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

Q1 2018 Weyerhaeuser Co Earnings Call

Federal Way May 8, 2018 (Thomson StreetEvents) -- Edited Transcript of Weyerhaeuser Co earnings conference call or presentation Friday, April 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

* 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

* 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 - 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

* Salvator Tiano

Vertical Research Partners, LLC - 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 First 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 [2]

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Thank you, Dennis. Good morning, everyone, and thank you for joining us today to discuss Weyerhaeuser's first 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 first quarter net earnings of $269 million or $0.35 per diluted share on net sales of $1.9 billion. First quarter results include net after-tax charges of $6 million for special items. Excluding special items, we earned $275 million or $0.36 per diluted share. This is an improvement of 18% compared with the fourth quarter and 65% higher than a year ago.

I'm extremely pleased with our first quarter performance as we fully capitalized on strong lumber, OSB and Western log markets to drive outstanding results, including the highest first quarter Wood Products EBITDA on record. Adjusted EBITDA for the company totaled $544 million, 20% more than a year ago and comparable to fourth quarter.

Before I discuss our business results in more detail, let me make a few comments regarding the housing market. The housing market continues to grow at a healthy rate. Total housing starts for the first quarter averaged 1.32 million units on a seasonally adjusted annual basis, the highest quarterly average since the second quarter of 2007. This is particularly notable given that a challenging winter delayed the start of the building season in a portion of the Eastern United States.

Year-to-date, total housing starts have improved 8% compared with the year ago and single-family starts are up 7%. Permit activity is also healthy with total permits averaging over 1.3 million for the first quarter. Activity in the West has been particularly strong, including in California, where permit activity has increased 47% through February compared with a year ago.

Builder confidence is high and our customers are reporting a strong start to the spring selling season, supported by continued employment growth, rising wages, historically strong consumer confidence and growing participation by the millennial homebuyer. The consistent optimism we hear from our customers reinforces our confidence that the housing market is well positioned to manage labor and lot challenges and build on its solid upward trajectory. 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 $189 million to earnings before special items, $23 million more than the fourth quarter and $41 million more than a year ago. Adjusted EBITDA increased to $268 million.

Western Timberlands delivered $165 million of first quarter EBITDA, $25 million more than the fourth quarter and $32 million more than a year ago. Western domestic market conditions were favorable throughout the quarter as strong lumber prices drove solid demand for logs. Mill inventory levels were moderate in most regions, although log supply in southern Oregon remained tight due to continued winter weather. Pricing for domestic logs strengthened through the quarter.

Fee harvest volume declined slightly compared with the fourth quarter, which had included fire season catch-up volume. Forestry expenses were seasonally lower.

Turning to our export markets. In Japan, log sales volumes and realizations improved nicely compared with the fourth quarter. Demand for our logs remained very solid as our customers' sales volumes are strong. Compared with the year ago quarter, sales volumes were slightly higher and realizations improved substantially.

In China, average realizations were flat compared with fourth quarter, while sales volumes declined modestly as construction activity paused seasonally for the Lunar New Year. Log inventories at Chinese ports increased during the Lunar New Year period, but takeaway bounced back sharply, as construction activity resumed and we anticipate inventories will return to normal levels over the next several months. Overall, Chinese demand for our logs remains very solid, and our volumes and realizations are substantially higher than a year ago.

Moving to the South. Southern Timberlands contributed $98 million to first quarter EBITDA, comparable to the fourth quarter despite a seasonal decline in fee harvest volume. Fee harvest declined 8% compared with fourth quarter, but it increased 6% from the first quarter of last year. Challenging wet weather in several regions created market opportunities in the quarter as operability was limited and mill inventories declined below target levels.

Our teams did an exceptional job of leveraging our significant scale to flex volume, take advantage of available harvest settings and increase deliveries to key customers while simultaneously ensuring adequate log decks at our own mills. For example, on one weekend, a team in the Gulf South delivered over 200 truckloads of logs to one of our lumber mills while continuing to fulfill commitments to all other customers.

Average sales realizations for Southern sawlog and pulpwood increased slightly compared with fourth quarter. Our per unit harvest and hauling costs decreased modestly as we flexed to more accessible harvest settings, and forestry costs declined due to wet weather.

Northern Timberlands contributed $6 million to EBITDA, $3 million less than the fourth quarter. Fee harvest volumes declined seasonally and average realizations were comparable to the fourth quarter.

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 2018. Our teams continue to generate and implement ideas to improve the productivity of harvesting and hauling operations, reduce road maintenance and construction cost, optimize spending on forestry activities and ensure we maximize the revenue from every log we harvest.

