Weyerhaeuser Co

NYSE:WY

Earnings Call Transcript 2019-Q2

[Operator]

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 2019 Earnings Conference Call. [Operator Instructions]

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

[Elizabeth Baum, Senior Director of IR]

Thank you, Dennis. Good morning, everyone. Thank you for joining us today to discuss Weyerhaeuser's second quarter 2019 earnings. This call is being webcast at www.weyerhaeuser.com. And 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 Devin Stockfish, Chief Executive Officer; and Russell Hagen, Chief Financial Officer. I will now turn the call over to Devin Stockfish.

[Devin Stockfish, CEO]

All right. Thanks, Beth. Good morning, everyone, and thank you for joining us today.

This morning, Weyerhaeuser has reported second-quarter net earnings of $128 million or $0.17 per diluted share on net sales of $1.7 billion. Excluding a small benefit from special items, we earned $123 million or $0.16 per diluted share. Adjusted EBITDA totaled $343 million. I'm extremely proud of our team as each of our businesses delivered strong operating performance despite various market and weather related challenges throughout the quarter.

In a moment I'll dive into our business results, but first let me set the stage with some brief comments on the housing market. Outside of the Pacific Northwest, the second quarter was extremely wet. Record setting precipitation constrained building activity in key areas across the country.

Housing starts in most regions, increased modestly quarter-over-quarter, despite the unusual weather and second quarter, housing starts totaled $126 million on a seasonally adjusted basis compared with $1.2 million in the first quarter.

However, housing starts in the south, which account for roughly half of U.S. homebuilding activity, declined on a seasonally adjusted basis as build our struggle to navigate flooding in near historic levels of rainfall. In addition to the weather related challenges during the first half of 2019, the industry continues to face many of the same supply side constraints that have been headwinds for housing over the last several years, namely affordability, regulatory burdens and labor and lot availability.

While these constraints continue to affect the housing market, we believe the fundamentals support modest growth for 2019. In particular, mortgage applications for purchase are up over 6% in the first half of 2019 versus the same period in 2018. New home sales are up 2% year-to-date, builder sentiment remains strong, economic data remains positive with increasing real wages, unemployment below 4% and consumer confidence near 15 year highs. And affordability has improved as mortgage rates have declined.

Our builder customers are optimistic that they will be able to return to a more normal pace of building activity in the third quarter and they continue to hope for catch up activity in the fourth quarter, weather permitting. We also expect builders will continue to adjust product offerings as they seek to meet solid and growing underlying demand for affordable housing.

Turning now to our second quarter business results. I'll begin the discussion with Timberlands, Charts 4 through 6. Timberlands contributed $102 million the second-quarter earnings and $175 million to adjusted EBITDA.

Western Timberlands EBITDA decreased by $8 million compared with the first quarter due to additional forestry and road building activity, which typically increases during the drier months.

Demand for Western domestic logs softened slightly at some lumber mills reduced hours in response to continued low lumber prices. Logging conditions improved significantly, compared with the first quarter, resulting in good log availability across the Northwest markets.

Although pricing trended modestly lower as the quarter progressed, our second quarter domestic log pricing was comparable to the first quarter average.

Moving to the export markets. In Japan, post and beam housing starts are up almost 2% year-to-date and demand for our logs remained steady. Average sales realizations for our Japanese export logs were comparable to the first quarter. Second quarter log sales volumes to Japan were stronger than we had originally expected and were down only slightly compared with the prior quarter. In China, overall log inventories at Chinese ports decreased 11% during the second quarter to 4.1 million cubic meters.

However, the inventory trend varied by species. Inventories of North American hemlock and Douglas fir logs decreased by 44% but inventories of Radiata pine continue to build in the quarter. At the end of June, Radiata radio represented approximately 73% of the ports inventory volumes compared with 60% at the end of March.

The oversupply of Radiata pine has had only a modest effect on demand and pricing for our logs as the Douglas fir and hemlock that we export generally serve different end-markets than Radiata.

Second quarter realizations for our China export logs were slightly lower than the first quarter. Log sales volumes decreased, but this was primarily due to the timing of vessel sailings. Overall, second quarter log export revenues were lower than the year ago quarter, due to lower realizations for our Japan and China logs and lower sales volumes to China due to timing of shipments. For Western Timberlands as a whole, EBITDA is significantly lower than a year ago due to the lower prices for domestic and export logs.

Moving to the South, Southern Timberlands EBITDA decreased by $4 million compared with the first quarter due to lower fee harvest volumes. Extremely wet weather created challenging logging conditions during the second quarter our fee harvest volume decreased only slightly, as our scale operability and supply chain infrastructure enabled us to largely maintained our planned harvest volume through the record rainfall.

Log availability was tight across Southern markets particularly in the Mid-South resulting in low mill inventories and continued solid pricing. Average realizations for our Southern saw logs were flat with the first quarter and realization for our fiber logs increased slightly.

On the export side, Southern log export volumes and realizations were comparable to the first quarter. Comparing overall Southern Timberlands results with the year ago quarter, EBITDA increased slightly due to higher average log sales realizations, partially offset by lower harvest volumes and slightly higher harvest in whole cost due to the wet weather.

Northern Timberlands EBITDA decreased by $6 million compared with the first quarter. Fee harvest volumes declined seasonally as spring breakup limited activity across most of our Northern operations and average realizations improved as our harvest mix shifted seasonally to a higher proportion of hardwood sawlogs. Compared with the year ago quarter, EBITDA from Northern Timberlands decreased slightly due to lower harvest volumes.

