 19,264  |      |  |   | 63,654    |   |  |   | 54,587  |  
|Restructuring charges                                                                                         |  |                           |        |   |                               |   |        |      |  |   | 1,193     |   |  |   | 227     |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|                                                                                                              |  |                           | 318,697 |   |                               |   | 299,834 |      |  |   | 953,381   |   |  |   | 884,306 |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Earnings from operations                                                                                      |  |                           | 51,403  |   |                               |   | 7,340   |      |  |   | 76,493    |   |  |   | 11,121  |  
|Interest expense                                                                                              |  |                           | (12,484 | ) |                               |   | (12,234 | )    |  |   | (36,822   | ) |  |   | (37,124 | )
|Interest income                                                                                               |  |                           | 1,078   |   |                               |   | 515     |      |  |   | 1,697     |   |  |   | 13,155  |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Earnings (loss) before taxes                                                                                  |  |                           | 39,997  |   |                               |   | (4,379  | )    |  |   | 41,368    |   |  |   | (12,848 | )
|Provision (benefit) for taxes (Note 3)                                                                        |  |                           | 15,798  |   |                               |   | (3,165  | )    |  |   | 16,340    |   |  |   | (6,468  | )
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Earnings (loss) from continuing operations                                                                    |  |                           | 24,199  |   |                               |   | (1,214  | )    |  |   | 25,028    |   |  |   | (6,380  | )
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Discontinued operations (Note 4):                                                                             |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Earnings from discontinued operations (including gain (loss) on disposal of $269,544, $, $269,544 and ($45)) |  |                           | 306,857 |   |                               |   | 38,312  |      |  |   | 423,480   |   |  |   | 42,000  |  
|Income tax provision                                                                                          |  |                           | 121,209 |   |                               |   | 14,942  |      |  |   | 167,275   |   |  |   | 16,380  |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|                                                                                                              |  |                           | 185,648 |   |                               |   | 23,370  |      |  |   | 256,205   |   |  |   | 25,620  |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Net earnings                                                                                                  |  |                           | 209,847 |   |                               |   | 22,156  |      |  |   | 281,233   |   |  |   | 19,240  |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Other comprehensive loss, net of tax:                                                                         |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Cash flow hedges (Note 5):                                                                                    |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Net derivative losses, net of income tax benefit of $, $220, $44 and $220                                    |  |                           |        |   |                               |   | (427    | )    |  |   | (68       | ) |  |   | (427    | )
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Comprehensive income                                                                                          |  | $                         | 209,847 |   |                               | $ | 21,729  |      |  | $ | 281,165   |   |  | $ | 18,813  |  
|                                                                                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Earnings (loss) per common share from continuing operations (Note 6):                                         |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Basic                                                                                                         |  | $                         | .82     |   |                               | $ | (.04    | )    |  | $ | .85       |   |  | $ | (.22    | )
|Diluted                                                                                                       |  |                           | .81     |   |                               |   | (.04    | )    |  |   | .85       |   |  |   | (.22    | )
|Earnings per common share from discontinued operations:                                                       |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Basic                                                                                                         |  |                           | 6.26    |   |                               |   | .81     |      |  |   | 8.70      |   |  |   | .89     |  
|Diluted                                                                                                       |  |                           | 6.24    |   |                               |   | .81     |      |  |   | 8.66      |   |  |   | .89     |  
|Net earnings per common share:                                                                                |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Basic                                                                                                         |  |                           | 7.08    |   |                               |   | .77     |      |  |   | 9.55      |   |  |   | .67     |  
|Diluted                                                                                                       |  |                           | 7.05    |   |                               |   | .77     |      |  |   | 9.51      |   |  |   | .67     |  
|Dividends per common share (annual rate)                                                                      |  |                           | .60     |   |                               |   | .60     |      |  |   | .60       |   |  |   | .60     |  
|Average shares outstanding (in thousands):                                                                    |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |         |  
|Basic                                                                                                         |  |                           | 29,638  |   |                               |   | 28,734  |      |  |   | 29,460    |   |  |   | 28,677  |  
|Diluted                                                                                                       |  |                           | 29,769  |   |                               |   | 28,760  |      |  |   | 29,570    |   |  |   | 28,677  |  



Certain 2003 amounts have been
reclassified to conform to the 2004 presentation.



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



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Potlatch Corporation and Consolidated Subsidiaries



Condensed Balance Sheets

Unaudited (Dollars in thousands  except pershare amounts)



|                                                           |  |                   |           |                  |   |          
|---------------------------------------------------------- |  | ----------------- | --------- | ---------------- | - | ---------
|                                                           |  | September 30,2004 |           | December 31,2003
|Assets                                                     |  |                   |           |                  |   |          
|Current assets:                                            |  |                   |           |                  |   |          
|Cash                                                       |  | $                 | 9,297     |                  | $ | 7,190    
|Restricted cash (Note 8)                                   |  |                   | 2,033     |                  |   |         
|Short-term investments (Note 9)                            |  |                   | 737,700   |                  |   | 40,091   
|Receivables, net                                           |  |                   | 106,070   |                  |   | 91,050   
|Inventories (Note 10)                                      |  |                   | 136,135   |                  |   | 140,351  
|Prepaid expenses                                           |  |                   | 23,572    |                  |   | 18,315   
|Assets held for sale (Note 4)                              |  |                   |          |                  |   | 176,596  
|                                                           |  |                   |           |                  |   |          
|Total current assets                                       |  |                   | 1,014,807 |                  |   | 473,593  
|Land, other than timberlands                               |  |                   | 8,344     |                  |   | 7,850    
|Plant and equipment, at cost less accumulated depreciation |  |                   | 574,562   |                  |   | 600,964  
|Timber, timberlands and related logging facilities         |  |                   | 401,843   |                  |   | 396,482  
|Other assets                                               |  |                   | 114,912   |                  |   | 118,488  
|                                                           |  |                   |           |                  |   |          
|                                                           |  | $                 | 2,114,468 |                  | $ | 1,597,377
|                                                           |  |                   |           |                  |   |          
|Liabilities and Stockholders Equity                       |  |                   |           |                  |   |          
|Current liabilities:                                       |  |                   |           |                  |   |          
|Current installments on longterm debt (Note 12)           |  | $                 | 255,903   |                  | $ | 507      
|Accounts payable and accrued liabilities                   |  |                   | 323,956   |                  |   | 158,185  
|Liabilities related to assets held for sale (Note 4)       |  |                   |          |                  |   | 11,125   
|                                                           |  |                   |           |                  |   |          
|Total current liabilities                                  |  |                   | 579,859   |                  |   | 169,817  
|Long-term debt (Note 12)                                   |  |                   | 362,405   |                  |   | 618,278  
|Other long-term obligations                                |  |                   | 253,166   |                  |   | 266,514  
|Deferred taxes                                             |  |                   | 150,365   |                  |   | 71,917   
|Stockholders equity                                       |  |                   | 768,673   |                  |   | 470,851  
|                                                           |  |                   |           |                  |   |          
|                                                           |  | $                 | 2,114,468 |                  | $ | 1,597,377
|                                                           |  |                   |           |                  |   |          
|Stockholders equity per common share                      |  | $                 | 25.86     |                  | $ | 16.33    
|Working capital                                            |  | $                 | 434,948   |                  | $ | 303,776  
|Current ratio                                              |  |                   | 1.8:1     |                  |   | 2.8:1    



Certain 2003 amounts have been
reclassified to conform to the 2004 presentation.



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



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Potlatch Corporation and Consolidated Subsidiaries



Condensed Statements of Cash Flows

Unaudited (Dollars in thousands)



|                                                                              |  |                               |          |   |      |   |         |  
|----------------------------------------------------------------------------- |  | ----------------------------- | -------- | - | ---- | - | ------- | -
|                                                                              |  | Nine Months EndedSeptember 30 |         
|                                                                              |  | 2004                          |          |   | 2003 |  
|Cash Flows From Continuing Operations                                         |  |                               |          |   |      |   |         |  
|Net earnings                                                                  |  | $                             | 281,233  |   |      | $ | 19,240  |  
|Adjustments to reconcile net earnings to net operating cash flows:            |  |                               |          |   |      |   |         |  
|Earnings from discontinued operations                                         |  |                               | (93,131  | ) |      |   | (25,647 | )
|Loss (gain) on disposal of discontinued operations                            |  |                               | (163,074 | ) |      |   | 60      |  
|Depreciation, amortization and cost of fee timber harvested                   |  |                               | 66,796   |   |      |   | 65,921  |  
|Deferred taxes                                                                |  |                               | (44      | ) |      |   | 9,691   |  
|Working capital changes                                                       |  |                               | 41,040   |   |      |   | 31,148  |  
|Other, net                                                                    |  |                               | (1,588   | ) |      |   | (1,859  | )
|                                                                              |  |                               |          |   |      |   |         |  
|Net cash provided by operating activities of continuing operations            |  |                               | 131,232  |   |      |   | 98,554  |  
|                                                                              |  |                               |          |   |      |   |         |  
|Cash Flows From Investing                                                     |  |                               |          |   |      |   |         |  
|Decrease (increase) in restricted cash                                        |  |                               | (2,033   | ) |      |   | 15,069  |  
|Increase in short-term investments                                            |  |                               | (697,609 | ) |      |   | (10,445 | )
|Additions to plant and properties                                             |  |                               | (36,038  | ) |      |   | (59,692 | )
|Other, net                                                                    |  |                               | (4,807   | ) |      |   | (7,263  | )
|                                                                              |  |                               |          |   |      |   |         |  
|Net cash used for investing activities of continuing operations               |  |                               | (740,487 | ) |      |   | (62,331 | )
|                                                                              |  |                               |          |   |      |   |         |  
|Cash Flows From Financing                                                     |  |                               |          |   |      |   |         |  
|Change in book overdrafts                                                     |  |                               | 3,822    |   |      |   | (3,311  | )
|Decrease in notes payable                                                     |  |                               |         |   |      |   | (40,000 | )
|Repayment of long-term debt                                                   |  |                               | (477     | ) |      |   | (16,377 | )
|Issuance of treasury stock                                                    |  |                               | 29,011   |   |      |   | 4,091   |  
|Dividends                                                                     |  |                               | (13,212  | ) |      |   | (12,901 | )
|Other, net                                                                    |  |                               | 5,912    |   |      |   | 8,847   |  
|                                                                              |  |                               |          |   |      |   |         |  
|Net cash provided by (used for) financing activities of continuing operations |  |                               | 25,056   |   |      |   | (59,651 | )
|                                                                              |  |                               |          |   |      |   |         |  
|Cash from continuing operations                                               |  |                               | (584,199 | ) |      |   | (23,428 | )
|Cash from discontinued operations                                             |  |                               | 586,306  |   |      |   | 30,543  |  
|                                                                              |  |                               |          |   |      |   |         |  
|Increase in cash                                                              |  |                               | 2,107    |   |      |   | 7,115   |  
|Cash at beginning of period                                                   |  |                               | 7,190    |   |      |   | 8,973   |  
|                                                                              |  |                               |          |   |      |   |         |  
|Cash at end of period                                                         |  | $                             | 9,297    |   |      | $ | 16,088  |  
|                                                                              |  |                               |          |   |      |   |         |  



Net interest payments (net of amounts
capitalized) for the nine months ended September 30, 2004 and 2003 were $35.9 million and $34.9 million, respectively. Net income tax payments (refunds) for the nine months ended September 30, 2004 and 2003 were $2.5 million and ($12.3) million,
respectively.



