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Edited Transcript of PCH presentation 8-Mar-17 4:00pm GMT

Potlatch Corp at Raymond James Institutional Investors Conference

Orlando Apr 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Potlatchdeltic Corp presentation Wednesday, March 8, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mike Covey

Potlatch Corporation - Chairman, CEO

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Conference Call Participants

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* Collin Mings

Raymond James - Analyst

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Presentation

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Collin Mings, Raymond James - Analyst [1]

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Good morning. I am Collin Mings. I am the timber REIT analyst here at Raymond James and very excited that you are able to join us this morning for Potlatch's presentation. Very excited again to have back this year Mike Covey as well as Jerry Richards from Potlatch; they will be taking us through the slide presentation. After that, I will open it up for some Q&A. I have a few questions myself.

As most of you are aware, or some of you are aware at least, we were very excited about the prospects for the timber REITs here in 2017 just against a backdrop of improving residential construction activity as well as some of the protectionist trade policies that have been talked about. We do think the timber REITs and, Potlatch in particular, stand to benefit from that. So really against that backdrop, I will turn it over to you, Mike, and -- for the presentation.

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Mike Covey, Potlatch Corporation - Chairman, CEO [2]

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Thanks, Collin. Good morning, everyone. We will walk through the comments on the slides fairly quickly but, I think to Collin's point, if -- compared to a year ago when we were here, spring forward to today, things couldn't have played out much better for Potlatch. We've got a favorable administration, Softwood Lumber Agreements kind of tipped in our favor, housing demand and construction continue to improve and we are seeing capacity additions of manufacturing facilities around many of the forests that we own and manage.

Potlatch is unique compared to some of the other timber REITs that were at the conference in that we have the highest leverage to lumber prices of any of the timber REITs. And certainly in the current environment with lumber prices approaching highs that they have been in the last decade or more, we are certainly seeing the benefits of that in the earnings stream from the Company.

We are, I think, the ninth largest lumber manufacturer in the United States, a top 10 producer. We will talk more about our leverage to lumber in just a minute.

For those of you who aren't familiar with the Company, we are the largest private landowner in Idaho, one of the largest landowners in the state of Arkansas also with a footprint in Alabama and Mississippi and a rural recreational Real Estate business in the Lake States, primarily in the state of Minnesota. Current dividend yield of 3.4% and we had a share purchase authorization in place for about the last year and we have executed on a portion of that to date.

A map depicting the Company's timberland ownership; I mentioned in Northern Idaho, 600,000 acres in Northern Idaho with two manufacturing facilities there; the three southern states where we have a footprint, a total of 1.4 million acres; and lumber capacity, well actually, lumber production last year of 700 million board feet at our four lumber mills, and that does not count about 150 million square feet of plywood, which we also make in Idaho at one of our plywood facilities. So our Wood Products business is quite large and mostly proximate to the timberland that we own around the country.

To the point that I started with, Potlatch has the highest leverage to our earnings stream, or EBITDA, of any of the timber REITs. This slide helps illustrate that. On the left, you can see that about half of our EBITDA stream comes from either directly our Wood Products manufacturing business and lumber, or the fact that we also index the price of our saw logs in the north, in Idaho, to the price of lumber.

So those two things account for about 50% of our EBITDA stream, compared to the other timber REIT universe, which only Weyerhaeuser has lumber manufacturing capacity. Of course, they have a much bigger business than we do in total, but as a percentage of their contribution for their company's earnings stream; it is only about 18%, while ours is almost half while you couple both Wood Products and our Resource business together.

A $30 change in the price of lumber, which today is a little bit less than a 10% change in the price of lumber, translates to about $25 million of EBITDA for the Company. So when you put a multiple on that, you can see how powerful that leverage is for Potlatch.

I am sure Collin mentioned in his remarks, and some of you are aware of the long-standing dispute between Canada and the United States and the Softwood Lumber Agreement, which expired about a year ago. We are in the process of getting a new set of countervailing duties and anti-dumping duties established by the Department of Commerce; that comes later this spring, in late April.

