After having endured two tough years in a row, Potlatch Corp. is setting a new direction.


When the big Spokane-based wood-products company announced March 18 it was selling its coated printing papers business, Chairman and CEO L. Pendleton Siegel told shareholders that Potlatch had charted a new course. Even though the divestiture would result in a $150 million after-tax write-down in the first quarter, the move would enable Potlatch to concentrate on more profitable business lines that had tremendous potential to grow, Siegel said.


In an interview last week, Siegel said one of the focuses of the companys new efforts will be improving quality and cutting costs at its paperboard operation at its big Lewiston, Idaho, mill complex. Among other products, the complex makes more than half of all the ice cream cartons sold in the U.S. and paper-cup stock that we think is the best in the world, Siegel says.


That cup stock, he says, is strong enough to be used for cups that hold the 32-ounce and bigger sodas sold by the millions at U.S. fast-food restaurants. Says Siegel, Its one thing if a paper cup is the size of a coffee cup; its something else again if youve got a 32-ounce drink.


In other efforts, Potlatch is striving to keep up with demand for its private-label consumer tissue business, which Siegel says will be the companys growth engine for the next decade.


We will have something to announce in the next couple of months involving additional production capacity for that business, Siegel says. Even though the business is centered at Lewiston, one cant assume that the announcement will involve the Idaho complex, he says.


The company just announced that it will add to its tissue business a 400,000-square-foot warehouse in Elwood, Ill., that another party will develop on a build-to-suit basis. The company has an option to have another 600,000 square feet of space added on to that Chicago-area warehouse.


Meanwhile, Potlatch also is introducing a slew of new specialty productsand expects to double this year the percentage of its sales that such alternative products produce. Finally, the company is chopping its debt, which had grown unacceptably, and is looking to earn new revenue from its widespread timberlands.


Mike Sullivan, the companys spokesman, says, The next few months, we think therell be a succession of good-news stories coming out of our company reflecting the change in direction.


Potlatch posted $1.75 billion in sales last year, down from $1.81 billion the year before.


Last year, Potlatch suffered a net loss of $79.5 million, or $2.81 a share, which came on the heels of a net loss of $33.2 million, or $1.16 a share, in 2000. In the first quarter of this year, when it took an estimated $149.8 million after-tax write-down from the sale of the coated printing papers business, the company reported a net loss of $167.4 million, or $5.90 a share, down from a net loss of $31.4 million, or $1.11 a share, in the year-earlier quarter.


Still, in the first quarter this year the companys wood-products business lost a net of just $1.6 million, a marked improvement from a net loss of $20.7 million in the first quarter of 2001. The better results came in part because of improvements in markets. Siegel declines to predict when Potlatch might return to profitablility, but says hes optimistic about the companys prospects in the second half of this year.


The third quarter this year will provide a better perspective on Potlatchs earnings power, since the company completed the sale of its coated printing papers business midway through the second quarter, Steven Chercover, a Lake Oswego, Ore.-based securities analyst with D.A. Davidson & Co., said in a May 29 comment on Potlatch.


The division was a financial drain within Potlatch, and its absence coupled with a reduction in financial leverage are likely to make the companys earnings prospects more robust, said Chercover. Nonetheless, Potlatch remains a show me story, and we believe that additional asset sales remain the most efficient means of enhancing shareholder value. Earlier, D.A. Davidson downrated Potlatchs stock to underperform from neutral.


One thing, however, already is clear. Siegel says Potlatch is up to date on major capital improvements at its wood-products plants, which should help it to hold down spending.


The rest of our wood-products facilities, were very happy with, Siegel says. That includes both how the plants are performing for Potlatch and how they stack up against similar plants in the industry, he says.


Potlatch, which supplies 10 percent of the U.S. and foreign paperboard market, plans to take advantage of the strengths of its two bleached paperboard plants by moving all paper-cup stock production to Lewiston and all folding-carton stock production to a plant that it operates at Cypress Bend, Ark. In addition to being a low-cost operation, the Cypress Bend plant produces paperboard that meets the highest standards for surface quality and brightness, which makes product packaging stand out on store shelves, Sullivan says. Potlatch began supplying paperboard for such packaging, which includes high-value drug and cosmetics packaging and frozen-food cartons, just months ago.


To bring the Lewiston plant up to comparable quality and cost standards, Potlatch is working on a whole series of things, none of which are make or break, Siegel says. He says the goal is to increase the amount of time in which we produce on-quality, on-grade product with the mills paperboard machines, which run 24 hours a day, seven days a week.


Siegel calls the companys private-label tissue business a great business for us. He says Potlatch produces more than 90 percent of the private-label facial tissue, paper towels, and toilet tissue sold in the West. It makes, labels, and packages much of that production at Lewiston, but also makes there and buys elsewhere parent rolls of tissue that it converts into finished products at conversion centers in North Las Vegas, Nev., and Benton Harbor, Mich.


Potlatchs private-label tissue business serves such giants as Safeway and Albertsons and also supplies tissue to virtually every small grocery chain in the West, Siegel says. Whether youre talking about Super 1, Tidymans, or Rosauers, we label it and deliver it to them.