Certain 2003 amounts have been reclassified to conform to the
2004 presentation.



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



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Potlatch Corporation and Consolidated Subsidiaries



Notes to Consolidated Financial Statements

Unaudited (Dollars in thousands)



NOTE 1. GENERAL  The accompanying condensed balance sheets at
September 30, 2004, and December 31, 2003, the statements of operations and comprehensive income for the quarters and nine months ended September 30, 2004 and 2003, and the condensed statements of cash flows for the nine months ended September 30,
2004 and 2003, 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.
All adjustments were of a normal recurring nature; there were no material nonrecurring adjustments. On August 25, 2004, we entered into a definitive agreement with Ainsworth Lumber Co. Ltd. for the sale of our oriented strand board (OSB) facilities
and associated assets. The sale was completed in late September. As a result, the OSB operations have been classified as discontinued operations and assets held for sale in the financial statements presented herein.



This Form 10-Q should be read in conjunction with our Annual
Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission.



NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS  In December 2003, the Financial Accounting Standards Board issued a revision of Statement of
Financial Accounting Standards (SFAS) No. 132, Employers Disclosures about Pensions and Other Postretirement Benefits. The revised statement was effective for financial statements with fiscal years ending after December 15, 2003.
It requires annual disclosures in addition to those required by the original Statement No. 132 regarding assets, obligations, cash flows and the net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The
revised statement also adds new disclosure requirements for interim financial reports. The required disclosures are contained in Note 11, Pension and Other Postretirement Benefit Plans, on pages 8-9 of this Form 10-Q.



NOTE 3. INCOME TAXES  The income tax provision and benefit
presented in the statements of operations have been computed by applying an estimated annual effective tax rate. This rate was 39.5% for the quarter and nine months ended September 30, 2004. During the third quarter of 2003, the tax rate of 39%,
which had been used in the first half of 2003, was revised to 34% to reflect our ability to apply anticipated tax credits to our 2003 tax provision. The revised rate resulted in a tax provision for 2003s first nine months of $9.9 million. In
allocating the $9.9 million tax provision between continuing operations and discontinued operations for presentation in the current Statements of Operations, the benefit from the anticipated tax credits was allocated to continuing operations,
resulting in a tax benefit of $6.5 million for the nine months ended 2003. A tax rate of 39% was applied to income from discontinued operations in 2003.



NOTE 4. DISCONTINUED OPERATIONS  On August 25, 2004, we entered into a definitive agreement with Ainsworth Lumber Co. Ltd. for the sale of
our OSB facilities and associated assets for $452.6 million in cash, after closing adjustments. The sale was completed in late September. As a result of the transaction, we recorded a pre-tax gain of $269.5 million in the third



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quarter of 2004. For the third quarter and nine months of 2004, pre-tax operating income of $37.3 million and $153.9
million, respectively, are classified as discontinued operations in the Statements of Operations and Comprehensive Income, as required by SFAS No. 144.



Amounts reported for Discontinued operations in the Statements of Operations and Comprehensive Income for 2003 include quarterly and nine
months pre-tax operating income for the OSB operations of $38.3 million and $43.4 million, respectively. Also included in the amount for the 2003 nine month period was a $1.4 million pre-tax loss related to our former printing papers mill in
Brainerd, Minnesota, which was sold in February 2003.



The
assets and liabilities of the OSB operations 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 were as follows:



|                                                   |  |                    |   |                   |   |        
|-------------------------------------------------- |  | ------------------ | - | ----------------- | - | -------
|(Dollars in thousands)                             |  | September 30, 2004 |   | December 31, 2003
|Assets                                             |  |                    |   |                   |   |        
|Receivables, net                                   |  | $                  |  |                   | $ | 14,295 
|Inventories                                        |  |                    |  |                   |   | 19,327 
|Land, other than timberlands                       |  |                    |  |                   |   | 981    
|Plant and equipment, net                           |  |                    |  |                   |   | 139,378
|Timber, timberlands and related logging facilities |  |                    |  |                   |   | 2,417  
|Other assets                                       |  |                    |  |                   |   | 198    
|                                                   |  |                    |   |                   |   |        
|Total assets held for sale                         |  | $                  |  |                   | $ | 176,596
|                                                   |  |                    |   |                   |   |        
|Liabilities                                        |  |                    |   |                   |   |        
|Accounts payable and accrued liabilities           |  | $                  |  |                   | $ | 11,125 
|                                                   |  |                    |   |                   |   |        



NOTE 5. CASH FLOW
HEDGES  During the third quarter of 2003, we entered into several derivative financial instruments designated as cash flow hedges for a portion of our natural gas purchases during November 2003 through March 2004. As designated cash flow
hedges, changes in the fair value of the financial instruments are recognized in Other comprehensive loss, net of tax to the extent the hedges are deemed effective, until the hedged item is recognized in the statement of operations. As
of March 31, 2004, the derivative financial instruments entered into in the third quarter 2003 had expired, and we have not entered into any additional instruments to hedge our expected future natural gas purchases.



NOTE 6. NET EARNINGS (LOSS) PER COMMON SHARE  Net earnings
(loss) per common share are computed by dividing the net earnings (loss) and earnings (loss) from continuing operations by the weighted average number of common shares outstanding in accordance with SFAS No. 128, Earnings Per Share.



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



|                                               |  |                            |  |                                |  |            |  |           
|---------------------------------------------- |  | -------------------------- |  | ------------------------------ |  | ---------- |  | ----------
|                                               |  | Quarter Ended September 30 |  | Nine Months Ended September 30
|                                               |  | 2004                       |  | 2003                           |  | 2004       |  | 2003      
|Basic average common shares outstanding        |  | 29,638,372                 |  | 28,733,600                     |  | 29,460,494 |  | 28,676,662
|Incremental shares due to common stock options |  | 130,619                    |  | 26,621                         |  | 109,705    |  | 70        
|                                               |  |                            |  |                                |  |            |  |           
|Diluted average common shares outstanding      |  | 29,768,991                 |  | 28,760,221                     |  | 29,570,199 |  | 28,676,732
|                                               |  |                            |  |                                |  |            |  |           



Stock options to
purchase 515,075, 2,331,075, 1,002,125 and 2,695,575 shares of common stock for the quarters ended September 30, 2004 and 2003 and nine months ended September 30, 2004 and 2003, 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 7. STOCK-BASED COMPENSATION  We currently have three stock incentive plans under which options or performance share awards are
outstanding. We apply the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25 and related Interpretations in accounting for our stock-based compensation. No compensation cost is recognized for options granted under the
plans when the exercise price is equal to market value at the grant date. For performance share awards, which were first granted in December 2003, compensation expense is recorded ratably over the performance period based upon the market value of
our stock and the likelihood that performance measures will be met. Compensation expense related to performance shares was $0.2 million and $0.7 million, before taxes, for the quarter and nine months ended September 30, 2004, respectively.



Had compensation costs been determined based on the fair value
at the grant dates for option and performance share awards under those plans as prescribed by SFAS No. 123, our net earnings (loss) and net earnings (loss) per share would have been the pro forma amounts indicated below:



|                                                                            |  |                           |         |   |                               |   |        |      |  |   |         |   |  |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ----------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                            |  | Quarter EndedSeptember 30 |         |   | Nine Months EndedSeptember 30 |  
|(Dollars in thousands-except per-share amounts)                             |  | 2004                      |         |   | 2003                          |   |        | 2004 |  |   | 2003    |  
|Net earnings, as reported                                                   |  | $                         | 209,847 |   |                               | $ | 22,156 |      |  | $ | 281,233 |   |  | $ | 19,240 |  
|                                                                            |  |                           |         |  
|Add: stock based compensation expense recorded under APB No. 25, net of tax |  |                           | 146     |   |                               |   |       |      |  |   | 405     |   |  |   |       |  
|                                                                            |  |                           |         |  
|Deduct: stock based compensation determined under SFAS No. 123, net of tax  |  |                           | (358    | ) |                               |   | (496   | )    |  |   | (1,190  | ) |  |   | (1,492 | )
|                                                                            |  |                           |         |   |                               |   |        |      |  |   |         |   |  |   |        |  
|Pro forma net earnings                                                      |  | $                         | 209,635 |   |                               | $ | 21,660 |      |  | $ | 280,448 |   |  | $ | 17,748 |  
|                                                                            |  |                           |         |   |                               |   |        |      |  |   |         |   |  |   |        |  
|Basic net earnings per share, as reported                                   |  | $                         | 7.08    |   |                               | $ | .77    |      |  | $ | 9.55    |   |  | $ | .67    |  
|Diluted net earnings per share, as reported                                 |  |                           | 7.05    |   |                               |   | .77    |      |  |   | 9.51    |   |  |   | .67    |  
|Pro forma basic net earnings per share                                      |  |                           | 7.07    |   |                               |   | .76    |      |  |   | 9.52    |   |  |   | .62    |  
|Pro forma diluted net earnings per share                                    |  |                           | 7.04    |   |                               |   | .76    |      |  |   | 9.49    |   |  |   | .62    |  



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NOTE 8. RESTRICTED CASH  In September 2004, we placed $2.0 million into an escrow account
which were invested in U.S. Treasury obligations. The use of the escrow account is restricted to the repayment in November 2004 of $2.0 million in industrial revenue bonds plus accrued interest. The bonds were called in conjunction with the sale of
our OSB operations.



NOTE 9. SHORT-TERM INVESTMENTS
 Proceeds from the sale of the OSB operations, as well as cash flow not needed for operations, have been invested in short-term money market and triple-A rated corporate and municipal bonds. These investments have very short maturity periods
(from 1 day to 28 days) and earn interest at slightly under two percent on average. We expect to utilize a substantial portion of the short-term investments in the fourth quarter of 2004 for debt repayment, a special dividend, an accelerated stock
buyback program, qualified pension plan funding and working capital needs.



