NOTE 3. MERGER WITH DELTIC

On February 20, 2018 (merger date), Deltic Timber Corporation (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 stock, 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 12: 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.

On August 30, 2018, the board of directors approved a special distribution of $222.0 million, payable on November 15, 2018, to stockholders of record on September 27, 2018. The special distribution amount equals the company’s determination of the accumulated earnings and profits of Deltic as of merger date and must be distributed by the company prior to December 31, 2018 in order to maintain the company’s qualification as a REIT for U.S. federal income tax purposes. Common stockholders can elect to receive payment of the special distribution in the form of stock or cash, with the total cash payment to all stockholders limited to no more than 20%, or $44.4 million (Cash Amount), of the total distribution. If the aggregate amount of stockholder cash elections exceeds the Cash Amount, then the payment of such cash elections will be made on a pro rata basis to stockholders who made the cash election such that the aggregate amount paid in cash to such stockholders equals the Cash Amount, with the balance paid in shares of common stock. The declaration of this special distribution created a $222.0 million unconditional obligation for the company as of August 30, 2018 which is recorded as distribution payable on the Condensed Consolidated Balance Sheets at September 30, 2018. See Note: 3 Earnings Per Share for further discussion on the impact of the special distribution on diluted earnings per share.

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 $21.2 million of merger-related costs during the three and nine months ended September 30, 2018, respectively. See Note 13: 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 September 30, 2018 are as follows:

(Dollars in thousands)

Three Months Ended

September 30, 2018

Nine Months Ended

September 30, 2018

Net sales

83,385

192,244

Income before income taxes

17,180

25,869

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 September 30,				For the Nine Months Ended September 30,
(Dollars in thousands, except per share amounts)	2018		2017		2018		2017
Net sales	$	289,199	$	252,097	$	795,992	$	673,575
Net earnings attributable to PotlatchDeltic common shareholders	$	61,327	$	30,099	$	142,314	$	63,862
Basic earnings per share attributable to PotlatchDeltic common Shareholders	$	0.91	$	0.44	$	2.13	$	0.95
Diluted earnings per share attributable to PotlatchDeltic common shareholders	$	0.91	$	0.44	$	2.12	$	0.95

Pro forma net earnings attributable to PotlatchDeltic common shareholders excludes $1.0 million and $26.7 million of non-recurring merger-related costs incurred by both companies during the three and nine months ended September 30, 2018, respectively, of which $5.4 million were incurred by Deltic prior to the merger.

Pro forma basic and diluted earnings per share assumes issuance of approximately 22.0 million shares that were issued at the merger date as of the beginning of 2017. Pro forma basic and diluted earnings per share also assumes the issuance of 4.2 million shares as of the beginning of 2017, which is the estimated number of shares from the special distribution required to settle the estimated stock portion of the liability at September 30, 2018. 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 September 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, except for 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.

The following table summarizes the preliminary fair value measurements of assets acquired and liabilities assumed as of merger date:

(Dollars in thousands)	February 20, 2018		Measurement Period Adjustments			As Adjusted February 20, 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		524			8,800
Real estate held for development and sale		79,000		(2,000	)		77,000
Property, plant and equipment		265,901		(5,132	)		260,769
Timber and timberlands		1,060,000		913			1,060,913
Mineral rights		—		6,236			6,236
Trade name and customer relationships intangibles		19,000		500			19,500
Other long-term assets		2,010		1,546			3,556
Total assets acquired		1,467,631		2,587			1,470,218
LIABILITIES
Accounts payable and accrued liabilities		12,604		3,418			16,022
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		(831	)		43,608
Other long-term liabilities		936		—			936
Total liabilities assumed		324,856		2,587			327,443
Net assets acquired	$	1,142,775	$	—		$	1,142,775

The real estate held for development and sale adjustment of $2.0 million was based on continued refinement of information as of the merger date factored into the valuation. The property, plant and equipment adjustment of $ 5.1 million related to further refinement and review of the inputs associated with valuation of the acquired buildings and equipment including items such as estimated useful lives, maintenance expenditures and market comparables. The $ 0.9 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. 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 accounts payable and accrued liabilities measurement period adjustment of $3.4 million was primarily for estimated 2017 Deltic taxes payable estimated at merger date and adjusted with the 2017 tax return filing. 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 three and nine months ended September 30, 2018 we recorded approximately $0 and $0.2 million, respectively, 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

•

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.