Real estate, energy and natural resources, Chart 7 and 8. Real estate and ENR contributed $35 million to second quarter earnings and $71 million to adjusted EBITDA. So second quarter EBITDA was $35 million lower than the first quarter by $24 million higher than a year ago. As we previously indicated, due to strong activity at the end of 2018, our 2019 real estate activity is heavily weighted towards the first half of the year. Interest from recreational and high net worth buyers remained solid in the second quarter.

We also closed a large acreage transaction in Montana, which accounted for approximately half of the acres sold. As a result, the number of acres sold in the second quarter increased 21% compared with the first quarter and there was nearly three times higher than a year ago.

Average price per acre decreased significantly compared with the first quarter and the year-ago quarter, due to the large proportion of acres sold in Montana, where Timberland prices are regionally lower. In energy and natural resources, EBITDA increased slightly compared with the first quarter due to a small seasonal increase in construction materials volumes. Compared with the year ago quarter, ENR EBITDA increased due to higher volumes and pricing for construction materials and hard minerals.

Wood Products, Charts 9 and 10. Wood Products contributed $81 million to second quarter earnings and $128 million to adjusted EBITDA. Compared with the first quarter, earnings and EBITDA increased despite lower average pricing for our commodity products. EBITDA for lumber decreased $3 million, as slightly lower lumber realizations and higher log costs were mostly offset by a seasonal increase in sales volumes.

Lumber pricing trended unevenly throughout the quarter, holding flat through April, declining in May as continued wet weather and limited customer purchasing and improving in June with the announcement of curtailments in mill closures in British Columbia.

On average, the framing lumber composite price decreased 3% in the second quarter compared with the first and our average realizations decreased by 1%. Lumber sales volumes increased 12% compared with the first quarter while production was up 4%. Our mills had another excellent quarter operationally.

Unit manufacturing costs decreased slightly compared with the first quarter and our lumber system achieve the lowest controllable manufacturing cost per unit it is ever recorded. This is a strong indication that our OpEx efforts are yielding meaningful results.

Our Timberlands and Wood Products teams also worked exceptionally well together to keep our mill supplied with logs in very challenging harvest conditions. Despite record levels of precipitation across the U.S. South and Alberta, we experienced only minor out of log downtime at one mill in our system.

Comparing second quarter results with the year ago quarter, lumber EBITDA decreased significantly due to lower average sales realizations, partially offset by lower log and manufacturing cost. EBITDA for the second quarter of 2019 includes a charge of $5 million for countervailing and antidumping duties on Canadian softwood lumber. OSB EBITDA decreased $11 million compared with the first quarter. This is almost entirely attributable to lower average realizations.

The second quarter pricing trajectory for OSB mirror that of lumber. Benchmark North Central pricing averaged 12% below the first quarter and our average realizations declined 4%. Our sales and production volumes were comparable to the first quarter, slightly lower than a year ago as we took a bit more downtime than originally forecasted. Comparing our second quarter results to the year ago quarter, EBITDA was significantly lower due to a 42% decrease in average sales realizations and slightly lower sales volumes.

Engineered Wood Products EBITDA increased by $17 million compared with the first quarter. Average sales realizations for solid section products were flat and average realizations for I-Joists decreased by 3%, primarily due to seasonal mix. Sales volumes increased by 17% for solid section products and 27% for I-Joists due to seasonally higher building activity.

Production volumes for solid section and I-Joists products increased only modestly as we began the customary draw down of our first quarter inventory build. Fiber cost declined due to lower cost for logs in oriented strand board web stock and unit manufacturing costs for MDF improved due to higher operating rates.

Compared with the year ago quarter, lower costs for logs in oriented strand board were partially offset by lower sales volumes. Distribution EBITDA increased by $7 compared with the first quarter due to improved sales volumes. EBITDA was slightly lower than a year ago as sales continue to lag last year's levels.

I'd like to now turn to operational excellence. Our businesses are making good progress against our collective 2019 operational excellence target of $80 million to $100 million. Year-to-date, our biggest OpEx benefits in Timberlands continue to come from improved logging in hauling efficiencies in our Southern operations and marketing and merchandising improvements across the West and South.

In Wood Products, our greatest benefits have come from our ongoing initiatives to reduce controllable manufacturing costs for lumber and OSB and improve log recovery and engineered wood products. Our real estate business is also on track to meet or exceed its targeted 30% premium to timber value.

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

[Russell Hagen, CFO]

Thanks Devin, and good morning.

Key outlook guidance for the third quarter are presented on Chart 13 of the earnings slides. In our Timberlands business, as is customary, third quarter earnings and adjusted EBITDA will be seasonally about we expect a seasonal decrease, similar to what we saw in the third quarter of 2018 when earnings and adjusted EBITDA decreased by approximately $35 million compared with the second quarter. In our Western Timberland operations, we expect our third quarter harvest volumes will be lower than the second quarter.

As is typical for this time of year, our road spending will be slightly higher. Operating conditions in the West had been favorable for the past several months. Domestic log inventories are at healthy levels ahead of fire season. Our domestic log sales realizations trended down late in the second quarter and we anticipate our average realizations for the third quarter will be moderately below in the second quarter average, absent significant fire-related disruptions or restrictions.

In Japan, post and beam housing starts are expected to remain steady and we continue to experience solid demand for our export logs. In the third quarter, we expect Japanese export sales volumes will be comparable with the second quarter and average log sales realizations will be slightly lower. Chinese export log sales volumes are expected to increase in the third quarter due to the timing of vessel selling's. We anticipate average sales realizations will decline modestly compared to the second quarter.

Although demand remains fairly steady, we do anticipate the recent sharp drop in Radiata pine pricing will create some downward pressure on our prices for a Chinese export logs. In the South, forestry spending will increase as we entered the drier summer months and complete activities that were deferred by wet conditions in the first half of the year.