NOTE 10. INVENTORIES  Inventories at the balance sheet dates consist of:



|                       |  |                    |         |                   |   |        
|---------------------- |  | ------------------ | ------- | ----------------- | - | -------
|(Dollars in thousands) |  | September 30, 2004 |         | December 31, 2003
|Raw materials          |  | $                  | 64,668  |                   | $ | 59,451 
|Finished goods         |  |                    | 71,467  |                   |   | 80,900 
|                       |  |                    |         |                   |   |        
|                       |  | $                  | 136,135 |                   | $ | 140,351
|                       |  |                    |         |                   |   |        



NOTE 11. PENSION
AND OTHER POSTRETIREMENT BENEFIT PLANS  The tables below detail the components of net periodic costs (benefit):



Quarters ended September 30:



|                                   |  |                       |         |   |                                   |   |         |      |  |   |       |   |  |   |       |  
|---------------------------------- |  | --------------------- | ------- | - | --------------------------------- | - | ------- | ---- |  | - | ----- | - |  | - | ----- | -
|                                   |  | Pension Benefit Plans |         |   | Other PostretirementBenefit Plans |  
|(Dollars in thousands)             |  | 2004                  |         |   | 2003                              |   |         | 2004 |  |   | 2003  |  
|Service cost                       |  | $                     | 2,651   |   |                                   | $ | 2,301   |      |  | $ | 965   |   |  | $ | 813   |  
|Interest cost                      |  |                       | 8,459   |   |                                   |   | 8,656   |      |  |   | 4,808 |   |  |   | 5,524 |  
|Expected return on plan assets     |  |                       | (14,494 | ) |                                   |   | (14,721 | )    |  |   |      |   |  |   | (137  | )
|Amortization of prior service cost |  |                       | 452     |   |                                   |   | 445     |      |  |   | (520  | ) |  |   | (524  | )
|Recognized actuarial loss (gain)   |  |                       | 54      |   |                                   |   | (44     | )    |  |   | 1,044 |   |  |   | 1,923 |  
|Recognized net initial asset       |  |                       |        |   |                                   |   | (10     | )    |  |   |      |   |  |   |      |  
|                                   |  |                       |         |   |                                   |   |         |      |  |   |       |   |  |   |       |  
|Net periodic cost (benefit)        |  | $                     | (2,878  | ) |                                   | $ | (3,373  | )    |  | $ | 6,297 |   |  | $ | 7,599 |  
|                                   |  |                       |         |   |                                   |   |         |      |  |   |       |   |  |   |       |  



Nine
months ended September 30:



|                                   |  |                       |         |   |                                   |   |         |      |  |   |        |   |  |   |        |  
|---------------------------------- |  | --------------------- | ------- | - | --------------------------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------ | -
|                                   |  | Pension Benefit Plans |         |   | Other PostretirementBenefit Plans |  
|(Dollars in thousands)             |  | 2004                  |         |   | 2003                              |   |         | 2004 |  |   | 2003   |  
|Service cost                       |  | $                     | 7,965   |   |                                   | $ | 6,755   |      |  | $ | 2,519  |   |  | $ | 1,717  |  
|Interest cost                      |  |                       | 25,416  |   |                                   |   | 25,412  |      |  |   | 14,116 |   |  |   | 11,667 |  
|Expected return on plan assets     |  |                       | (43,551 | ) |                                   |   | (43,218 | )    |  |   |       |   |  |   | (289   | )
|Amortization of prior service cost |  |                       | 1,358   |   |                                   |   | 1,307   |      |  |   | (1,333 | ) |  |   | (1,107 | )
|Recognized actuarial loss (gain)   |  |                       | 164     |   |                                   |   | (129    | )    |  |   | 5,517  |   |  |   | 4,060  |  
|Recognized net initial asset       |  |                       |        |   |                                   |   | (30     | )    |  |   |       |   |  |   |       |  
|                                   |  |                       |         |   |                                   |   |         |      |  |   |        |   |  |   |        |  
|Net periodic cost (benefit)        |  | $                     | (8,648  | ) |                                   | $ | (9,903  | )    |  | $ | 20,819 |   |  | $ | 16,048 |  
|                                   |  |                       |         |   |                                   |   |         |      |  |   |        |   |  |   |        |  



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The pension benefits presented above do not reflect a cost of $1.1 million related to the sale of our OSB
operations, which is included in Earnings from discontinued operations in the statement of operations.



Due to the funded status of our pension plans at December 31, 2003, no minimum pension contributions are required for 2004. In the footnotes to our
financial statements for the year ended December 31, 2003, we estimated contributions to our non-qualified pension plan in 2004 would total approximately $1.2 million. As of September 30, 2004, $0.9 million of contributions had been made. As a
result of our cash position from the sale of our OSB operations, we recently announced our intention to make a contribution of $57.9 million to our qualified pension plans in the fourth quarter, which represents the maximum deductible amount allowed
in 2004.



In December 2003, the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) was signed into law. The Act introduces a drug benefit under Medicare Part D, as well as a federal subsidy to sponsors of retiree health care benefit plans that provide an equivalent benefit.
Pursuant to guidance provided in FASB Staff Position (FSP) FAS 106-2, we have determined, with the assistance of consulting actuaries, that certain benefits provided under our plans are actuarially equivalent to the Medicare Part D standard plan and
are eligible for the employer subsidy. We have chosen the prospective application option for adoption of the FSP as of July 1, 2004. The effects of the Act on the accumulated postretirement benefit obligation (APBO) were measured at July 1, 2004 and
were determined to reduce the APBO by $25.9 million. The aggregate effect on service cost, interest cost, and amortization of (gain)/loss for the second half of 2004 is an actuarial gain of $2.2 million. A portion of this gain is reflected in the
tables presented above.



NOTE 12. DEBT  In
September 2004 we notified holders of certain of our outstanding revenue bonds, totaling $10.3 million, of our intention to redeem the bonds in the fourth quarter of 2004. A portion of the bonds has been defeased through the creation of a restricted
cash account (see Note 8). Accordingly, at September 30, 2004, the bonds have been classified as current installments on long-term debt in the Balance Sheets.



On October 6, 2004, we announced that our Board of Directors had authorized a tender offer for our outstanding $250 million 10% Senior Subordinated
Notes due 2011. As of October 20, $244.5 million of the notes were tendered, and they were subsequently redeemed on October 21. Accordingly, $244.5 million of the notes have been classified as current installments on long-term debt in the Balance
Sheets. The related premium of $40.0 million, deferred debt issuance costs of $4.7 million and interest rate swap settlements of $24.4 million will be recognized in operations in the fourth quarter, resulting in a total net charge of $20.4 million.



In August 2003 we entered into a fixed-to-variable interest
rate swap to hedge a portion of our 10% senior subordinated notes. The swap was designated as a fair value hedge and called for the company to pay a variable interest amount, determined semi-annually in arrears and equal to the London Interbank
Offered Rate (LIBOR) plus 4.80%, and receive a fixed-rate payment from a financial institution, calculated on $165.0 million of our 10% senior subordinated notes. The terms of the swap allowed us to assume no ineffectiveness in the hedge. In March
2004, we terminated the swap and received a cash settlement of $6.0 million. In May 2004, we reinstated the fixed-to-variable interest rate swap under the same terms as the swap that was terminated in March. In August 2004, we terminated the
reinstated swap and received a cash settlement of $3.2 million. In October



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2004, as a result of our early repayment of $244.5 million of our senior subordinated notes, we recognized in earnings
$24.4 million of the aggregate cash settlements received from these and prior interest rate swaps. The remaining portion of the cash settlements on the swaps, totaling $0.5 million, is being accreted to earnings until the remaining 10% senior
subordinated notes mature in 2011. We have the right to call these notes beginning July 15, 2006.



NOTE 13. SEGMENT INFORMATION 



|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|-------------------------------------------------------------------- |  | ------------------------- | ------- | - | ----------------------------- | - | ------- | ---- |  | - | --------- | - |  | - | --------- | -
|(Dollars in thousands)                                               |  | Quarter EndedSeptember 30 |         |   | Nine Months EndedSeptember 30 |  
|                                                                     |  | 2004                      |         |   | 2003                          |   |         | 2004 |  |   | 2003      |  
|Segment Sales                                                        |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Resource                                                             |  | $                         | 93,039  |   |                               | $ | 73,616  |      |  | $ | 199,613   |   |  | $ | 180,416   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Wood products                                                        |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Lumber                                                               |  |                           | 97,402  |   |                               |   | 74,903  |      |  |   | 269,329   |   |  |   | 212,622   |  
|Plywood                                                              |  |                           | 15,422  |   |                               |   | 13,973  |      |  |   | 47,039    |   |  |   | 33,090    |  
|Particleboard                                                        |  |                           | 5,196   |   |                               |   | 4,182   |      |  |   | 15,285    |   |  |   | 11,378    |  
|Other                                                                |  |                           | 6,832   |   |                               |   | 6,532   |      |  |   | 20,672    |   |  |   | 21,835    |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|                                                                     |  |                           | 124,852 |   |                               |   | 99,590  |      |  |   | 352,325   |   |  |   | 278,925   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Pulp and paperboard                                                  |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Paperboard                                                           |  |                           | 125,302 |   |                               |   | 101,967 |      |  |   | 353,695   |   |  |   | 322,188   |  
|Pulp                                                                 |  |                           | 16,901  |   |                               |   | 17,381  |      |  |   | 47,442    |   |  |   | 43,903    |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|                                                                     |  |                           | 142,203 |   |                               |   | 119,348 |      |  |   | 401,137   |   |  |   | 366,091   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Consumer products                                                    |  |                           | 82,354  |   |                               |   | 78,974  |      |  |   | 239,467   |   |  |   | 224,452   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|                                                                     |  |                           | 442,448 |   |                               |   | 371,528 |      |  |   | 1,192,542 |   |  |   | 1,049,884 |  
|Elimination of intersegment sales                                    |  |                           | (72,348 | ) |                               |   | (64,354 | )    |  |   | (162,668  | ) |  |   | (154,457  | )
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Total consolidated net sales                                         |  | $                         | 370,100 |   |                               | $ | 307,174 |      |  | $ | 1,029,874 |   |  | $ | 895,427   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Intersegment sales or transfers                                      |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Resource                                                             |  | $                         | 56,232  |   |                               | $ | 49,881  |      |  | $ | 118,578   |   |  | $ | 114,487   |  
|Wood products                                                        |  |                           | 3,112   |   |                               |   | 2,936   |      |  |   | 8,927     |   |  |   | 8,864     |  
|Pulp and paperboard                                                  |  |                           | 12,980  |   |                               |   | 11,517  |      |  |   | 35,100    |   |  |   | 31,042    |  
|Consumer products                                                    |  |                           | 24      |   |                               |   | 20      |      |  |   | 63        |   |  |   | 64        |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Total                                                                |  | $                         | 72,348  |   |                               | $ | 64,354  |      |  | $ | 162,668   |   |  | $ | 154,457   |  
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Operating Income (Loss)                                              |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Resource                                                             |  | $                         | 30,206  |   |                               | $ | 13,578  |      |  | $ | 49,015    |   |  | $ | 48,233    |  
|Wood products                                                        |  |                           | 26,352  |   |                               |   | 5,621   |      |  |   | 61,975    |   |  |   | (724      | )
|Pulp and paperboard                                                  |  |                           | 12,212  |   |                               |   | (3,308  | )    |  |   | 10,323    |   |  |   | (13,800   | )
|Consumer products                                                    |  |                           | (4,977  | ) |                               |   | 108     |      |  |   | (10,032   | ) |  |   | 1,936     |  
|Eliminations                                                         |  |                           | (2,299  | ) |                               |   | 90      |      |  |   | (195      | ) |  |   | (1,240    | )
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|                                                                     |  |                           | 61,494  |   |                               |   | 16,089  |      |  |   | 111,086   |   |  |   | 34,405    |  
|Corporate                                                            |  |                           | (21,497 | ) |                               |   | (20,468 | )    |  |   | (69,718   | ) |  |   | (47,253   | )
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  
|Consolidated earnings (loss) from continuing operations before taxes |  | $                         | 39,997  |   |                               | $ | (4,379  | )    |  | $ | 41,368    |   |  | $ | (12,848   | )
|                                                                     |  |                           |         |   |                               |   |         |      |  |   |           |   |  |   |           |  



NOTE 14. SUBSEQUENT
EVENT  On October 25, 2004, we announced that, following the successful tender offer for the companys $250 million in senior subordinated notes, the Board of Directors authorized a special cash dividend of $2.50 per share, payable on
November 29, 2004, to stockholders of record as of the close of business on November 10, 2004. Based on the



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current 29.7 million shares outstanding, the dividend payout is expected to total approximately $75 million. The Board of
Directors also authorized the repurchase of $75 million of company stock through an accelerated stock buyback program. The Board authorization for this stock repurchase supercedes a previous authorization to repurchase up to 2 million shares
announced in December 1999, under which authorization 910,900 shares were repurchased.



