##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





Quarterly Report Under Section 13 or 15(d)


of the Securities Exchange Act of 1934





For Quarter Ended June 30, 2002





Commission file number 1-5313





---




POTLATCH CORPORATION


(Exact name of registrant as specified in its charter)





A Delaware Corporation

82-0156045(State or other jurisdiction ofincorporation or organization)

(I.R.S. EmployerIdentification 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  ̈





The number of shares of common stock outstanding as of June 30,
2002:  28,464,844 shares of Common Stock, par value $1 per share.








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##### Table of Contents

POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





Index to Form 10-Q





Page NumberPART I.    FINANCIAL INFORMATIONItem 1.

Financial StatementsStatements of Operations for the quarters and six months ended June 30, 2002 and 2001

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

3Condensed Statements of Cash Flows for the six months ended June 30, 2002 and 2001

4Notes to Financial Statements

5-16Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

17-27Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28PART II.    OTHER INFORMATIONItem 4.

Submission of Matters to a Vote of Security Holders

28-29Item 6.

Exhibits and Reports on Form 8-K

29SIGNATURES

30EXHIBIT INDEX

31




1




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##### Table of Contents

PART I





Item 1.    Financial Statements





Potlatch Corporation and Consolidated Subsidiaries





Statements of Operations


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





Quarter Ended June 30


Six Months Ended June 302002


2001


2002


2001Net sales

$
333,178


$
335,026


$
651,367


$
647,898Costs and expenses:Depreciation, amortization and cost of fee timber harvested


31,157



27,630



61,641



54,872Materials, labor and other operating expenses


278,119



276,392



551,259



570,213Selling, general and administrative expenses


20,928



20,848



42,947



41,042Restructuring charge














4,217330,204



324,870



655,847



670,344Earnings (loss) from operations


2,974



10,156



(4,480
)


(22,446
)Interest expense


(15,679
)


(18,634
)


(34,305
)


(35,368
)Other income, net


1,956



2,076



3,548



2,530Loss before taxes on income


(10,749
)


(6,402
)


(35,237
)


(55,284
)Provision (benefit) for taxes on income (Note 2)


(4,192
)


(2,497
)


(13,742
)


(21,561
)Loss from continuing operations


(6,557
)


(3,905
)


(21,495
)


(33,723
)Discontinued operations (Note 3):Loss from discontinued operations, (including loss on disposal of $9,397, $0, $254,970 and $0)


(22,182
)


(9,646
)


(272,090
)


(12,252
)Income tax benefit


(8,650
)


(3,762
)


(106,115
)


(4,778
)Net loss

$
(20,089
)

$
(9,789
)

$
(187,470
)

$
(41,197
)Net loss per common share from continuing operations (Note 4):Basic

$
(.23
)

$
(.14
)

$
(.76
)

$
(1.19
)Diluted


(.23
)


(.14
)


(.76
)


(1.19
)Net loss per common share:Basic


(.70
)


(.35
)


(6.60
)


(1.46
)Diluted


(.70
)


(.35
)


(6.60
)


(1.46
)Dividends per common share (annual rate)


.60



1.74



.60



1.74Average shares outstanding (in thousands):Basic


28,441



28,254



28,397



28,292Diluted


28,441



28,254



28,397



28,292


---

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





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




2




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##### Table of Contents

Potlatch Corporation and Consolidated Subsidiaries





Condensed Balance Sheets


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





June 30,2002

December 31,2001AssetsCurrent assets:Cash

$
6,325

$
7,475Restricted cash (Note 5)





98,200Short-term investments


176,657


30,509Receivables, net (Note 6)


154,751


118,632Inventories (Note 7)


104,480


107,713Prepaid expenses


36,121


31,274Assets held for sale (Note 3)


28,429


772,033Total current assets


506,763


1,165,836Land, other than timberlands


8,667


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


774,429


808,763Timber, timberlands and related logging facilities


394,342


395,668Other assets


114,084


108,211$
1,798,285

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

$
15,607

$
132,603Accounts payable and accrued liabilities


198,343


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





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


3,672


33,933Total current liabilities


217,622


553,452Long-term debt


758,158


820,522Other long-term obligations


199,506


195,258Deferred taxes


106,605


210,610Stockholders equity


516,394


707,304$
1,798,285

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

$
18.14

$
24.98Working capital

$
289,141

$
612,384Current ratio


2.3:1


2.1:1


---

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





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




3




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##### Table of Contents

Potlatch Corporation and Consolidated Subsidiaries





Condensed Statements of Cash Flows


Unaudited (Dollars in thousands)





Six Months Ended June 302002


2001Cash Flows From Continuing OperationsNet loss

$
(187,470
)

$
(41,197
)Adjustments to reconcile net loss to net operating cash flows:Loss from discontinued operations


10,443



7,474Loss on disposal of discontinued operations


221,223



Depreciation, amortization and cost of fee timber harvested


61,641



54,872Deferred taxes


(104,004
)


(18,539
)Working capital changes


(21,734
)


(5,361
)Other, net


(2,651
)


(729
)Net cash used for operating activities of continuing operations


(22,552
)


(3,480
)Cash Flows From InvestingDecrease (increase) in restricted cash


98,200



(96,600
)Increase in short-term investments


(146,157
)


(1,916
)Additions to investments


(2,277
)


(2,171
)Reductions in investments


970



944Additions to plant and properties


(13,520
)


(24,172
)Net cash used for investing activities of continuing operations


(62,784
)


(123,915
)Cash Flows From FinancingChange in book overdrafts


(7,572
)


(5,137
)Decrease in notes payable






(188,943
)Proceeds from long-term debt






450,000Repayment of long-term debt


(376,360
)


(100,285
)Long-term debt issuance fees






(14,133
)Issuance of treasury stock


4,168



1,669Purchase of treasury stock






(8,349
)Dividends


(8,515
)


(24,629
)Other, net


(9,213
)


(3,378
)Net cash provided by (used for) financing activities of continuing operations


(397,492
)


106,815Cash from continuing operations


(482,828
)


(20,580
)Cash from discontinued operations


481,678



19,321Decrease in cash


(1,150
)


(1,259
)Balance at beginning of period


7,475



10,657Balance at end of period

$
6,325


$
9,398


---

Net interest payments (net of amounts capitalized) for the six months ended
June 30, 2002 and 2001 were $40.6 million and $35.4 million, respectively. Net income tax payments (refunds) for the six months ended June 30, 2002 and 2001 were $(16.0) million and $.5 million, respectively.