We anticipate higher fee harvest volumes in the third quarter and average sales realizations are expected to be comparable to the second quarter. In the North, third quarter fee harvest volumes will be significantly higher in the second quarter as we move past the spring breakup season.

Turning to our real estate energy and natural resources segment, as previously discussed the cadence of our real estate sales will be more heavily weighted to the first half of the year in 2019. We continue to see strong interest in higher and better use lands from high net worth individuals and recreational buyers. Markets in the South and the West are particularly strong. We anticipate third quarter adjusted EBITDA for the real estate energy natural resources segment will be approximately $15 million lower than in the second quarter.

Land basis as a percentage of real estate sales will be slightly higher than the second quarter at approximately 60%. We expect third quarter earnings will be $10 million lower than the second quarter. We continue to expect adjusted EBITDA of approximately $270 for the full year of 2019. And we now expect land basis as a percentage of real estate sales will be between 50% and 55% for the full year.

For Wood Products we expect third quarter earnings and adjusted EBITDA will be comparable to the second quarter before the benefit from the improvement in sales realizations. We anticipate comparable sales volumes and slightly lower fiber costs offset by slightly higher unit in manufacturing costs, engineered wood products due to scheduled downtime.

We expect third quarter realizations for lumber and OSB will be higher than the second quarter average. For both lumber and OSB third quarter to date average sales realizations are comparable with the second quarter average, and current realizations are $5 higher than the second quarter average. As a reminder, for lumber every $10 change in realizations is approximately $11 million of EBITDA on a quarterly basis.

And for OSB, every $10 change in realizations is approximately $8 million of EBITDA on a quarterly basis; Chart 11 outlines the major components of our unallocated items. The $13 million favorable variance in earnings before special items compared with the first quarter is primarily attributable to lower variable compensation expense. Second quarter also included a small non-cash foreign exchange gain as compared with a non-cash charge in the first quarter.

Each year in the second quarter, we finalized prior year-end estimates for pension plan assets and liabilities. As a result, our second quarter pretax special items include a $6 million benefit from finalization of the non-cash settlement charge related to the transfer of pension assets and liabilities to the purchase of a group annuity contract, which we completed in the first quarter. Excluding pension settlement items, our second quarter non-cash, non-operating pension and post-retirement benefit costs were comparable to the first quarter. We continue to expect to record approximately $60 million of expense for the full year 2019.

Turning to our key financial items, which are summarized on Chart 12, we ended the second quarter with a cash balance of $212 million. Cash from operations during the second quarter was $396 million, an increase of $410 million over the first quarter, which is typically the lowest cash flow quarter of the year.

Capital expenditures for the second quarter totaled $84 million. We expect total CapEx for 2019 will be approximately $380 million. $120 million for Timberlands inclusive of reforestation costs, $250 million for wood products and $10 million for planned corporate IT system upgrades.

Moving on to financing we ended the quarter with approximately $6.3 billion of total debt outstanding. We have no debt maturities until 2021. We expect full-year 2019 interest expense will be approximately $375 million excluding special items.

I'll wrap up with taxes. In the second quarter, we recorded an income tax benefit as we recalibrated our annual effective tax rate to account for lower than expected wood products pricing. We currently expect our full-year effective tax rate will reflect the benefit of approximately 20% before special items. We expect to pay minimum cash taxes in 2019.

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

[Devin Stockfish, CEO]

Great, thank you, Russell.

Looking forward, we continue to believe there is a modest growth trajectory for US housing. As the market addresses supply-side constraints it narrows the gap to fundamental demand, but we also remain positioned and prepared to fully capitalize on a range of market conditions. Most importantly, we will continue to focus on what we can control.

Optimizing our operations and portfolio, capturing efficiencies, capitalizing on our diversification and scale and delivering operational excellence every single day. We will remain focused on these things so that we will drive industry-leading operational and financial performance and deliver superior value to our shareholders.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Brian Maguire with Goldman Sachs. Please go ahead.

[Brian Maguire, Goldman Sachs]

Russell, I just wanted to clarify the comments you made on the 3Q outlook for wood products. I think you noted in the release you expect it to be flat sequentially assuming that price realizations are flat, but then I think in the prepared remarks, you also talked about assuming higher lumber and OSB prices. So I just wanted to reconcile those. And then when you talk about prices being flat are you talking about versus the 2Q average or where you ended 2Q, or kind of where we are today?

[Russell Hagen, CFO]

Yes, I think really what we're looking at is: one, we're operating very well in our manufacturing operations. The cost structure is clearly as Devin mentioned, really well positioned. So as we look at quarter-over-quarter, and the activity pricing has been pretty flat, but we would expect as we come into later in the summer, as activity increases, that we'll see improving pricing.

So that's kind of how we're looking at it. We're really in just really a good position to benefit from that improvement in pricing.

[Devin Stockfish, CEO]

Just to follow-up on that, I think directionally, we're expecting a pricing uplift. As we see construction activity continue to pick up in the back half of the year, obviously, there have been a lot of curtailments and mill closure announcements.

I think those are still working their way through the system. So directionally, we're expecting an uplift. I think, for us, the challenge is quantifying the timing and the magnitude.

[Brian Maguire, Goldman Sachs]

And just to be clear, if that uplift developed, that would be upside to the flat sort of outlook on earnings?

[Russell Hagen, CFO]

Correct. Yes, correct.

[Brian Maguire, Goldman Sachs]

Okay. Just wanted to be clear on that. And then you commented on some of the curtailments that have been announced. Just wondering how long you think it will take for some of that to create some tension on the market?

