Potlatchdeltic Corp (PCH) 2016 Q2 法說會逐字稿

Good morning. My name is Latonya and I will be your conference Operator today. At this time, I would like to welcome everyone to the Potlatch second quarter 2016 conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session.

(Operator Instructions)

I would now like to hand the floor to Mr. Jerry Richards, Vice President and Chief Financial Officer, for opening remarks. Thank you, and Mr. Richards, I hand the floor to you.

Thank you, Latonya, and good morning. Welcome to Potlatch's investor call and webcast covering our second quarter 2016 earnings. With me in the room are Mike Covey, Chairman and Chief Executive Officer; and Eric Cremers, President and Chief Operating Officer.

This call will contain forward-looking statements. Please review the warning statements in our press release, on the presentation slides and in our filings with the SEC concerning the risks associated with these forward-looking statements. Also please note that a reconciliation of non-GAAP measures can be found on our website at www.PotlatchCorp.com.

I will now turn the call over to Mike for some comments and then I will cover our second quarter results and outlook.

Thank you, Jerry, and good morning. Improved markets and solid execution against our capital allocation strategy put the wind back into our sales this year. In April we announced the sale of 172,000 acres of Timberland in central Idaho, at an attractive EBITDA multiple, for $114 million. We also announced that our Board authorized a $60 million share repurchase program, and that we plan to pay down debt with part of the proceeds.

During the 34 days available in our recent open window, we repurchased just under 170,000 shares at an average price of $35 per share. This represents approximately 10% of our share repurchase authorization. Our window to purchase shares was closed during the Brexit vote even though our stock price recovered after the vote and is currently up over 20% year-to-date, we continue to trade at a meaningful discount to our net asset value. It is our intent to continue to execute against our share repurchase authorization opportunistically when our stock trades at a deep discount to our net asset value.

We also used $42.6 million of the Timberlands sale proceeds to repay 5.9% debt during the quarter. This will reduce interest expense $2.5 million per year in addition to executing against our goal of reducing leverage and regaining an investment grade credit rating. In addition, we are in the process of refinancing $65.7 million of tax exempt revenue bonds that currently bear interest at 6%. This is scheduled to close in August and we expect the interest rate to drop significantly.

Turning to the economic factors; solid job creation, continued strength in consumer confidence levels, historically low mortgage rates and rising household formations all support continued steady growth in US housing starts. Through the first half of the year, housing starts are up about 8% on a year-over-year basis. We're encouraged by the fact that single family starts are up almost 15% on a year-over-year basis given that single family starts use about three times the amount of lumber as multi-family units.

We continue to believe that lumber inventory levels in the supply chain are low and the increase in lumber prices this year has been driven by demand and takeaway, not speculation about what may occur when the softwood lumber agreement stand still expires this October. The DIY market has been very strong and has compensated for slower than expected growth in the US housing starts this year.

The Canadian Dollar has strengthened about 6% against the US dollar so far this year. This has benefited lumber manufacturers located in the United States by reversing some of the competitive advantage that is accrued to Canadian producers. The profitability of our wood products segment continued to improve this quarter. We are set up well for the second half of the year now that the one discretionary capital project planned for the year at our Warren, Arkansas sawmill is behind us, and lumber prices have started to move up from their recent plateau.

Resource operated well through the first half of the year and we are ahead of our harvest plan. That reduces the risk that a fire season or early snow could cause us to not meet our planned harvest which remains at 4.2 million tons this year. Real estate continues to be a steady contributor and we closed a conservation sale for an attractive price of almost $2,600 per acre this quarter.

Finally our dividend yield remains over 4% despite the appreciation of our stock price this year. This provides an attractive return in addition to the upside potential as we execute against our capital allocation strategy and the US housing market continues its recovery.

I'll now turn it back over to Jerry to talk about the quarter and our outlook.