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



Cautionary Statement Regarding Forward-Looking Information



This report contains, in addition to historical information, certain forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including without limitation, statements regarding future revenues, costs, manufacturing output, capital expenditures and timber supply issues. These forward-looking statements reflect
managements current views regarding future events based on estimates and assumptions, and are therefore subject to known and unknown risks and uncertainties and are not guarantees of future performance. Our actual results of operations could
differ materially from those expressed or implied by forward-looking statements contained in this report. Factors that could cause or contribute to such differences include, but are not limited to, changes in the United States and international
economies; changes in exchange rates between the U.S. dollar and other currencies; changes in the level of construction activity; changes in worldwide demand for our products; changes in worldwide production and production capacity in the forest
products industry; competitive pricing pressures for our products; unanticipated manufacturing disruptions; changes in general and industry-specific environmental laws and regulations; unforeseen environmental liabilities or expenditures; weather
conditions; and changes in raw material, energy, and other costs. Forward-looking statements contained in this report present managements views only as of the date of this report. Except as required under applicable law, we do not intend to
issue updates concerning any future revisions of managements views to reflect events or circumstances occurring after the date of this report.



Overview



We are a vertically integrated and diversified forest products company. We own approximately 1.5 million acres of timberland and operate 13 manufacturing
facilities, located primarily in Arkansas, Idaho, Minnesota and Nevada. Our business is organized into four segments:



| |  | The Resource segment manages our timberlands, which supply a portion of the logs, wood chips, pulpwood and other fiber to our manufacturing segments, as well as to third parties.
Intersegment sales are based on prevailing market prices for wood fiber. For the first nine months of 2004, Resource segment net sales were $199.6 million, representing approximately 17% of our net sales from continuing operations, before
elimination of intersegment sales. Intersegment sales were $118.6 million for the period. In addition to wood fiber sales, net sales for the segment include revenue generated from the sale of land that occurs from time to time as part of the normal
management of our timberland base.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | The Wood Products segment manufactures lumber, plywood, and particleboard at seven mills located in Arkansas, Idaho and Minnesota. These products are largely commodity products,
which are sold to wholesalers primarily for use in home building and other construction activity. Wood Products segment net sales from continuing operations were $352.3 million for the first nine months of 2004, representing approximately 29% of our
net sales from continuing operations, before elimination of intersegment sales. Intersegment sales were $8.9 million for the period. In September 2004, we sold three facilities and related assets in Bemidji, Cook and Grand Rapids, Minnesota, which
produce OSB to Ainsworth Lumber Co. Ltd. Financial results for the OSB operations and sale of the facilities have been included in discontinued operations in the financial statements.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Pulp and Paperboard segment manufactures bleached paperboard used in packaging and bleached softwood market pulp. The Pulp and Paperboard segment operates two pulp and
paperboard mills located in Arkansas and Idaho. Pulp and Paperboard segment net sales were $401.1 million for the first nine months of 2004, representing approximately 34% of our net sales from continuing operations, before elimination of
intersegment sales. Intersegment sales were $35.1 million for the period.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Consumer Products segment manufactures tissue products primarily sold on a private label basis by major grocery store chains. The segment operates two tissue mills with related
converting facilities in Idaho and Nevada, and two additional tissue converting facilities located in Illinois and Michigan. Consumer Products segment net sales were $239.5 million for the first nine months of 2004, representing approximately 20% of
our net sales from continuing operations before elimination of intersegment sales. The segment did not have significant intersegment sales during the period.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Amounts reported for Discontinued operations in the Statements of Operations and Comprehensive Income include
the results of operations for the first nine months of 2004 and 2003 for the OSB operations sold to Ainsworth Lumber Co. Ltd. in September 2004 and the gain recognized as a result of the sale. Also included in discontinued operations for 2003 are
costs related to our former printing papers mill in Brainerd, Minnesota, which was sold in February 2003.



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 and energy costs, changes in the production capacity of our manufacturing operations as a result of major capital spending projects, asset dispositions or
acquisitions and other factors.



Our operating results
generally reflect the cyclical pattern of the forest products industry. Historical prices for our products have been volatile, and we, like other manufacturers 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. Product supply is influenced primarily by fluctuations in available manufacturing capacity. Demand is



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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 paperboard products is primarily affected by the general state of the global economy, and the economies in North America and east Asia in particular. The demand for our tissue
products is primarily affected by the state of the United States economy.



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 lines of business. Logs and other fiber from our
timberlands, as well as our wood products, are subject to competition from timberland owners and wood products manufacturers in North America and to a lesser extent in South America, Europe, Australia and New Zealand. Our pulp-based products, other
than tissue products, are globally-traded commodity products. Because our competitors in these segments are located throughout the world, variations in exchange rates between the U.S. dollar and other currencies can significantly affect our
competitive position compared to our international competitors. As it is generally not profitable to sell tissue products overseas due to high transportation costs, currency exchange rates do not have a major effect on our ability to compete in our
tissue business.



Tariffs, quotas or trade agreements can also
affect the markets for our products, particularly our softwood lumber products. In 2002, the United States imposed duties on imported lumber from Canada in response to a dispute over the stumpage pricing policies of some provincial governments.
Negotiations continue between the two countries to resolve the dispute, although both countries are pursuing their own independent litigation and administrative remedies. Any resulting agreement or other determination could have a significant effect
on lumber markets in the United States.



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. For the
periods presented in this Form 10-Q, we did not suspend or cease production at any of our facilities due to a situation where prices were not sufficient to cover variable costs.



Energy has become one of our most volatile operating expenses over the past several years. 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 such increased costs could adversely affect our operating results. We have taken steps through conservation and electrical
production 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. From time to time we have entered into derivative financial instruments as a hedge against potential increases in the cost of natural gas.



Another significant expense is the cost of wood fiber needed to supply our manufacturing facilities. Our overall results of
operations are favorably affected to the extent we can supply wood fiber from our own



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timberlands, due to its low cost basis relative to wood fiber purchased on the open market. 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, changes in our manufacturing capacity and changes in the amount of timber sales to third parties. 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, nor have
wood fiber prices always decreased in conjunction with declining product prices. On occasion, our results of operations have been and may in the future be adversely affected if we are unable to pass cost increases through to our customers.



The disparity between cost of fee timber harvested and the
cost of timber purchased is caused by the fact that the capitalized costs to establish the fee timber were expended many years ago. The initial stand establishment costs remain as a capitalized asset until the timber reaches maturity (becomes
merchantable), which typically ranges from 30 to 60 years. On-going forest management costs include recurring items necessary to the ownership and administration of timber producing property and are expensed as incurred. The cost of purchased timber
is significantly higher due to the fact that the timber being purchased from third parties is mature and is sold by them at the current market price.



Finally, changes in our manufacturing capacity, primarily as a result of capital spending programs or asset dispositions, have significantly affected our
results of operations in recent periods. 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.
During the first nine months of 2004, we have been in the process of bringing a newly constructed tissue machine in Las Vegas, Nevada, up to full operating production, which we anticipate will produce 30,000 tons a year. In June 2004, we began
operating a tissue converting facility in Elwood, Illinois. In September 2004, we sold our three OSB operations in Bemidji, Cook and Grand Rapids, Minnesota. Each of these changes has affected or will affect 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 would be adversely affected if market demand does not justify operating at these levels or if our operations are inefficient or suffer significant interruption for any reason.



Critical Accounting Policies



Our principal accounting policies are discussed on pages 40-43 of our Annual
Report on Form 10-K for the year ended December 31, 2003. 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.



Long-lived assets.    Due to the capital-intensive nature
of our industry, a significant portion of our total assets are invested in our manufacturing facilities. Also, the cyclical patterns of our businesses cause cash flows to fluctuate by varying degrees from period to period. As a result, long-



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lived assets are a material component of our financial position with the potential for material change in valuation if
assets are determined to be impaired. We account for impairment of long-lived assets in accordance with SFAS 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, as measured by its undiscounted estimated future cash flows. We use our operational budgets to estimate future cash flows. Budgets are inherently uncertain estimates of future performance due
to the fact that all inputs (revenues, costs, capital spending) are subject to frequent change for many different reasons, as previously described in Factors Affecting Our Results of Operations. Because of the number of variables
involved, the interrelationship between the variables, and the long-term nature of the impairment measurement, sensitivity analysis of individual variables is not practical. Budget estimates are adjusted periodically to reflect changing business
conditions and operations are reviewed, as appropriate, for impairment using the most current data available. To date, this process has not resulted in an impairment charge for any of our assets.



Timber and timberlands.    Timber and timberlands are
recorded at cost, net of fee timber harvested. Expenditures for reforestation, including all costs related to stand establishment, such as site preparation, costs of seeds or seedlings and tree planting, are capitalized. Expenditures for forest
management, consisting of regularly recurring items necessary to the ownership and administration of our timber and timberlands, are accounted for as current operating expense. Our cost of timber harvested is determined based on costs capitalized
and the related current estimated recoverable timber volume. Recoverable volume does not include anticipated future growth, nor are anticipated future costs considered.



There are currently no authoritative accounting rules relating to costs to be capitalized in timber and timberlands. We have
used relevant portions of current accounting rules, industry practices and our judgment in determining costs to be capitalized or expensed. Alternate interpretations and judgments could significantly affect the amounts capitalized. Additionally,
models and observations used to estimate the current recoverable timber volume on our lands are subject to judgments that could significantly affect volume estimates. For example, harvest cycles can vary by geographic region and by species of
timber, weather patterns can affect harvest cycles, environmental regulations and restrictions may limit the companys ability to harvest certain timberlands, changes in harvest plans may occur, or scientific advancement in seedlings and timber
growing technology may affect future harvests. Different assumptions for either the cost or volume estimates, or both, could have a significant effect upon amounts reported in our statements of operations and financial condition. Because of the
number of variables involved and the interrelationship between the variables, sensitivity analysis of individual variables is not practical.



