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Edited Transcript of WY earnings conference call or presentation 27-Jul-18 2:00pm GMT

Q2 2018 Weyerhaeuser Co Earnings Call

Federal Way Sep 1, 2018 (Thomson StreetEvents) -- Edited Transcript of Weyerhaeuser Co earnings conference call or presentation Friday, July 27, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Doyle R. Simons

Weyerhaeuser Company - President, CEO & Director

* Elizabeth L. Baum

Weyerhaeuser Company - Senior Director of IR & Enterprise Planning

* Russell S. Hagen

Weyerhaeuser Company - Senior VP & CFO

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Conference Call Participants

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* Anthony James Pettinari

Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst

* Brian P. Maguire

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Clyde Alvin Dillon

Vertical Research Partners, LLC - Partner

* Collin Philip Mings

Raymond James & Associates, Inc., Research Division - Analyst

* Gail S. Susan Glazerman

Roe Equity Research, LLC - Senior Analyst – Paper, Packaging and Forest Products

* George Leon Staphos

BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research

* Mark Adam Weintraub

The Buckingham Research Group Incorporated - Former Director & Research Analyst

* Mark William Connelly

Stephens Inc., Research Division - MD & Senior Equity Research Analyst

* Mark William Wilde

BMO Capital Markets Equity Research - Senior Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Steven Pierre Chercover

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Weyerhaeuser Second Quarter 2018 Earnings Conference Call. (Operator Instructions)

I will now turn the call over to Ms. Beth Baum, Senior Director of Investor Relations. Please go ahead, ma'am.

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Elizabeth L. Baum, Weyerhaeuser Company - Senior Director of IR & Enterprise Planning [2]

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Thank you, Dennis. Good morning, everyone, and thank you for joining us today to discuss Weyerhaeuser's second quarter 2018 earnings. This call is being webcast at www.weyerhaeuser.com. Our earnings release and presentation materials can also be found on our website.

Please review the warning statements in our press release and on the presentation slides concerning the risks associated with forward-looking statements, as forward-looking statements will be made during this conference call. We will discuss non-GAAP financial measures, and a reconciliation of GAAP can be found in the earnings materials on our website.

On the call this morning are Doyle Simons, Chief Executive Officer; and Russell Hagen, Chief Financial Officer. I will now turn the call over to Doyle Simons.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [3]

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Thank you, Beth, and welcome, everyone. This morning, Weyerhaeuser reported second quarter net earnings of $317 million or $0.42 per diluted share on net sales of $2.1 billion.

Second quarter results include net after tax charges of $15 million for special items. Excluding special items, we earned $332 million or $0.44 per diluted share. This is an improvement of 21% compared with the first quarter and 57% higher than a year ago. Adjusted EBITDA for the company totaled $637 million, 17% more than the first quarter and 26% more than a year ago.

I'm very pleased with our second quarter results. Our business has delivered solid operating performance and capitalized on very favorable markets for lumber, OSB and Western logs. This enabled us to drive the highest Wood Products EBITDA on record and Weyerhaeuser's highest quarterly EBITDA since 2006 when the company's operations were nearly 3x larger than they are today.

Before I discuss our business results in more detail, let me make a few comments regarding the housing market. Housing market fundamentals remain strong. Employment growth continues, wages are rising and consumer confidence has surpassed prerecession highs. Although mortgage rates have risen, housing affordability remains very favorable compared with historical averages.

First-time and entry-level buyers are eager to enter the market and builder sentiment remains positive. As has been the case through this entire recovery, housing data remains volatile. Total starts surged to 11-year highs in May then pulled back in June, and those variations will likely continue as heat, wet weather and many other factors affect monthly construction activity.

However, year-to-date trends illustrate the steady upward trajectory we anticipated. Through June, total housing starts have averaged approximately 1.3 million on a seasonally adjusted annual basis, an improvement of nearly 8% year-to-date. Single-family starts have improved by over 8%. Permit activity remains strong, with total permits averaging over 1.3 million year-to-date.

Our builder customers tell us they are effectively navigating labor and lot availability and cost, and are well positioned to continue meeting pent-up demand. For 2018, we continue to expect approximately 1.3 million total housing starts with single-family starts up nearly 10%.

Let me now turn to our business segments. I will begin the discussion with Timberlands, Charts 4 to 6. Timberlands contributed $161 million to second quarter earnings compared with $189 million in the first quarter. Adjusted EBITDA totaled $240 million, $28 million lower than the first quarter but $18 million more than a year ago.

Western Timberlands delivered $152 million of second quarter EBITDA, $13 million lower than the first quarter but $28 million higher than a year ago. Demand for Western domestic logs remained favorable throughout the quarter as record lumber prices drove continued purchases and average log sales realizations improved slightly.

Pricing in some regions softened late in the quarter due to a seasonal increase in log supply from nonindustrial landowners, however, many Oregon markets remained tensioned as mills built log decks in advance of the third quarter fire season, which has begun earlier than usual.

Fee harvest volume declined slightly compared with the first quarter. Unit logging and hauling costs increased due to rising fuel costs and longer hauling distances as snow diminished and crews began to harvest higher-elevation stands. Silviculture and road expenses also increased. This activity typically accelerates in the second quarter due to improved weather.

