NOTE 3. MERGER WITH DELTIC

On February 20, 2018 (merger date), Deltic merged into Portland Merger, LLC, a wholly-owned subsidiary of Potlatch. Deltic owned approximately 530,000 acres of timberland, operated two sawmills and a medium density fiberboard plant and was engaged in real estate development primarily in Arkansas. The merger creates a combined company with a diversified timberland base of nearly 2 million acres, including approximately 930,000 acres in Arkansas. It uniquely positions us to expand our integrated model of timberland ownership and lumber manufacturing, provide significant tax savings on Deltic’s timber harvest earnings and increase our exposure to the fast-growing Texas housing market.

Under the merger agreement, each issued and outstanding share of Deltic common stock was exchanged for 1.80 shares of Potlatch common shares, with cash paid in lieu of any fractional shares. Upon consummation of the merger, all outstanding Deltic stock options (which fully vested as of the merger date) and restricted stock units (RSUs) were converted into Potlatch stock options and RSUs, after giving effect to the 1.80 exchange ratio. Because the Deltic stock options are fully vested and relate to services rendered to Deltic prior to the merger, the replacement stock options are also fully vested and their fair value is included in the consideration transferred. A portion of the replacement RSUs relate to services to be performed post-merger and therefore are not included in consideration transferred. See additional details about replacement share-based payment awards in Note 13: Equity-Based Compensation.

The following table summarizes the total consideration transferred in the merger:

(Dollars in thousands, except share and per share amounts)
Number of shares of Deltic common stock outstanding¹		12,121,223
Number of Deltic performance awards²		90,515
		12,211,738
Exchange ratio³		1.80
Potlatch shares issued		21,981,128
Price per Potlatch common share⁴	$	51.95
Aggregate value of Potlatch common shares issued	$	1,141,920
Cash paid in lieu of fractional shares	14
Fair value of stock options and RSUs⁵	841
Consideration transferred	$	1,142,775

¹	Number of shares of Deltic common stock issued and outstanding as of February 20, 2018, net of fractional shares.

²	Number of shares of Deltic performance awards for pre-combination services rendered that vested upon closing of the merger.

³	Exchange ratio per the merger agreement.

⁴	Closing price of Potlatch common shares on February 20, 2018.

⁵	Fair value of Deltic stock options for pre-combination services rendered that vested upon closing of the merger, as well as RSUs for pre-combination services rendered.

The company entered into a two-year consulting agreement for $1.85 million with Deltic’s former Chief Executive Officer. While the agreement was terminated in the first quarter of 2018, payments are required to be made through the end of the two year term. This agreement was considered a separate transaction from the business combination, therefore the $1.85 million was recorded as merger costs in the first quarter of 2018.

We expensed approximately $1.0 million and $20.3 million of merger-related costs during the three and six months ended June 30, 2018, respectively. See Note 14: Merger, Integration and other Costs for the components of merger-related costs. These costs are included in Deltic merger-related costs in our Condensed Consolidated Statements of Income.

The amount of revenue and income before income taxes from acquired Deltic operations included in our Condensed Consolidated Statement of Income for February 21, 2018 through June 30, 2018 are as follows:

(Dollars in thousands)

Three Months Ended June 30, 2018

Six Months Ended

June 30, 2018

Net sales

80,053

108,859

Income before income taxes

16,724

7,613

Summarized unaudited pro forma information that presents combined amounts as if this merger occurred at the beginning of 2017 is as follows:

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(Dollars in thousands, except per share amounts)	2018		2017		2018		2017
Net sales	$	268,233	$	218,582	$	506,793	$	421,478
Net earnings attributable to PotlatchDeltic common shareholders	$	47,225	$	20,984	$	80,928	$	33,829
Basic earnings per share attributable to PotlatchDeltic common Shareholders		0.71		0.32		1.22		0.51
Diluted earnings per share attributable to PotlatchDeltic common shareholders		0.71		0.31		1.21		0.51

Pro forma net earnings attributable to PotlatchDeltic common shareholders excludes $1.0 million and $25.7 million of non-recurring merger-related costs incurred by both companies during the three and six months ended June 30, 2018, respectively, of which $5.4 million were incurred by Deltic prior to the merger. No non-recurring merger-related costs were incurred during the three and six months ended June 30, 2017. Pro forma basic and diluted earnings per share assumes issuance of approximately 22.0 million shares at the beginning of 2017 that were issued upon merger. Pro forma basic and diluted earnings per share also assumes issuance of 3.9 million additional shares at the beginning of 2017, which is the approximate amount of the stock dividend to be issued in connection with the earnings and profits (E&P) distribution. Prior to December 31, 2018, Deltic’s E&P will be distributed to shareholders of the combined company in a special distribution consisting of 80% stock and 20% cash. Pro forma data may not be indicative of the results that would have been obtained had these events occurred at the beginning of the periods presented, nor is it intended to be a projection of future results.