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





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




4




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##### Table of Contents




POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS


Unaudited (Dollars in thousands)





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





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





NOTE 3.    DISCONTINUED OPERATIONS  On March 18, 2002, we announced that we had signed a definitive agreement with a domestic subsidiary of
Sappi Limited for the sale of our Cloquet, Minnesota, pulp and printing papers facilities and certain associated assets (Printing Papers segment assets) for $480 million in cash. The sale was completed in May 2002. In conjunction with
the sale, we closed our Brainerd, Minnesota, printing papers mill and exited the coated printing papers business. An active search is currently underway to identify potential buyers for the Brainerd facility.





As a result of the transaction, we recorded an after-tax charge of $149.8 million in the first quarter of 2002. The charge represents
estimated costs associated with the write-down of the carrying value of the assets involved in the sale and closure, as well as other costs associated with exiting the coated paper business. The charge and year-to-date operating losses of $9.9
million, after-tax, are presented as discontinued operations in the Statements of Operations, as required by SFAS No. 144.





On June 3, 2002, we announced that we would close our Bradley hardwood mill in Warren, Arkansas, and exit the hardwood lumber business. We recorded an after-tax charge of $5.7 million for estimated asset write-down and closure costs.
The charge and year-to date operating losses of $.6 million, after-tax, are presented as discontinued operations in the Statements of Operations, as required by SFAS No. 144.




5




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







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





June 30, 2002

December 31, 2001(Dollars in thousands)AssetsCash

$


$
292Receivables, net





40,715Inventories


10,015


76,858Land, other than timberlands


121


374Plant and equipment, net


18,293


653,785Other assets





9Total assets held for sale

$
28,429

$
772,033LiabilitiesAccounts payable and accrued liabilities

$
3,672

$
33,933





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





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





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





Quarter Ended June 30

Six Months Ended June 302002

2001

2002

2001Basic average common shares outstanding

28,441

28,254

28,397

28,292Incremental shares due to common stock options and put options







Diluted average common shares outstanding

28,441

28,254

28,397

28,292





Incremental shares due to common stock options and put options were
not included in the diluted average common shares outstanding totals due to their antidilutive effect as a result of our net loss for the periods presented. The amounts (in thousands) not included for stock options and put options totaled 48 and 0,
respectively, for the quarter ended June 30, 2002; 19 and 43, respectively, for the quarter ended June 30, 2001; 29 and 0, respectively, for the six months ended June 30, 2002; and 10 and 51,




6




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)




respectively, for the six months ended June 30, 2001. Stock options to purchase 2,309, 1,967, 2,309 and 1,967 shares (in thousands) of common stock for the quarters ended June 30, 2002 and 2001
and six months ended June 30, 2002 and 2001, respectively, were not included in the computation of diluted earnings per share because the exercise prices of the stock options were greater than the average market price of the common shares.





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





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





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





June 30,2002

December 31,2001Raw materials

$
44,458

$
55,443Work in process


663


456Finished goods


59,359


51,814$
104,480

$
107,713





NOTE 8.    DEBT  Our current bank
credit facility contains certain financial maintenance covenants. Although no amounts were outstanding under the credit facility at June 30, 2002, we obtained a waiver of the fixed charge coverage ratio covenant contained in the facility. We expect
it may be necessary to obtain an additional waiver of the fixed charge coverage ratio covenant to be in compliance as of September 30, 2002. However, we are currently negotiating amendments to our bank credit facility, including a revision to the
fixed charge coverage ratio, to reflect our current financial condition following the closing of the sale of the Printing Papers segment assets.




7




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







NOTE 9.    SEGMENT INFORMATION 





Quarter Ended June 30


Six Months Ended June 302002


2001


2002


2001(Dollars in thousands)Segment SalesResource

$
88,115


$
81,473


$
207,738


$
172,760Wood productsOriented strand board


46,840



48,211



93,505



80,537Lumber


71,850



74,346



139,283



128,916Plywood


9,248



11,827



18,813



22,553Particleboard


4,575



3,813



7,751



7,702Other


5,644



7,206



11,379



12,960138,157



145,403



270,731



252,668Pulp and paperPaperboard


98,973



105,153



192,935



221,793Tissue


81,315



78,889



162,337



162,016Pulp


4,186



4,665



7,326



7,495184,474



188,707



362,598



391,304410,746



415,583



841,067



816,732Elimination of intersegment sales


(77,568
)


(80,557
)


(189,700
)


(168,834
)Total consolidated net sales

$
333,178


$
335,026


$
651,367


$
647,898Intersegment sales or transfersResource

$
74,234


$
75,149


$
182,516


$
159,484Wood products


3,327



5,397



7,165



9,330Pulp and paper


7



11



19



20Total

$
77,568


$
80,557


$
189,700


$
168,834Operating Income (Loss)Resource

$
12,502


$
10,007


$
22,527


$
17,870Wood products


853



7,593



(263
)


(12,691
)Pulp and paper


5,166



4,711



(574
)


(10,384
)Eliminations and adjustments


17



(1,468
)


355



86618,538



20,843



22,045



(4,339
)Corporate


(29,287
)


(27,245
)


(57,282
)


(50,945
)Consolidated loss from continuing operations before taxes on income

$
(10,749
)

$
(6,402
)

$
(35,237
)

$
(55,284
)


---

Certain 2001 balances have been conformed to the 2002 presentation.