Restructuring charges and discontinued operations.    In May 2002 we completed the sale of a majority of the assets of our Printing
Papers segment and closed a printing papers facility in Brainerd, Minnesota, which was subsequently sold in 2003. In July 2002, we closed a hardwood lumber mill in Warren, Arkansas. The mill was sold in August 2002. In January 2004, we recorded a
charge for a workforce reduction in our Consumer Products segment. In September 2004, we sold our three OSB operations in Minnesota. These events required us to record estimates of liabilities for employee benefits, environmental clean-up and other
costs at the time of the event. In making these judgements, we considered contractual obligations, legal liabilities, and possible incremental costs incurred as a result of



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restructuring plans to determine the liability. Our estimated liabilities could differ materially from actual costs
incurred, with resulting adjustments to future period earnings for any differences, although no material adjustments to our original estimates have occurred for the events described above.



Environmental liabilities.    We record accruals for
estimated environmental liabilities in accordance with SFAS No. 5, Accounting for Commitments and Contingencies. These estimates reflect assumptions and judgments as to the probable nature, magnitude and timing of required investigation,
remediation and monitoring activities. In making these estimates, we consider, among other things, the activities we have conducted at any particular site, information obtained through consultation with applicable regulatory authorities and
third-parties, and our historical experience at other sites that are judged to be comparable. We must also consider the likelihood of changes in governmental regulations, advancements in environmental technologies, and changing legal standards
regarding liability. 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.    The determination of pension plan expense and the requirements for funding our pension plans are based on a number of actuarial assumptions. Two critical
assumptions are the discount rate applied to pension plan obligations and the rate of return on plan assets. For other postretirement employee benefit (OPEB) plans, which provide certain health care and life insurance benefits to qualified retired
employees, critical assumptions in determining OPEB expense are the discount rate applied to benefit obligations and the assumed health care cost trend rates used in the calculation of benefit obligations.



Note 12 to our 2003 Form 10-K consolidated financial statements includes
information for the three years ended December 31, 2003, on the components of pension and OPEB expense, the underlying actuarial assumptions used to calculate periodic expense, as well as the funded status for our pension and OPEB plans as of
December 31, 2003 and 2002. Note 11, Pension and Other Postretirement Benefit Plans, on pages 8-9 of this Form 10-Q, includes information on the components of pension and OPEB expense for the quarters and nine months ended September 30,
2004 and 2003.



The discount rate used in the determination of
pension benefit obligations and pension expense is based on high-quality fixed income investment interest rates. At December 31, 2003, we calculated obligations using a 6.25% discount rate. The discount rates used at December 31, 2002 and 2001 were
6.75% and 7.25%, respectively. To determine the expected long-term rate of return on pension assets, we employ a process that analyzes historical long-term returns for various investment categories, as measured by appropriate indices. These indices
are weighted based upon the extent to which plan assets are invested in the particular categories in arriving at our determination of a composite expected return. The assumed long-term rate of return on pension plan assets used for 2003-2001 was
9.5%. Over the past 25 years our actual average annual return on pension plan assets has been 12.0%.



An increase in the discount rate or the expected return on plan assets, all other assumptions remaining the same, would reduce pension plan expense, and
conversely, a decrease in either of these measures would increase plan expense. Total periodic pension plan income in 2003 was $13.3 million. As



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an indication of the sensitivity that pension expense has to the discount rate assumption, a 25 basis point change in the
discount rate would affect plan expense by approximately $1.1 million. A 25 basis point change in the assumption for expected return on plan assets would affect plan expense by approximately $1.5 million. The actual return rates on plan assets may
vary significantly from the assumption used because of unanticipated changes in financial markets.



No minimum pension contributions are required for 2004 due to the funded status of our pension plans at December 31, 2003. We estimate contributions to
our nonqualified pension plan will total approximately $1.2 million in 2004. As a result of our cash position from the sale of our OSB operations, we recently announced our intention to make a contribution of $57.9 million to our qualified pension
plans in the fourth quarter, which represents the maximum tax-deductible amount allowed in 2004.



For our OPEB plans, expense for 2003 was $23.4 million. The discount rate used to calculate OPEB obligations was also 6.25% at December 31, 2003, and
6.75% and 7.25% at December 31, 2002 and 2001, respectively. The assumed health care cost trend rate used to calculate OPEB obligations and expense at December 31, 2003, was an 8% increase over the previous year, declining 1 percent annually to a
long-term ultimate rate increase assumption of 6% for 2005 and thereafter.



As an indication of the sensitivity that OPEB expense has to the discount rate assumption, a 25 basis point change in the discount rate would affect plan expense by approximately $0.8 million. A 1% change in the
assumption for health care cost trend rates would have affected 2003 plan expense by approximately $2.2-$2.6 million and the total postretirement obligation by approximately $27.0-$31.7 million. The actual rates of health care cost increases may
vary significantly from the assumption used because of unanticipated changes in health care costs.



Periodic pension and OPEB expense are included in Materials, labor and other operating expenses and Selling, general and administrative
expenses in the statements of operations. The expense is allocated to all business segments. Depending upon the funded status of the different plans, either a long-term asset or long-term liability is recorded for plans with overfunding or
underfunding, respectively. Any unfunded accumulated pension benefit obligation in excess of recorded liabilities is accounted for in stockholders equity as accumulated other comprehensive income. See Note 12 to our 2003 Form 10-K financial
statements for related balance sheet effects at December 31, 2003 and 2002.



Recent Accounting Pronouncements



In December 2003, the FASB issued a revision of SFAS No. 132, Employers Disclosures about Pensions and Other Postretirement Benefits. The revised statement was effective for financial statements with
fiscal years ending after December 15, 2003. It requires disclosures in addition to those contained in the original Statement No. 132 about assets, obligations, cash flows and the net periodic benefit cost of defined pension plans and other
postretirement benefit plans. The information contained in Note 12 to our 2003 Form 10-K financial statements incorporates the additional annual disclosure requirements. The revised statement also added new disclosure requirements for interim
financial reports. The information contained in Note 11, Pension and Other Postretirement Benefit Plans, on pages 8-9 of this Form 10-Q, incorporates the additional interim disclosure items required by the revised Statement No. 132.



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Results of Operations



As noted above, our business is organized into four reporting segments: Resource; Wood Products; Pulp and Paperboard; and
Consumer Products. Sales or transfers between 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, intersegment sales
represent a significant portion of the Resource segments total net sales. Intersegment sales represent a substantially smaller 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.



Amounts reported for Discontinued operations in the Statements of Operations and Comprehensive Income for the quarter and nine months ended
September 30, 2004 and 2003, include the results of operations for the OSB operations sold to Ainsworth Lumber Co. Ltd. in September 2004 and the gain recognized as a result of the sale. Also included in the results for the nine months ended
September 30, 2003, are costs related to our former printing papers mill in Brainerd, Minnesota, which was sold in February 2003. The discussion below addresses our continuing businesses. Certain 2003 amounts discussed below have been conformed to
2004 classifications as a result of the OSB divestiture.



Quarter Ended
September 30, 2004, Compared to Quarter Ended September 30, 2003



Net Sales  Consolidated net sales increased 20%, to $370.1 million for the quarter ended September 30, 2004, from $307.2 million for the same period in 2003. Resource segment net sales of $36.8 million increased $13.1 million
compared to the third quarter of 2003 largely due to increased land sales revenue. Wood Products net sales increased $25.1 million to $121.7 million as a result of higher selling prices for lumber and panel products. Pulp and Paperboard segment net
sales were $129.2 million, $21.4 million higher than the prior year period due to increased paperboard shipments and selling prices. Net sales for the Consumer Products segment increased $3.4 million, to $82.3 million for the third quarter of 2004,
due to higher selling prices for consumer tissue products.



Depreciation, amortization and cost of fee timber harvested  For the quarter ended September 30, 2004, depreciation, amortization and cost of fee timber harvested totaled $22.5 million, slightly higher than the prior year
amount of $21.8 million. Small increases in depletion expense in Idaho and Arkansas constitute the majority of the difference between the periods.



Materials, labor and other operating expenses  Materials, labor and other operating expenses increased 6% to $275.6 million for the quarter
ended September 30, 2004, from $258.7 million for the third quarter of 2003. The higher costs were due primarily to an increase in shipments of paperboard and higher production costs for consumer tissue products.



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Selling, general and administrative expenses  Selling, general and administrative expenses
were $20.7 million for the third quarter of 2004, compared to $19.3 million incurred for the same period of 2003, due principally to an increase in corporate administration and research expense.



Interest expense, net of capitalized interest  Interest expense
totaled $12.5 million for the quarter ended September 30, 2004, compared to $12.2 million in the prior year period. During the third quarter of 2003, we capitalized $0.9 million of interest for our tissue machine project in Las Vegas. No interest
was capitalized in the third quarter of 2004. The interest capitalized in 2003 more than offset interest expense for borrowings outstanding under our bank credit facility during the third quarter of 2003. We had no borrowings outstanding under our
bank credit facility in the third quarter of 2004.



Interest
income  For the quarter ended September 30, 2004, interest income was $1.1 million, compared to $0.5 million for the 2003 period. Higher shortterm investment balances during the current quarter were responsible for the favorable
comparison.



Provision (benefit) for taxes  For
the quarter ended September 30, 2004, we recorded an income tax provision of $15.8 million on earnings from continuing operations of $40.0 million, based on an estimated annual effective tax rate of 39.5%.



During the third quarter of 2003, the tax rate of 39% that had been used in
the first half of 2003 was revised to 34% to reflect our ability to apply anticipated tax credits to our 2003 tax provision. The revised rate resulted in a tax provision for 2003s third quarter of $11.8 million. In allocating the $11.8 million
tax provision between continuing operations and discontinued operations for presentation in the current statements of operations, the benefit from the anticipated tax credits was allocated to continuing operations, resulting in a tax benefit of $3.2
million. A tax rate of 39% was applied to income from discontinued operations in 2003.



Earnings (loss) from continuing operations  We recorded earnings from continuing operations of $24.2 million for the quarter ended September 30, 2004, compared to a loss of $1.2 million for the same
period in 2003. Improved earnings in the Resource, Wood Products and Pulp and Paperboard segments were largely responsible for the favorable comparison.



Discontinued operations  Discontinued operations for the third quarters of 2004 and 2003 include the results for our OSB operations. For the
portion of the third quarter of 2004 during which they operated under our ownership, these operations recorded pretax income of $37.3 million. For the third quarter of 2003, pre-tax earnings on discontinued operations were $38.3 million. Third
quarter 2004 and 2003 discontinued operations net sales were $92.7 million and $93.1 million, respectively. A gain on the sale of the operations, totaling $269.5 million before taxes, was recorded in September 2004.



Other comprehensive loss, net of tax  For the quarter ended
September 30, 2003, we recorded a net derivative loss due to cash flow hedges of $0.4 million, after tax. There were no cash flow hedges outstanding during the third quarter of 2004.



Discussion of business segments  The Resource segment reported
operating income of $30.2 million for the third quarter of 2004, $16.6 million higher than the $13.6 million earned in the same period of 2003.



