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PCL > SEC Filings for PCL > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for PLUM CREEK TIMBER CO INC

Form 10-K for PLUM CREEK TIMBER CO INC


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statement

This Report contains forward-looking statements within the meaning of the Private Litigation Reform Act of 1995. Some of the forward-looking statements can be identified by the use of forward-looking words such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," "projects," "strategy," or "anticipates," or the negative of those words or other comparable terminology. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those described in the forward-looking statements, including those factors described in "Risk Factors" under Item 1A in this Form 10-K. Some factors include changes in governmental, legislative and environmental restrictions, catastrophic losses from fires, floods, windstorms, earthquakes, volcanic eruptions, insect infestations or diseases, as well as changes in economic conditions and competition in our domestic and export markets and other factors described from time to time in our filings with the Securities and Exchange Commission. In addition, factors that could cause our actual results to differ from those contemplated by our projected, forecasted, estimated or budgeted results as reflected in forward-looking statements relating to our operations and business include, but are not limited to:

            the failure to meet our expectations with respect to our likely
             future performance;


            an unanticipated reduction in the demand for timber products and/or
             an unanticipated increase in supply of timber products;


            an unanticipated reduction in demand for higher and better use or
             non-strategic timberlands;


            our failure to make strategic acquisitions or to integrate any such
             acquisitions effectively or, conversely, our failure to make
             strategic divestitures; and

our failure to qualify as a real estate investment trust, or REIT.

It is likely that if one or more of the risks materializes, or if one or more assumptions prove to be incorrect, the current expectations of Plum Creek and its management will not be realized. Forward-looking statements speak only as of the date made, and neither Plum Creek nor its management undertakes any obligation to update or revise any forward-looking statements.

Organization of the Company

In management's discussion and analysis of financial condition and results of operations (Item 7 of this form), when we refer to "Plum Creek," "the company," "we," "us," or "our," we mean Plum Creek Timber Company, Inc. and its consolidated subsidiaries. References to Notes to Consolidated Financial Statements refer to the Notes to the Consolidated Financial Statements of Plum Creek Timber Company, Inc. included in Item 8 of this Form 10-K.

Plum Creek Timber Company, Inc., a Delaware Corporation and a real estate investment trust, or "REIT", for federal income tax purposes, is the parent company of Plum Creek Timberlands, L.P., a Delaware Limited Partnership (the "Operating Partnership" or "Partnership"), and Plum Creek Ventures I, LLC, a Delaware Limited Liability Company ("PC Ventures"). Plum Creek conducts substantially all of its activities through the Operating Partnership and various wholly-owned subsidiaries of the Operating Partnership.

The Operating Partnership has borrowed and has currently outstanding $2.9 billion principal amount of debt, including $1.3 billion of publicly issued notes. PC Ventures has borrowed and has currently outstanding $783 million in principal amount of debt ("the Note Payable to Timberland Venture") from an entity ("the Timberland Venture") in which a subsidiary of the Operating Partnership has a common and preferred equity interest. See Note 17 of the Notes to Consolidated Financial Statements. PC Ventures used the proceeds from the borrowing to make a $783 million capital contribution to the Operating Partnership in exchange for a preferred equity interest in the Operating Partnership. PC Ventures has no other activities and the Operating Partnership has no ownership interest in PC Ventures.

The Note Payable to Timberland Venture is an obligation of PC Ventures and not an obligation of the Operating Partnership. Therefore, any discussion of the Note Payable to Timberland Venture below is not applicable to the Operating Partnership. Unless otherwise specified, all other discussion and analysis below are applicable to both Plum Creek and the Operating Partnership.

PLUM CREEK 2013 FORM 10-K | 26

Table of Contents PART II / ITEM 7

Overview

2013 Operating Performance Compared to 2012

Our operating income for 2013 was $295 million compared to $281 million for 2012. Prices for nearly all the log and wood products we sell improved during 2013 due primarily to the improving U.S. economy and the increase in housing starts. U.S. housing starts for all of 2013 were 923,000 units, which was an increase of 18% over the prior year and have increased by over 60% compared to the record low starts of 554,000 in 2009 (lowest since 1945). We expect this positive trend to continue in 2014. We reported higher operating income from our timber and manufacturing businesses as a result of the improving prices and reported lower operating income from our Real Estate Segment due, in part, to our planned reduction in land sales. Per acre timberland sales prices during 2013 were generally comparable to the prior year.