Real Estate, Energy and Natural Resources, Charts 7 and 8. Real Estate and ENR contributed $25 million to first quarter earnings and $41 million to adjusted EBITDA. Adjusted EBITDA was $46 million lower than the fourth quarter, but comparable to a year ago. Fourth quarter is typically our seasonally strongest quarter, while first quarter usually reflects the lowest level of transaction activity.

Average price per acre sold decreased compared with the fourth quarter due to mix. Over half the acreage sold in first quarter 2018 was located in Montana, where timberland prices are regionally lower. In contrast, the majority of sales in the fourth quarter and the first quarter of 2017 were located in the U.S. South.

EBITDA from Energy and Natural Resources declined slightly compared with fourth quarter due to seasonally lower sales of construction materials. The Real Estate business is well positioned to meet or exceed its 30% targeted premium to timber value for 2018.

Wood Products, Charts 9 and 10. Wood Products contributed $250 million to first quarter earnings before special items, $29 million more than the fourth quarter and $78 million more than a year ago. Adjusted EBITDA totaled $286 million. This is the highest first quarter EBITDA on record for this business and an improvement of nearly 40% compared with a year ago.

Canadian rail transportation remained a challenge throughout the quarter, and our Wood Products teams did an outstanding job of devising creative ways to mitigate the disruptions by repositioning available railcars and shifting volume to trucks. Although the overall effect on our first quarter results was relatively minimal, we did experience some shipment delays, resulting in lower sales volumes for lumber and OSB compared with a year ago.

EBITDA for lumber totaled $140 million, $24 million more than the fourth quarter and over 40% more than a year ago. Lumber pricing rose steadily during the first quarter as demand remained very solid, channel inventories were low and transportation delays limited availability. Compared with the fourth quarter, our average sales realizations improved 7%, and sales volumes increased 3%. This was partially offset by higher Western log cost.

First quarter adjusted EBITDA for lumber includes charges of $5 million for countervailing and antidumping duties on Canadian softwood lumber. The duties are calculated based on the final combined rate of 20.23% and are no longer reported as a special item.

OSB contributed $92 million to EBITDA, $12 million lower than the fourth quarter but 40% more than a year ago. Compared with the fourth quarter, a 6% decline in average sales realizations was partially offset by a 6% increase in sales volumes. Engineered wood products contributed $45 million to EBITDA, $11 million more than the fourth quarter and $8 million more than a year ago. Average sales realizations improved 1% to 2% compared with the fourth quarter as we began to capture the benefit of our first quarter price increase.

Sales volumes for solid section products improved due to seasonally higher demand, but I-joist volumes declined as East Coast sales lagged due to winter weather. Manufacturing costs decreased due to lower prices for oriented strand board.

Distribution contributed $15 million to first quarter EBITDA, the best quarter results ever reported for this business. EBITDA improved $10 million compared with the fourth quarter and $7 million more -- and $7 million compared with a year ago. This business continues to focus on managing cost and product margins. The [fourth] quarter Wood Products results include one special item, a pretax benefit of $20 million from product remediation insurance proceeds.

Each of the Wood Products businesses made good progress on their respective OpEx initiatives during the quarter, with teams focused on reducing controllable costs, improving mill reliability, enhancing product margins and maximizing the benefit of focused capital investments. We continue to expect collective OpEx benefits of $40 million to $60 million from this segment in 2018.

I will now turn it over to Russell to discuss some financial items and our second 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 second quarter is presented in Chart 13 of the earnings slides.

In our Timberlands business, we're expecting second quarter earnings and adjusted EBITDA will be significantly higher than second quarter of last year, but approximately $25 million lower than the first quarter due to normal seasonality.

In our Western Timberland operations, we expect second quarter fee harvest volumes will be comparable to the first quarter. We anticipate slightly higher log sales realizations will be more than offset by seasonally higher unit logging costs and increased road and forestry costs.

Log and haul costs will increase due to the planned shift of harvest activity to higher elevations in the spring months. Western road costs are expected to be higher than the first quarter due to additional road-building activities, which is typical in the second quarter.

Japanese export log sales realizations are expected to be comparable to the first quarter, while sales volumes are expected to decline modestly due to the timing of shipments during the second quarter. We're seeing continued steady demand from our Japanese customers.

Chinese export log volumes are expected to increase in the second quarter as construction activity has picked back up following the February holidays. We anticipate average sales realizations will decrease slightly compared with the first quarter.

In the South, we anticipate second quarter average sales realizations and fee harvest volumes will be comparable to the first quarter. Per unit log and haul costs are expected to be higher in the second quarter due to additional thinning activities and increased fuel and trucking costs. Silviculture spending in the South is expected to increase, which is typical coming into the spring season.

In the North, we anticipate second quarter harvest volumes will be significantly lower than the first quarter due to spring break-up. Average sales realizations are expected to increase modestly compared to the first quarter.