Turning to our export markets. In Japan, demand for our logs remains solid and average log sales realizations were comparable to the first quarter. Log sales volumes declined slightly due to timing of shipments. Compared with the year-ago quarter, sales volumes were moderately higher and realizations improved substantially.

In China, sales volumes increased nicely compared with the first quarter and average realizations were slightly higher. Construction activity and daily log takeaway remained very solid and log inventories at Chinese ports declined during the quarter. Overall, Chinese demand for our logs remains very favorable, and our volumes and realizations were significantly higher than a year ago.

Moving to the South. Southern Timberlands contributed $84 million to second quarter EBITDA compared with $98 million in the first quarter. Average log sales realizations decreased slightly due to a heavier mix of pulpwood and slightly lower pulpwood realizations. Average realizations for southern sawlogs were flat.

Fee harvest declined 2% versus the first quarter, and per unit harvest and hauling costs increased due to additional thinning activity and higher fuel cost. Other revenue also declined seasonally. Compared with the year-ago quarter, EBITDA declined due to higher fuel cost and lower average pulpwood realizations.

Northern Timberlands contributed $3 million to EBITDA, $3 million less than the first quarter but $1 million more than a year ago. Fee harvest volumes declined seasonally as spring breakup limited activity in some areas. Average realizations improved compared to the first quarter as strong lumber prices drove demand for hardwood sawlogs.

The Timberlands business is making good progress against its 2018 operational excellence initiatives and is on track to achieve its $40 million to $50 million OpEx target for the year. Key focus areas include improving the productivity of harvesting and hauling operations, reducing road cost, optimizing forestry spending and maximizing the revenue from every log we harvest.

Real Estate, Energy and Natural Resources, Charts 7 and 8. Real Estate and ENR contributed $22 million to second quarter earnings and $47 million to adjusted EBITDA. EBITDA was $6 million higher than the first quarter and $10 million more than a year ago.

The contribution to earnings decreased slightly compared with the first quarter due to a higher average land basis for the mix of properties sold. Average price per acre increased significantly compared with the first quarter due to mix [for] acreage sales were in Montana, where timberland prices are regionally lower.

EBITDA from Energy and Natural Resources increased compared with first quarter due to seasonally higher sales of construction materials. The Real Estate business is solidly on track to meet or exceed its targeted 30% premium to timber value for 2018.

Wood Products, Charts 9 and 10. Wood Products contributed $349 million to second quarter earnings before special items, nearly $100 million more than the first quarter. Adjusted EBITDA totaled $385 million. This is the highest quarterly EBITDA ever for this business, an improvement of over 40% compared with a year ago.

EBITDA for lumber totaled $195 million, $55 million more than the first quarter and over 50% more than a year ago. Compared with the first quarter, our average sales realizations improved 9%, and sales volumes increased by nearly 11%. This was partially offset by higher Western and Canadian log cost.

Lumber prices increased through much of the second quarter as strong building activity drove consistent demand and rail supply issues continued to constrain shipments for many Canadian producers. As rail service began to normalize late in the quarter, industry shipment volumes increased. With framing lumber usage typically moderating as the second quarter concludes, pricing and selling while channel inventories recalibrate.

Although the worst Canadian rail disruptions have been resolved, transportation logistics remain challenging for both rail and truck shipments due to tight supply and strong summertime shipping demand. Our Wood Products team has done an outstanding job identifying options such as direct trucking, additional reloads and railcar repositioning to flow product to customers. And as of today, we have cleared all of our shipment backlog.

Second quarter charges for countervailing and antidumping duties on Canadian softwood lumber totaled $6 million compared with $5 million in the first quarter. As of first quarter 2018, these duties are no longer reported as a special item.

OSB contributed $129 million to EBITDA, $37 million more than the first quarter and nearly 50% more than a year ago. Pricing rose throughout the quarter due to continued strong demand, and average sales realizations increased by 17%. Sales volumes increased 2% and fiber cost increased slightly.

Engineered wood products contributed $58 million to EBITDA, $13 million more than the first quarter and $6 million more than a year ago. Average sales realizations improved approximately 3% compared with the first quarter as we continue to capture the benefit of our early 2018 price increase, and sales volumes improved due to seasonally higher demand. Unit manufacturing costs were comparable to the first quarter as improved operating rates offset higher prices for oriented strand board.

Distribution contributed $12 million to second quarter EBITDA, $3 million more (sic) [less] than the first quarter and slightly lower than 1 year ago due to higher fuel and labor costs. This business remains highly focused on managing cost and product margins.

Second quarter Wood Products results include one special item, a net pretax charge of $20 million for finalization of remediation costs associated with our Flak Jacket product.

Wood Products is on track to achieve its OpEx target of $40 million to $60 million in 2018. Teams are highly focused on reducing controllable costs, increasing fiber recovery, improving mill reliability, enhancing product margins and maximizing the benefit of focused capital investments.

I will now turn it over to Russell to discuss some financial items and our third quarter outlook.

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [4]

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Thank you, Doyle, and good morning. The outlook for the third quarter is presented in Chart 13 of the earnings slides. In our Timberlands business, as is customary, we expect our third quarter earnings and adjusted EBITDA will be seasonally lower than the second quarter, slightly higher than the third quarter a year ago.

