Two years ago on the eve of their annual meeting, officials at Spokane-based Potlatch Corp. believed the big forest-products company was positioned to begin reaping the rewards of a massive capital-improvement program, new corporate efficiencies, and strengthening markets for its products.


But the rewards havent come.


Potlatch posted only modest gains in 1999 and suffered an uncharacteristic loss in 2000. This year doesnt look much better.


So what happened? Prices for lumber and panel goods fell to 10-year lows, and supplies overshot demand. Housing starts softened. Markets improved for printing papers, but those gains were offset by a strong U.S. dollar that beckoned imports and put downward pressure on prices. Then the higher energy prices hit, impacting profitability at all of Potlatchs plants and causing temporary curtailments at some.


(The rewards) certainly havent come in terms of the market, says Potlatch spokesman Mike Sullivan. We have seen them in productivity and less waste, but theyve been masked by the fact that the markets have been so very poor.


The result was a year 2000 net loss of $4.9 million, before one-time charges of $28.3 million related to work force reductions and the permanent closure of Potlatchs Jaypee, Idaho, plywood mill. Sales in 2000 came in at a flat $1.81 billion, and earnings from operations plummeted to about $8.8 million, from about $112 million in 1999. The annual net loss was Potlatchs first since 1993.


In a painful past 12 months, Potlatch has trimmed its work force to about 6,340 from nearly 6,900. Its in the process of shaving another 140 jobs at its Lewiston, Idaho, complex, for which it will take another charge against earnings in the first quarter. All told, Potlatch will be operating with about 9 percent fewer employees.


Its stock, meanwhile, is hovering in the low $30s per share, considerably off its 52-week high of $44.50.


In February meetings with security analysts in Chicago and New York, Potlatch Chairman and CEO L. Pendleton Siegel acknowledged the market forces that are dragging the longtime company down, but reiterated his belief that its lean work force and newly modernized plants would begin to generate surplus cash, allowing the company to reduce debt, repurchase stock, and invest in high-return projects at its plants.


But the clouds remain over Potlatch. Late last month it announced that its first quarter 2001 earnings would be significantly lower than analysts estimates, which have called for a quarterly loss of about 60 cents a share. Siegel again blamed high energy costs and poor markets for its products.


Added Siegel last week, Current energy costs are a major challenge for all our operations, particularly in Idaho. At current rates for electricity, our Lewiston operations could not be profitable under any likely near-term market conditions.


Siegel says the Lewiston complexs January energy costs were $7 million higher than the year earlier. We are working vigorously to reduce our energy costs to remain viable, he says, adding that Potlatch is already taking steps to conserve energy internally, and to increase internal generating capacity. It also hopes to restructure its power contract with Avista Corp. when that pact expires at the end of the year.


The consensus among analysts now is that Potlatch will incur a 76 cent-per-share loss for all of 2001, though that estimate has changed greatly in the past three monthsonce predicting a $1.23 per share net gainand could change again if its markets dont improve.


D.A. Davidson & Co. analyst Steven Chercover says Potlatch has taken the difficult steps necessary to deal with the poor market environment, and probably isnt much better or worse off than its peers.


I dont think theres an awful lot more that they can do, he says. Companies have to keep an eye on the bottom line, and Potlatch is doing that. It doesnt come down to anything but trying to operate as efficiently as possible.


Not alone


To be sure, Potlatch isnt alone under the dark forest canopy. Companies ranging from Georgia-Pacific Corp. and Weyerhaeuser Co. to Louisiana-Pacific Corp. and International Paper Co. all recently have had their earnings estimates cut by analysts or have warned that earnings might not meet analysts expectations.