PotlatchDeltic has accounted for the merger transaction as the acquirer and has applied the acquisition method of accounting. Under the acquisition method, the assets acquired and liabilities assumed from Deltic were generally recorded as of the date of the merger at their respective estimated fair values.

Our June 30, 2018 Condensed Consolidated Balance Sheet includes the assets and liabilities of Deltic, which have been measured at fair value as of the merger date. The fair values of the assets acquired and liabilities assumed were preliminarily determined using the income, cost and market approaches, as applicable. The fair value measurements were generally based on significant inputs that are not observable in the market and thus represent Level 3 measurements as defined in ASC 820, Fair Value Measurements and Disclosures, with the exception of certain long-term debt instruments assumed in the acquisition that can be valued using observable market inputs and are therefore Level 2 measurements. The income approach and cost approach were primarily used to value acquired timber and timberlands. The income approach was primarily used to value the acquired real estate held for development and sale. The income approach estimates fair value for an asset based on the present value of cash flow projected to be generated by the asset. Projected cash flows are discounted at rates of return that reflect the relative risk of achieving the cash flows and the time value of money. The cost approach, which estimates value by determining the current cost of replacing an asset with another of equivalent economic utility, was used, as appropriate, for property and equipment. The cost to replace a given asset reflects the estimated reproduction or replacement cost for the property, less an allowance for loss in value due to depreciation. The market approach was primarily used to value long-term debt instruments. The market approach estimates fair value for an asset based on values of recent comparable transactions.

During the three months ended June 30, 2018, we continued to revise our valuation of the net assets acquired as of the merger date, including the following adjustments to the preliminary estimated fair values of the identifiable assets acquired and liabilities assumed:

	Amount recognized as of:
(Dollars in thousands)	March 31, 2018		Measurement Period Adjustment			June 30, 2018
ASSETS
Cash and cash equivalents	$	3,419		—		$	3,419
Customer receivables, net		12,709		—			12,709
Inventories		17,316		—			17,316
Other current assets		8,276		—			8,276
Real estate held for development and sale		79,000		(2,000	)		77,000
Property, plant and equipment		265,901		(4,570	)		261,331
Timber and timberlands		1,060,000		(2,000	)		1,058,000
Mineral rights		—		6,236			6,236
Trade name and customer relationships intangibles		19,000		500			19,500
Other long-term assets		2,010		1,462			3,472
Total assets acquired		1,467,631		(372	)		1,467,259
LIABILITIES
Accounts payable and accrued liabilities		12,604		150			12,754
Current portion of pension and other postretirement employee benefits		754		—			754
Long-term debt		229,968		—			229,968
Pension and other postretirement employee benefits		36,155		—			36,155
Deferred tax liabilities, net		44,439		(522	)		43,917
Other long-term liabilities		936		—			936
Total liabilities assumed		324,856		(372	)		324,484
Net assets acquired	$	1,142,775		—		$	1,142,775

The mineral rights measurement period adjustment of $6.2 million related to certain oil and gas royalty payments from third party extractive activities on the acquired land. This amount is included in other long-term assets in the condensed consolidated balance sheets. The other long-term asset measurement period adjustment of $1.5 million was related to sales and use tax credits from the State of Arkansas. The property, plant and equipment adjustment of $4.6 million related to further refinement of the value associated with acquired buildings and equipment. The $2.0 million adjustment to timber and timberlands is a combination of the separation of the mineral rights value previously included in the timber and timberlands, offset by further revisions to the underlying valuation assumptions. Other measurement changes were not significant and mainly a result of continued refinement of information as of the merger date that have been factored into the valuation. As a result of these adjustments, during the second quarter of 2018 we recorded approximately $0.2 million of additional depreciation, depletion and amortization expense as measurement period adjustments.

These estimated fair values are preliminary in nature and subject to adjustments, which could be material. We have not identified any material unrecorded pre-merger contingencies where the related asset, liability or impairment is probable and the amount can be reasonably estimated. We are currently in the process of finalizing our valuations related to the following:

•

Timber and timberlands, including mineral rights

•

Property, plant and equipment

•

Real estate held for development and sale

•

Intangible assets, which includes trade names and customer relationships

•

Other contractual rights and obligations

•

Income taxes

Our valuations will be finalized when certain information arranged to be obtained has been received, our review of that information has been completed and our review of the underlying assumptions within the valuation models has been completed. Prior to the finalization of the purchase price allocation, if information becomes available that would indicate it is probable that such events had occurred and the amounts can be reasonably estimated, such items will be included in the final purchase price allocation.