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Segment net sales were $93.0 million for the third quarter of 2004 compared to $73.6 million for the 2003 period. A
significant portion of the increases in operating income and net sales was due to increased sales of nonstrategic land (land either unsuited for long-term timber management or of greater value to others for non-timber uses) and the sale of
conservation easements, totaling $12.0 million in the third quarter of 2004 versus $3.1 million in the third quarter of 2003. The portion of land sale revenue generated by the sale of conservation easements amounted to $4.1 million in the third
quarter of 2004 and $0.5 million in the third quarter of 2003. Land sale revenue amounts (including easement revenues) usually vary, sometimes significantly, from period to period due to the unique characteristics of each transaction, and therefore
no trends should be inferred by period to period comparison of these transactions. Higher sales prices for logs in Idaho also contributed significantly to the positive results for 2004s third quarter. Resource segment expenses were $62.8
million in the third quarter of 2004 compared to $60.0 million in the third quarter of 2003, as a result of slightly higher costs for purchased timber and logging. Land sales generally do not have a material effect on segment expenses due to the low
cost basis on most of our timberland.



The Wood Products
segment reported operating income of $26.4 million for the third quarter of 2004, compared to $5.6 million recorded in the third quarter of 2003. Markets for wood products, which have been strong since the third quarter of 2003, continued to be
favorable during the third quarter of 2004. Net sales for the segment rose to $124.9 million for the third quarter of 2004, 25% higher than the $99.6 million recorded for the 2003 period. Lumber net sales were $97.4 million, up from $74.9 million in
2003. The favorable comparison was due to a 31% increase in lumber selling prices. Plywood net sales increased to $15.4 million for the third quarter of 2004, compared to $14.0 million in 2003. Sales prices were 27% higher than the same period a
year ago, which more than offset 13% lower shipment volume. Shipments in the third quarter of 2004 were comparable to production during the period, whereas third quarter 2003 shipments reflected the reduction of inventory levels as well.
Particleboard net sales were $5.2 million for the third quarter of 2004, compared to $4.2 million for the third quarter of 2003, as a result of a 47% increase in sales prices, partially offset by a 16% decline in shipments. Particleboard shipments
for the third quarter of 2003 also reflected a reduction in inventory levels. Segment expenses were slightly higher for the third quarter of 2004, totaling $98.5 million versus $94.0 million in 2003. Higher wood fiber costs were primarily
responsible for the higher expense amount.



The Pulp and
Paperboard segment reported operating income for 2004s third quarter of $12.2 million, compared to a loss of $3.3 million for the same period of 2003. Segment net sales were $142.2 million for the third quarter of 2004, up from $119.3 million
for the 2003 period. Paperboard net sales increased to $125.3 million, compared to $102.0 million in the third quarter of 2003. Shipments increased 21% and selling prices were slightly higher compared to the prior years third quarter. Higher
production at the segments Idaho and Arkansas facilities and improving demand were responsible for the increase in shipments. Pulp sales (including intersegment sales) were $16.9 million for the third quarter of 2004, compared to $17.4 million
for the same period in 2003. The decrease in pulp sales for 2004 was due largely to a decrease in shipments to external customers and to the Consumer Products segment. Higher pulp selling prices partially offset the reduction in shipments. Although
pulp production was slightly higher than the third quarter of 2003, greater internal usage due to increased paperboard production reduced the volume available for sale. Segment expenses were $130.0 million for the third quarter of 2004, compared to
$122.7 million in the third quarter of 2003. The increase reflected



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greater volumes of paperboard shipments for the current quarter of 2004 compared to 2003, although costs per ton of
shipments were less due to production improvements. Operating income for the third quarter of 2004 included $3.0 million received from the bankruptcy liquidation of Beloit Corporation. The entire amount was recorded as income due to the write-off in
2001 of the claim.



The Consumer Products segment incurred an
operating loss of $5.0 million for the third quarter of 2004, compared to operating income of $0.1 million recorded in the third quarter of 2003. Markets for consumer tissue products continued to be very competitive during the quarter. Segment net
sales improved to $82.4 million versus the $79.0 million recorded for the 2003 period. Selling prices increased 6%, but were partially offset by a 2% decline in product shipments compared to the prior year period. Shipments and selling prices were
positively affected by the addition to the segments product mix of the new ultra towel product manufactured at the Las Vegas tissue facility. Higher segment expenses more than offset the increase in net sales, totaling $87.3 million for the
third quarter of 2004, versus $78.9 million in 2003. Higher production costs due to higher pulp, freight, energy and labor costs contributed to the quarter-over-quarter increase.



Nine Months Ended September 30, 2004, Compared to Nine Months Ended September 30, 2003



Net Sales  Net sales increased 15%, to $1,029.9 million for the
nine months ended September 30, 2004, from $895.4 million for the same period in 2003. Resource net sales increased to $81.0 million, compared to $65.9 million for the first nine months of 2003. Increased log sales to third parties and higher
selling prices were largely responsible for the improvement. Wood Products net sales increased 27% to $343.4 million as a result of higher selling prices for lumber, plywood and particleboard products, and higher plywood shipments. Pulp and
Paperboard segment net sales were $366.0 million, $31.0 million higher than the 2003 period due to increased paperboard shipments. Consumer Products segment net sales increased to $239.4 million from $224.4 million due to a 4% increase in shipments
and slightly higher selling prices compared to the first nine months of 2003.



Depreciation, amortization and cost of fee timber harvested  For the nine months ended September 30, 2004, depreciation, amortization and cost of fee timber harvested totaled $66.8 million, a slight
increase compared to $65.9 million recorded in the first nine months of 2003.



Materials, labor and other operating expenses  Materials, labor and other operating expenses increased to $821.7 million for the nine months ended September 30, 2004, from $763.6 million for the nine
months ended September 30, 2003. The higher costs were due primarily to an increased volume of log sales and increased shipments of plywood, paperboard and consumer tissue products. Higher wood fiber costs for all segments and higher energy costs
for the consumer products segment also contributed to the increase.



Selling, general and administrative expenses  Selling, general and administrative expenses were $63.7 million for the first nine months of 2004, compared to $54.6 million incurred for the same period of 2003. The higher expense
was due principally to an increase in corporate administration expense, higher research expense and slightly higher selling expenses for the Consumer Products and Pulp and Paperboard segments.



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Restructuring charges A pre-tax charge of $1.3 million was recorded in January 2004
for a workforce reduction at our Consumer Products segment. A total of 60 production and 8 salaried employees were terminated. By June 2004, all costs had been incurred for the workforce reduction, resulting in a reversal in the second quarter of
less than $0.1 million to the initial charge. During the first quarter of 2003 we recorded a pre-tax charge of $0.2 million for costs related to terminated employees whose services had been retained beyond the initial 60-day period following
announced job eliminations in 2002.



Interest expense, net
of capitalized interest  Interest expense totaled $36.8 million for the nine months ended September 30, 2004, compared to $37.1 million in the prior year period. Higher interest expense in the first nine months of 2003 was due to
borrowings outstanding under our bank credit facility during the period and interest on $15.0 million of medium-term notes, which matured in April 2003. Interest expense in 2003 did not include $1.8 million of capitalized interest, compared to $0.4
million of capitalized interest for the first nine months of 2004.



Interest income  For the nine months ended September 30, 2004, interest income was $1.7 million, compared to $13.2 million for the same period in 2003. The 2003 amount consisted primarily of the receipt of $12.5 million of
interest income in conjunction with a settlement with the Internal Revenue Service for tax years 1989 through 1994.



Provision (benefit) for taxes  For the nine months ended September 30, 2004, we recorded an income tax provision of $16.3 million on earnings
from continuing operations of $41.4 million, based on an estimated effective tax rate of 39.5%.



During the third quarter of 2003, the tax rate of 39% that had been used in the first half of 2003 was revised to 34% to reflect our ability to apply
anticipated tax credits to our 2003 tax provision. The revised rate resulted in a tax provision for 2003s first nine months of $9.9 million. In allocating the $9.9 million tax provision between continuing operations and discontinued operations
for presentation in the current statements of operations, the benefit from the anticipated tax credits was allocated to continuing operations, resulting in a tax benefit of $6.5 million for the nine months ended 2003. A tax rate of 39% was applied
to income from discontinued operations in 2003.



Earnings
(loss) from continuing operations  We recorded earnings from continuing operations of $25.0 million for the nine months ended September 30, 2004, compared to a loss from continuing operations of $6.4 million for the same period in 2003.
Improved earnings in the Wood Products and Pulp and Paperboard segments more than offset a decline in Consumer Products segment results.



Discontinued operations  Discontinued operations for the nine months ended September 30, 2004 and 2003 included the results for our OSB
operations. Also included in the results for the 2003 period are costs related to our former printing papers mill in Brainerd, Minnesota, which was sold in February 2003. For the first nine months of 2004 the OSB operations recorded pre-tax income
of $153.9 million. A gain on the sale of the OSB operations, totaling $269.5 million before taxes, was recorded in September 2004. For the first nine months of 2003, pre-tax earnings for the OSB operations were $43.4 million and the pre-tax loss
related to the printing papers mill totaled $1.4 million. Net sales for discontinued operations for the nine months ended September 30, 2004 and 2003 were $326.0 million and $207.7 million, respectively.



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Other comprehensive loss, net of tax  For the nine months ended September 30, 2004, we
recorded a net derivative loss due to cash flow hedges of $0.1 million, after-tax, compared to an after-tax loss of $0.4 million recorded for the same period of 2003.



Discussion of business segments  The Resource segment reported operating income of $49.0 million for the first
nine months of 2004, slightly higher than $48.2 million recorded in the same period of 2003. Segment net sales were $199.6 million for the first nine months of 2004, compared to the $180.4 million recorded for the 2003 period. Increased log sales to
third parties in Idaho during the first nine months of 2004 were responsible for the improvement. Revenue from sales of nonstrategic land was $17.1 million in the first nine months of 2004 compared to $16.5 million in the first nine months of 2003.
Conservation easement revenue of $4.1 million was included in the total land sales revenues for 2004, while $0.5 million was included in the 2003 figure. Although land sale revenues were approximately equal for the 2004 and 2003 periods, the types
of transactions generating revenues and the transaction dates within the periods varied significantly, indicating that no long-term pattern or trends should be associated with this portion of the segments operating activities. Resource segment
expenses were $150.6 million in the first nine months of 2004, compared to $132.2 million in the first nine months of 2003, reflecting the higher log sales volume in Idaho and a corresponding increase in log purchases from third parties, as well as
increased logging costs. Land sales generally do not have a material effect on segment expenses due to the low cost basis on most of our timberland.



The Wood Products segment reported operating income of $62.0 million for the first nine months of 2004, compared to a loss of $0.7 million recorded in the
first nine months of 2003. Wood product markets during the first nine months of 2004 have benefited from continued strong homebuilding activity and a weaker U.S. dollar, which has increased the cost of imported competitive products. Net sales for
the segment rose to $352.3 million for the first nine months of 2004, 26% higher than the $278.9 million recorded for the 2003 period. Lumber net sales were $269.3 million, up from $212.6 million in 2003. The favorable comparison was due to a 28%
increase in lumber selling prices. Shipments of lumber products were comparable to the prior year. Plywood net sales increased to $47.0 million for the first nine months of 2004, compared to $33.1 million in 2003. Shipment volume increased 8% and
sales prices were 32% higher than in the same period a year ago. Plywood shipments have slightly outpaced production for the first nine months of 2004, while shipments were equal to production in 2003. Particleboard net sales were $15.3 million for
the first nine months of 2004 compared to $11.4 million for the first nine months of 2003, as a result of a 40% increase in sales prices, which was partially offset by slightly lower shipments. Segment expenses were higher for the first nine months
of 2004, totaling $290.4 million, versus $279.6 million in 2003. Increased plywood shipments and higher wood fiber costs accounted for the increase over 2003.