But the more important thing isn't so much what the duties are going to be, although the market has factored in that to a large degree, we believe, but what is the longer-term solution with Canada and the United States going forward?

And our belief, and that of the softwood lumber coalition, which we are part of in the US, is what we need between Canada and the US is a quota that limits the amount of imports to Canada or exports Canada can make into the United States in lumber, and that is really the long-term solution that we are striving for, which will take some time to resolve.

And why that is so important is largely to do, for us, as a timberland owner in the US South; it isn't so much our lumber business that benefits long-term. It is the timber business that benefits long-term from a more favorable agreement with Canada. And that is because, if there is going to be capacity additions in the United States to support a rising housing market, where is the lumber going to come from? It has to come from the Southern United States forest where there is plentiful availability of trees, of logs.

As a southern timberland owner, we would like to see more capacity additions in the US South because it will put tension on the log market and log prices will rise and, as a large timberland owner, we stand to benefit from that.

You can see that process has begun to happen a little bit on the left-hand side of the graph here. You can see where lumber prices are today, about $380 per thousand board feet in Western SPF prices. They have come up over time. This is a graph of the relationship between the demand in capacity in the industry and pricing.

So when capacity ratios approach 90%, which we are close to that today, we are in the high 80s, we start to see the lumber prices rise and you can see where we are in 2017. 2016 was right there. So we feel like there is more tension in the market; lumber prices still have a ways to go.

I think housing is a well-understood story; it is not robust but it is steady. We look for about 1.25 million starts this year up to 1.3 million starts, or a few more, next year. That steady rate of increase is important.

And two other components of that that are critical are the percentage of single-family starts that make up that mix, and that is increasing, and the other kind of hidden component beyond absolute housing starts are how important the repair and remodel segment is to the -- not only to the economy, but to our lumber business as well. Demand is very strong and that is mostly served through the retail home centers like Lowe's and Home Depot.

I mentioned one other real catalyst that is important for Potlatch long-term, and it hasn't happened yet, is the rise in southern log prices. So the forest that we grow in the US South, the price of those trees has declined significantly from a price of around $35 to $40 per ton in the forest a few years ago before the Great Recession. It has fallen all the way down into this $20 to $25 range, and it has not improved.

And the catalyst to change that over time is higher demand, which comes from more capacity in the South. And until we see that happen, this oversupply of timber in the forest is not going to get worked off, and that process is going to take some time. So we are encouraged by what is happening.

If you look at Potlatch's wood baskets in Arkansas, Mississippi and Alabama, there are a number of new capacity additions that have been announced or are already in place. The first one on the list is Biewer Lumber Company in Newton, Mississippi. That sits right over here just below our timberland; brand-new mill, greenfield mill, about $100 million investment started by a family investment. The company comes from the Lake States. It is going to consume 900,000 tons of logs.

So South wide, we only grow and sell about 1 million tons of sawlogs as a Company. This one mill is going to use 900,000 tons. So those kinds of additions, and there's several more on the list, are really important.

We have got a Canadian company right here dead center in South Central Arkansas called Conifex, who is building or modernizing and restarting a closed mill in El Dorado, Arkansas, and they are spending about $80 million doing that. That is scheduled to start up later this year.

So the solution to this oversupply of timber in the South is to get more capacity in place to produce more lumber. That is going to take several quarters to bring that supply and demand equilibrium back into place and, when it does, we will start to see that $25 a ton log price I showed on the previous slide begin to rise.

We have already seen -- I'm going to jump ahead here -- significant log price increases in the North. If you look at our northern business, this is the price of sawlogs in the North at $75 a ton a few years ago; today it stands at $90 a ton. Across the US South, log pricing has been stuck and it's flat. So the North is already seeing this powerful dynamic, partly because of an export market in China and Japan, but also in the South, we don't have the oversupply of timber in the Pacific Northwest that we do in the US South.

So our Resource business in the North is terrific and it is only getting better. And one big driver of that is we are a fairly large producer in the Northwest of cedar logs. Cedar logs produce cedar lumber which largely goes into the vacation home market: Sun Valley, Park City, Jackson Hole, Western ski resort areas, a lot of the homes are sided with cedar. It is a product that is in short supply. Canada makes some of it, the Northwest makes some of it, but there is not enough of it.