Real Estate and Energy and Natural Resources earnings and adjusted EBITDA for the second quarter are expected to be comparable with the first quarter. As is typical for the Real Estate business, the summer and fall months are the most active selling seasons, 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 and Natural Resources business in 2018.

First quarter land bases, as a percentage of Real Estate sales, was slightly lower than our full year guidance of 40% to 50% due to the mix of acres sold. We continue to expect that land bases, as a percentage of Real Estate sales, will be between 40% and 50% for the full year 2018.

For Wood Products, we anticipate second quarter earnings and adjusted EBITDA will be significantly higher than the first quarter earnings before special items. Sales volumes are expected to increase quarter-over-quarter for all product lines. We expect slightly higher average sales realizations for lumber and significantly higher sales realizations for OSB, partially offset by higher Western log costs.

Engineered wood products sales realizations will also be higher as we continue to capture the 6% to 12% price increase we announced early in the first quarter. Operating rates are expected to improve in the second quarter, with seasonal increase in demand.

Overall, we expect adjusted EBITDA for our Wood Products segment to improve approximately 15% to 20% compared to the first quarter if lumber and OSB pricing remain at or near current levels for the balance of this quarter.

Looking forward, we expect to take maintenance downtime in the third quarter at our Grayling OSB mill as we undertake a scheduled press replacement. As a result of this extended outage, we currently expect our third quarter OSB sales volumes will be approximately 10% lower than the third quarter of 2017.

Chart 11 outlines the major components of our unallocated items. Adjusted EBITDA decreased compared with the fourth quarter due to the higher noncash charges for elimination of intercompany profit in inventory and LIFO. This was primarily driven by increasing values for softwood lumber and Western logs and seasonally higher inventory volumes.

As stated in our prior earnings call, our pension and postretirement benefit costs increased in the first quarter. We continue to expect to record approximately $100 million of noncash nonoperating pension and postretirement expense for the full year 2018.

First quarter unallocated items also included a pretax special charge of $28 million for environmental remediation associated with a formerly owned mill site.

Chart 12 summarizes our key financial items. We ended the quarter with a cash balance of $598 million. Cash from operations from the first quarter was $136 million. The first quarter is usually our lowest operating cash flow quarter due to inventory and other working capital build as well as the timing of semiannual interest payments. Capital expenditures for the first quarter totaled $81 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 repaid $62 million maturity during the quarter using available cash and we have no remaining maturities in 2018. Interest expense was $93 million in the first quarter. We expect interest expense of approximately $380 million for the full year.

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 our earnings.

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. First quarter was an outstanding quarter for Weyerhaeuser, and we have much more opportunity ahead. With a strong housing market trajectory, favorable market dynamics across our Timberlands and Wood Products businesses and a culture focused on operational excellence, we have the tools and runway to further improve on these strong financial results.

Looking forward, we are relentlessly focused on capturing the full benefit of the opportunities in front of us in 2018 and beyond to drive as much value as possible for our 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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From a big-picture perspective, you're generating record cash from the Wood Products business and leverage seems fairly conservative here. I'm wondering if you could just share how you're thinking about capital allocation at this point. And with regards specifically to maybe acquiring Timberlands, how would you weigh opportunities that maybe you're seeing in the South versus maybe just repurchasing your own shares? You still have, I think, $0.5 billion, roughly, on the share repurchase authorization.

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

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Yes, Anthony, good question. And our financial priorities remain unchanged, first and foremost. We're committed to returning cash to shareholders. As we continue to capitalize on very favorable market conditions and our OpEx improvements, we're expecting strong cash flow generation for 2018. Our board will continue to regularly review opportunities to return cash to shareholders, and this may come in the form of an increased dividend or, as you pointed out, opportunistic share repurchases as appropriate, and we do have $500 million of authorization.

Secondly, we'll continue to invest in our businesses. As you know, we're going to invest roughly $420 million back into our businesses this year. And then in addition, we'll look at growth opportunities going forward, primarily in Timberland, but we'll be very disciplined in terms of growth opportunities as we move forward to make sure any acquisition that we may make would be value accretive for our shareholders. And then finally, our balance sheet, as you know, is in really good shape. So that's kind of how we think about capital allocation.

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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 a clarification on the 2Q outlook. I think you're expecting higher average sales realizations for lumber and OSB. I know that you have maybe a little bit of lag with Random Lengths. Do you expect list kind of lumber and OSB prices in 2Q to maybe stay roughly in the same range that they are where they are currently here at the end of April? Or do you think those spot prices might decline or step down a little bit in 2Q as some of this kind of weather and transportation issues resolve themselves?