Operating income in our Northern Resources Segment increased by $12 million from $20 million in 2012 to $32 million in 2013. This increase was primarily due to a 15% increase in sawlog prices as a result of improving demand for domestic and export logs and a limited log supply. Operating income in our Southern Resources Segment increased by $18 million from $90 million in 2012 to $108 million in 2013. This increase was primarily due to a 9% increase in sawlog prices and a 13% increase in pulpwood prices. Sawlog prices improved due in part to an increase in lumber production as a result of higher housing starts, and pulpwood prices improved due primarily to an increase in Oriented Strand Board production and new demand from exporters of wood pellets.

Operating income in our Manufacturing Segment increased by $14 million from $29 million in 2012 to $43 million in 2013. This increase was due primarily to a 7% increase in MDF sales volume and a 6% increase in MDF sale prices as a result of improving demand and a limited supply from domestic production and foreign imports.

Operating income in our Real Estate Segment decreased by $18 million from $187 million in 2012 to $169 million in 2013. This decrease was due primarily to selling fewer acres; in 2013 we sold approximately 170,000 acres compared to selling approximately 270,000 acres in 2012.

Operating income in our Energy and Natural Resources Segment was $19 million for both 2013 and 2012. Effective December 31, 2013, we changed the name of our "Other Segment" to "Energy and Natural Resources Segment" in anticipation of reporting income associated with our new procurement services business in our Other Segment starting in 2014. Previously, our Other Segment consisted solely of our energy and natural resources business activities.

Finally, our earnings for 2013 were reduced by costs related to our MeadWestvaco timberland acquisition, which closed on December 6, 2013. We incurred $5 million of transaction related costs which are included in our Selling, General and Administrative expenses in the Consolidated Statements of Income. Additionally, in connection with financing the acquisition, and the related equity offering and partial use of proceeds to retire debt, we incurred $4 million of debt prepayment penalties and premiums, which are included in Loss on Extinguishment of Debt in the Consolidated Statements of Income.

Recent Acquisitions

During the past fifteen months the company made several significant acquisitions which are expected to impact our 2014 operating results. The recent acquisitions are summarized as follows:

On December 6, 2013, we acquired approximately 501,000 acres of timberlands in Alabama, Georgia, South Carolina, Virginia and West Virginia, along with related minerals and wind power leases and an equity interest in approximately 109,000 acres of high-value rural and development quality lands (see Note 2 to the Notes to Consolidated Financial Statements). The total purchase price was approximately $1.1 billion, which consisted of a $221 million cash payment and the issuance of an installment note payable for $860 million. Prior to closing the transaction, we completed an equity offering in November 2013, resulting in the issuance of 13.9 million shares of common stock for net proceeds of $607 million. We used the proceeds from the equity offering to pay the cash portion of the purchase price, with the balance used to pay down approximately $376 million of outstanding debt.

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Table of Contents PART II / ITEM 7

In September 2013, we acquired mineral rights in approximately 255 million tons of aggregate reserves at four quarries in Georgia for approximately $156 million (see Note 6 of the Notes to Consolidated Financial Statements).

In April 2013, we acquired approximately 46,000 acres of timberlands in Georgia and Alabama for approximately $72 million.

In December 2012, we acquired mineral rights in approximately 144 million tons of aggregate reserves at four quarries in South Carolina for approximately $76 million.

The December 6, 2013 acquisition had almost no impact on our 2013 operating results (other than the previously mentioned transaction expense and debt prepayment penalties). We expect 2014 harvest levels to increase by approximately 2.9 million tons (approximately 45% sawlogs) in our Southern Resources Segment and approximately 0.3 million tons (approximately 40% sawlogs) in our Northern Resources Segment as a result of this acquisition. We expect our interest expense to increase by approximately $27 million due to the combined impact of issuing an $860 million installment note to finance a portion of the acquisition, partially offset by using $376 million from our November 2013 equity offering to retire a portion of our debt. Finally, we expect the net impact on 2014 earnings associated with the related minerals, wind power leases, and equity interest in real estate development properties to be less than $5 million.