Pricing for the product is at record levels and, just this year, since the start of this year, we have seen cedar pricing go up enough to have an incremental impact to our EBITDA on an annualized basis of pricing holds of between $6 million and $10 million a year. So it is very substantial.

Obviously, as a timber company, we want to make sure our harvests long term are sustainable. This just depicts over a very long period of time, clear out into 2065 and beyond, what we expect harvest levels to do. We are at a level today of about 4.2 million tons; that is where we were last year. We expect to be there this year and we expect to be between 3.8 and 4.6 on an annualized basis going forward assuming we don't buy or sell any more land.

I mentioned our Company's Real Estate business. We sell about 20,000 acres a year of rural recreational land, mostly in 40- to 80-acre tracts in Minnesota. We do a little bit in Idaho and a little bit in Arkansas and the other southern states, especially Alabama. But largely, it is a Minnesota-based business and we sell land for between roughly $1,000 and $2,000 an acre. But, more importantly, we usually sell it for somewhere between 3 and 5 times what it is worth to grow trees on, so that is why we are in the rural recreational business. We don't develop anything, we don't build houses, we don't do infrastructure improvements. We sell raw, rural, recreational land mostly used by deer hunters and recreationists on weekends within a couple hours of the Twin Cities.

We have talked about Wood Products. This has been a powerful earnings stream for the Company in the past. This represents our four sawmills and one plywood plant. EBITDA in this business averaged around $50 million to $60 million in 2012 to 2014.

Lumber prices came down a bit in 2015. Log prices went up in the Northwest. Earnings got pinched in 2015. Last year we reported $32 million in EBITDA in the Wood Products business and we expect, based on what lumber prices have done already this year; that is going to substantially improve in 2017 over 2016.

A couple comments about capital structure and Jerry can answer any detailed questions about this. A couple of important things I think to point out. We were active in 2016 to reduce our interest expense. We have lowered it by about $5 million a year through both refinancing debt as well as paying down long-term debt last year. Both of those initiatives are largely completed and we are kind of out of options to pull more levers here.

This big stack of debt maturities in 2019, there is $150 million there that was issued 10 years ago that matures in 2019 at an interest rate of 7.5%, but it has an egregious make-whole premium of $26 million on it today. It makes no sense to prepay it. So we are kind of out of options on the balance sheet to do work here, but we are very comfortable with where it is at. Net debt to enterprise value, kind of a key metric we look at, stands at a very comfortable 22%.

Finally, a comment about our dividend, which is an important part of the capital allocation strategy that we have to return value to shareholders; it is at $1.50 today. And what we look to increase the dividend, the single most important thing we are looking for is a rise in southern log prices. If we can see those southern log prices, which are stuck at $25 a ton stumpage rate, when we see those begin to tick up in the demand and capacity; there is supply and demand that come back in equilibrium. That will be a catalyst for us to look to raise the dividend.

And going forward, we expect that is not a 2017 event unless things change substantially through the balance of the year. We do not expect southern log prices to rise this year despite a strong lumber market.

So in summary, we like where we are positioned. We think the softwood lumber case is another -- is a strong near-term catalyst for earnings streams for us, particularly in the first quarter. The lumber business has been terrific. We have got a lot of leverage to the housing market. We think a compelling story for investors.

So with that we will stop and take questions from Collin and the audience.

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Questions and Answers

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Collin Mings, Raymond James - Analyst [1]

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Thanks, Mike. I think to maybe just start off, maybe expand a little bit on the lines of the momentum on lumber pricing here recently. So we have seen an uplift really over the last five or six weeks, pretty notable. And I think that is above what most people in the industry maybe were expecting. So maybe talk about how much of that is a reflection of maybe less lumber coming in from Canada? Is it stronger housing demand? What is your take on the market right now?