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

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Yes, so let me answer that in a couple of ways. Number one, just to give you a sense, as you said, there is a lag and as prices have moved up, it takes some time to catch up. Number two, just to give you a sense of where we are currently, quarter-to-date in lumber pricing, we're up roughly $10 versus the first quarter average; and quarter-to-date in OSB, we're up roughly $40. As we look out, we continue to be encouraged by what we see in the markets. Fundamentally, it's -- the improvement in pricing in the markets overall is being driven by continued growth in demand, which is being driven by the improvement in housing, and thin inventories across the system.

In the first quarter, we all know we had some transportation issues. It's going to take a while, a couple of quarters, for those to fully resolve in the industry. And as that additional capacity comes online -- or additional inventory comes online, it is going to be coming online in a period which is a stronger building season. We did have some disruptions on the demand side during the first quarter due to weather. Those should be behind us and we'll be moving into a stronger building season. So as we factor all that in, we're pretty optimistic about prices for lumber and OSB as we move through the balance of the year.

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Operator [6]

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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 [7]

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A couple or 3 questions, and thanks for all the details. I guess, the first question, Doyle, obviously, it sounds like weather and transportation impacted the volume trends that you otherwise would have seen in the first quarter. Is there a way to put a number, an approximate one, in terms of what your shipments would have looked like if you had a more normal, both logistics and weather environment, in the first quarter, recognizing it's wintertime every time in the first quarter? But what do you think you might have lost in terms of volume trends in the quarter?

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

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Yes, let me -- rather than answering it in volume trends, let me try to answer it in terms of dollar impact on the quarter, George. And our best guess -- and as you indicated, there's lots of moving parts, but our best guess is that weather had a roughly $5 million -- and I'm talking about our Wood Products group -- had a roughly $5 million negative impact in the first quarter. And that the transportation challenges, specifically rail in Canada, had a $5 million impact. So total those 2 things, there is probably a $10 million -- roughly a $10 million impact on our first quarter versus what you would call a more normal first quarter, if there is such a thing.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [9]

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Okay. I appreciate that, Doyle. Second question, obviously, you have a couple of projects coming to maturation over the next year or so with Dierks and Millport. What ability do you have within your system as it's currently constructed, in other words, no new, no steel and concrete? But given what you have right now to tweak your capacity, where would you have more flexibility whether it be in lumber -- that's where I'd guess, but waiting on your answer -- or OSB or wherever, should demand continue to -- hopefully, it's a high-class problem -- materialize positively?

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

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Yes, great question. And you're right, the biggest opportunity is in lumber. We will have both Dierks and Millport coming online as we move through -- late this year and in early next year. Those will increase our capacity by roughly 6%. And then on top of that, George, just through ongoing capital and just running better, we think we can increase our capacity by another 2% to 3% on top of that 6% that's going to come from Millport and Dierks. So that's our biggest opportunity on the volume side as we move forward.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [11]

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And just for clarification, 2% to 3% is an annual figure or that's total over the rest of the cycle?

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

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Thank you for the clarification. That is an annual figure, 2% to 3%.

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Operator [13]

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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 [14]

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My first question, just looking at Chart 5, I'm sort of struck by the huge gap between Western and Southern log prices. And it's always been a big gap, but we've opened up to about $100 a ton difference. Just I know they're sort of different markets to a large degree. But I just wondered if there's -- if you've ever seen a gap this wide before, and if there's ever -- if there's really a point where you or others could look to arbitrage that? I mean, I know shipping costs overland are prohibitive, but just also thinking about the export markets and some of the opportunities you're trying to create out of the South, just wondering if the super wide gap that's opened up could potentially just change some of the thinking behind what a Western market is and what a Southern market is.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [15]

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Brian, so you're right, there is a large gap. We've been very encouraged by what's happened in the West and think there is additional opportunity as we move forward. In terms of arbitrage, for the reasons you identified, very difficult because of the high cost of trucking logs from one portion of the United States to another. I think more likely what's going to happen is you're going to see that gap close as Southern log prices start to move in. And as we think about Southern log prices, Brian, we're actually encouraged by what we see in the South, and we are starting to see some very early signs of pricing improvement in markets.

If you say, well, what are the key drivers of that? Number one, continued growth in demand, and you heard what we had to say about our optimism about housing. Number two is the declining share of -- declining Canadian share of the U.S. market. That's 26% year-to-date versus 30% last year. Third and very importantly is all the new Wood Products capacity that's coming online. Specifically, the 4-plus billion board feet of capacity additions that are coming online 2017 to 2020. Just to give you a sense, that's 20% of Southern capacity. And as that new capacity comes online, we expect to see those specific wood baskets tension and put upward pressure on sawlog pricing overall. And in fact, we're already starting to see that in a couple of areas with new capacity. One is in Central Mississippi, where the new Biewer mill is up and running and prices have moved up over there.

And then secondly, even in markets where the capacity isn't up and running yet, but it's been announced, for example, the Warrenton, Augusta, Georgia area, the new mill announcements by GP and Canfor have already caused that wood basket to tension.