In our Western Timberland operations, we expect third quarter fee harvest volumes will be comparable to the second quarter. Domestic log demand is expected to be stable during the third quarter, with third quarter average sales realizations at levels slightly below the second quarter average. Third quarter realizations could be higher if a severe fire season limits regional log supply during the quarter.

Japanese export log volumes are expected to be comparable to the second quarter while average sales realizations are expected to be slightly lower. Overall, we are seeing continued steady demand from our Japanese customers.

Chinese export demand remains strong. However, sales volumes are expected to soften, which is typical during the summer months. Log realizations are expected to be slightly lower.

Western road costs are expected to be seasonally higher. Log and haul costs will also increase as we continue to harvest at higher elevations through the summer months, resulting in longer haul distances. Fuel costs are also expected to increase.

In the South, we anticipate third quarter average sales realizations will be comparable to the second quarter and fee harvest volumes will be seasonally higher. Silviculture and forestry spending in the South is expected to increase as we perform more hardwood management and site prep work during the drier weather and continue our thinning activity. We also anticipate higher fuel costs and per unit log and all expenses.

In the North, we anticipate third quarter harvest volumes will be significantly higher than the second quarter as we move past the spring breakup season.

Real Estate and Energy & Natural Resources earnings and adjusted EBITDA for the quarter are expected to be 35% to 40% higher than the second quarter. As is typical in the Real Estate business, markets are most active in the summer and fall months, with the largest portion of sales closing in the fourth quarter. We continue to expect approximately $250 million of adjusted EBITDA from our Real Estate and Energy & Natural Resources business in 2018.

Second quarter land bases, as a percentage of Real Estate sales, was slightly higher than our full year guidance of 40% to 50% due to the mix of acres sold. We now anticipate that land bases will be at the higher end of this range for the full year 2018.

For Wood Products, we expect third quarter earnings before special items and adjusted EBITDA will be 10% to 15% lower than second quarter but significantly higher than a year ago. This includes a $25 million impact from extended maintenance downtime at our Grayling OSB mill as we undertake a scheduled press replacement.

Although pricing has softened from record highs, we anticipate lumber and OSB prices will stabilize over the next few weeks, and average realizations for the third quarter will be moderately lower than the second quarter average. Sales volumes for lumber should be comparable to the second quarter. The sales volumes for engineered wood products should increase. Third quarter OSB volumes will be approximately 10% lower than the second quarter due to the Grayling press replacement.

Chart 11 outlines the major components of our unallocated items. The $26 million favorable variance in earnings before special items compared to the first quarter is primarily attributable to the noncash elimination of intersegment profit in inventory and LIFO reserve. During the first quarter, we incurred an expense as we built inventory of logs and lumber at higher prices. In the second quarter, we began to deplete those inventories.

Our unallocated pension and postretirement benefit costs also decreased. Each year in the second quarter, we finalize prior year-end estimates for pension plan assets and liabilities. As a result of this work, we now expect to record a total of approximately $75 million in noncash, nonoperating pension and postretirement expense for the full year 2018, a reduction of $25 million from our prior guidance. This should result in a nonoperating pension and postretirement expense of approximately $19 million for each of the remaining quarters in 2018.

Chart 12 summarizes our key financial items. We ended the quarter with a cash balance of $901 million. Cash from operations during the second quarter was $597 million, an increase of $461 million over the first quarter, which is typically the lowest cash flow quarter of the year. Capital expenditures for the second quarter totaled $97 million. We continue to expect total CapEx will be approximately $420 million, $300 million for Wood Products and $120 million for Timberlands.

Moving on to debt. We ended the quarter with approximately $5.9 billion of debt outstanding. We have no remaining maturities in 2018.

Moving on to taxes. We continue to expect our 2018 effective tax rate to be between 11% and 13% based on the forecasted mix of earnings.

Finally, I'd like to update you on our share repurchase activity. During July, we have purchased $75 million or approximately 2 million shares at an average price of $34.82 per share. As of yesterday, we have $425 million remaining on our share repurchase authorization.

Now I'll turn the call back to Doyle and look forward to your questions.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [5]

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Thank you, Russell. Our second quarter financial performance was the strongest in over a decade, and I am incredibly proud of the effort our teams have put into achieving these results. They reflect several years of hard work to capture OpEx opportunities, improve relative performance in each of our businesses and position us to capitalize on the markets we are experiencing today.

At the same time, we have significant runway ahead. Our operational excellence work is not complete; and with favorable housing fundamentals, strong market outlooks and a relentless focus on improving our relative performance, we will be well positioned to drive as much value as possible for shareholders.

And now I'd like to open the floor for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from the line of Anthony Pettinari with Citi.