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Mike Covey, Potlatch Corporation - Chairman, CEO [2]

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Well, I think the big surge that we have seen in lumber pricing in the last several weeks came from elements largely associated with the Softwood Lumber Agreement. Principally, I think, there was some pullback from the market of large Canadian producers for a short period of time in February as it became clear that they may face retroactive duties.

So the duties that I spoke of will go into play -- so be announced on April 24. There is a possibility that they could be retroactive for a three-month period of time, 90 days. That 90-day period started about February 1. I think that was a -- one leg up in lumber pricing.

Coupled with that, I think as we started the building season this year with most parts of the country, except for California and maybe the Pacific Northwest where we have had quite a winter, most of the country has been dry and warm and building season has been pretty good. So I think spring building season started a bit sooner than expected.

Single-family homes starts have been a little stronger than expected, maybe not the total number, but the single-family share. So those things fuel demand for lumber and the supply chain has been tight.

People that buy lumber, stocking distributors and dealers that we deal with, don't have big lines of credit. They live kind of hand to mouth and they got caught shorthanded and, when that happens, the price of lumber gets bid up, so -- and it stayed up, so we are pretty enthusiastic about that.

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Collin Mings, Raymond James - Analyst [3]

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Maybe to just expand on that a little bit further, how sustainable do you see the recent increases in lumber? How much volatility, to put it maybe another way, how much volatility do you expect throughout the year given some of the trade case, how that is going to play out?

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Mike Covey, Potlatch Corporation - Chairman, CEO [4]

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Well, when we started the year we expected it to be quite volatile and I don't think that has changed any. It is a commodity business and it is certainly very strong right now and it will tip over at some point and go back down. But I think as we think about the lens for this year, I think certainly through April, when the duties are finally determined by the Department of Commerce, and then later in June, the anti-dumping duties, I think that keeps lumber pricing strong through the spring.

I think coupled with that, you have got this more important negotiation to take place between Canada and the US on what is the longer-term solution to the trade dispute between the countries. And I don't think there could be a case -- there can't be anything that is a clearer home run for the Trump administration than the lumber case in terms of -- it is rural America. It hits him in his sweet spot where a lot of his base support is.

So we think that he is going to -- he has appointed a US trade representative, who hasn't been confirmed yet, Robert Lighthizer, who we think is going to be a strong advocate for quotas on lumber. And if we can get a quota system in place this year, I think that further supports and holds up strong lumber prices for the balance of the year.

And meanwhile, housing continues to chug along. The headwinds for housing I think really come from only a catastrophic kind of interest-rate increase. I think two or three 25-basis point increase in the Fed funds rate is not going to choke off housing. It may slow things down on the margins but it is not certainly going to hurt it. So we feel really good about lumber for the year.

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Collin Mings, Raymond James - Analyst [5]

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Maybe especially in the backdrop of strong lumber pricing, at least an outlook for that this year. In the remarks, you touched on the fact you wouldn't look to increase the dividend really until you started to see some more momentum on log pricing. But how are you thinking about capital allocation? Because a year ago, I mean, the stock price was clearly significantly lower, a lot of conversation around share repurchases, you have a buyback in place.

Is it still attractive in your mind to be buying back your own stock or do you see better returns of deploying some of that cash you are generating from your mills elsewhere?

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Mike Covey, Potlatch Corporation - Chairman, CEO [6]

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Well, we have not repurchased -- we bought $6 million of our stock, a small amount, when we got our repurchase authorization in place in the second quarter of 2016. We haven't bought any since and I think the commentary on that is we think we have better uses of cash today.

Our -- the consensus estimate of net asset value for the Company published by the analysts, Collin and his industry colleagues, is around $45 a share. It varies, but -- and we are trading very close to that -- and so we don't think that a share repurchase program makes as much sense as a use of cash as other things.

And the primary opportunity that we -- we have already invested heavily in our mills. We had a robust capital improvement program in our mills a year ago. We have done about as much as we think makes sense currently. We paid down as much debt as we could and we thought that made sense.