The combined impact on 2013 operating income related to the December 2012 and September 2013 acquisition of mineral rights was approximately $2 million. We expect the 2014 operating income related to our December 2012 and September 2013 mineral rights acquisitions to be approximately $6 million.

Key Economic Factors Impacting Our Resources and Manufacturing Businesses

Our operating performance for the Resources and Manufacturing Segments is impacted primarily by the supply and demand for logs and wood products in the United States. The short-term supply of logs is impacted primarily by weather and the level of harvesting activities. The demand for logs and wood products in the United States is impacted by housing starts, repair and remodeling activities and industrial activity. The demand for U.S. logs and lumber is reduced, in part, by the amount of imported lumber, primarily from Canada.

Selected U.S. housing economic data for the last five years was as follows at December 31:

                                                  2013     2012     2011     2010     2009
U.S. Housing Starts (in millions)                0.92     0.78     0.61     0.59     0.55
Supply of Existing Homes for Sale (in months)       5        4        6        8        7
30-yr. Fixed Interest Mortgage Rates (average)    4.0 %    3.7 %    4.5 %    4.7 %    5.0 %

Housing starts for 2013 increased by 18% from the prior year and have increased by over 60% from the record low housing starts in 2009 (lowest since 1945). This increase was due in part to the improving U.S. economy, the decline in home foreclosures and home mortgage delinquencies to more normal levels, the increase in home builders' confidence, and the near record low number of new homes available for sale. However, despite the recent improvement, housing starts remain at recessionary levels compared to the historical level (and projected long-term typical demand) of 1.5 million to 1.6 million annual housing starts.

Housing starts continue to be impacted by high unemployment, low wage growth, concerns over the direction of the U.S. economy, and high consumer debt. Despite the recent decline in the unemployment rate to 6.6%, a more representative statistic regarding the health of the U.S. economy is the labor participation rate, which currently is at 63% and is near a 35 year low. One of the key factors why housing starts continue to remain well below the historical level is the inability for many young families to purchase a home due to weak job opportunities and strict lending standards.

Another factor that is negatively impacting the demand for logs and wood products is the characteristics of today's housing starts. More families today are finding it difficult to purchase a home and instead are living in apartments. As a result, current housing starts consist of approximately 30% multifamily starts and 70% single-family starts, where

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Table of Contents PART II / ITEM 7

historically multifamily starts have only represented approximately 20% of total housing starts. Since multifamily starts use only about one-third the amount of wood that single family starts use, this change is having an impact on the overall demand for wood products.

The recessionary level of housing starts has mostly impacted our Southern Resources Segment. Average sawlog prices in our Northern Resources Segment during 2013 were $79 per ton (delivered basis), which is the highest average realization during the past ten years. In comparison, average sawlog prices in our Southern Resources Segment were $22 per ton (stumpage basis), which was approximately 40% lower than our 2005 average of $37 per ton. Some of the key reasons for this difference is that in our Northern Resources Segment, mill owners have been more willing to add shifts, and there has been strong export demand for logs and wood products on the West coast. However, in our Southern Resources Segment, log prices have increased modestly since our recent low in 2011 when the average for the year was $19 per ton. This limited price improvement is due to Southern mill owners being more reluctant to add shifts or restart mills, and due to readily available supply of logs for the current level of lumber and plywood production.

We believe favorable demographics will bode well for the wood products business in the long-run and that eventually housing starts will return to normal levels. In the meantime, there remains uncertainty around the extent and timing of improved demand for wood products and around the demand and supply for sawlogs, both of which can have a significant impact on our operating results.

We use independent third-party contract loggers and haulers to deliver our logs to our customers. Following the weak business conditions in the timber business that persisted for several years, there are fewer of these contractors available in certain markets to produce and deliver logs. While we continue to enhance strong working relationships with the independent loggers and haulers, as log markets continue to improve there may be production and delivery constraints that could impact log prices and/or delivery.