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Anthony James Pettinari, Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst [2]

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Doyle, you're generating record cash from Wood Products, you're very conservatively levered coming into the quarter and now you're kind of more under-levered. I was wondering if you could talk about capital allocation. Are there Timberland -- are there properties out there in the market that are potentially good value? Are there parts of your portfolio that could be augmented through acquisition? Or Russell talked about your share repurchases in July, are there opportunities to accelerate your buybacks? Is that a sign of things to come? Kind of any thoughts you could share would be helpful.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [3]

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Sure, let me talk about our capital -- how we think about capital allocation and our financial priorities. And first and foremost, as we talked about, is returning cash to shareholders. As you alluded to, as we continue to capitalize on strong market conditions and our OpEx improvements, we're generating lots of cash. We are committed to returning cash to shareholders primarily through a growing dividend but also through opportunistic share repurchase. As Russell just mentioned, in the last week or so, we have repurchased $75 million of shares, and we will continue to work very closely with our board to review opportunities to continue to return cash to shareholders through a growing dividend, share repurchase or both. In terms of other uses, we're -- our CapEx is going to be roughly $420 million this year, probably similar level next year and then it'll start to trend down. We will also look for growth opportunities, Anthony. And as we've said, those will be primarily in Timberlands, but we will be very disciplined in finding opportunities that we think create incremental shareholder value on a go-forward basis, and with our land base that allows us to be very disciplined and very choosy as to what opportunities we look at from a growth perspective. And then finally, in terms of capital allocation, and you already alluded to it, we're committed to maintain a strong balance sheet, but our balance sheet is in very good shape currently.

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Anthony James Pettinari, Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst [4]

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Okay, that's helpful. And then just on the Wood Products side. Do you still expect to complete the "black at the bottom" initiative by year-end? And then where do you think Wood Products CapEx could shake out moving forward kind of relative to the $300 million you expect this year? And do you see opportunities after the work at Dierks and Millport for CapEx investments in your lumber mills?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [5]

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So in terms of the CapEx, Anthony, as you know, we're about $300 million this year. I would anticipate a similar number next year and then start to trend down, probably an ongoing number, round numbers would be in the $250 million range in terms of CapEx. In terms of additional opportunities, we'll continue to find opportunities to spend capital in our Wood Products operation primarily to focus on driving -- continuing to drive down cost. And we will -- some of that $250 million will be spent on exactly those type of projects. In terms of black at the bottom, and to just remind everybody what that is, is when you go back and recreate the situation that occurred back in the last downturn, we modeled that and we figured out what our cost structure needed to be to -- if we have that type of situation again, which none of us anticipate or hope that we do, but if we do go through another recession of that level, we wanted to make sure that our Wood Products operation would be positive cash flow. And by the end of 2018, when we accomplish our $40 million to $60 million of OpEx, we will be at the level where we would be black at the bottom if we went back into what we refer to as the Great Recession.

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Operator [6]

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Your next question is from the line of Brian Maguire with Goldman Sachs.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [7]

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Doyle, just wanted to ask on some of those inflationary cost pressures you talked about, like fuel and transportation in general, kind of probably the worst one. But labor, I suppose also, probably seeing some tightness. Just wondering if you could comment on what trends, as you exited the quarter and head into 3Q and the outlook of the back half of the year, are you seeing? Are you expecting some pickup in those inflationary pressures? And are there any opportunities to put in surcharges or other things to sort of offset it? Or do you just let the market prices sort of take care of that?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [8]

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So as you just referenced, we are experiencing cost inflation. It's primarily related to fuel and transportation. Labor and input costs are also rising but to a much lesser extent. Just to give you a sense, those costs [owned] from fuel and transportation were up less than $5 million in the second quarter versus the first quarter. So they're our numbers, but we're doing everything we can to manage those and offset those primarily through our OpEx efforts and things like improving our efficiency, our truck scheduling, capital and noncapital improvements, the efficiency of our materials usage, all those type of things are things we're focused on to try to offset the inflationary cost that we are experiencing and probably will continue to experience for the next few quarters.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [9]

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Okay. Appreciate that. Obviously, in the quarter, lumber and OSB prices got pretty high. It's corrected some lately. Just wondering maybe you can share your thoughts on where you think that the correction needs to eventually rebase out at? And how much of it is just tied to seasonality and how much of it is just tied to the better rail availability and logistics and better supply availability in general?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [10]

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Sure. And we've spent a lot of time thinking about this, and so let me kind of give you our perspective on what's happened in the lumber markets this year. So if you start back in Q1, we had lean inventories, we had continued growth and demand driven by housing. That was partially offset by weather. You had supply constraints primarily due to transportation, so you had a positive pricing environment and prices were up nicely in the first quarter as we all know. You then moved into the second quarter, you tend to have lean inventories, had strong demand driven by continuing improvement in housing and seasonality. You had continued supply challenges, although those -- the transportation got better late in the second quarter. But in the second quarter, you had a very positive pricing environment and prices were up sharply. As we moved into the third quarter, inventories were still in good shape but you had slower demand seasonally. You had the transportation challenges abating, resulting in more supply. So not surprisingly, pricing is pulling back, which is normally -- which is normal seasonally. Looking forward, to your point, while we continue to see some volatility, we anticipate, for the remainder of 2018 and '19, that lumber prices will continue to be at favorable levels supported by lean inventories, strong U.S. housing demand and a lagging industry supply response. In connection with what's happening right now, as Russell said in his comments, prices are soft. We anticipate that they will stabilize over the next few weeks. And that's what we have built into our third quarter projections.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [11]

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Sorry, stabilizing around current levels or maybe just modestly lower than where we're at today, is that about right?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [12]

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Correct. That is correct.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [13]

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Okay. That makes sense. Just one last one from me. The June housing starts were weak. We don't want to make too much out of 1 month, a lot of noise in the numbers. But some people were calling out maybe impacts of higher lumber prices, maybe giving some of the homebuilders pause and caution. Do you see any signs of that? And do you think with this correction back in lumber prices, we might see some pickup back in that starts activity now?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [14]

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We heard some of that. You got to remember that only roughly 2% of the cost of a new house is attributable to lumber prices. So while I think it may have some effect on the margin, both when it's up and when it's down, I don't think that's a big catalyst for what happens on the housing starts or housing sales numbers.