8




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







NOTE 10.    SUBSIDIARY GUARANTORS  A
portion of our outstanding debt is unconditionally guaranteed, on a joint and several basis, by four of our subsidiaries, which are also guarantors, on an unconditional, joint and several basis, of any obligations under our current bank credit
facilities.





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





For the quarter ended June 30, 2002Parent Company


Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)Net sales

$
333,178


$
211


$
(211
)

$
333,178Costs and expenses:Depreciation, amortization and cost of fee timber harvested


31,137



20







31,157Materials, labor and other operating expenses


278,272



58



(211
)


278,119Selling, general and administrative expenses


20,823



105







20,928330,232



183



(211
)


330,204Earnings (loss) from operations


2,946



28







2,974Interest expense


(15,679
)










(15,679
)Other income (expense), net


1,957



(1
)






1,956Earnings before taxes on income and equity in net income of consolidated subsidiaries


(10,776
)


27







(10,749
)Equity in net income of consolidated subsidiaries


16







(16
)


Provision (benefit) for taxes on income


(4,203
)


11







(4,192
)Earnings (loss) from continuing operations


(6,557
)


16



(16
)


(6,557
)Discontinued operations:Loss from discontinued operations


(22,182
)


(4
)


4



(22,182
)Income tax benefit


(8,650
)


(2
)


2



(8,650
)Net earnings (loss)

$
(20,089
)

$
14


$
(14
)

$
(20,089
)




9




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







For the quarter ended June 30, 2001Parent Company


Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)Net sales

$
335,026


$
296


$
(296
)

$
335,026Costs and expenses:Depreciation, amortization and cost of fee timber harvested


27,608



22







27,630Materials, labor and other operating expenses


276,695



(7
)


(296
)


276,392Selling, general and administrative expenses


20,750



98







20,848325,053



113



(296
)


324,870Earnings from operations


9,973



183







10,156Interest expense


(18,634
)










(18,634
)Other income, net


2,076











2,076Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(6,585
)


183







(6,402
)Equity in net income of consolidated subsidiaries


111







(111
)


Provision (benefit) for taxes on income


(2,569
)


72







(2,497
)Earnings (loss) from continuing operations


(3,905
)


111



(111
)


(3,905
)Discontinued operations:Earnings (loss) from discontinued operations


(9,646
)


168



(168
)


(9,646
)Income tax provision (benefit)


(3,762
)


65



(65
)


(3,762
)Net earnings (loss)

$
(9,789
)

$
214


$
(214
)

$
(9,789
)




10




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







For the six months ended June 30, 2002Parent Company


Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)Net sales

$
651,367


$
498


$
(498
)

$
651,367Costs and expenses:Depreciation, amortization and cost of fee timber harvested


61,601



40







61,641Materials, labor and other operating expenses


551,600



157



(498
)


551,259Selling, general and administrative expenses


42,742



205







42,947655,943



402



(498
)


655,847Earnings (loss) from operations


(4,576
)


96







(4,480
)Interest expense


(34,305
)










(34,305
)Other income (expense), net


3,549



(1
)






3,548Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(35,332
)


95







(35,237
)Equity in net income of consolidated subsidiaries


58







(58
)


Provision (benefit) for taxes on income


(13,779
)


37







(13,742
)Earnings (loss) from continuing operations


(21,495
)


58



(58
)


(21,495
)Discontinued operations:Loss from discontinued operations


(272,090
)


(82
)


82



(272,090
)Income tax benefit


(106,115
)


(32
)


32



(106,115
)Net earnings (loss)

$
(187,470
)

$
8


$
(8
)

$
(187,470
)




11




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







For the six months ended June 30, 2001Parent Company


Subsidiary Guarantors

Eliminations


Consolidated(Dollars in thousands)Net sales

$
647,898


$
590

$
(590
)

$
647,898Costs and expenses:Depreciation, amortization and cost of fee timber harvested


54,827



45






54,872Materials, labor and other operating expenses


570,697



106


(590
)


570,213Selling, general and administrative expenses


40,854



188






41,042Restructuring charge


4,217










4,217670,595



339


(590
)


670,344Earnings (loss) from operations


(22,697
)


251






(22,446
)Interest expense


(35,368
)









(35,368
)Other income, net


2,530










2,530Earnings (loss) before taxes on income and equity in net income of consolidated subsidiaries


(55,535
)


251






(55,284
)Equity in net income of consolidated subsidiaries


153






(153
)


Provision (benefit) for taxes on income


(21,659
)


98






(21,561
)Earnings (loss) from continuing operations


(33,723
)


153


(153
)


(33,723
)Discontinued operations:Earnings (loss) from discontinued operations


(12,252
)


449


(449
)


(12,252
)Income tax provision (benefit)


(4,778
)


175


(175
)


(4,778
)Net earnings (loss)

$
(41,197
)

$
427

$
(427
)

$
(41,197
)




12




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







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





June 30, 2002Parent Company

Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)AssetsCurrent assets:Cash

$
6,258

$
67


$



$
6,325Short-term investments


176,657










176,657Receivables, net


154,560


191







154,751Inventories


104,301


179







104,480Prepaid expenses


36,164


(43
)






36,121Assets held for sale


28,426


3







28,429Total current assets


506,366


397







506,763Land, other than timberlands


8,271


396







8,667Plant and equipment, at cost less accumulated depreciation


773,592


837







774,429Timber, timberlands and related logging facilities


394,342










394,342Other assets


115,330






(1,246
)