And then the final thing, which is regarding your comment on the Southern export markets, we are making really good progress in developing our export business out of the Southern U.S. We're already running an export program on the Atlantic Coast out of Charleston and Wilmington, and we're also working to establish a new program out of the Gulf South, which we expect to have up and running in a few months. We expect to triple the size of our export program in 2018, which, to try to mention that, would be comparable to a midsized sawmill. And we think there is meaningful potential for significant additional upside in both China and India going forward.

So that's how we think about the South. And to your original question, we think that gap will close over time as a result of improving Southern log prices.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [16]

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And just related to that, the exports that you are starting to see out of the South, are the realizations there comparable to Southern realizations? Or are you seeing any signs of a little bit better pricing because it's the export market, recognizing that your shipping costs are going to be higher, obviously? But netting that against the shipping costs, would the netbacks to the mill on exports be comparable to other Southern sales that you've got?

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

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What I would say is, to date, they're comparable to a little bit better.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [18]

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Okay. Just one last one from me on just the Timberland markets themselves. It seems like [Ricci] and some others have written about transaction activity being really slow, really -- starting maybe in the second half of '17 continuing into '18. Just wondering if you're seeing that also as you bring some parcels to land -- some land parcels to market. And any sense what could break that logjam? Is it prices that need to move lower or do people need to feel a bit better about the housing markets or interest rates? Just any color you can give on that would be helpful.

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [19]

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Sure, Brian. This is Russell. I'm going to break it into 2 pieces. One, I think you're asking a little bit about our Real Estate program. That's definitely a different market than the Timberlands, the broader Timberland market. So just on Real Estate on the first quarter, it was comparable to last quarter. Second quarter should be comparable to first quarter, and then we'll start seeing activity pick up as people get into the marketplace. And then we'll see a majority of that closings in the fourth quarter. And that's pretty typical for the Real Estate business.

On the Timberland side, it has been a slow first quarter, and that's pretty typical also. We would expect that the transaction volume for 2018 will be comparable to 2017. We are seeing fewer transactions or fewer offerings in the market kind of in the beginning. But I think that will start loosening up as some of the TIMOs start bringing some of their properties out of some of the funds that are terminating or coming to full life. But overall, we think the market should pick up in the second half of the year.

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Operator [20]

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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 [21]

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I just wanted to dig into the lumber and OSB markets a little bit more and the impact, just maybe psychological impact of some of the supply shortages. I guess, one, can you just give a little more color on where inventories started the year on both the producer and the customer side, and where you think they are currently? And just any -- maybe a little bit more color, you did try to lay out the argument as to why maybe things won't get worse. But as that -- as those inventories do clear from Western Canada, how confident are you that the market will be able to absorb it without kind of easing off some of that panic that was in the market earlier?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [22]

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Yes. So as you look at inventories, Gail, other than the build and mills in Canada, inventories throughout the system remain very lean, both for lumber and OSB. In terms of the -- those inventories at the mills becoming available, I would tell you all indications are that's going to take some time. CN railway is hiring more people, putting in new cars, but they've indicated it's not going to be until the third quarter until that actually starts to make an impact. So I think that additional inventory that's at the mills is going to come online over time, not in one big chunk. And it's going to come online at a time, as I said, where we're going to need more because if we're going to be in the seasonally strong period when we have winter weather behind us and there will be more building activity.

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

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Okay. And then just switching gears. Realize you had the $20 million insurance recovery in the quarter. There was a headline earlier in the week that kind of suggested maybe you're having some issues. And could you just give an update on where -- about a court case kind of seeking $260 million. Can you just put some color on that and where you stand?

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

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Yes, the court case -- all it was, was there was a filing to clarify venue for any disputes that may arise regarding coverage. We're pleased with the progress we've made. We've recovered $20 million in the first quarter, another $5 million so far in the second quarter. And we remain confident that we will recover a significant portion of the costs associated with Flak Jacket, ultimately.

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

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Okay. Just one last one. Obviously, somewhat of a moot point, given the delivery issues in the quarter. But just your latest thinking and what you're hearing on the trade dispute and how that fits into current NAFTA negotiations.

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

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You're talking about -- say that again, Gail. I'm not sure I followed your question.

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

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Just your current thinking on the softwood lumber trade dispute and where that may or may not be impacted relative to the current NAFTA negotiations.

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

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Yes, good question. So the SLA negotiations have been sidelined due to the focus on NAFTA. The 2 are not, as you know, directly linked, but there have not been ongoing discussions. Bottom line is we remain hopeful that over time we will be able to reach a quota-based agreement.