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Operator [15]

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Your next question is from the line of George Staphos with Bank of America Merrill Lynch.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [16]

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Doyle, maybe starting out big picture, and I had a couple of nuts and bolts to follow. You've been through more than 1 cycle. What gives you comfort, given your many years of experience and a lot of that in Wood Products, that this isn't based on what we're seeing, and the market's concern, isn't a beginning of a bigger downturn? What gives you comfort based on your experience? Putting aside we know what the longer-term housing start number should be based on demographics, what, based on your experience, tells you this is a path that still has a lot of runway?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [17]

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Well, I think it's all the things or some of the things that you just referred to. If you're talking specifically about housing, George, it just is the demographics. It's the wages, it's all of the things that ultimately drive demand for housing and all of those continue to be very positive. We spend a lot of time with our homebuilder customers, and they continue to be positive and are seeing good activity. If you're talking about the lumber or OSB, if I've learned anything, and I think your nice way of -- what you say is a nice way of saying I've been around a long time and I'm getting old, and that's correct. But ultimately...

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [18]

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Join us back in the line.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [19]

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Yes, exactly. The one thing I've learned, George, and I assume you've learned as well, is supply and demand ultimately is what matters. And if you look at -- let's just take lumber for example, while there is additional supply coming on the South, the additional supply that's coming over on -- overall from a lumber overall perspective is less than is going to be needed to meet the demand if housing continues to grow at the rates we think it's going to. And supply and demand ultimately matters, and that's why we -- I made the comments I made a little bit earlier, that we feel optimistic about lumber prices being generally favorable for the foreseeable future.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [20]

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All right. Doyle, I guess, maybe to the point you were mentioning on supply and demand, one of the questions I had is a good segue. Can you comment at all what your operating rates look like over the back portion of the year again within the key Wood Products businesses, and whether there's been any significant change in your outlook or the rates you're running at in the first half of the year, adjusted for seasonality if you could? And then 2 quickies and I'll turn it over. One, how do you define modestly down in terms of your pricing sensitivity? Would that be like within 5% from current levels? And then there's capacity going in, in panels but it's obviously not in OSB, it's in MDF and other products that don't really compete against yours and Grayling as well. But does that create any kind of labor competitive issue for you as you're operating there and bringing that new press on?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [21]

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Thank you, George. What I would tell you on operating rates is for the first half of the year, lumber's run in the mid-90s, pretty much full out. OSB is running in the mid-90s, and ELP running in the high 80s, low 90s. And I would anticipate continued strong markets as we talked about, and those type of rates going forward, excluding our scheduled maintenance, of course, including scheduled maintenance of our Grayling mill being down the entire third quarter as we had previously announced. In terms of your last question regarding additional capacity coming online and what the impact that has on labor. Labor is a constant struggle. It's something we spend a lot of time on. We feel like we've done a pretty good job on finding the labor that we need. But as additional capacity comes online, that will continue to be a challenge going forward. I think your other question, George, referenced to what we think is going to happen with lumber and OSB prices and what we mean by moderately. I guess I would say, as I think as we said earlier, we do think and have built into our third quarter numbers that prices will stabilize over the next few weeks, so that's kind of what we have built in. I think it's also important to realize we're talking about averages to averages. So if you look at it right now, our third quarter-to-date averages for lumber and OSB are basically in line with the second quarter. Now clearly, spot prices are down as we've talked about. But as you look at quarter-to-quarter, I think it's important that you realize that there is some averaging that happens there in terms of what we've built into those numbers.

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Operator [22]

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Your next question is from the line of Gail Glazerman with Roe Equity Research.

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Gail S. Susan Glazerman, Roe Equity Research, LLC - Senior Analyst – Paper, Packaging and Forest Products [23]

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Maybe just sticking on pricing for a second. You're looking for pretty near-term stabilization. And I'm just wondering, given that the recent trend has been actually, if anything, acceleration of the decline. Are you seeing that? I mean, are you seeing those signs emerge? Or is that still somewhat hopeful that over the next few weeks, incremental supply plan to Western Canada or whatever, will have worked its way out.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [24]

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Yes. I think, Gail, as you said, at least in the last week, the decline has accelerated so we are not yet seeing signs of that, but as we step back and look at supply and demand fundamentals, we are. And who knows, right? But we are hopeful and we do anticipate that prices will stabilize. If they don't, then we'll need to adjust the numbers for that. But we -- and based on everything we know today, prices ran up more than I think anybody anticipated in the second quarter. They are now recalibrating, we'll see where that is. But the fundamental supply and demand balance has not changed other than the timing issues.