114,084$
1,797,901

$
1,630


$
(1,246
)

$
1,798,285Liabilities and Stockholders EquityCurrent liabilities:Current installments on long-term debt

$
15,607

$



$



$
15,607Accounts payable and accrued liabilities


198,247


96







198,343Liabilities related to assets held for sale


3,672










3,672Total current liabilities


217,526


96







217,622Intercompany transfers


30,683


(30,683
)






Long-term debt


758,158










758,158Other long-term obligations


199,506










199,506Deferred taxes


106,605










106,605Stockholders equity


485,423


32,217



(1,246
)


516,394$
1,797,901

$
1,630


$
(1,246
)

$
1,798,285




13




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







December 31, 2001Parent Company

Subsidiary Guarantors


Eliminations


Consolidated(Dollars in thousands)AssetsCurrent assets:Cash

$
7,391

$
84


$



$
7,475Restricted cash


98,200










98,200Short-term investments


30,509










30,509Receivables, net


118,509


123







118,632Inventories


107,553


160







107,713Prepaid expenses


31,274










31,274Assets held for sale


770,784


1,249







772,033Total current assets


1,164,220


1,616







1,165,836Land, other than timberlands


8,272


396







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


807,886


877







808,763Timber, timberlands and related logging facilities


395,668










395,668Other assets


109,457






(1,246
)


108,211$
2,485,503

$
2,889


$
(1,246
)

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

$
132,603

$



$



$
132,603Accounts payable and accrued liabilities


189,823


93







189,916Early maturing long-term debt


197,000










197,000Liabilities related to assets held for sale


34,023


(90
)






33,933Total current liabilities


553,449


3







553,452Intercompany transfers


29,872


(29,872
)






Long-term debt


820,522










820,522Other long-term obligations


195,258










195,258Deferred taxes


210,610










210,610Stockholders equity


675,792


32,758



(1,246
)


707,304$
2,485,503

$
2,889


$
(1,246
)

$
2,487,146




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







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





For the six months ended June 30, 2002Parent Company


Subsidiary Guarantors


Eliminations

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

$
(187,478
)

$
8


$


$
(187,470
)Adjustments to reconcile net earnings (loss) to net operating cash flows:Loss from discontinued operations


10,393



50






10,443Loss on disposal of discontinued operations


221,223










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


61,601



40






61,641Deferred taxes


(104,004
)









(104,004
)Working capital changes


(21,693
)


(41
)





(21,734
)Other, net


(2,651
)









(2,651
)Net cash provided by (used for) operating activities of continuing operations


(22,609
)


57






(22,552
)Cash Flows From InvestingDecrease in restricted cash


98,200










98,200Increase in short-term investments


(146,157
)









(146,157
)Additions to investments


(2,277
)









(2,277
)Reductions in investments


970










970Investments and advances from subsidiaries


341



(341
)





Additions to plant and properties


(13,520
)









(13,520
)Net cash used for investing activities of continuing operations


(62,443
)


(341
)





(62,784
)Cash Flows From FinancingChange in book overdrafts


(7,572
)









(7,572
)Repayment of long-term debt


(376,360
)









(376,360
)Issuance of treasury stock


4,168










4,168Dividends


(8,515
)









(8,515
)Other, net


(9,213
)









(9,213
)Net cash used for financing activities of continuing operations


(397,492
)









(397,492
)Cash from continuing operations


(482,544
)


(284
)





(482,828
)Cash from discontinued operations


481,412



266






481,678Decrease in cash


(1,132
)


(18
)





(1,150
)Balance at beginning of period


7,391



84






7,475Balance at end of period

$
6,259


$
66


$


$
6,325




15




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##### Table of Contents



POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





NOTES TO FINANCIAL STATEMENTS(Continued)


Unaudited (Dollars in thousands)







For the six months ended June 30, 2001Parent Company


Subsidiary Guarantors


Eliminations

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

$
(41,624
)

$
427


$


$
(41,197
)Adjustments to reconcile net earnings (loss) to net operating cash flows:Loss (earnings) from discontinued operations


7,748



(274
)





7,474Depreciation, amortization and cost of fee timber harvested


54,827



45






54,872Deferred taxes


(18,539
)









(18,539
)Working capital changes


(5,385
)


24






(5,361
)Other, net


(729
)









(729
)Net cash provided by (used for) operating activities of continuing operations


(3,702
)


222






(3,480
)Cash Flows From InvestingIncrease in restricted cash


(96,600
)









(96,600
)Increase in short-term investments


(1,916
)









(1,916
)Additions to investments


(2,171
)









(2,171
)Reductions in investments


944










944Investments and advances from subsidiaries


948



(948
)





Additions to plant and properties


(24,172
)









(24,172
)Net cash used for investing activities of continuing operations


(122,967
)


(948
)





(123,915
)Cash Flows From FinancingChange in book overdrafts


(5,137
)









(5,137
)Decrease in notes payable


(188,943
)









(188,943
)Proceeds from long-term debt


450,000










450,000Repayment of long-term debt


(100,285
)









(100,285
)Long-term debt issuance fees


(14,133
)









(14,133
)Issuance of treasury stock


1,669










1,669Purchase of treasury stock


(8,349
)









(8,349
)Dividends


(24,629
)









(24,629
)Other, net


(3,378
)









(3,378
)Net cash provided by financing activities of continuing operations


106,815










106,815Cash from continuing operations


(19,854
)


(726
)





(20,580
)Cash from discontinued operations


18,622



699






19,321Decrease in cash


(1,232
)


(27
)





(1,259
)Balance at beginning of period


10,526



131






10,657Balance at end of period

$
9,294


$
104


$


$
9,398




16




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##### Table of Contents

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




Overview





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





In May 2002, we exited a fourth business segment, Printing Papers, which produced primarily high grade coated printing papers and bleached hardwood market pulp. Our exit from this business was done in conjunction with the
sale of our Cloquet, Minnesota, pulp and printing papers facilities and certain associated assets to a domestic subsidiary of Sappi Limited for $480 million in cash. We closed our Brainerd, Minnesota, printing papers mill at the same time. We are
currently seeking buyers for the Brainerd facilities. The sale reflects a strategic realignment to focus in particular on our natural resources, wood products and consumer tissue businesses, which we believe have the greatest potential for growth.