And I guess tied into that question; how would you assess the inventories in the channel and sort of your own inventories? Because obviously there have been a lot of curtailments. So far, it hasn't really moved the needle a lot on pricing. But I'm guessing there's still a little bit of excess inventory in the channels.

[Devin Stockfish, CEO]

Yes, so let me speak to channel inventory first and then I'll get back to your second question. I'd say, as a general statement across the industry, I would say that inventory levels are in the normal range. Now there may be a few geographies where it's a little high or a little low. But on balance, I think they're in a normal range.

I do think one of the dynamics that you're seeing at present is that buyers are generally not building inventories. They feel pretty confident that they can get supply on an 'as needed' basis to meet their needs. And so I wouldn't say that inventories are in an extreme level by any means.

The one I guess caveat to that is on SPF as you alluded to with some of the mill closures and curtailments, some of that volume from those mills that are closing down seems to be finding its way into the market. And I think that's been a little bit of a headwind on SPF here just recently.

That being said, there have been a lot of capacity that's coming out of the system for the announced mill closures. There is a little noise in the system as that volume flows through, as you think about mills that are closing down. They're going to have to move their inventories out into the market and sometimes that will put a little pressure on things.

But after that it sort of works its way through the system. We would expect that to normalize over time, whether that's two weeks, four weeks, what have you, hard to predict. But certainly, directionally, that's what we would expect to happen.

[Brian Maguire, Goldman Sachs]

And just last one from me. The log costs in Western Canada been elevated I think the pine beetle impact that you guys have been talking about for a number of years. Maybe it's finally starting to work its way from the initial stages of creating an oversupply of logs that maybe now restricting supply a bit.

I was wondering if you could talk about that market and how in general that's impacting you? I know you have a little bit of lumber capacity in that area. But net-net, I would think the pressure that it creates on some of the imports to the U.S. would be a benefit for you. But I just wanted to get some perspective from you on that.

[Devin Stockfish, CEO]

Yes. So there are really two things going on in British Columbia. One, as you mentioned, is the impact of the pine beetle and forest fire, which has reduced the overall supply of timber. Now, I would say that it's differential by region.

And so when you're talking about certain areas in sort of the mid-B.C. range, it's a little bit more heavily impacted. Where we own a mill is a little bit further south. The wood basket that we operate in, hasn't been impacted in a meaningful way by the pine beetle or forest fire. So our fiber supply at our mill is actually in reasonably good shape.

The other piece that you've been hearing about from a log cost perspective is the way that they do stumpage rates in British Columbia. And that reset on July 1st. It went up. You've probably heard that talk to you from a number of our competitors that are bigger in that region. And so that's the other impact on log cost, it's just the method that they used to calculate stumpage rates.

For us, given the wood basket that we operate in, where fiber is a little bit more available, we have a mill that's a low-cost mill, top quartile cost structure in that region. And so even with the increased stumpage rates, I think we're feeling pretty good about the operations that we have in British Columbia.

[Operator]

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

[Mark Wilde, BMO Capital Markets]

I wondered, Devin, if you could just give us any color on the lumber trade dispute. Is the pain that we're seeing in lumber markets right now, is this sparking anymore interest in discussions or is it still a back burner issue?

[Devin Stockfish, CEO]

Yes, I'd say there hasn't been a whole lot of movement on that front. Really, the activity is primarily in the litigation channels with the WTO and NAFTA. And so that process is going to take several years to work its way through. Ultimately, we would hope to come do a resolution that both sides can live with. From our perspective, that would be quota-based. But there hasn't been a whole lot of movement on that front recently.

[Mark Wilde, BMO Capital Markets]

And then just to come back to this kind of Canadian log issue, can we get a general sense of what you think at current SPF pricing levels, - many of the mills up there actually cash positive, would you guess?

[Devin Stockfish, CEO]

Yes, Mark, it's really hard for us to speculate on the cost structure for our competitors. Really, what we can speak to is our mill in British Columbia, as I mentioned; we think that's a top quartile mill and we can make money even at these levels.

And so you can do the math. If we think we're a top quartile cost structure, that means others aren't, at least not everyone. And so you can probably run your own math. It's hard for us to speculate specifically on their cost structure though.

[Mark Wilde, BMO Capital Markets]

Last one from me is just maybe you can provide a little bit of color on what you're seeing in U.S. Timberland markets, both in terms of the volume of properties that are in the market and then what you're seeing in terms of Timberland valuations.

[Russell Hagen, CFO]

2019 has actually been a pretty slow start. We've seen a little more activity as we come in the summer months. But I think. in general, our expectation is that 2019 will be a pretty light year from a timber transaction kind of from the broader market timber transaction base.

Typically, we expect around $2 billion to trade. And then every year you see maybe one large transaction sit on top of that. And so the average over the last number of years has been $2 billion to $4 billion. But I would speculate that we'd be hard-pressed to hit $2 billion in 2019, given the amount of transactions that we've seen close and the amount of acres that are on market or we would expect to see come to the market.

One thing I'd say is, I think it's just a timing of transactions. I don't think it points to any fundamental change in the timber market. We're still seeing strong values. We're still seeing quality properties trade. good prices, and we're still seeing capital coming into the market seeking out the investments. So I think we're just going to see a slow year this year.

[Mark Wilde, BMO Capital Markets]

If can slip one more; is it possible, Devin, for you to just to update people on your thinking around the dividend? I think there has been some concern that you won't cover the dividend this year and I think it would be good to just hear how you hand the board. Our thinking about that, clearly there's a lot of volatility in your cash flows, just because of what's been going on in the wood markets?

[Devin Stockfish, CEO]

Yes, sure, Mark. Obviously, the first half of the year has been a little soft on pricing across a number of our products. And that impacts cash flow. I would say, just as a starting point, we're expecting prices to pick up over the back half of the year, as I mentioned earlier.