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Gail S. Susan Glazerman, Roe Equity Research, LLC - Senior Analyst – Paper, Packaging and Forest Products [25]

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All right. And maybe shifting to Southern, I guess, both log and lumber markets. Last quarter, you talked about seeing some pockets of tension perhaps starting to build in some of your log markets. And taking a step back, lumber production, the data is pretty lagged, but it's only up about 2% in the South through April, but it was up 10% in the West. I'm just wondering, does that surprise you? And are you seeing Southern output starting to respond? Or do you think that's really just capacity constrain that doesn't seem consistent with the operating rates being reported on industry level?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [26]

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Yes, I think in the South, Gail, our sense of what's happening there is there is a lot of additional capacity that you know that's been announced, but it's taking a while to get that built and get that fully up and running. So I think that number will continue to grow as we move forward, but it's just going to take a little time to get there.

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Gail S. Susan Glazerman, Roe Equity Research, LLC - Senior Analyst – Paper, Packaging and Forest Products [27]

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And on the log side, are you still seeing some pockets of tension around where there has been announcements?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [28]

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Yes, Gail, we are. We are encouraged by what we've seen where -- some of the pockets of where new mills have started up. And there's a mill in [Biewer], Mississippi where -- has started up and we've seen some tensioning there. And then in Georgia, there's a couple of mills that have been specifically announced, not yet started, but we've seen some tensioning in that wood basket. So we are seeing -- starting to see pockets of tensioning in wood baskets where additional capacity has either come online or been announced.

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Gail S. Susan Glazerman, Roe Equity Research, LLC - Senior Analyst – Paper, Packaging and Forest Products [29]

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All right. And then just one last quick one. There's been a lot of headlines lately on labor negotiations out West. I'm just wondering if you can give some insight into where that stands.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [30]

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Yes. So there have been some headlines regarding labor relations. We are negotiating with our labor union out here in the West. We are continuing to work with union leaders, and we look forward to reaching an agreement on that front.

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Operator [31]

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Your next question comes from the line of Collin Mings with Raymond James.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [32]

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Going back to Anthony's question just on the capital allocation front. Just as you think about the aforementioned strength in Wood Products, the balance sheet and the progress toward the "black at the bottom" initiative, has the thinking regarding tying a more sizable dividend bump to Southern log prices evolved at all?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [33]

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Collin, as we said, we are generating a lot of cash in the company right now. We're spending a lot of time with our board regarding how to best deploy that cash. We, as Russell talked about, have bought $75 million of shares back, and we'll continue to work with our board regarding the proper level of a dividend going forward. Southern sawlog will be a factor. Clearly, that is considered an important factor, but it's just one of many factors that we and the board think about regarding the appropriate dividend level going forward.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [34]

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Okay. Switching over to Wood Products. Recognizing there is some seasonality. But on EWP, just how do you think about the sustainability of kind of the recent EBITDA generation from that segment in particular? Because again, very strong results during the quarter and kind of some outsized strength there.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [35]

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Yes, we're encouraged by what we see in EWP. As you know, Collin, we had a price increase announced in early 2018. We've captured about half of that. We anticipate capturing the other half through the fourth quarter. Demand continues to be good for that product. Our teams have done a really nice job of figuring out ways to lower cost and run more efficiently and more effectively in our EWP operations. So we're encouraged by what we have accomplished, but we think we still have some runway ahead of us.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [36]

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Okay. And then just one last one from me, and I'll turn it over. Just can you expand on, just prepared remarks, on Japan, it appears wooden construction starts there have been trending down year-over-year for several months. Just what are you hearing from your customers in that market? How have they responded to really the strength in log price in the Pacific Northwest over the last several months? Just if you could put a little bit more color on the Japan business, just given how important it is to your export platform.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [37]

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Sure. And I'll try to do that and it is important. And what I would tell you is Japanese demand remains steady. Log inventories are moderate. Post-and-beam -- while general housing starts are down I think 4% year-to-date, post-and-beam, which is our market, is relatively stable. I think down 1%, 1.5% so far this year. Our outlook for third quarter is for stable volumes and slightly lower pricing. And the other thing you should probably start to think about is there is another consumption tax increase scheduled for the fall of 2019, and we do typically see some demand pull forward in advance of such increases assuming that actually plays out. So that's kind of how we think about Japan.

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Operator [38]

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Your next question is from the line of Mark Wilde with BMO Capital Markets.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [39]

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Doyle, just to kind of start out here. I wonder, can you give us an update on your first half southern log exports? I mean, you've had some pretty aggressive targets for this year in terms of kind of year-over-year improvement in southern log exports.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [40]

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Yes, we're encouraged by what's happening in the southern export markets. We're continuing to grow our export business out of the South. As you know, we've been exporting southern yellow pine from the Atlantic coast, that's to India and China. And then early this month in July, we expanded our operations by starting up another program out of the Gulf South, specifically New Orleans, where we're shipping to China from New Orleans. As we had originally said, we expect to triple the size of our export program in 2018 versus 2017, and we're on track to do that. And as you look further out, we think there's potential for significant additional upside as we move into 2019 and beyond.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [41]

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Okay. And then switching over to the distribution. Do you have any kind of read from your distribution business and what you kind of -- you hear from others just in terms of how full that distribution channel is right now? I know we've been lean in recent years. But I've been hearing, and supply was tight in the first and second quarters, that maybe some distributors were placing multiple orders. And now that product is starting to flow, the system is a little fuller.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [42]

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Yes. I would say from inventory levels, it's kind of lean to normal, in that range, is how I would characterize from a distribution perspective.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [43]