The Pulp and Paperboard segment reported operating income for 2004s first nine months of $10.3 million, compared to a loss of $13.8 million for
the first nine months of 2003. Segment net sales were $401.1 million for the first nine months of 2004, up from $366.1 million for the 2003 period. Paperboard net sales increased to $353.7 million, compared to $322.2 million in the first nine months
of 2003. Shipments increased 10% compared to the prior years first nine months as a result of increased production at the segments two facilities in Idaho and Arkansas. Selling prices were



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approximately equal for the two periods. Pulp sales (including intersegment sales) were higher for the first nine months
of 2004, totaling $47.4 million, compared to $43.9 million for the same period in 2003. The increase in pulp sales for 2004 was due to 22% higher selling prices, partially offset by a decrease in shipments. Segment expenses were higher for the first
nine months of 2004, totaling $390.8 million, compared to $379.9 million in the first nine months of 2003. The increase reflected greater volumes of paperboard shipments for the first nine months of 2004 compared to 2003 combined with higher wood
fiber costs, partially offset by lower per ton costs resulting from improved production. Operating income for the first nine months of 2004 included $3.0 million received from the bankruptcy liquidation of Beloit Corporation. The entire amount was
recorded as income due to the write-off in 2001 of the claim.



The Consumer Products segment incurred an operating loss of $10.0 million for the first nine months of 2004, compared to operating income of $1.9 million for the first nine months of 2003. Market conditions have remained very competitive
for consumer tissue products throughout 2004. Segment net sales were $239.5 million for the first nine months of 2004, 7% higher than the $224.5 million recorded for the 2003 period. The increase in net sales was due to a 4% increase in product
shipments compared to the prior year period combined with slightly higher selling prices. Shipments were positively affected by the rollout of our ultra towel product. Segment expenses were higher for the first nine months of 2004, totaling $249.5
million, versus $222.5 million in the first nine months of 2003. Increased product shipments as well as start-up costs related to the new tissue machine in Las Vegas contributed to the increase. Also, higher production costs due to higher pulp,
freight, energy and labor costs adversely affected segment expenses. In addition, the segment recorded a pre-tax charge of $1.2 million early in the year for a workforce reduction.



Liquidity and Capital Resources



At September 30, 2004, our financial position included long-term debt of $618.3 million, including current installments on
long-term debt of $255.9 million. Long-term debt at September 30, 2004 (including current installments) declined slightly from the December 2003 balance of $618.8 million due to normal repayments on maturing debt of $0.5 million. In October 2004,
long-term debt decreased by $244.5 million due to the successful redemption of 97.8% of our 10% senior subordinated notes. A portion of the proceeds from the sale of our OSB operations was used to redeem these notes. Stockholders equity for
the first nine months of 2004 increased $297.8 million, largely due to net earnings and the gain on sale from discontinued operations of $256.2 million, earnings from continuing operations of $25.0 million, and the issuance of treasury stock
totaling $29.0 million, which were partially offset by dividend payments of $13.2 million. The ratio of long-term debt (including current installments) to stockholders equity was .80 to 1 at September 30, 2004, compared to 1.31 to 1 at
December 31, 2003.



Scheduled payments due on long-term debt
during each of the five years subsequent to December 31, 2004, are as follows:



|                       |  |   |        
|---------------------- |  | - | -------
|(Dollars in thousands) |  |  
|2005                   |  | $ | 1,108  
|2006                   |  |   | 2,358  
|2007                   |  |   | 6,159  
|2008                   |  |   | 209    
|2009                   |  |   | 100,410



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Working capital totaled $434.9 million at September 30, 2004, an increase of $131.2 million from December
31, 2003. The significant changes in the components of working capital are as follows:



| |  | Short-term investments increased $697.6 million. Positive cash flow from increased operating earnings not immediately needed for operations or capital expenditures and the proceeds
from the sale of the OSB operations were invested in short-term bank instruments.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Receivables increased $15.0 million primarily as a result of increased sales and the corresponding increase in customer receivables.
| | - | ------------------------------------------------------------------------------------------------------------------------------------



| |  | Inventories declined $4.2 million largely as a result of seasonal decreases in log inventories, which were partially offset by an increase in tissue parent roll inventories.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Assets held for sale and related liabilities had a net decrease of $165.5 million due to the completion in September 2004 of the sale of the OSB operations.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Current installments on long-term debt increased $255.4 million due to the reclassification from long-term to current of $244.5 million of senior subordinated notes and $10.3
million of revenue bonds. Our tender offer in October 2004 for the 10% senior subordinated notes was accepted by holders of $244.5 million of the notes, which were redeemed on October 21. In September we notified holders of $10.3 million of our
revenue bonds of our intent to redeem the bonds in the fourth quarter of 2004. Accordingly, these amounts were reclassified to current installments at September 30, 2004.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Accounts payable and accrued liabilities increased $165.8 million largely due to a $102.6 million increase in accrued taxes resulting from the sale of the OSB operations, as well as
increases in accounts payable and accrued liability accounts related to the sale of the OSB operations and the redemption of the 10% senior subordinated notes.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Net cash provided by continuing operations for the first nine months of 2004 totaled $131.2 million, compared with $98.6
million for the same period in 2003. Net earnings from continuing operations, versus a net loss in 2003, combined with an increase in cash provided by working capital changes were largely responsible for the favorable comparison. The net earnings
were generally due to higher selling prices for wood products and pulp and increased paperboard shipments.



For the nine months ended September 30, 2004, net cash used for investing was $740.5 million, compared to $62.3 million for the first nine months of 2003.
In 2004 we used $697.6 million to increase our short-term investments, as discussed above, and $36.0 million for capital spending. Capital spending in 2004 included $5.1 million towards completion of our new tissue machine in Las Vegas and $4.1
million towards the establishment of a tissue converting facility in Elwood, Illinois. The balance of capital spending in 2004 focused on forest resources and various small projects designed to improve product quality and manufacturing efficiency.
Cash was used in the first nine months of 2003 primarily for capital spending projects and for increasing short-term investments. The use of restricted cash in 2003 to repay debt partially offset these activities.



Net cash provided by financing totaled $25.1 million for the nine months
ended September 30, 2004, compared with cash used for financing of $59.7 million during the same period in 2003. The majority of cash provided by



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financing in 2004s first nine months resulted from the issuance of treasury stock totaling $29.0 million related to
the exercise of stock options. This amount was partially offset by dividend payments of $13.2 million. The majority of the cash used in 2003 was for the repayment of notes payable, the retirement of long-term debt and the payment of dividends.



Cash generated from discontinued operations in the first nine
months of 2004 totaled $586.3 million, all of which was related to operating results for OSB and proceeds from the sale of the OSB facilities. Discontinued operations in 2003 generated cash of $30.5 million, which was from the OSB operations,
partially offset by costs associated with our former printing papers mill in Brainerd, Minnesota.



On June 29, 2004, we entered into a new three-year unsecured bank credit facility, which replaced a secured bank credit facility that expired on June 28,
2004. The new credit facility provides a revolving line of credit of up to $125 million, including a $35 million subfacility for letters of credit and a $10 million subfacility for swing line loans. Usage under either or both subfacilities reduces
availability under the revolving line of credit. As of September 30, 2004, there were no borrowings outstanding under the new credit facility; however, approximately $10.6 million of the letter of credit subfacility was being used to support several
outstanding letters of credit.



As of September 30, 2004, both
the agreement governing our bank credit facility and the indenture governing our $250 million 10% senior subordinated notes, $244.5 million of which were redeemed in October 2004, as mentioned above, contained certain covenants that, among other
things, restricted our ability and our subsidiaries ability to create liens, merge or consolidate, dispose of assets, incur indebtedness and guarantees, pay dividends, repurchase or redeem capital stock and indebtedness, make certain
investments or acquisitions, enter into certain transactions with affiliates, make capital expenditures, or change the nature of our business. The bank credit facility also contained financial maintenance covenants establishing a maximum funded
indebtedness to capitalization ratio, a minimum consolidated net worth requirement, and a minimum interest coverage ratio. Events of default under the bank credit facility and the indenture included, but were not limited to, payment defaults,
covenant defaults, breaches of representations and warranties, cross defaults to certain other material agreements and indebtedness, bankruptcy and other insolvency events, material adverse judgments, actual or asserted invalidity of security
interests or loan documentation, and certain change of control events involving our company. As of September 30, 2004, we were in compliance with the covenants of our bank credit facility and the $250 million 10% senior subordinated notes. In
connection with the successful redemption of substantially all of the outstanding $250 million senior subordinated notes in October 2004, we obtained sufficient consents from the note holders to remove from the Indenture all restrictive covenants
and all events of default, except for payment and bankruptcy defaults. The removal of these restrictive covenants and events of default occurred pursuant to the terms of a Supplemental Indenture dated October 21, 2004.



We believe that our cash, short-term investments, cash flows from operations
and available borrowings under our current bank credit facility will be sufficient to fund our operations, capital expenditures and debt service obligations for the next twelve months. In 2003 and 2004, our OSB operations generated a significant
portion of our operating income and cash flows. In certain years prior to 2003, those same operations generated operating losses due to poor market conditions. We believe that our remaining operations will generate sufficient cash flows to fund
operations



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and that the use of a portion of the proceeds from the OSB sale to reduce debt will improve future cash flows by reducing
interest expense. We cannot assure, however, that our business will generate sufficient cash flows from operations or that we will be in compliance with the financial covenants in our bank credit facility so that future borrowings thereunder will be
available to us. Thus, our ability to fund our operations will be dependent upon our future financial performance, which will be affected by general economic, competitive and other factors, including those discussed above under Factors
Influencing Our Results of Operations, many of which are beyond our control.



As of September 30, 2004, Standard & Poors Ratings Services (S&P) rated our senior unsecured debt at BB+, with a stable outlook. The ratings have remained unchanged since January 30, 2003. Since the
first quarter of 2003, Fitch, Inc. has rated our senior unsecured debt at BB+. In October 2004, Fitch reaffirmed our ratings and removed the company from its Ratings Watch Evolving list. In October 2004, Moodys Investors Service Inc.
downgraded its rating of our senior unsecured debt from Baa3 with a negative outlook to Ba1 with a stable outlook. Moodys also downgraded our senior secured subordinated rating from Ba1 to Ba2. The interest rate we pay on some of our debt is
influenced by our credit ratings. See Item 3  Quantitative and Qualitative Disclosures About Market Risk on pages 29-30 for additional information.



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, as in the recent sale of our OSB operations. 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.



Subsequent
Events



On October 6, 2004, we announced that our
Board of Directors had authorized a tender offer for our outstanding $250 million 10% Senior Subordinated Notes due 2011. As of October 20, $244.5 million of the notes were tendered, and they were subsequently redeemed on October 21. The related
premium of $40.0 million, deferred debt issuance costs of $4.7 million and interest rate swap settlements of $24.4 million will be recognized in operations in the fourth quarter, resulting in a total net charge of $20.4 million.