Thanks, Mike. Beginning with Page 3 of the slides accompanying this call, we reported a net loss of $31.3 million or $0.77 per diluted share in the second quarter. This result includes a net loss of $36.7 million on the sale of 172,000 acres of central Idaho Timberland that we announced in April. Excluding that loss, we earned $5.4 million or $0.13 per diluted share. This compares to net income of $200,000, which rounds to $0.00 per diluted share in the first quarter.

EBITDA for the second quarter was $25.1 million, excluding $111.5 million generated by the central Idaho Timberlands sale. EBITDA generated by the northern and southern regions of resource, wood products and real estate were all higher on a sequential basis.

I'll now review the results of our operating segments. Information for our resource segment is displayed on Slides 4 through 6. Operating income for the segment was $15.7 million in the second quarter, compared to $10.2 million last quarter. We harvested 916,000 tons in the second quarter, which is 66,000 tons higher than the estimate that we provided on last quarters call.

Turning to Slide 5, we delivered 389,000 tons of sawlogs in the north in the second quarter. As we discussed on the first quarter earnings call, it was an unseasonable warm winter in Idaho which resulted in sawlog deliveries being lower than planned in the north in the first quarter. Hauling activities resumed earlier than normal in the second quarter, due to favorable weather conditions and logging roads drying out. As a result, we more than made up the shortfall in sawlog volume in the north in the second quarter, and mill log inventories are back to more normal levels in the region.

Northern sawlog prices increased 14% on a per ton basis in the second quarter. A little over half of this increase was the result of seasonally lighter logs due to lower moisture content. Log prices are set on a dimensional basis in Idaho, not based on weight. The remainder of the increase was primarily due to higher prices for cedar sawlogs on a dimensional basis in Idaho as demand for cedar logs remained strong.

Moving to the south on Slide 6. Harvest volumes slightly exceeded our plan in the second quarter despite wet weather in April and May that periodically interrupted operations. Our team did a good job taking advantage of market demand and available logging capacity. Sawlog prices in the south increased 6% and pulpwood prices were up slightly, both due primarily to seasonally higher volume of hardwood logs in the sales mix.

Results for the wood products segment are displayed on Slides 7 and 8. Operating income was $4.7 million in the quarter compared to $1 million in the first quarter. This is the third consecutive quarter that this segment's results have improved. Our average lumber prices increased 8% and lumber shipments were 5% higher in the second quarter.

Our Warren, Arkansas sawmill took 12 days of downtime in the quarter related to a capital project and maintenance. This negatively affected earnings by approximately $3 million. The project is complete and the mill has resumed normal operations.

I will now shift to our real estate segment on slides 9 and 10. Excluding the book loss on the central Idaho sale, real estate's operating income was $5 million in the second quarter, up from $2.1 million earned in the first quarter. We sold 5,530 acres in the second quarter, which is higher than we anticipated. A conservation sale was completed earlier than expected at an attractive price of almost $2,600 per acre.

Corporate expenses of $10.3 million in the second quarter are higher than normal, largely because of an $800,000 pretax charge related to an environmental remediation project that we completed in northern Idaho in 2013. More background on this matter is disclosed in our form 10-Q, which we plan to file later today.

Turning to financial highlights on Slide 11. We ended the quarter with cash of $65.4 million. We also have $249 million available on our revolver.

As Mike mentioned in his comments, we redeemed our $42.6 million, 5.9% Minnesota tax exempt bonds in June, and are in the process of refinancing our $65.7 million, 6% Nez Perce County, Idaho tax exempt bonds. The latter transaction is scheduled to close in August. We expect the redemption and the refinancing will combine to reduce our interest expense run rate by over $4 million per year.

Capital expenditures, excluding acquisitions, were $5.8 million in the second quarter. We continue to expect that capital expenditures will be $19 million for the year.

Now I'd like to comment on our outlook which is summarized on Slide 12. We plan to harvest between 1.4 and 1.5 million tons in the third quarter with roughly half the volume in the north and the other half in the South. Sawlogs are expected to comprise approximately 90% of the third quarter harvest in the north, and approximately 50% of the third quarter harvest in the south, inclusive of stumpage sales.