And so the priority for us really as we stand here today is to try to grow the Company through acquisitions, and that has been our focus, and to try to do bolt-on acquisitions, small acquisitions that are in the same operating area where we already have a footprint, especially in the US South. And if they can be coupled with a manufacturing facility that would be even better, because we feel that is right in our wheelhouse. So that is where we have kind of shifted our priorities.

The dividend, we'll have to -- the Board will evaluate the dividend later in the year, kind of with what makes sense. We are building cash on the balance sheet, but we have said all along that we would want to couple the dividend with southern log price increases, not do it just based on lumber prices, which can go down and have gone down in the past.

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Collin Mings, Raymond James - Analyst [7]

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As it relates to potential acquisition opportunities maybe touch on the pipeline you see for 2017. I know a lot in the industry, I mean I was at -- went to a timber industry conference last week and there was a lot of optimism about deal flow here in 2017. Just curious your take on what you are seeing out there right now as far as opportunities to grow both maybe smaller bolt-on type deals or maybe even some larger acquisition opportunities out there?

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Mike Covey, Potlatch Corporation - Chairman, CEO [8]

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Well, the larger acquisition opportunities I think largely come from the TIMO business, the pension fund and endowment investments that have been made in the asset class and those funds then mature and then get put on the market. Those are largely in the US South. There is a small pipeline of those that's coming to market and some of those are meaningful in size, $200 million to $500 million in size. That gets to be kind of outside of our wheelhouse a bit.

We made an acquisition two years ago for $374 million in Alabama and Mississippi and that is probably the upper range of what we could do. Bolt-on acquisitions don't really come from the TIMO world as much as they do from small private land owners that are in our operating circle and we think that is the place where we have the most attractive returns.

We have gone back and looked at our acquisition history for the Company and where we have had the most success and the best return for shareholders have been in small deals, not big negotiated public auction deals, and that is where our focus will be.

But I do think there will be a number of -- last year was reasonably robust. I can't remember the total deal flow, but it was a few billion dollars in timberland that came to market last year and I'm not counting the large Plum Creek/Weyerhaeuser transaction. I think that we will see a number similar to that this year.

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Collin Mings, Raymond James - Analyst [9]

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One other thing, just switching gears maybe back to the shift in administration. There has been some conversation as far as some changes in the tax reform, regulatory policy, environmental policies. Just curious how you think about, I mean, potential ramping up of any sort of harvest activity on federal lands or anything like that? Do you see that as a potential risk or is that something you are not that concerned about?

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Mike Covey, Potlatch Corporation - Chairman, CEO [10]

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We are not that concerned about it, although there is certainly -- I think there's a lot of talk at the state levels in the West about the state management of federal lands, that they could do a better and more responsible job and provide more timber to local communities that need the jobs in the timber supply.

At the end of the day, there are a lot of environmental regulations and policies that have been firmly in place for a long time, the National Forest Management Act, NEPA, the national -- the environmental review requirements. I don't think any -- this administration can't wipe those things away; those are well-founded in Congress and in law. And until those would change, the flow of federal timber to the market I don't think is going to change materially, so we don't expect that.

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Collin Mings, Raymond James - Analyst [11]

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Okay. Would like to open it up to the audience if there is any questions from anyone in the room. Sure, go ahead.

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Questions and Answers

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Unidentified Audience Member [1]

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So, are you at all concerned that increasing lumber capacity offset some of (inaudible) --?

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Mike Covey, Potlatch Corporation - Chairman, CEO [2]

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So the question was about do the new capacity additions maybe trump the supply issues from Canada? And the answer to that is, we don't think so. The supply additions that are coming take about anywhere from 8 to 12 months or more to put each one of those in place and then there is a startup curve affiliated with each one of those projects, which takes time.

And I think at the current rate of demand growth, which we think is about 3 billion board feet of lumber a year, that's kind of what the expectation is for the lumber market to grow is about 3 billion board feet. The capacity additions still fall short of that number. So that further puts tension in the lumber market.

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Collin Mings, Raymond James - Analyst [3]

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One thing I think that is unique, and you started off the presentation highlighting is just the exposure to lumber pricing relative to some of the timber REIT peers. Something that -- again you are more levered to that with over half your EBITDA -- than anyone else. Maybe just walk us through, for some that maybe not as familiar, why you have so much leverage outside of just the manufacturing capacity, but maybe touch on how your pricing is based a little bit more in Idaho.