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Operator [29]

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

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Salvator Tiano, Vertical Research Partners, LLC - Analyst [30]

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This is Salvator Tiano filling in for Chip. So a couple of questions. Number one, just clarify, to dig a little bit deeper into George's earlier question. On OSB and lumber sales, you mentioned I think a $10 million combined hit, but how should we be thinking in terms of what can be recovered in the second quarter? Is there anything that's just been pushed there and we can see even stronger volumes? Or is this also higher expense-related and there's nothing you can do about it anymore?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [31]

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Well, if it's product that was made that we weren't able to ship for whatever reason, that could show up in the second quarter. If it was weather-related and we weren't able to make it, which was -- we did have some downshifts in the -- primarily in the Southern U.S. during the first quarter, not able to make that up. So I would say it's a combination of both.

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Salvator Tiano, Vertical Research Partners, LLC - Analyst [32]

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So -- but can you provide kind of any clarification with regard to -- out of this $10 million, what can be recovered? Or is it something you cannot comment?

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

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I would say a portion of it will be recovered in the second quarter. Not able to quantify that exactly.

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Salvator Tiano, Vertical Research Partners, LLC - Analyst [34]

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Okay. Understood. And the second big-picture question here. Just wanted to get your thinking now that we're seeing indeed more lumber mills coming via the South, what do you think will be required to start seeing higher timber prices there in terms of perhaps additional projects, the inventory -- kind of the log inventory clearing? What is your thinking towards moving to higher prices on a more sustainable basis?

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

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Yes. As we said earlier, we're encouraged by what we are seeing in the South. A key driver of that is the additional capacity that is coming online. The additional amounts, roughly 4-plus billion board feet, which is 20% add in the South, that's -- we're encouraged by that. That, combined with the increase in the Southern export market, less lumber coming in from Canada and just, very importantly, the overall improvement in demand driven by housing growing at 7%, 8%, 9%, all are positive things that are going to result in us reaching that point where -- the inflection point where we will start to see improvement in southern log prices. And as I mentioned earlier, we've already started to see some slight improvement in some select markets where additional capacity has either come online or slated to come online.

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Operator [36]

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

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [37]

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First question. Doyle, you touched on this already on the -- around the Canadian side of things, but you guys were pretty successful delivering results in 1Q despite some of the cost pressures out there. Can you maybe just talk a little bit more about the trucking and labor cost pressures? You discussed that in detail a little bit last quarter. How are those kind of looking as you go into 2Q now?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [38]

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Yes. So from a trucking perspective, truck availability continues to be challenging across the U.S. and Canada. We expect, as we indicated in the -- in our earlier call, that we expect these challenges to persist. And trucking rates are, in fact, increasing somewhere in the 5% to 8% range, but we are working really hard to mitigate those cost increases through OpEx. And then in terms of labor, that's just going to be a constant headwind. But again, a lot of work that's going on there to make sure that we're all setting that through OpEx.

And then the final thing I would highlight is things like resin costs are going to be a headwind as well. But we'll work to either -- both to primarily to reduce our usage of resin to the extent we can and other ways to offset that cost pressure (technical difficulty) forward.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [39]

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Okay. And then just switching to the Real Estate front. I mean, you noted in the past that there have been some maybe government funding issues that was keeping a lid on sales activity, to some extent, on the Real Estate side. Any change or any sense that, that is changing on the margin at all? Or again, do you expect that to kind of be a headwind relative to maybe what adjusted EBITDA from that segment would have been otherwise?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [40]

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Collin, this is Russell. You're correct, the federal budget included $200 million for conservation funding. That's a real positive. But those types of transactions take a little bit of time to form up, and so we would expect to see the benefit of that coming in really in 2019. As far as our outlook for 2018, as we stated, we still -- we expect to hit the $250 million of EBITDA for the Real Estate and Energy and Natural Resources business, so -- and meet our premium targets of 30%.

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Operator [41]

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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 [42]

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I want to just start out by you saying that I think this Wood Products performance is pretty impressive, because if you look back the last time you were running like this was in the mid-2000s and we had much higher housing starts and the Weyerhaeuser footprint was much bigger in Wood Products.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [43]

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Thank you for saying that, Mark. Our folks have done a lot of really hard work to get to where we are today. More to do, but I appreciate that acknowledgment.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [44]

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Yes. I wondered, Doyle, you've talked for the last 3 or 4 years about this goal of kind of black at the bottom. Where would you say you are on that metric right now? Things are great right now; we know they're not going to always be great.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [45]

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They're not always going to be great and that's the way we're running our company and, specifically, the Wood Products group. We've made a lot of progress on that front. And basically, just remind everybody what we've done is gone back and recreated the results that were during the last recession. Hopefully, we never go back to those. But making sure that we have a cost structure in place that if we do go back to that -- that type of situation, that we would be generating a positive cash flow. Very encouraged by the progress we've made there as a result of the OpEx work. We were roughly 90% there at the end of 2017 and anticipate being 100% of the way to being black at the bottom by the end of 2018. So a lot of really good work, a lot of good progress on that.