On October 25, 2004, we announced that, following the successful tender offer
for the companys $250 million in senior subordinated notes, the Board of Directors authorized a special cash dividend of $2.50 per share, payable on November 29, 2004, to stockholders of record as of the close of business on November 10, 2004.
Based on the current 29.7 million shares outstanding, the dividend payout is expected to total approximately $75 million. The Board of Directors also authorized the repurchase of $75 million of company stock through an accelerated stock buyback
agreement which was executed on October 25, 2004. The Board authorization for this stock repurchase supercedes a previous authorization to repurchase up to 2 million shares announced in December 1999, under which authorization 910,900 shares were
repurchased.



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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 30 |  
|                                                            |  | 2004                       |         |   | 2003                           |   |         | Increase(Decrease) |  |     | 2004 |  |   | 2003      |   |  | Increase(Decrease) |        
|Net sales                                                   |  | $                          | 370,100 |   |                                | $ | 307,174 |                    |  | 20  | %    |  | $ | 1,029,874 |   |  | $                  | 895,427 |   |  | 15    | % 
|Costs and expenses:                                         |  |                            |         |   |                                |   |         |                    |  |     |      |  |   |           |   |  |                    |         |   |  |       |   
|Depreciation, amortization and cost of fee timber harvested |  |                            | 22,465  |   |                                |   | 21,822  |                    |  | 3   | %    |  |   | 66,796    |   |  |                    | 65,921  |   |  | 1     | % 
|Materials, labor and other operating expenses               |  |                            | 275,564 |   |                                |   | 258,748 |                    |  | 6   | %    |  |   | 821,738   |   |  |                    | 763,571 |   |  | 8     | % 
|Selling, general and administrative expenses                |  |                            | 20,668  |   |                                |   | 19,264  |                    |  | 7   | %    |  |   | 63,654    |   |  |                    | 54,587  |   |  | 17    | % 
|Restructuring charges                                       |  |                            |        |   |                                |   |        |                    |  |    |      |  |   | 1,193     |   |  |                    | 227     |   |  | 426   | % 
|Earnings from operations                                    |  |                            | 51,403  |   |                                |   | 7,340   |                    |  | 600 | %    |  |   | 76,493    |   |  |                    | 11,121  |   |  | 588   | % 
|Interest expense                                            |  |                            | (12,484 | ) |                                |   | (12,234 | )                  |  | 2   | %    |  |   | (36,822   | ) |  |                    | (37,124 | ) |  | (1    | %)
|Interest income                                             |  |                            | 1,078   |   |                                |   | 515     |                    |  | 109 | %    |  |   | 1,697     |   |  |                    | 13,155  |   |  | (87   | %)
|Provision (benefit) for taxes                               |  |                            | 15,798  |   |                                |   | (3,165  | )                  |  | *   |      |  |   | 16,340    |   |  |                    | (6,468  | ) |  | *     |   
|Earnings (loss) from continuing operations                  |  |                            | 24,199  |   |                                |   | (1,214  | )                  |  | *   |      |  |   | 25,028    |   |  |                    | (6,380  | ) |  | *     |   
|Discontinued operations:                                    |  |                            |         |   |                                |   |         |                    |  |     |      |  |   |           |   |  |                    |         |   |  |       |   
|Earnings from discontinued operations                       |  |                            | 306,857 |   |                                |   | 38,312  |                    |  | 701 | %    |  |   | 423,480   |   |  |                    | 42,000  |   |  | 908   | % 
|Income tax provision                                        |  |                            | 121,209 |   |                                |   | 14,942  |                    |  | 711 | %    |  |   | 167,275   |   |  |                    | 16,380  |   |  | 921   | % 
|Net earnings                                                |  | $                          | 209,847 |   |                                | $ | 22,156  |                    |  | 847 | %    |  | $ | 281,233   |   |  | $                  | 19,240  |   |  | 1,362 | % 

---

|* | Not a meaningful figure.
|- | ------------------------



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ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk



Our exposure to market risks on financial instruments includes interest rate risk on our short-term investments, bank credit facility and long-term debt,
and credit rate risk on our credit sensitive debentures.



Our
short-term investments are invested in money market funds and bonds with very short maturity periods and earn an interest rate commensurate with low-risk instruments. We do not attempt to hedge our exposure to interest rate risk for our short-term
investments.



During the quarter ended September 30, 2004, we
had no borrowings outstanding under our bank credit facility. The interest rates applied to borrowings under the bank credit facility are adjusted often and therefore react quickly to any movement in the general trend of market interest rates. We do
not attempt to mitigate the effects of short-term interest rate fluctuations on our bank credit facility borrowings through the use of derivative financial instruments.



All of our long-term debt is fixed-rate and therefore changes in market interest rates do not expose us to interest rate
risk for these financial instruments. However, in August 2003 we entered into a fixed-to-variable interest rate swap to hedge a portion of our 10% senior subordinated notes. The swap was designated as a fair value hedge and called for the company to
pay a variable interest amount, determined semi-annually in arrears and equal to LIBOR plus 4.80%, and receive a fixed rate payment from a financial institution, calculated on $165.0 million of our 10% senior subordinated notes. The terms of the
swap allowed us to assume there was no ineffectiveness in the hedge. In March 2004, we terminated the interest rate swap and received a cash settlement of $6.0 million. The settlement represented the value of the swap at the time of termination. In
May 2004, we reinstated our fixed-to-variable interest rate swap, with identical terms as the swap we terminated in March 2004. The reinstated swap was terminated on August 31, 2004, at which time we received a cash settlement of $3.2 million. In
October 2004, as a result of our early repayment of $244.5 million of our senior subordinated notes, we recognized in earnings $24.4 million of the aggregate cash settlements received. The remaining portion of the cash settlements, totaling $0.5
million, is being accreted to earnings until the remaining 10% senior subordinated notes mature in 2011. We have the right to call the notes for redemption beginning July 15, 2006.



We currently have $100 million of credit sensitive debentures outstanding that pay interest to the debt holder based upon
our credit ratings as established by Standard & Poors Ratings Services (S&P) or Moodys Investors Services, Inc. The following table denotes the interest rate applicable based on various credit ratings:



Ratings



|            |  |             |  |                   
|----------- |  | ----------- |  | ------------------
|Moodys     |  | S&P         |  | Applicable Rate(%)
|Aaa         |  | AAA         |  | 8.825             
|Aa1  Aa3   |  | AA+  AA   |  | 8.925             
|A1  Baa2   |  | A+  BBB    |  | 9.125             
|Baa3        |  | BBB-        |  | 9.425             
|Ba1         |  | BB+         |  | 12.500            
|Ba2         |  | BB          |  | 13.000            
|Ba3         |  | BB         |  | 13.500            
|B1 or lower |  | B+ or lower |  | 14.000            



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##### Table of Contents

On January 30, 2003, S&P announced that it had lowered our senior unsecured debt rating to BB+ from
BBB. The ratings downgrade caused the interest rate on our credit sensitive debentures to increase from 9.425% to 12.5%, effective January 30, 2003. On October 11, 2004, Moodys announced that it had lowered the rating on our senior
unsecured debt to Ba1 from Baa3. Because S&Ps rating is already at that level the change had no effect on the interest rate for the credit sensitive debentures.



During the third quarter of 2003, we entered into several derivative financial instruments designated as cash flow hedges
for a portion of our natural gas purchases during November 2003 through March 2004. As designated cash flow hedges, changes in the fair value of the financial instruments are recognized in Other comprehensive loss, net of tax to the
extent the hedges are deemed effective, until the hedged item is recognized in the statement of operations. As of March 31, 2004, the derivative financial instruments entered into in the third quarter of 2003 had expired, and we have not entered
into any additional instruments to hedge our expected future natural gas purchases.



The following table discloses quantitative information about market risks:



|                       |  |                                                  |         |   |      |   |       |      |  |   |       |   |  |      |       |   |            |   |     |       |  |   |         |   |  |   |         |  
|---------------------- |  | ------------------------------------------------ | ------- | - | ---- | - | ----- | ---- |  | - | ----- | - |  | ---- | ----- | - | ---------- | - | --- | ----- |  | - | ------- | - |  | - | ------- | -
|                       |  | Expected Maturity Date(as of September 30, 2004) |        
|(Dollars in thousands) |  | 2004                                             |         |   | 2005 |   |       | 2006 |  |   | 2007  |   |  | 2008 |       |   | Thereafter |   |     | Total | 
|Long-term debt:        |  |                                                  |         |   |      |   |       |      |  |   |       |   |  |      |       |   |            |   |     |       |  |   |         |   |  |   |         |  
|Fixed rate             |  | $                                                | 254,796 |   |      | $ | 1,108 |      |  | $ | 2,358 |   |  | $    | 6,159 |   |            | $ | 209 |       |  | $ | 353,678 |   |  | $ | 618,308 |  
|Average interest rate  |  |                                                  | 7.3     | % |      |   | 6.1   | %    |  |   | 6.3   | % |  |      | 6.1   | % |            |   | 6.9 | %     |  |   | 8.7     | % |  |   | 8.0     | %
|Fair value at 09/30/04 |  |                                                  |         |   |      |   |       |      |  |   |       |   |  |      |       |   |            |   |     |       |  |   |         |   |  | $ | 685,933 |  



ITEM 4.    Disclosure Controls and Procedures



Potlatch maintains disclosure controls and procedures, as such term is defined in Rule 13a-14(c) under the Securities and Exchange Act of 1934
(the Exchange Act), which are designed to ensure that information required to be disclosed by Potlatch in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to Potlatchs management, including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow
timely decisions regarding required disclosure. In designing and evaluating Potlatchs disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, Potlatchs management necessarily was required to apply its judgment
in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under all potential future conditions.



Subject to the limitations noted above, our management, with the participation of our CEO and CFO, has evaluated the effectiveness of the design and
operation of Potlatchs disclosure controls and procedures as of the end of the fiscal quarter covered by the quarterly report on this Form 10-Q. Based on that evaluation, the CEO and CFO have concluded that Potlatchs disclosure controls
and procedures are effective to meet the objective for which they were designed and operate at the reasonable assurance level.



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There were no changes in Potlatchs internal control over financial reporting that occurred during
the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, Potlatchs internal control over financial reporting.



PART II



ITEM 6.    Exhibits



Exhibits



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



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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. ZuehlkeVice President, Finance, ChiefFinancial Officer(Duly Authorized; Principal Financial Officer)By

/s/ Terry L. CarterTerry L. CarterController(Duly Authorized; Principal Accounting Officer)




Date: November 9, 2004



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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.
|        |      
|(2      | )(a)* |  | Asset Purchase Agreement, filed as Exhibit 2.1 to the current report on Form 8-K filed September 27, 2004.                             
|        |      
|(3      | )(c)* |  | By-laws, filed as Exhibit 3(ii) to the current report on Form 8-K dated September 23, 2004.                                            
|        |      
|(31     | )     |  | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                
|        |      
|(32     | )     |  | Furnished statements of the Chief Executive Officer and Chief Financial Officer under 18 U.S.C. Section 1350                           

---

|* | Incorporated by reference.
|- | --------------------------



33