As some of the grocers Potlatch serves expand into the Midwest and the East, the company hopes to make inroads in those parts of the country, where private-label tissue has much lower consumer acceptance and less than half the market share that it does in the West.


Already, however, Were seeing the same kind of customer acceptance in Florida with Albertsons, which has expanded there, that Potlatch has gained in the West for its consumer tissue lines, he says.


Asked whether Potlatch will add facilities in the East to augment its tissue business, Siegel says, I think our next step will be the Midwest.


New products


Sullivan says the company also has stepped up its introduction of new products. We hadnt introduced any new products for some time, he says.


This week, the company has scheduled at its Grand Rapids, Minn., oriented strand board (OSB) plant its first production run of an anti-fungal, termite-resistant product. Siegel says Potlatch tested the product on the wet side of the Hawaiian Islands, where they have a lot of humidity and lots of bugs, and it held up well.


Late last year, Potlatch introduced a thermal barrier panel and a flooring product, both of which resist edge swelling, that the company makes at its Bemidji, Minn., OSB plant.


At year-end, Potlatch introduced a foil-lined OSB product, also made at Bemidji, that reduces the amount of energy needed to air condition or heat buildings in the Southwest, which will help building contractors meet stiff new energy codes there.


Thats a big market, Siegel says. The company also just has begun making, at its St. Maries, Idaho, plywood plant, a foil-lined plywood product to serve the Southwest. Both products are used as a sub-base for roofing and for other purposes.


Siegel says the company is working on another very interesting product that he cant talk about yet, and Sullivan says Potlatch also has other new products in the pipeline.


Altogether, Sullivan says, Potlatch expects that by the fourth quarter of this year, sales of alternative products will make up 25 percent of its wood-products revenues, nearly double the percentage at the end of 2001.


Potlatch decided a couple of years ago, when it became apparent that the U.S. dollar would remain strong and continue to buoy foreign producers, that it couldnt compete in the coated printing papers business any longer, Siegel says. Imports into the U.S. market were shooting up by 20 percent a year, but Potlatch faced a dilemma because it was well under way on a $500 million modernization and expansion of its Cloquet, Minn., coated printing papers plant.


We couldnt sell the business with the mill half-built, Siegel says. Potential buyers, being unfamiliar with Potlatchs design for the mill, would have wondered whether the mill would have run when it was completed, he says. Besides, Siegel says, Rarely can you earn a return in the first 10 years after a new mill opens.


The company didnt have a good option, Siegel says. We could walk awayor complete it.


We completed it, but we borrowed a lot of money to complete it, which compounded things and got our balance sheet in bad shape. Also, he says, that left the company with a new asset under significant international pressure.


At length, Potlatch struck the deal to sell its coated printing paper business to a U.S. subsidiary of Sappi Ltd., a South African company, for $480 million. At one time, the business had been a lucrative one for Potlatch, and the company still was the No. 1 U.S. producer of the highest grades of coated printing papers.


As a result of the transaction, Potlatch has slashed $250 million from the more than $1 billion in debt it had accumulated, Siegel says. Too much debt in a commodity business is dangerous, because of the price swings such businesses must endure, he says.


Thanks to the sale, Potlatch also is structuring plans to retire another $250 million in debt by the end of this year, which should make its stock more attractive to investors and get its balance sheet into better shape, but not quite back to where Id like it, Siegel says.


Theres no question but what an improvement in Potlatchs markets would help the company. In 2001, Potlatchs OSB sales plunged 20 percent, and its particleboard sales nose-dived 31 percent. Plywood sales fell 19 percent, though part of that drop occurred because Potlatch lost volume when it closed its Jaype mill near Pierce, Idaho, in September 2000. In Potlatchs wood-products business, only lumber sales increased last year, and that was due to increased shipments rather than improved markets.


The paperboard market began to rebound late last year, and order backlogs started to grow, Siegel says. Those backlogs are better than theyve been for two years, with recent price increases for a couple of grades sticking rather than falling back, he says.


The notoriously jumpy pulp market appears to be healthier, which usually is an indicator that paper markets are going to improve. Depending on its needs, Potlatch both buys and sells pulpincluding purchasing Eucalyptus pulp from Spain and other locations for use in making facial tissues.


Siegel contends that Canadian lumber producers pushed down lumber prices in the U.S. sharply recently when they took advantage of a one-month window for shipments across the border before a U.S. countervailing duty on Canadian softwood lumber imports went into effect.


As far as we and the reporters (who had been covering the story) can tell, every stick of lumber that could be begged, borrowed, or stolen (in Canada) was shipped across the border, boosting supply in the U.S. and depressing prices, Siegel says. That problem should correct itself in a couple of months, he says.


Potlatch also sees new potential in its timberland business, which it began operating as a profit center more than two years ago after having run its forests for decades merely as a supplier to its mills.


Now, Potlatch hopes to increase its timberland revenue by giving groups exclusive leases to hunt and do other activities on its lands. The company, which owns 671,000 acres of timberland in North Idaho, 498,000 acres in Arkansas, and 333,000 acres in Minnesota, is testing the waters on 10,000 acres in Minnesota after having leased some of its Arkansas lands to hunting groups there, Siegel says.