But putting that aside, I think we've been clear, returning cash to shareholders through our sustainable dividend is a core capital allocation priority, as is reinvesting in the business and maintaining an appropriate capital structure.

And so to the extent that we continue to see a soft pricing environment. we've got leverage, we can pull. There is a little bit we can do around CapEx and further cost control. We're obviously always working on OpEx.

But over and above that, we have two key levers to pull. First, as we continue to look to optimize our portfolio, we have opportunities to monetize non-core assets. You've seen us do that in the past with our Uruguay divestiture with what we did on the Twin Creeks transaction. And so that's a lever that we have to pull.

Additionally, we have a strong balance sheet and lots of liquidity. And we're prepared to tap some of that liquidity to bridge as needed. I do think it's important to point out, we value our investment grade credit rating and so we'll obviously balance that in consideration of the other levers that we have to pull. But again, we do think you're going to see some uptick in pricing, but we've got levers that we can pull to continue to execute on our capital allocation priorities in the meantime.

[Operator]

Your next question is from the line of George Staphos with Bank of America. Please go ahead.

[George Staphos, Bank of America]

I had three questions, one on homebuilding and housing, one on cost and operations and then one on timber pricing. First, some of the research and some of the commentary that we've heard and seen suggest that one of the issues that's been impacting homebuilding is a lot of issues that you had mentioned in terms of land availability, labor availability and so on. But one of the things that's hurting affordability is permitting costs and those are somewhat intractable and being driven by fiscal issues and other issues that kind of feedback and community.

So to the extent, that your customers have a view on this, and whether that comes down. That's become a very meaningful price for a new homeowner to get over to build that new home. What are you hearing in the marketplace, and I'll come in with my follow-ons?

[Devin Stockfish, CEO]

Yes, there is no question that is one of the things that's driving the affordability issue. We've heard estimates as high as 25% of the costs of some homes being built are due to some of the regulatory burdens that are put on the builders. And so that's a challenge. Now the issue there is that something, typically that you have to battle out at the local level. The one thing that does give me some optimism around that, however, is there is a growing appreciation I think in the public policy space that affordable housing is a real issue that must be resolved.

You've heard the governor of California talk about building 2.5 million to 3 million units to just get back up to base level demand. Here in Seattle, where the markets tight. It's a topic of conversation regularly. And I think you're seeing that play out. Now, the challenge in moving local governments is going to be differential depending on where you are in the country. But I do think that has really found its way into the public debate and that gives me some level of optimism that perhaps it's an issue that we can figure out to help with the affordability issue.

[George Staphos, Bank of America]

All right, thanks for thoughts on that Devin we'll keep coming back to that. In terms of costs, I mean you pointed to it from our vantage point you did really, really well this quarter. How did you keep SG&A really well aligned I think it was flat year-on-year, flat in the quarter, especially within wood products? And what is repeatable in terms of your manufacturing cost – leverage in wood products, looking at in the next couple of quarter. Was there anything aberrational in your ability to keep cost as low as they were in the quarter?

[Devin Stockfish, CEO]

No, absolutely not. And you know both from an SG&A perspective and an operating cost within the businesses, whether it's wood products or elsewhere. The reason that we've been on the positive trajectory there is, because we focus on it. We talk about it all the time we're always focused on it. OpEx has become part of the D&A of this organization that's true in the business, it's true with the corporate level.

And so I wouldn't say there's anything aberrational in Q2. My expectation is, as we mentioned we're targeting another $80 million to $100 million of improvement in 2019. And we're confident that we're going to get it.

[George Staphos, Bank of America]

And Devin, just the SG&A, we should be able to see or you should be able to maintain that leverage going forward?

[Devin Stockfish, CEO]

That's certainly the goal.

[George Staphos, Bank of America]

And the last I didn't hear you, Russell talk about, you just mentioned there was a downtick in Western realizations and logs. If you could comment in terms of what was driving that end of quarter, pressure that would be helpful? Thank you, guys and good luck in the quarter.

[Devin Stockfish, CEO]

Yes, let me just comment on the Western system generally, because that's a little context for what's going on with the pricing. I'd say over Q2, the demand was steady in the Western system, but as it's typically the case as the weather improves as you get into the drier months. You see additional volume coming into the market from the non-industrial former wood. And so that's an incremental volume that we see every year. I think the two additional factors at play this year are number one.

While, our demand has been steady to China, I do think you've seen a little bit of a drop off within the Western region on shipments to China so some of that volume has stayed domestic. And then the third piece is, there were some ice storms in Southern Oregon over the winter time and you're seeing a lot of the landowners, moving some of that salvage volume to market, which is impacting the dynamic in Southern Oregon and is bleeding up a little bit to mid Oregon as well.

And so those three things together, I think have put a little bit of a softness in pricing in the West. That's not a typical of what you typically see this time of year, as you see the former wood come to market. But that's sort of where we are. And I would say that's likely going to continue here until we get into – the more wet months here in the Pacific Northwest. So as we said, we would anticipate Q3 pricing in the West to be down moderately compared to Q2.

[Operator]

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

[Collin Mings, Raymond James]

Going back to Mark's question earlier around the dividend and capital allocation, it does not look like you repurchased any shares during the quarter. Can you maybe just update us on how share repurchases fit into your capital allocation priorities?

[Russell Hagen, CFO]

Yes, sure Collin, this is Russell. As you know, our first priority is – returning cash to the shareholders through the sustainable dividend. And then we'll do share repurchases on an opportunistic basis. In the first quarter, we repurchased around $60 million worth of shares and we did not have any repurchase in the second quarter. But it's something that we look at on an ongoing basis as part of our overall capital allocation program, and we'll update you next quarter as to our activity.