And Mark, you're right. We know things won't stay this way forever, but the beauty of the work we've done, it allows us to fully capitalize on the upside, but also, when this thing does roll over, which we know it ultimately will, we will be in a cash flow positive position on a go-forward basis.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [46]

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Okay. And then I noted, Doyle, in response to an earlier question about acquisitions, you said that, primarily, you would be focusing on Timberland but you didn't say exclusively. If you were going to do things in building products, can you just give us some sense of what your criteria would be?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [47]

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Sure, Mark. So we'll -- like I said, we will be focused primarily on Timberland. But we do think there may be opportunities for what I would call more bolt-on acquisitions in Wood Products that some of the key criteria would be if it fit into our wood basket, that would be a positive. But even more than that, it would be making sure that we were acquiring a mill or a set of mills at a price where we could generate long-term value for our shareholders on a go-forward basis. So we'll continue to actively look for those type of bolt-on acquisitions. Most assets, I think, are pretty fairly valued right now from a Wood Products perspective, but we'll continue to look but be disciplined in acquisition opportunities on our Wood Products side.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [48]

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Okay. Last question I had is for either you or Russell. I'm just trying to get a sense, given this big move we've had in the West Coast log prices, whether that is really starting to constrain some of the domestic converters, whether the log price is just too high for them to carry at this point, whether it's for plywood or lumber or whatever.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [49]

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Mark, because of the run-up in lumber prices, in plywood, but more specifically in lumber prices, even at these higher Western log costs, lumber mills -- I think most lumber mills are profitable. I know ours are. So that margin is still there to be had based on current log prices and current lumber prices on the West Coast.

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Operator [50]

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

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [51]

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So first off, we've been hearing about new sawmill capacity coming on stream in the South for some time, but it sounds like the ramp is slower than anticipated. And it sounds like some of the equipment deliveries are behind schedule. So maybe you can confirm that, and is it impacting any of your projects?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [52]

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So not impacting our projects at all. As I indicated, Dierks will be up later this year and Millport early next year, and we are on schedule on both of those projects. In terms of the overall increase in sawmill capacity, we anticipate that's going to be 4-plus billion. We anticipate the timing of that is roughly 1 billion a year, 2017 to 2020. Clearly, some of that has been pushed back a little bit because of the lack of contractor availability. But it will -- our sense is, while it is being delayed somewhat because of the competition for contractors, it's ultimately going to come online but may be pushed back temporarily.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [53]

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Got it. And then my second question was on the work at Grayling. I want to clarify, first of all, is it a press rebuild because I thought you said replacement? So which is it, and will you gain any capacity?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [54]

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So Steve, this is Russell. It is a press replacement. And as far as the capacity, the capacity will be about the same as prior. So this is just an old press and it's time to replace it, and it will make the mill much more cost-effective as we go forward.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [55]

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Got it. And could you just remind us, I missed it, the financial production impact in Q3?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [56]

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About 10% is what we said on the sales volume in Q3 compared to prior -- the prior year.

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Operator [57]

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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 - Research Analyst [58]

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Doyle, so you're mentioning about 1 billion a year in lumber, I think, in the U.S. South, which I guess is not that much if we think about a 50 billion-plus market. That's only 2% or so. Now is there also incremental capacity that you think is also going to be coming on in addition to that? And/or what would be happening in some of the other regions? And might there actually even be even possible offsets in Western Canada, for instance?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [59]

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Yes, that's a good question, Mark. So what I would say is the way we're thinking about these numbers is, it is a 20% -- the 4-plus billion board feet is a 20% increase in Southern capacity. But if you look across the entire system, it's much more like a 5% increase across the entire industry. As you further indicated, we don't anticipate much, if any, additional increase in the West. And in fact, we think there will be shrinking capacity in Canada. So net-net, while there is a lot of capacity coming on in the South, we think, from a supply and demand perspective for lumber, that's going to continue to be very good as we look forward.

As you know, operating rates are already north of 90%. If you look at the numbers, demand is growing 7%, 8% a year. And this additional supply, if you look at it from an overall industry perspective, not just the South, but an overall industry perspective, it's growing about 5% a year. So demand, we think, is going to continue to outpace supply, which should be positive as we move forward.