And there is light filtering down on Potlatch through those tall Douglas fir. The company opened its newly modernized and expanded oriented-strand-board (OSB) mill at Cook, Minn., in January, culminating a 15-year capital improvement push that cost about $2 billion. The $40 million to $60 million it now expects to spend annually to keep its plants competitive is far less than the $166 million and $247 million it spent in 2000 and 1999, respectively, and considerably below the cash those plants are expected to generate, the company says. That expected extra cash will be used to pay down long-term debt, which grew uncomfortably as Potlatch pushed to complete its Cook plant project and its new Cloquet, Minn., pulp mill.


Meanwhile, the new Cloquet pulp mill, which has double the capacity of its replacement, came on line with pulp prices relatively strong, though they now are softening because of the strong U.S. dollar. That plant now is considered one of the U.S.s most efficient hardwood pulp operations, and is nearing its goal of reducing pulp costs by 25 percent over the previous plant there, Potlatch says. It has an expected capacity of 1,300 tons of pulp per day, and is supplying the companys printing-paper facilities at Cloquet and Brainerd, Minn., as well as selling on the open market.


The printing-paper industry, however, remains worrisome for Potlatch, says Sullivan. There has been additional capacity come on line, particularly in Europe, and although the company believes it is well positioned to compete, there will be additional downward price pressure.


Bleached paperboard pricesincluding for packaging and paper plateshave been improving, as have markets for the tissue products Potlatch makes at its big Lewiston, Idaho, complex. The company upgraded its paperboard plant in Cypress Bend, Ark., and restructured scheduling at that plant and its paperboard operation in Lewiston, reducing downtime and boosting product quality. Further staff cuts and efficiency moves at the Lewiston plants are expected to partially offset the big increases in energy costs that complex is suffering, Potlatch says.


Tissue, says Sullivan, is perhaps Potlatchs brightest prospect. The company, which controls about 90 percent of the private-label tissue market in the West, recently rented a small tissue conversion plant in Chicago that will enable it to expand into the Midwest and East Coast markets. He says that the supermarket chains that Potlatch currently supplies are starting to expand in those markets, and want Potlatch to be able to supply such products further east.


This is a significant step for us, Sullivan says.


The value of trees


Potlatch owns about 1.5 million acres of timberland in Idaho, Minnesota, and Arkansas, which it uses to supply its wood-products and pulp-based operations, as well as a plantation of hybrid poplars in Oregon. In 1999, it separated that resource component from its wood-products division to emphasize its value more to outside investors, and to treat it more like a profit center of its own.


Last year, the company also made a decision to redirect the use of its hybrid poplar plantation, located near Boardman, Ore., from chips for its pulp mills to fiber for plywood and lumber for furniture and other nonstructural uses.


Sullivan says that when Potlatch launched the plantation last decade, the cost of chips for pulp was high and demand looked strong. Later, however, demand subsided and the price of chips declined below the level where the plantation was viable. So now Potlatch will grow the trees for what it believes will be growing Northwest demand for hardwood lumber, he says.


On the wood-products side, Potlatchs newly expanded OSB plant in Minnesota is ramping up to its expected 435 million board feet annual capacity. It also operates OSB plants in Bemidji and Grand Rapids, Minn.


In September, the company began using at its Prescott, Ark., lumber mill a new curve-sawing technology, that reduces waste by sawing along a trees natural contours. Net recovery at Prescott has improved 9 percent and production has shot up 30 percent in some wider widths of lumber. It expects to add that technology to its Warren, Ark., mill in the future.


Wood products, though, remain Potlatchs biggest worry. Though housing starts are expected to get a boost from recent Federal Reserve rate cuts, lumber prices remain low. Framing lumber prices are off more than 30 percent from a year ago, and prices for OSB are down more than 50 percent.


U.S. lumber demand is expected to fall 3.9 percent this year and production is expected to be off 4.8 percent, according to the Portland-based Western Wood Products Association.


This week, the Coalition for Fair Lumber Imports, to which Potlatch belongs, filed a complaint with the U.S. Commerce Department seeking duties on Canadian lumber imports that it alleges are subsidized by the Canadian government.