[Collin Mings, Raymond James]

Switching gears just as far as China and really appreciate all the detail around log inventories in China across the different species you broke out earlier. But can you maybe just expand on why you think there is such a divergence there and maybe expand on how you think that's going to impact that market going forward?

[Devin Stockfish, CEO]

Yes and so the overall rationale for why the radiata pine inventory built up, is a little bit hard for us to project. We obviously don't have Timberlands in New Zealand. What I will say is on an ongoing basis, I do think you've seen a bit of a price correction on radiata pine ordinarily, that would impact the volumes going in, in going into the fall. The other piece I would just say in terms of the overall dynamic in China, typically July and August are warmer months in the Southern China region. And so you ordinarily would see a little bit of a slowdown in take away.

And I think in certain end markets, you're also seeing a little bit of lessened economic activity impacting the takeaway at the ports. And so, I think both on the supply and demand side. That's why it has gotten a little bit out of balance and why you've seen some of that price correction. I will say, as we mentioned earlier, though for our business for Hemlock and Douglas fir. We're still seeing good steady demand from our customers. Pricing soften a little bit, but we haven't seen the same kind of price correction that we've seen in some of the other species.

[Collin Mings, Raymond James]

Appreciate all the detail there, and then just shifting to the U.S. South. I mean clearly wet weather has helped support log pricing throughout the first half of the year in the South. Maybe just as we've kind of moved into the summer and starting to roll into 3Q, have you seen any shifts across different wood baskets in terms of log pricing here? Just maybe it maybe the wet weather hasn't been as pronounced in some areas?

[Devin Stockfish, CEO]

Yes and I think you're absolutely right. The first half of the year, very wet that really kept log inventories at the mills down kept pricing tension in the market. And so, part of the uplift that you saw was attributable to weather. I will say, as we continue to see the manufacturing capacity come into the region and get up and running in those wood baskets. I think that's another piece that added to the uplift on pricing.

Our view is that will be something that will continue on. Now that's local to those specific wood baskets, but I do think where we've seen that that's putting an upward pricing pressure. With respect to going into Q3, I think on balance we're expecting comparable quarter-over-quarter pricing. You're going to see maybe a little bit more pricing pressure in some of those regions that have just recently seen a whole bunch of rain, maybe a little less so in regions that have been dryer. But on balance across the south, we're looking at comparable quarter-over-quarter.

[Operator]

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

[Chip Dillon, Vertical Research]

Thanks for all the details much appreciated yeah. Just to get a handle on the second half cash flow I know that you're unwinding. And I think this is going to be largely done by next year the timberland transactions from 15 years ago with the SPEs. Is it fair to say that you're going to probably need to make it what a $300 million payment in the second half and you get that back next year? And therefore should we, unless there's a dramatic recovery and pricing expect that net debt number which I get to about 6.1, you mentioned gross debt 6.3, should rise a little bit into year-end and then hopefully drop off next year?

[Russell Hagen, CFO]

Chip. Yes, I think you actually described that pretty well. We entered into a couple of timber transactions back in 2002 and 2004, and set up the financial instruments to monetize those. And the first set of those transactions or vehicles were completed last year.

And then we have the second step or a second set coming due this year. In the third quarter, we'll make a payment of $302 million. And then in the first quarter of 2020, we'll receive $362 million. So I would expect at year-end, you're going to see a little bit elevation on that. We'll probably tap a revolver to cover that. But it will be repaid back right in the first quarter. So it'll be very temporary.

[Chip Dillon, Vertical Research]

And then just to clarify, on the Timberlands expectation for the third quarter, I think you said down $35 million EBITDA from a year ago, which I think would mean just a very small like $5 million drop from the second quarter, is that the right zip code?

[Russell Hagen, CFO]

Chip, it's $35 million quarter-over-quarter.

[Chip Dillon, Vertical Research]

So it's from second to third?

[Russell Hagen, CFO]

Correct. Similar though to the drop that we had in 2018, second and third quarters. So it's really impact - it's a seasonal effect really around harvest levels and pricing. And then also drill cost…

[Chip Dillon, Vertical Research]

And then last question is, in the OSB business, I know, and I'll be the first to admit, I was a little skeptical about you guys running so hard. But you clearly have made the right choice because of - we see folks falling by the wayside, so to speak. And you're making money, and that's totally up on the up and up. But you did miss and you took some downtime in OSB.

And I'm just curious, was that because you have a different approach there or is it because you were approaching cash cost at a couple of facilities? I'm just curious why you chose to take downtime in OSB?

[Devin Stockfish, CEO]

Yes, Chip. And that really was just some maintenance downtime that extended a little bit longer than we had anticipated. At a high level, we're obviously always trying to match our supply with profitable demand, generate appropriate returns over time.

I think with our products mix, and remember, we're predominantly a value-added OSB product. So we are not as heavy into the commodity sheeting business. And when we combine that with all the work that we've done on our cost structure, it allows us to be cash flow positive where others perhaps may not.

And so in Q2, every one of our OSB mills was cash flow positive in every month, unless they had scheduled maintenance downtime. And I'd say, obviously the ultimate goal is not to just to be cash flow positive. The goal is to exceed earnings in excess of your cost-to-capital over time and that's certainly our expectation. But we're continuing to watch that and monitor it closely.

[Chip Dillon, Vertical Research]

So said differently, if you needed an extra coat of paint this year or next year, why not extend it a few days when the prices are low and do it this year? Because maybe next year it will be a much better market.

[Devin Stockfish, CEO]

Well said.

[Operator]

Your next question is from the line of Mark Weintraub with Seaport Global. Please go ahead.