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Okay. And then if we look at not only your kind of I-joist and LVL volumes, but the industry numbers out of the APA, they're kind of flattish for the first half of this year, which is a little bit hard to reconcile with that housing start data that is out there. Have you got any thoughts on that?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [44]

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What I would say is I think from a weather perspective and some other things, there's been some challenges in your part of the world and the East. If you look -- break it down between the East and West as we do, the West has been strong, the East has been a little weak. I think over time, that will rectify itself, Mark. But you're right, the numbers look a little out of sync, but I think it's much more of a timing and weather-related issue than anything fundamental.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [45]

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Okay. And then the last one from me. There's a timber MLP around Puget Sound, and it's got a large shareholder that's agitating for a sale. I'm just curious, are there any kind of practical or regulatory issues with you expanding your land position around Puget Sound?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [46]

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Mark, this is Russell. There's no constraints as far as us being able to expand our ownership in the West.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [47]

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And just any kind of -- any thoughts on the attractiveness of kind of the Northwest versus other parts of the U.S. like the South?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [48]

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Well, I mean, the West is very attractive given where current log prices are at and where timber values are, but the South is also very attractive from a long-term investment perspective. So we look at both of those areas very closely. As Doyle mentioned, we're in really every wood basket in the United States, and so we're very familiar with all the transactions that are out there and we look at everything. If it makes sense and add shareholder value, we'll pursue that.

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Operator [49]

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Your next question is from the line of Mark Connelly with Stephens.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [50]

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Doyle, just one question. How do you think about the cyclicality of the Real Estate business these days? And housing is obviously strong, but I'm trying to get a handle on how much of a secular tailwind you think you have in that business given the reemphasizing you've done over the last couple of years?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [51]

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So this is Russell. As far as our Real Estate business, we do have some tie-in with just the cyclical nature of the housing market as we see some of our properties go into more -- like sold to developers. But a lot of our Real Estate activity is driven by higher and better uses, so recreational uses, conservation uses, alternatives to commercial type timber operations. So while we do see a little bit of that, I think the overall trend really sits with the availability of the discretionary spending from the buy side. And we're seeing strong markets in the South and in the West for the -- for our Real Estate program.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [52]

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So Russell, do you think that's going to be a continued source of growth or sort of steady performance?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [53]

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Our target is for $250 million of EBITDA from the Real Estate and Energy & Natural Resources business. And we really positioned this business to run it for the long term. And so as we've mentioned, we've gone through our AVO process, which is really our methodology of identifying that subset of acres that have a higher value than commercial Timberland operations, and we positioned that portfolio really to sell true over the next 10 to 15 years. So Mark, I think that's going to be a steady-state business with some upside as we see continued pricing appreciation.

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Operator [54]

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Your next question is from the line of Mark Weintraub with Buckingham Research.

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Mark Adam Weintraub, The Buckingham Research Group Incorporated - Former Director & Research Analyst [55]

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I guess -- just wanted to [touch base] a little bit. You've kind of been grouping OSB and lumber together in some of the comments in terms of expecting stabilization, et cetera. But it strikes me that maybe there are some different dynamics in the markets as well and wanted to get your feel on it. In particular, there's been a lot of OSB capacity that has started up in the first part of this year. And curious as to whether or not you think that production is now being felt in the market and whether or not there's the likelihood of there being potentially divergent behavior between OSB and lumber, at least over the short to medium term, given maybe some different dynamics on the capacity side even if the demand drivers tend to be the same.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [56]

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Mark, good question. And I think short term -- not medium term or long term, but short term, there is the possibility for divergence for the reasons that you outlined. There has been additional capacity that's come online. It's been slower to come online than anybody expected, but it seems to now be happening. So I think in the very short term, you could see, as we've said all along, when it comes on it tends to be lumpy and you could see one of those lumps happening in the short term. But if you look at it a little longer term, essentially, demand is growing at about 1 billion board feet a year. Supply is ramping up at roughly the same rate. Yes, you're going to have these times where it gets chunky and you have a big chunk coming on at the same time. But if you just step back again, and like I said in lumber, and look at the supply and demand equation and the amount of growth and the amount of supply that's coming online, operating rate's very high, it feels like we should experience favorable pricing for OSB going forward.

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Mark Adam Weintraub, The Buckingham Research Group Incorporated - Former Director & Research Analyst [57]

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Okay. And then, obviously, lots of talk on trade wars in China in particular. As you think about potential implication for Weyerhaeuser, what would you highlight?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [58]

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Mark, there's a lot of uncertainty, as you very well know, regarding trade policy and China tariffs. What I would tell you at this point is the proposed tariffs on U.S. goods do not affect our export logs. Thus far, we've not seen any impacts to our business. If something does change, we'll figure out a way to manage through it. The bottom line is China does need to source some percentage of their logs from the United States on a go-forward basis.

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Mark Adam Weintraub, The Buckingham Research Group Incorporated - Former Director & Research Analyst [59]

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Okay, that's helpful. And just lastly, I know -- the tax rate seems to be, if I'm doing my math right, it was a fair bit higher in the second quarter. Was that just because you made more money in the Wood Products business than you were expecting and then it comes back down in the second half of the year and -- because again, it looks like there's like $0.02 or $0.03 of -- from a higher tax rate in the second quarter than what I would have expected?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [60]

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Mark, this is Russell. Yes, that's correct. We just generated more income in our taxable REIT subsidiary, basically the Wood Products business. But our full year guidance is still the 11% to 13%.