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





Critical Accounting Policies





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





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





Restructuring and other charges. In 2000 and 2001 we recorded charges for the restructuring of our salaried workforce, the closure of a manufacturing plant and the reduction of the hourly workforce at another site. We also completed
the sale of a majority of our Printing Papers




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##### Table of Contents

segment assets, and the corresponding closure of a printing papers facility in May 2002. In June 2002 we announced plans to close a hardwood lumber mill in Warren, Arkansas. These events require
estimates of liabilities for employee benefits, demolition, environmental clean-up and other costs, which could differ from actual costs incurred.





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





Pension and postretirement benefits.    Substantially all of our employees are covered by noncontributory defined benefit pension plans, and
certain salaried and hourly employees are covered by company-sponsored defined benefit retiree health care and life insurance plans. The cost of these plans is accounted for in accordance with FASB Statement No. 87 and Statement No. 106. Both
statements require assumptions regarding discount rates and asset returns and the postretirement benefits plan requires assumptions regarding medical cost trends. Actual asset returns and medical costs which are more favorable than our assumptions
can have the effect of lowering our expense and cash contributions, and conversely, actual results which are less favorable than our assumptions could increase our expense and cash contributions. Due to our recent exit from the coated printing
papers business and the resulting reduction in the number of salaried and hourly employees, we believe that our costs should decline in the future for pension and postretirement benefits.





Factors Influencing Our Results of Operations





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





Our operating results reflect the general cyclical pattern of the forest products industry. Our wood products are
subject to competition from manufacturers in North and South America. In addition, our pulp-based products, other than tissue products, are globally-traded commodity products. Historical prices for our products have been volatile, and we, like other
participants in the forest products industry, have limited direct influence over the timing and extent of price changes for our products. Product pricing is significantly affected by the relationship between supply and demand in the forest products
industry. Product supply is influenced primarily by fluctuations in available manufacturing capacity. Demand is affected by the state of the economy in general and a variety of other factors. The demand for our timber resources and wood products is
affected by the level of new residential construction activity and, to a lesser extent, home repair and remodeling activity, which are subject to fluctuations due to changes in economic conditions, interest rates, population growth, weather
conditions and other factors. The demand for most of our pulp and paper products is primarily affected by the state of the




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##### Table of Contents

global economy, in general, and, in particular, the economies in North America and east Asia.





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





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





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





Finally, changes in our
manufacturing capacity primarily as a result of capital spending programs have significantly affected our results of operations in recent periods. In September 2000, we closed our plywood mill in Jaype, Idaho, as a result of poor plywood markets,
lack of adequate raw materials and long-term transportation concerns. In January 2001, we completed a modernization and expansion of our OSB mill in Cook, Minnesota, resulting in an increase in annual production capacity from 250.0 million square
feet to 435.0 million square feet. In May 2002, we sold a majority of our Printing Papers segment assets to a domestic subsidiary of Sappi Limited




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##### Table of Contents

and exited the printing papers business. In June 2002, we announced our intention to close a hardwood sawmill in Arkansas and exit the hardwood lumber business. 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 could be harmed if market demand does not justify operating at these levels or if our operations are inefficient or suffer significant interruption for any
reason.





Results of Operations





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





A summary of period-to-period changes in items included in the statements of operations is presented on page 27 of this Form 10-Q. In the period-to-period discussion of our
results of operations below, when we discuss our consolidated net sales, contributions by each of the segments to our net sales are reported after elimination of intersegment sales. In the Discussion of Business Segments sections below,
each segments net sales are set forth before elimination of intersegment sales. Also, in discussing our operating results we refer to net sales realizations, which for each product line are calculated by subtracting freight from net sales and
then dividing the result by the relevant quantities of the product shipped for the period. We believe net sales realizations are helpful in showing trends in the pricing of our products.





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





Six Months
Ended June 30, 2002, Compared to Six Months Ended June 30, 2001





Net Sales  Net sales increased
less than 1%, from $647.9 million for the six months ended June 30, 2001, to $651.4 million for the same period in 2002. The increase was primarily the result of the increases in net sales for the Wood Products segment of $20.2 million and the
Resource segment of $11.9 million, which were substantially offset by a decline of $28.7 million in net sales for the Pulp and Paper segment. Increased shipments of oriented strand board and lumber were responsible for the increase in net sales for
the Wood Products segment. An increase in sales to external customers was responsible for the net sales rise in the Resource segment. Lower net sales realizations for paperboard and pulp and decreased paperboard shipments caused net sales for the
Pulp and Paper segment to decline.





Depreciation, amortization and cost of fee timber harvested  For
the six months ended June 30, 2002, depreciation, amortization and cost of fee timber




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##### Table of Contents

harvested expense totaled $61.6 million, an increase of $6.7 million from the prior year period total of $54.9 million. The increase was largely due to higher depletion and amortization expense.
Depletion expense was $3.2 million higher as a result of increased permit timber harvests in Minnesota and Arkansas and our activities at our hybrid poplar plantation in Boardman, Oregon. Amortization expense increased $3.2 million due to the early
repayment of debt in the second quarter of 2002, causing the write-off of related financing costs which are normally amortized over the period the debt is outstanding.