Higher Value and Non-Strategic Timberlands

We review our timberlands to identify properties that may have higher values other than as commercial timberlands (see discussion in Item 1 - Real Estate Segment). We estimate that included in the company's 6.8 million acres of timberlands at December 31, 2013, are approximately 800,000 acres of higher value timberlands which are expected to be sold, exchanged, and/or developed over the next fifteen years for recreational, conservation, commercial and residential purposes. Included within the 800,000 acres of higher value timberlands are approximately 600,000 acres we expect to sell for recreational uses, approximately 125,000 acres we expect to sell for conservation and approximately 75,000 acres that are identified as having development potential. Furthermore, the company has approximately 300,000 acres of non-strategic timberlands, which are expected to be sold over the near and medium term in smaller scale transactions ("small non-strategic"). Not included in the above 800,000 higher value acres and 300,000 small non-strategic acres are other acres that may be sold, from time to time, in large acreage transactions to commercial timberland buyers as opportunities arise ("large non-strategic"). Some of our real estate activities, including our real estate development business, are conducted through our wholly-owned taxable REIT subsidiaries. In the meantime, all of our timberlands continue to be managed productively in our business of growing and selling timber.

During 2013, we sold approximately 47,000 acres of higher and better use / recreational properties for proceeds of $95 million, approximately 26,000 acres of conservation properties for proceeds of $26 million, approximately 44,000 acres of small non-strategic properties for proceeds of $54 million, along with approximately 51,000 acres of large non-strategic properties for proceeds of $106 million. We expect revenue from real estate sales during 2014 to range between $240 million and $280 million. Revenue from large non-strategic sales during 2013 was approximately 35% of total real estate revenue. In 2014, we expect revenues from large non-strategic sales to be less than 25% of total real estate revenue.

Our land development business slowed dramatically starting in 2008 and has since remained weak. We do not expect any significant proceeds from the sale of real estate development properties in 2014.

PLUM CREEK 2013 FORM 10-K | 29

Table of Contents PART II / ITEM 7

Harvest Levels

The volume of trees we harvest each year and the percentage of sawlogs and pulpwood (product mix) included in our annual harvest also impact our operating performance. During 2013, we harvested a total of 17.4 million tons compared to a total of 17.9 million tons during 2012. We expect total 2014 harvest levels to increase approximately 20% to over 20 million tons from 2013 harvest levels due to the acquisition of 501,000 acres of timberlands from MeadWestvaco Corporation, which will add approximately 3 million tons annually to the harvest over the next five years. While we have the flexibility to modify our annual harvest volumes, based on market conditions, we expect harvest levels to be comparable to our expected 2014 harvest volumes over the near-term (next five years) and increase modestly over the long-term (ten years and beyond) as the timber inventory grows. Future harvest levels may vary from historic or expected levels due to weaker or stronger than anticipated markets or other factors outside of our control, such as weather and fires. Future harvest levels may also be impacted by the acquisition of timberlands or the disposition of timberlands beyond the 1.1 million acres described above in the Higher Value and Non-Strategic Timberlands section.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Under different assumptions or conditions, actual results may differ from these estimates.

We believe the following critical accounting policies affect our most significant judgments and estimates used in preparation of our consolidated financial statements:

Revenue Recognition for Timber Sales

Timber sales revenues are recognized when legal ownership and the risk of loss transfer to the purchaser and the quantity sold is determinable. We sell timber under delivered log agreements and through sales of standing timber (or "stumpage") using pay-as-cut sales contracts or timber deed sale agreements.

Delivered Log Sales. Under a delivered log sale agreement, we harvest the timber and deliver it to the buyer. Revenue is recognized when the log is delivered as risk of loss and title transfer to the buyer. With delivered log sales, we incur the cost of logging and hauling.

Pay-as-Cut Sales Contracts. Pay-as-cut sales contracts are agreements in which the buyer agrees to purchase and harvest specified timber on a tract of land for an agreed upon price for each type of tree over the term of the contract (usually 12 to 18 months). In some cases, an advance is received in connection with pay-as-cut sales contracts. In other cases, the buyer agrees to harvest only certain trees on a tract of land. Under pay-as-cut sales contracts, the buyer is responsible for all logging and hauling costs. Revenue is recognized when the timber is harvested, as title and risk of loss has transferred to the buyer. Total revenue recognized under a pay-as-cut sales contract is the total volume of wood removed multiplied by the unit price for each type of tree.