[Mark Weintraub, Seaport Global]

A couple of follow-ups. First, you had mentioned that in some of the southern geographies where new lumber capacity has been coming on, you felt a little bit more tension in pricing. Roughly what percentage of your Southern harvest would you say is in those baskets where there is lumber capacity coming on such that it can add some tension to those geographies?

[Devin Stockfish, CEO]

Yes, well, rather than give you a specific percentage, I can talk about sort of geographically. When you think about some of the capacity that's been coming into the Arkansas, Oklahoma region, that's an area where we've seen price tensioning. And, in fact, really some of our highest delivered log prices in Q2 were coming out of that region, sort of the Mississippi area where the [Beaver] mill came in, that's an area that's been tensioned.

We obviously have a significant land holdings in Mississippi. There are spots throughout the rest of the south, where some of the mill capacity is impacting our harvest. North Carolina is another strong operating region. We've got a mill that's coming up to speed in that region.

And so I think, regionally, there are spots where it's helpful. Obviously, there is new mill capacity coming in Alabama. We have some holdings there. That's not a state where we have a significant amount of a holdings. But it's having a little bit of a knock-on effect in some of those regions as well.

[Mark Weintraub, Seaport Global]

And are there certain locations where you have land where there is going to be capacity coming on shortly which wasn't covered in the list you gave where hopefully we're going to see that tension pick up?

[Devin Stockfish, CEO]

Well, I think those are the regions primarily that we're looking to see the new capacity. If you're asking if there is anything in the rumor mill that's coming on other than what's been publicly announced, I don't think we have anything to add there.

[Mark Weintraub, Seaport Global]

And just also a follow-up on the question of the levers that you have to pull. You had mentioned optimizing the portfolio and looking at non-core assets. Is there any color you can provide to us as to what some of the non-core assets might include?

[Devin Stockfish, CEO]

Yes, I don't know. They were prepared to really list out specific non-core assets other than just to say. Obviously, as we look across our acreage in our businesses, we're looking to generate good, strong return on our assets.

And that's really part and parcel to how we look to optimize our portfolio and to the extent that we have assets that we don't feel are generating the right return profile, that would be something that we would look at. And so I guess just directionally, we believe there are probably some non-core assets within the portfolio that we could monetize if and when we need to.

[Mark Weintraub, Seaport Global]

And then lastly, trying to make sure I understand. So on the tax rate, so for the full year, as I understand it, you expect that to be a 20% benefit; is that correct? And I also believe that you said that from a cash perspective, it basically would - maybe if you could just restate what you would expect, if anything on the cash side?

[Russell Hagen, CFO]

So that's correct. We expect a 20% benefit for the full year. And that's really just re-calibrating our tax provision to factor in the lower wood products pricing. So, as far as cash taxes, we'll pay minimal cash taxes. We have some refunds associated with the pension work that we did last year. And so we would expect to see minimal cash taxes in 2019.

[Mark Weintraub, Seaport Global]

So on a net basis, minimal cash taxes paid or were the refunds supplemental to that, so that on a net basis you have cash coming in from taxes?

[Russell Hagen, CFO]

Yes. No, on a net basis, it's minimal cash taxes. And then we do have, as we announced, I think in the prior quarter, we do have an outstanding refund that we've put in with the IRS.

[Operator]

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

[Mark Connelly, Stephens]

Russell, you spoke earlier about the slow timber transaction market. Has your view of the attractiveness of values in that market changed much, or is there just not enough out there to make you want to be more involved?

[Russell Hagen, CFO]

Mark, we really don't have a changed view. The transactions that we are seeing close, are strong values. We're just seeing a slow market right now. And I really don't have an answer as to why we don't see more volume on the market.

Just in context, there's about 120 million acres of investable timberlands in the United States. And so as we've seen in the past, those acres are going to trade hands over time, and we would expect that continue into the future. So I just think we're in a slow, slow part of time as it relates to timber transactions, but we really haven't seen any change in value. They remain strong.

[Mark Connelly, Stephens]

And then just one quick question. Devin, on the South; how much is the wet weather and the wet soil in the South, affecting your current harvesting? And when do you think we get back to normal, if there's any such thing as normal weather anymore?

[Devin Stockfish, CEO]

Yes. Well, in the second quarter, there is no question, it was difficult logging conditions. And we did lose some volume. It was only slight for us. And so, down just a few million dollars in terms of the actual dollar impact to us. But there is no question, logging conditions are very difficult when you have that amount of rain.

What I would say is, you know it doesn't typically take all that long for the woods to dry out this time of year. And so we did see a good rain storm coming through in Arkansas, we saw a little bit in Louisiana. Most of the other regions have dried out for the most part. So, I think by and large, you're probably seeing relatively normal logging – activity across the south at this point.

[Operator]

Your next question is from the line of Steve Chercover with Davidson. Please go ahead.

[Steven Chercover]

So just to begin with respect to your black at the bottom initiative within wood products, is this what black at the bottom, looks like. And of your 100 sorry, 80 million to 100 million OpEx targets how much more might trickle into the wood products bucket?

[Devin Stockfish, CEO]

Yes, with respect to the OpEx piece. So of the 80 to 100 or 40 to 50 of that is in our wood products business. And what I would say is, by the end of this year will be essentially there on back at the bottom, outside of maybe one or two mills. But I think certainly we're – by all intents and purposes, we're going to be there by the end of the year. In terms of what black at the bottom, looks like it certainly is not a great pricing environment. I wouldn't call this what I would see as the bottom. And so, we're certainly planning the black at the bottom initiative for pricing south of this.

[Steven Chercover]

And so with respect to your fleet, then it's effectively about as modern as you can get until there is a new generation of technology that you could invest in and deploy across the asset base?