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Mark Adam Weintraub, The Buckingham Research Group Incorporated - Research Analyst [60]

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And so following up, it's very encouraging to hear some pricing power in some of those markets in the U.S. South saw timber. I guess one of the toughest things, for me at least, to try to figure out is when things get good, where can U.S. saw timber prices go? I mean, I know where they went historically. But what would be the -- what are -- what's the kind of framework that maybe would be helpful in thinking through where U.S. saw timber prices could potentially go in tighter markets?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [61]

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Yes. So if you look at it historically, prior to the recession, Southern sawlog prices were $15, $20 higher than they are today. So I don't think there's any reason at all that as these things tighten up, and they will, as we indicated, that you could see that type of pricing improvement. If you use the West as a market or as a reference point, there's even more opportunity in front of that, especially as we start to develop these export markets. So if things really get humming domestically because of all the additional capacity that's coming online, you're going to have less coming in from Canada as we talked about, and then you have an export market on top of that. You can paint a scenario that could be pretty good for Southern sawlog prices in the future.

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Mark Adam Weintraub, The Buckingham Research Group Incorporated - Research Analyst [62]

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That's exactly where I was trying to go. If you do use the West, are you willing to hazard an estimate to what that would mean for U.S. Southern sawlog prices could go to be at kind of equivalent basis?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [63]

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Yes, I haven't done that exact math, Mark. But Southern -- in the West, sawlog prices recovered fairly quickly after the recession to where they were before. And they've gone up significantly past that level in the West. And again, with all the key drivers that I just outlined, I don't see any reason that you couldn't see over time the same type of improvement in the South that we've seen in the West over the past few years.

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Operator [64]

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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 [65]

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How much impact do you think that the freight issues are having on lumber prices? Because there's so many supply challenges in the past year, it's hard to keep track of what's going on, on the supply side.

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

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Yes, Mark, I think fundamentally, what's happening on lumber and OSB is you just have continued growth in demand coupled with a balance on the supply side of the equation, which is shown in the lean inventories throughout the system. Now there's no doubt that some of these temporary disruptions, like freight, are having a temporary impact. But I would say yes, we had freight disruptions or challenges in the first quarter, but we also had -- on the supply side, but we also had weather challenges on the demand side.

So as we think about it long term, we're optimistic because, again, it's ultimately lean inventories throughout the system coupled with where we are in terms of the demand side of the equation. So that's kind of how we think about it. We're going to continue to have these one-off situations. It happens. But as long as inventories continue to be at low levels and we continue to have growth in demand, which we anticipate because of what's happening on the housing front, we're pretty optimistic about pricing going forward.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [67]

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Okay. That's helpful. A question on Timberlands, do you think that the geographic mix of the EBITDA you're generating that we saw this quarter and last quarter is going to persist? I mean, obviously, log prices are up in the West. But is there something structural happening in mix or volume that we should be thinking about between the South and the West?

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Russell S. Hagen, Weyerhaeuser Company - Senior VP & CFO [68]

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So are you referring to Real Estate sales or...

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [69]

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No, I'm thinking about Timberland, the overall realizations that you're getting there, not the Real Estate side.

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [70]

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So Mark, I'd say there's nothing structural that's changing there. As you know, we've seen much more pricing improvement in the West than we have in the South over the past few quarters. But in terms of structurally, nothing that should change significantly in that mix of earnings going forward.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [71]

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So no significant gains in silviculture or anything like that in the South relative to the West?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [72]

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There are gains in silviculture, for example, on -- in both. As we've indicated, longer term, there will be -- from a harvest level perspective, the West will be coming down or did come down -- will be coming down this year, whereas the South in the near term will be going up. But other than that, no structural changes.

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Operator [73]

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

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [74]

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I just wanted to understand the criteria around the black at the bottom phrase and the testing that you've done. What's sort of log, lumber, OSB price metrics that you use?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [75]

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Paul, good question. Basically, what we did is we went back and looked at what those prices were back in the depths of the recession and said, "Okay, if we go back to that type of situation, what type of cost structure do we need in our Wood Products system to be black at the bottom?" So that's the work that we've done to model what -- where we needed to be. Hopefully, again, we don't go back to a recession as deep as the one we saw back in 2008, 2009, but that's the way we modeled it.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [76]

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So there's been quite a bit of investment in -- across a number of OSB as well as lumber mills that would suggest that the cost curve had been pushed down. Do you expect that those recessionary conditions are going to be the next -- similar to the next recession? Or is it -- there's a whole bunch of mills out there that haven't had a lot of investment and those marginal mills would come off and that'll be the bottom?

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Doyle R. Simons, Weyerhaeuser Company - President, CEO & Director [77]

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Yes. And we'll have to see how that plays out. But I think you highlighted exactly what we're focused on, is making sure that when the next recession happens, and we all know it will, that our mills are well positioned. There will be other mills in the industry that would -- have not focused on cost, or capital has not been spent in, where they will absolutely not be black at the bottom. And we'll be well positioned to continue to run during the next downturn.

So as I understand it, that is our last question. I would like to thank everybody for being on the call this morning and, as always, for your interest in Weyerhaeuser.

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Operator [78]

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Ladies and gentlemen, thank you for joining today's call. You may now disconnect.