Timber Deeds. Timber deed sales are agreements in which the buyer agrees to purchase and harvest specified timber (i.e. mature pulpwood and/or sawlogs) on a tract of land over the term of the contract (usually 18 months or less). Unlike a pay-as-cut sales contract, risk of loss and title to the trees transfer to the buyer when the contract is signed. The buyer pays the full purchase price when the contract is signed and we do not have any additional performance obligations. Under a timber deed, the buyer is responsible for all logging and hauling costs and the timing of such activity. Revenue from a timber deed sale is recognized when the contract is signed because the earnings process is complete. Timber deeds are generally marketed and sold to the highest bidder. Bids are typically based on a timber cruise which is an estimate of the total volume of timber on a tract of land broken down by the various types of trees (such as softwood sawlogs, hardwood pulpwood, etc.). Total revenue recognized under a timber deed is not dependent upon the volume or types of trees actually harvested.

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The following table summarizes amounts recognized under each method from sales to external customers in the company's consolidated financial statements for the years ended December 31 (in millions):

2013 2012 2011
Revenues from:
Delivered log sales $ 577 $ 553 $ 497 Pay-as-cut sales $ 35 $ 37 $ 35 Timber deed sales $ 19 $ 14 $ 3

Substantially all of our timber sales in the Northern Resources Segment are under delivered log sale agreements. In our Southern Resources Segment, approximately 13% of our timber sales in 2013 and 2012 and 11% of our timber sales in 2011 consisted of pay-as-cut sales contracts and timber deed sales. Under sales of stumpage, the buyer is responsible for the logging and hauling costs; therefore, the operating profit as a percentage of revenue is typically higher in our Southern Resources Segment.

Real Estate Sales

The timing of real estate sales is a function of many factors, including the general state of the economy, demand in local real estate markets, the ability to obtain entitlements, the ability of buyers to obtain financing, the number of competing properties listed for sale, the seasonal nature of sales (particularly in the northern states), the plans of adjacent landowners, our expectation of future price appreciation, the timing of harvesting activities, and the availability of government and not-for-profit funding (especially for conservation sales). As a result, the timing of our real estate sales may materially impact our reported operating income and net income.

During 2013, the Real Estate Segment reported an operating profit percentage of approximately 59%. Over the last ten years, the Real Estate Segment's annual operating profit percentage has ranged from 40% to 65% of revenues. The operating profit percentage depends on the nature of the interest sold and how much the market value of the property has risen over its book value. For example, sales of properties that have been held by the company for a long time (i.e. decades) will tend to have relatively higher operating profit percentages than properties that have been held by the company for shorter time periods. In contrast, the sale of conservation easements will generally have an operating profit percentage of close to 100% because historically no book basis was allocated to these development rights.

In general, timberlands are acquired primarily for long-term use in our timber operations. In connection with timberland acquisitions, we are generally not able to identify, with any level of precision, our future real estate sales (i.e. specific properties with a higher value than for use in timber production). However, our purchase price allocation and related appraisals for these acquisitions may reflect greater values for real estate which may be sold in the future but are not yet specifically identified. Therefore, in connection with our purchase price allocation for timberland acquisitions, the greater values for real estate are allocated proportionately among all of the acres acquired. Specific properties cannot be identified in advance because their value is dependent upon numerous factors, most of which are not known at the acquisition date, including current and future zoning restrictions, current and future environmental restrictions, future changes in demographics, future changes in the economy, current and future plans of adjacent landowners, and current and future funding of government and not-for-profit conservation and recreation programs. We believe that current and future results of operations could be materially different under different purchase price allocation assumptions.

Impairment of Long-Lived Assets

We evaluate our ability to recover the net investment in long-lived assets when required by the accounting standards. We recognize an impairment loss in connection with long-lived assets used in our business when the carrying value (net book value) of the assets exceeds the estimated future undiscounted cash flows attributable to those assets over their expected useful life. Impairment losses are measured by the extent to which the carrying value of a group of assets exceeds the fair value of such assets at a given point in time. Generally, our fair value measurements used in calculating an impairment loss are categorized as Level 3 measurements (i.e. unobservable inputs that are . . .

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