Materials, labor and other operating expenses  Materials, labor and other operating expenses decreased 3%, or $18.9 million, from $570.2 million for the six
months ended June 30, 2001, to $551.3 million for the six months ended June 30, 2002. A decline of $23.8 million in energy costs for the first six months of 2002 compared to 2001 was partially offset by higher wood fiber costs.





Selling, general and administrative expenses  Selling, general and administrative expenses amounted to $42.9
million for the six months ended June 30, 2002, up slightly from $41.0 million for the same period of 2001.





Restructuring charge  In March 2001 we recorded a $4.2 million pre-tax charge associated with a workforce reduction plan at our pulp, paperboard and consumer products operations in Idaho.





Interest expense, net of capitalized interest  Interest expense was $34.3 million for the six months ended June 30, 2002, a
decrease of $1.1 million from the prior year period. The decrease reflects our repayment of $376.4 million of debt during the first six months of 2002, offset partially by a reduction in the amount of interest capitalized for major construction
projects in 2002.





Other income, net  For the six months ended June 30, 2002, other income was $3.5
million, compared to $2.5 million for the 2001 period.





Provision (benefit) for taxes on income  For
the six months ended June 30, 2002, we recorded an income tax benefit from continuing operations of $13.7 million, reflecting our net loss before taxes, based on an estimated tax rate of 39%. For the six months ended June 30, 2001, we recorded an
income tax benefit from continuing operations of $21.6 million, also reflecting a tax rate of 39%.





Loss from
continuing operations  We recorded a loss from continuing operations of $21.5 million for the six months ended June 30, 2002, compared to a loss from continuing operations of $33.7 million for the same period in 2001.





Discussion of business segments  The Resource segment reported operating income of $22.5 million for the first six
months of 2002, up from $17.9 million earned in the same period of 2001. Segment net sales increased 20% from $172.8 million for the 2001 period to $207.7 million for the 2002 period. The increase in net sales was due to increased wood fiber sales
to our other operating segments in Arkansas, Idaho and Minnesota, and to increased sales to third parties in Idaho and Minnesota. Resource segment expenses increased $30.3 million, to $185.2 million for the first six months of 2002, compared to
$154.9 million for the first six months of 2001. Increased outside fiber purchases and logging costs were largely responsible for the increase in expenses.




21




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##### Table of Contents




The Wood Products segment reported an operating loss of $.3 million for the first
six months of 2002, a substantial improvement compared to the $12.7 million loss in the first six months of 2001. Segment net sales were $270.7 million for the first six months of 2002, 7% higher than the $252.7 million recorded for the 2001 period.
Oriented strand board net sales increased $13.0 million, to $93.5 million for the first six months of 2002 compared to 2001 due to an 18% increase in shipments. Lumber net sales rose to $139.3 million, from $128.9 million in 2001. Lumber shipments
increased 9%, although net sales realizations were slightly lower than in the first six months of 2001. Segment expenses were slightly higher in the first six months of 2002, totaling $271.0 million versus $265.4 million in 2001. Wood fiber costs
were higher for the first six months of 2002, largely due to higher log costs in Arkansas and operating the Cook, Minnesota, oriented strand board mill for the full six months in 2002. The mill was shut down for a portion of the first quarter of
2001 to complete a modernization and expansion project.





The Pulp and Paper segment reported an operating loss for
the first six months of 2002 of $.6 million, compared to a loss of $10.4 million for 2001s first six months. Segment net sales decreased to $362.6 million for the first six months of 2002 from $391.3 million for the 2001 period. The decrease
was due largely to lower net sales realizations and decreased shipments for paperboard. Net sales realizations declined 9% and shipments were 5% below first half 2001 levels. Segment expenses were also lower for the first six months of 2002,
totaling $363.2 million compared to $401.7 million for the first six months of 2001. Energy expenses were significantly lower than in the first half of 2001 and the decline in paperboard shipments and production also reduced expenses.





Our discontinued operations, which consist of our former Printing Papers segment and our Bradley sawmill in Warren, Arkansas,
reported a loss, before taxes, of $17.1 million in 2002s first six months, compared to a loss, before taxes, of $12.3 million in 2001. The Printing Papers segment operated until mid-May, when a majority of its assets were sold. The Bradley
sawmill is scheduled for closure in early August. Additionally, during the first six months of 2002 we recorded losses on the disposal of discontinued operations totaling $255.0 million, before taxes.





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





Net Sales  Net sales decreased less than 1%, from $335.0 million for the three months ended June 30, 2001, to $333.2 million
for the same period in 2002. An increase in Resource segment net sales of $7.6 million was offset by declines in net sales for the Wood Products segment of $5.2 million and the Pulp and Paper segment of $4.2 million. Resource segment net sales
benefited from increased sales to third parties in Idaho and Minnesota. Lower net sales realizations for oriented strand board and lumber were largely responsible for the decrease in net sales for the Wood Products segment. Lower net sales
realizations for paperboard caused net sales for the Pulp and Paper segment to decline.





Depreciation,
amortization and cost of fee timber harvested  For the three months ended June 30, 2002, depreciation, amortization and cost of fee timber harvested expense totaled $31.2 million, an increase of $3.5 million from the prior year amount of
$27.6 million. Higher amortization expense in the second quarter of 2002, due to the accelerated amortization of debt financing costs, resulting from early debt repayments, was responsible for the increase.




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##### Table of Contents




Materials, labor and other operating expenses  Materials, labor and
other operating expenses increased less than 1%, to $278.1 million for the three months ended June 30, 2002, from $276.4 million for the three months ended June 30, 2001. Increases in wood fiber and other production costs were mostly offset by lower
energy costs of $6.9 million in the second quarter of 2002 compared to 2001.





Selling, general and
administrative expenses  Selling, general and administrative expenses were not materially different between the two quarters, amounting to $20.9 million for the three months ended June 30, 2002, compared to $20.8 million for the same
period of 2001.