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Operator [61]

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Your next question is from the line of Chip Dillon with Vertical Research.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [62]

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First question has to do with the strong cash generation in the quarter. I think you mentioned that the second quarter was, if I heard you right, was typically not one of the stronger cash generations. I guess working capital builds up, and it has taken your leverage down to 2.2x. And I guess the question is, is do you see more of that kind of cash generation in the second half? And secondly, do you -- as you think about the buyback situation versus acquisition, are we to kind of read into the $75 million, and the fact that you're looking to do more on the buyback front, as pretty much saying that it's more attractive to buy timber -- buying your stock at current levels versus going out and buying land?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [63]

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So this is Russell. On the cash generation, we did have a strong quarter and it is our strongest quarter. I would say it's pretty consistent with our prior year trends as far as how that cash flow generation will look going forward. As far as the share repurchase, as Doyle said, we're committed to the return on the cash holder and we'll do that -- see that through dividends and share repurchase. So we had an opportunity in July to get into the market and buy $75 million worth of shares, and this is part of our overall capital allocation strategy. So whether it be dividends or share repurchase or investing in our business, they're all tied together.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [64]

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And Chip, we're constantly weighing the benefit of share repurchase versus potential acquisitions. That's a constant analysis that we do and we'll continue to do. Because just as Russell said, it's all tied together and we're trying to figure out how to allocate capital to create the most value for shareholders going forward.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [65]

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Okay. And then second quick question is, I think Russell mentioned in his comments that EBITDA and OSB would be down, I think, 10% sequentially due to the -- the downtime tied to the press replacement. Did I hear that correctly? Was that a way of saying that it would have been 10% lower in this past quarter? Or are you kind of guiding us to a $110 million number? If that's the case, how confident are you given the volatility that we typically see in OSB prices?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [66]

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So let's be very clear on this. What we said was that the impact from the Grayling being down for the entire quarter on EBITDA would be $25 million. We also said that volume out of OSB would be 10% less than it was a year ago based on Grayling being down for the quarter.

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Operator [67]

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Your next question is from the line of Steven Chercover with D.A. Davidson.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [68]

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I've got a couple of questions, and I guess the answer to number two is contingent on number one.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [69]

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Uh-oh.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [70]

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So first of all, just -- yes, get ready. Is the high level of earnings generated by Wood Products, and maybe Real Estate too, does it jeopardize the REIT status? I mean, as I recall, there used to be some threshold that the TRS couldn't exceed, I think, it was 15%.

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [71]

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So Steve, this is Russell. We have plenty of room in our REIT overall, REIT test and the income and asset test even with the elevated income generation and the taxable REIT subsidiary, so that's not a concern of ours.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [72]

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Okay, terrific. And even if we were to keep going at kind of current levels, it would remain that -- that would remain the case?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [73]

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Yes, we really don't have a concern with that.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [74]

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Okay. Which means let me get to number two. Have you looked into any -- into expanding your Wood Products beyond EWP and perhaps into cross-laminated timber or some of the panelized construction that I think WRECO used to actually do?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [75]

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Yes, so this is Russell. As far as the Wood Products portfolio, we're very happy with the way it's configured and the fit that it has with our Timberlands. As far as expanding even further downstream into CLT or some of these other emerging Wood Products businesses, again, we're very focused on what we do well. In each one of our Wood Products businesses, we're performing very well. We definitely welcome the emergence of those new products in the industry as CLT will pull on lumber demand, which also improves overall log demand. So -- but it's not an area that we would expand into readily.

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Operator [76]

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Your next question is from the line of Paul Quinn with RBC.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [77]

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I just have one question. Just wanted to dive in a little bit on the supply-demand on the lumber side. Lots of announcements have been made on capacity additions to the market, just what your feeling is on whether they'll all come up. And your sense from the equipment side, when you deal with equipment vendors, what their order files are like and how easy it is to bring on capacity.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [78]

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Yes, so Paul, I think they will. Well, all of them is a strong word, but I think nearly all of them. And I think we probably will see additional announcements as we move forward just because we, as an industry, are going to need the additional supply to meet the demand. So pretty encouraged by what we see there. And like I said, I think nearly all of the ones that have been announced will in fact happen, and we can even have additional announcements as we move forward. With that said, I think to your second point, it's going to take longer than most people factored in to get those up and fully running. Fortunately, our 2 big projects, Dierks and Millport, were kind of ahead of the curve so we were able to secure the contractors. And as you know, we'll be starting those up -- both of those up fairly shortly and in good shape. But I can tell you in talking to contractors and just getting a feel for order files, they are full. They are very full. So as a result, I think some of our competitors who are -- who have announced these mills, it's potentially going to take longer than the number -- longer and maybe cost a little more than they originally anticipated.

As I understand it, that is our last question. I want to thank everybody for joining us on the call and for your interest in Weyerhaeuser. And hopefully, everybody has a good day and a good weekend. Take care.

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Operator [79]

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Ladies and gentlemen, this does conclude the Weyerhaeuser Second Quarter 2018 Earnings Conference Call. You may now disconnect.