We estimate stumpage sales will be approximately 100,000 tons in the south in the third quarter. We continue to expect that we will harvest 4.2 million tons in total for the full year. Recall that our planned harvest volume was lower 200,000 tons last quarter due to the central Idaho Timberlands sale.

We expect northern sawlog prices to increase up to 5% in the third quarter to reflect higher lumber prices on a lag basis, and due to strong cedar sawlog prices. In the south, we expect sawlog prices to increase approximately 10% due primarily to a seasonal increase in the volume of hardwood logs in the sales mix. We expect pulpwood prices to be down slightly due to excess supply relative to pulp mill demand in the region. At these seasonally higher volumes and higher prices, we expect resource earnings to be just under the $36 million that the segment earned in the third quarter of 2015.

Turning to wood products. We expect lumber shipments to increase sequentially to approximately 175 million board feet in the third quarter. Our forecast assumes that the average lumber price realized will be 5% higher in the third quarter. Wood products earnings would increase to $8 million to $10 million in the third quarter at these volumes and prices.

For real estate we expect to sell about 7,000 acres in the third quarter at an average price of $1,300 per acre. Over 80% of the acres are expected to be rural real estate in third quarter. We estimate that land basis in the quarter will be 15% to 20%.

We expect that corporate expenses will be $9.5 million and that interest expense will be $8.1 million in the third quarter. The latter includes the write-off of unamortized loan costs of approximately $400,000 related to the Nez Perce County tax exempt bonds that are being refinanced. We estimate that the consolidated effective tax rate will be an expense of 10% to 15% of pretax earnings in the third quarter.

To summarize, we expect higher earnings in third quarter primarily due to seasonally higher harvest volumes and continued improvement in lumber prices and volumes. That concludes our prepared remarks.

Latonya, I'd now like to open up the call to the Q&A.

Thank you.

(Operator Instructions)

We do have a question from the line of George Staphos with Banc of America.

Hi guys, good afternoon, or good morning. Thanks for the details. I just wanted to go back and double check something a little -- we can do the calculations ourselves. The guidance on wood products where you said, I think, profitability would be up $8 million to $10 million, is that a sequential improvement that you're guiding to or year on year increase?

George, that is a sequential improvement in wood products that we're guiding to.

Okay. Thanks for that. I assumed so, but just wanted to be clear.

Yes, to clarify, George, it is not going to increase $8 million to $10 million, it will be between $8 and 10 million.

Okay, fine. Fair enough. I thought I heard sequentially increase. Okay. Second question I had, you talked to sawlog pricing in the south and obviously prices are moving up because of mix of hardwood. Can you comment at all in terms of what you're seeing on the softwood side of sawlogs and whether there's any beginning tension in pricing because of the improvement that you're seeing in housing and wood product markets?

Yes, George, this is Eric. No, on the softwood side, generally speaking we continue to see kind of flattish prices. If I look at the prices that we've seen over the course of the year, they really haven't changed a whole lot. In fact, there may even be a little bit of a sawlog weakness in Arkansas in the fourth quarter, though that's due to mills being unusually full at this point in time. But, no, we're not seeing upward price movement at this point in time.

If you look broadly across the south, at least at the markets that we're in in three states, inventory levels at sawmills are completely full, allowing sawmill owners and operators to still continue to put pressure downward on sawlog prices.

Yes, and George, just one step further. If you look at Timber Mart-South data across the 10 southern states that they track, year-over-year, sawlog -- this is pine sawlog now, price variance is down roughly 3% across the whole south and down about 2.5% just quarter-over-quarter.

Okay. Fair enough. We we're hoping for something else, but appreciate the affirmation there I guess. Two last ones and I'll turn it over. One, can you comment at all on what the financial impact was in earnings or volumes from recapturing the [lost run] from the first quarter in the north? And then you talked about wood product inventories being relatively low. Is there any way to put additional qualifiers or quantification around what you're seeing in distribution and at your customers? Thank you.