Interest expense, net of capitalized interest  Interest expense was $15.7 million
for the three months ended June 30, 2002, a decrease from $18.6 million in the prior year period. The decrease reflects our payment in the first half of 2002 of approximately $376.4 million in debt, which was outstanding during the second quarter of
2001.





Other income, net  For the three months ended June 30, 2002, other income was $2.0 million,
compared to $2.1 million for the 2001 period.





Provision (benefit) for taxes on income  For the three
months ended June 30, 2002, we recorded an income tax benefit from continuing operations of $4.2 million, reflecting our net loss before taxes, based on an estimated tax rate of 39%. For the three months ended June 30, 2001, we recorded a tax
benefit from continuing operations of $2.5 million, also reflecting a tax rate of 39%.





Loss from continuing
operations  We recorded a loss from continuing operations of $6.6 million for the three months ended June 30, 2002, compared to a loss from continuing operations of $3.9 million for the same period in 2001.





Discussion of business segments  The Resource segment reported operating income of $12.5 million for the second quarter of
2002, up from $10.0 million earned in the same period of 2001. Segment net sales increased 8% from $81.5 million for the 2001 period to $88.1 million for the 2002 period. The increase in net sales was due to increased wood fiber sales to our other
operating segments in Arkansas, Idaho and Minnesota, and to third parties in Idaho and Minnesota. Resource segment expenses increased $4.1 million, to $75.6 million in the second quarter of 2002, compared to $71.5 million in the second quarter of
2001. Increased outside fiber purchases in Arkansas were largely responsible for the increase in expenses.





The
Wood Products segment reported operating income of $.9 million for the second quarter of 2002, substantially below the $7.6 million earned in the second quarter of 2001. Segment net sales were $138.2 million for the second quarter of 2002, 5% lower
than the $145.4 million recorded for the 2001 period. Oriented strand board net sales decreased to $46.8 million for the second quarter of 2002, compared to $48.2 million in the 2001 period, due to an 8% decrease in net sales realizations. Increased
oriented strand board shipments partially offset the decline in realizations. Lumber net sales were $71.9 million, down from $74.3 million in 2001. Lumber shipments increased 4%. However, net sales realizations were 7% lower than in the second
quarter of 2001. Segment expenses were slightly lower in the second quarter of 2002, totaling $137.3 million versus $137.8 million in 2001.




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The Pulp and Paper segment reported operating income for the second quarter of
2002 totaling $5.2 million, compared to income of $4.7 million for 2001s second quarter. Segment net sales decreased to $184.5 million for the second quarter of 2002 from $188.7 million for the 2001 period. The decrease was due largely to
decreased net sales for paperboard that were partially offset by slightly increased tissue net sales. Net sales realizations for paperboard declined 10% and for tissue declined 2%. However, increased shipments of 2% for paperboard and 5% for tissue
compared to second quarter 2001 levels favorably affected results. Segment expenses were lower for the second quarter of 2002, totaling $179.3 million, compared to $184.0 million in the second quarter of 2001. Energy expenses were approximately $6
million lower than in the second quarter of 2001.





Our discontinued operations incurred a loss of $22.2 million,
before taxes, for the second quarter of 2002. The amount reflects a $9.4 million charge for estimated closure costs at the Bradley hardwood sawmill, $.5 million in operating losses for the mill, and $12.3 million in losses related to the winding
down of operations in the former Printing Papers segment.





Liquidity and Capital Funding





At June 30, 2002, our financial position included long-term debt of $773.8 million, including current installments on long-term
debt of $15.6 million. Our ratio of long-term debt (excluding current installments) to stockholders equity was 1.47 to 1 at June 30, 2002, compared to 1.16 to 1 at December 31, 2001. Long-term debt at June 30, 2002 (including current
installments and early maturing long-term debt) declined $376.4 million from the December 2001 balance. Our debt declined due to normal payments on maturing debt of $131.0 million and the early repayment of $245.4 million of long-term debt, using a
portion of the proceeds from the sale of a majority of the Printing Papers segment assets. We anticipate using the proceeds from the sale to make further reductions in our long-term debt. Stockholders equity declined $190.9 million, largely
due to a net loss of $187.5 million for the first six months of 2002.





We had working capital of $289.1 million at
June 30, 2002, a decrease of $323.2 million from December 31, 2001. The decrease was largely due to a decrease in assets held for sale of $743.6 million, as a result of the sale of Printing Papers segment assets, and a decrease in restricted cash of
$98.2 million, used to repay maturing debt. Partially offsetting these amounts were increases in short-term investments of $146.1 million and receivables of $36.1 million, combined with decreases in current installments on long-term debt of $117.0
million, early maturing long-term debt of $197.0 million and liabilities related to assets held for sale of $30.3 million.





Net cash used for operations for the first six months of 2002 totaled $22.6 million, compared with $3.5 million for the same period in 2001. An increase in cash used for working capital items accounts for the unfavorable comparison.





For the six months ended June 30, 2002, net cash used for investing was $62.8 million, compared to cash used for
investing of $123.9 million during the six months ended June 30, 2001. In March 2002 we applied the balance in our restricted cash account to the repayment of current installment debt. Short-term investments increased $146.2 million in the first
half of 2002 due to proceeds received from the sale of Printing Papers segment assets. Capital spending totaled $13.5 million in the first six months of 2002, compared to $24.2 million for the same period in 2001. Spending in 2002 has




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been focused on routine general replacement, safety, forest resource and environmental projects.





Net cash used for financing was $397.5 million for the six months ended June 30, 2002, compared to cash provided by financing of $106.8 million during the same period in 2001. The majority of the cash
used in the current year was for the repayment of $376.4 million of long-term debt. As discussed above, we used our restricted cash to repay our $100 million 6.25% debentures, and paid other debt using a portion of the proceeds from asset sales. Our
dividend payments declined for the first six months of 2002, to $8.5 million from $24.6 million for the same period in 2001, due largely to a dividend rate cut announced on August 10, 2001.