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Mike Covey, Potlatch Corporation - Chairman, CEO [4]

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So that's a -- a few years ago -- we have a couple of very large customers in Idaho that are lumber producers about the same size as we are. They produce around 1 billion board feet -- one of them produces about 1 billion board feet of lumber. And they own no timberland so they rely on the open market to purchase it. And so we struck a bargain with them that we would supply timber to their mills so long as we indexed the price of the trees to the price of lumber.

So it turned out to be somewhat of a tolling type of agreement. They knew that if lumber prices went up, they could still make a margin, and if lumber prices went down, we still had a market as well. So for over two-thirds of our volume in Idaho, both to a third-party mill and to the Potlatch sawmill that we operate in St. Maries, Idaho, we indexed the price of trees or logs to the price of lumber.

And so, in this rising lumber market that we have had, that has been very beneficial to the price of our logs over the last several years in a rising lumber market. So that is, in part, why we have so much leverage. Absent that agreement of indexing that I referred to, only about a quarter of our EBITDA stream would be related to the EBITDA from Wood Products.

So the Resource piece of it provides a large, meaningful chunk, and it has worked very well for us. And it has allowed them, our customer, to invest heavily in their mills to produce world-class facilities that will be there for a long time. The worst thing that could happen to us as a timberland owner is to have a stranded timberland with no manufacturing facilities around it and, that wouldn't happen in the South, but in the Northwest, that is a real risk, so we are happy we did it.

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Collin Mings, Raymond James - Analyst [5]

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You touched on, as it relates to the acquisition opportunities and growth opportunities as far as looking at timberland and particularly focused on more bolt-on acquisitions, but how do you think about wood products as far as standalone investment, especially at this point in the cycle where lumber pricing is very beneficial? You've kind of fixed the cost structure, improved your cost structure at some of your mills. How do you think about just going out and buying a mill?

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Mike Covey, Potlatch Corporation - Chairman, CEO [6]

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Well, it is tempting. Certainly the lumber business is terrific and the returns are great but, at the end of the day, we are a timber REIT and we think our investors buy us because we are a large timberland owner and a timberland manager. If you want to buy standalone wood products manufacturing expertise, there are a number of great companies to choose from, the Canadians being at the top of the list.

And so standalone wood products manufacturing capacity additions are not something that we are going to do. We are going to stay focused on timberlands and, where we can, couple the two together, but not standalone wood products manufacturing.

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Collin Mings, Raymond James - Analyst [7]

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We have time for one or two questions. Again from audience? One more on my list before we wrap up is just on the Real Estate platform. How do you think about the demand there? You touched on how you are pretty strategic about what you look to sell in a given year, but just maybe an update on the demand for the HBU side.

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Mike Covey, Potlatch Corporation - Chairman, CEO [8]

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Well, the Real Estate business, as I mentioned, comes largely within a couple hours of the Twin Cities and Minneapolis-St. Paul in North Central Minnesota where we sell about 40 tracts of land a quarter, mostly to people in the Twin Cities, doctors and lawyers and business people who want a place to recreate. And that product has been steady demand and steady pricing for a decade and really hasn't changed.

The other component that we have is a conservation business, which is actually growing a little bit. We are selling land in Alabama and in Minnesota to the state, through the state fish and game or through funds in Minnesota that support public ownership of private land for recreation purposes.

So the 20,000 acres a year, most of it comes from the small tracts, but every year we have a few one-off deals that are in the conservation basket and we expect those to continue. So we are very confident about the cash flow stream from the Real Estate business for many, many years to come.

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Collin Mings, Raymond James - Analyst [9]

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Great. Well, again, we do have a breakout session downstairs for anyone who would like to dig a little deeper into some of these topics. But thank you again, Mike, Jerry, for joining us today. Thank you for attending the presentation as well.

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Mike Covey, Potlatch Corporation - Chairman, CEO [10]

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Thank you.