[Devin Stockfish, CEO]

Yes, I actually wouldn't say that at all. I mean it's a range we have certain mills in our systems Dierks and millport, which are clearly best-in-class technology. But we have plenty of other mills in our system that are a bit more aged and we're slowly building up that technology and that's part of our capital expenditure plan in our program we have roadmaps at each mill. So I wouldn't say that we're anywhere near having best-in-class technology across our entire wood product portfolio.

[Steven Chercover]

And then switching gears a bit, and keeping in mind the statement, the timber values remain strong. Would it be fair to say that in this environment, you have more sellers than buyers and would you have the financial flexibility to transact if an attractive asset came to market?

[Russell Hagen, CFO]

Yes, Steve, this is Russell. Yeah, we're obviously in the market we have timber operations in every major wood basket in the United States. So, we see everything that comes to the market. I would say that if there is an opportunity to acquire Timberlands that created shareholder value and fit within our portfolio. And we could demonstrate that we could capture the synergies from that that's clearly something that we would look at. I mean, our long-term view is to build the most valuable timber portfolio.

So that would add to that overall strategy. As far as how we're looking this on the buyer sell side. As Devin mentioned, we're constantly looking at our portfolio to optimize it to make sure that we are the rightful owner of every asset in every market. And in doing so we may identify areas or properties that don't fit on the long-term basis, but again that's just an ongoing process that we work through every day.

[Operator]

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

[Paul Quinn, RBC Capital Markets]

I just had a couple of easy questions on the wood product side, one surprise to me was EWP and the outperformance there and it doesn't seem to be price related at all. I guess there is a little bit of tailwind on cost but real big volume pick up. And noting that business is really into new home construction just trying to understand, we didn't see a lot of big pickup in new home construction in the first half. So why was that segment so strong?

[Devin Stockfish, CEO]

Yes well, that's a great point I'd just say I'm incredibly proud of the work that our EWP team is doing. Really there are a couple of things there it's first and foremost, our manufacturing team is doing a great job managing costs, running our mills efficiently, and that's a great starting point. We've got terrific products in our EWP business and our sales and marketing team does an excellent job of servicing customers and that's a good recipe for success regardless of market conditions.

And so, we were able to move profitable volume across our portfolio of products in the quarter and I think that's really what drove the results.

[Paul Quinn, RBC Capital Markets]

And then, just you did a good job at outlining sort of BC log cost, you know you’ve got a couple mills in Alberta what are you seeing there, log cost wise and any type of inflation you're seeing as well?

[Devin Stockfish, CEO]

Not really any sort of meaningful appreciation of log costs in Alberta those remaining reasonable. Again, it's all wood basket dependent in one respect and we have good fiber availability near the mills that we're running in Alberta. And so they don't have the same stumpage model in Alberta as they do in BC so didn't seem that that same uptick in July that you saw in the British Columbia region. So log costs are pretty much comparable.

[Operator]

And today's final question will come from the line of Anthony Pettinari with Citi. Please go ahead.

[Anthony Pettinari, Citi]

You've spoken about very wet weather depressing homebuilder demand throughout the first half of the year. I guess when you look at July, are you seeing or can you quantify any kind of demand-pull or reacceleration of job site activity? And then just generally when you have this kind of prolonged poor weather do these projects just get pushed later into the season or is there some portion that's just sort of loss for the year?

[Devin Stockfish, CEO]

Yes with respect to July from what we're seeing with our customers. There seems to be steady demand and steady pull-through. And so we still anticipate the construction activity will continue to build momentum and we haven't seen anything that would lead us to a different conclusion in July. With respect to the projects that were delayed in the first half due to weather. I think there is a general optimism among our customers and the homebuilders that they're going to make some of that up now.

Realistically, there is a limit on how much of that they're going to be able to make up this year, primarily because of labor availability. I think if people can get the folks to actually go out and do the building, they're going to make up a pretty fair amount, but I think has been much discussed that remains a challenge throughout the industry. So they will make up some, I doubt they will make up all but we would anticipate as I said, a pickup in activity to see when we get to the end of the year some moderate level of growth year-over-year.

[Anthony Pettinari, Citi]

And then just a quick question on Southern log obviously, there is still a 25% tariff in China and you discussed the weakness in radiata pine and some of the underlying weakness in China. With all that said, are you still shipping Southern Yellow Pine to China, if you can quantify that? And then just while you're at India obviously a smaller market, but one that had been growing pretty quickly, just wondering if there's anything you kind of add-on, on India as well?

[Devin Stockfish, CEO]

With respect to China Southern Yellow Pine at a 25% tariff that's a pretty steep headwind. And so we're still shipping to China at a relatively low level really the amount that we need just to keep the supply chain open. We've got a few really good customers in China for Southern Yellow Pine and they're using that still. And so we're still getting a bit of a takeaway on the Southern Yellow Pine but certainly at a much-reduced rate than we had been on a trajectory even a year ago.

With respect to India, we have been shipping into that market sort of off and on over the last 18 months. One of the things that we saw when they put the tariffs on Southern Yellow Pine that caused some market disruptions. Some of the volume that was headed for China ended up in India. And so it was a little choppy, but I think that's normalized a bit and so I think that will be an interesting market for us, still very small, but an opportunity to grow over time.

[Anthony Pettinari, Citi]

Okay, that's helpful. I'll turn it over.

[Devin Stockfish, CEO]

All right terrific. All right well, I think that was our final question, so thank you to everyone for joining us this morning and thank you for your continued interest in Weyerhaeuser. Have a great day.

[Operator]

Ladies and gentlemen, thank you for joining the Weyerhaeuser second quarter 2019 earnings conference call. You may now disconnect.