In connection with the sale of our Printing Papers segment assets, we were required under the terms of our bank credit facility to use the proceeds to repay approximately
$198.5 million under the term loan portion of the facility, and all outstanding debt under our revolving credit line, totaling $33.2 million. We have also used a portion of the proceeds to repay approximately $46.9 million of additional debt. We
expect to use the proceeds from the sale to further reduce our other outstanding debt and for capital expenditures.





Our current bank credit facility is comprised of a three-year revolving line of credit of up to $200.0 million that expires June 28, 2004, including a $110.0 million subfacility for letters of credit, usage of which reduces
availability under the revolving line of credit. Our obligations under the bank credit facility are secured by approximately 130,000 acres of our timberlands in Arkansas and our accounts receivable and inventory. As of June 30, 2002, there were no
amounts outstanding under the credit facility. Approximately $59.0 million of the revolving line of credit was used to support outstanding letters of credit. Approximately $55.4 million of these letters of credit provide credit enhancement for a
portion of our outstanding floating interest rate bonds. As of June 30, 2002, we obtained a waiver of the fixed charge coverage ratio covenant contained in our bank credit facility. We expect it may be necessary to obtain an additional waiver of the
fixed charge coverage ratio covenant to be in compliance as of September 30, 2002. However, we are currently negotiating amendments to our bank credit facility, including a revision to the fixed charge coverage ratio, to reflect our current
financial condition following the closing of the sale of the Printing Papers segment assets.





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





On July 12, 2002, Standard & Poors Ratings Services announced that it had affirmed
its ratings on our debt, including our BBB- corporate rating. Standard & Poors also announced that it has removed us from CreditWatch, where we had been placed in April 2001. During the quarter Fitch also reaffirmed our BBB- rating,
classifying us as stable, and removed us from CreditWatch. Moodys has yet to act on updating our credit ratings.




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




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##### Table of Contents

POTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES





Changes in Statements of Operations


(Dollars in thousands)





Quarter Ended June 30


Six Months Ended June 302002


2001


Increase (Decrease)


2002


2001


Increase (Decrease)Net sales

$
333,178


$
335,026


(1
%)

$
651,367


$
647,898


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


31,157



27,630


13
%


61,641



54,872


12
%Materials, labor and other operating expenses


278,119



276,392


1
%


551,259



570,213


(3
%)Selling, general and administrative expenses


20,928



20,848






42,947



41,042


5
%Restructuring charge

















4,217


*Earnings (loss) from operations


2,974



10,156


(71
%)


(4,480
)


(22,446
)

(80
%)Interest expense


(15,679
)


(18,634
)

(16
%)


(34,305
)


(35,368
)

(3
%)Other income, net


1,956



2,076


(6
%)


3,548



2,530


40
%Provision (benefit) for taxes on income


(4,192
)


(2,497
)

68
%


(13,742
)


(21,561
)

(36
%)Loss from continuing operations


(6,557
)


(3,905
)

68
%


(21,495
)


(33,723
)

(36
%)Discontinued operations:Loss from discontinued operations


(22,182
)


(9,646
)

130
%


(272,090
)


(12,252
)

2,121
%Income tax benefit


(8,650
)


(3,762
)

130
%


(106,115
)


(4,778
)

2,121
%Net loss

$
(20,089
)

$
(9,789
)

105
%

$
(187,470
)

$
(41,197
)

355
%


---

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



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##### Table of Contents




ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk





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





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





PART II





ITEM 4.    Submission of Matters to a Vote of Security Holders





At
the annual meeting of stockholders of the company held on May 15, 2002, the companys stockholders voted on four proposals as follows:





Proposal 1





Election of Three Directors





Votes For

Votes WithheldJerome C. Knoll

51,442,431

2,008,408Toni Rembe

51,451,774

1,999,065William T. Weyerhaeuser

51,481,864

1,968,975





Proposal 2





Amendment of the Restated Certificate of Incorporation





Shares For

24,393,372Shares Against

283,678Shares Withheld

106,850





Proposal 3





Stockholder Proposal Requesting Preparation of Dividend Policy Report





Votes For

6,539,377Votes Against

39,371,288Votes Withheld

1,538,763




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Proposal 4





Ratification of the Selection of KPMG LLP as Independent Auditor for 2002





Votes For

51,707,072Votes Against

1,301,742Votes Withheld

442,025





ITEM 6.    Exhibits and Reports on Form 8-K





Exhibits





The exhibit index is located on page 31 of this Form 10-Q.





Reports on Form 8-K





A current report on Form 8-K was filed on May 24, 2002. Under Item 2, Disposition of Assets, we reported that on May 13, 2002, we completed the sale of our Cloquet, Minnesota, pulp and printing papers facilities and
associated assets to Sappi Cloquet LLC (formerly named Northern Holdings LLC), a domestic subsidiary of Sappi Limited. In consideration for the assets, Northern Holdings paid us approximately $480 million in cash and assumed certain liabilities.
Under Item 7, Financial Statements and Exhibits, we filed unaudited pro forma condensed consolidated financial statements.




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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. Zuehlke Vice
President, Finance, Chief Financial Officer and Treasurer (Duly Authorized; Principal Financial Officer)








By:

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





Date:  August 12, 2002




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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.(10)(o)(v)

Consent and Modification, dated June 12, 2002, amending the definition of Consolidated Net Worth.(10)(o)(vi)

Fourth Amendment to Credit Agreement and Waiver, dated as of July 16, 2002, waiving the fixed charge coverage ratio
covenant for the second quarter of 2002 and various other amendments.




31