George, let me take the first question which is the incremental volume that we got and what did that translate to in terms of incremental profitability. As Jerry had mentioned, we outperformed our forecast by about 66,000 tons and roughly 40,000 tons of that was northern sawlog, so if I think about roughly $40 a ton margin on that northern sawlog, that equates to about $1.6 million. So there will be extra margin, of course, from pulpwood and from southern products as well, but more or less it's between $1.5 million and $2 million. Does that answer your question?

That's fine. Yes, thank you. And then in terms of just your view being that lumber is moving with takeaway and builder expectations and inventories being low, can you put -- realizing it's difficult -- put maybe a bit finer point in terms of what you're seeing in terms of distribution level inventories and, again, the outlook for wood products the rest of the year. Thank you, guys.

Yes, so as we stated on the last call, it's our belief now that dealers run with low inventories perpetually. They no longer will build inventories and then draw those inventories down, so they tend to run order to order. And when you get in a period of strength like we're in right now where take away is very firm, it translates into pricing strength back at the mill because we see that increase in demand very, very quickly.

In terms of what do we see for the rest of the year, our view is that prices have had a really nice run here we're probably going to start to enter in the fall. We don't think there's downward pressure on prices. There may be even a little upward price opportunity here, but I think when you get out into next year if you look at what the pundits are forecasting, which is roughly a 10% year-over-year increase, or call it $30 a thousand, that's roughly in line with what the futures market is showing.

It's our belief that as capacity utilization continues to increase in the industry and you see very limited new capacity coming online, and it does take awhile to build a new sawmill, I think the pundits may be correct here in that we're going to see further price gains.

Thanks very much, Eric.

Thank you. Your next question comes from the line of Gail Glazerman with Roe Equity Research.

Hi, good morning. I guess, Eric, can you just start by talking about maybe how you see the softwood lumber agreement playing out for the markets as we get closer and closer to the end of that standstill, if customers haven't been building inventory ahead of it?

Gail, this is Mike. We've seen a lot of recent growth in the US market with stronger demands, especially in single-family housing, repair/remodel has surged, and almost all of that growth in the market has been captured by Canadian imports. Their market share today is about 34%, at least it was in the first quarter of the year. That compares to about 28% two years ago, so a lot of the uplift has been captured by Canada.

The Softwood Lumber Coalition continues to pursue a negotiated settlement that focuses on maintaining Canadian exports at or below an agreed upon US market share, so essentially a quota system. And the USTR, our Trade Representative and Canadian counterparts have been meeting. We think they are having meaningful dialogues, but if negotiations fail, the US is free to file remedies in the courts after October 13, as you know, under the trade laws. That one year standstill expires on that date, and then we can file a trade case.

But I think the strength we've seen in the lumber market to date has been more demand driven and consumption driven, and I don't think that most traders, at least as we talk to our salespeople everyday, it's not a big topic of conversation what the SLA is going to be now. I think two months from now that will be the case, but today I think it's driven on fundamentals, which are encouraging.

Okay. And can you give an update -- I know you said very limited capacity is coming online, but there has been some relative news, particularly in some of your baskets, can you just give an update on some of the investments that you may or may not be seeing in your southern wood basket, maybe touch on a little bit of what has been going on in Idaho?

Yes, in Idaho specifically, Gail, one of our -- our largest pulpwood customer, Clearwater Paper, has announced an expansion at their pulp mill down in Lewiston, and that's supposed to come on line next year. And we believe that will increase pulpwood demand by roughly 100,000 tons per year, and we hear they're making progress on that.

Across the south, I've got a list here in front of me. It's roughly 17 projects under way. Ten are in Arkansas, four in Mississippi and three are in Alabama. Those projects combined amount to about 12 million tons of incremental wood demand. Roughly 2/3 of that is pulpwood and 1/3 of that is sawlog. They are all in various stages of development ranging from Sun Paper's announcement that they are going to build a fluff pulp mill in Arkadelphia.

We think that will consume 3 million tons per year, but that's not going to come online until -- they are talking about earliest would be late 2017. And that's just when it starts up. It won't hit full production until a couple years after that.

And then you've got other projects that are in the south that are actually already about to up and start. The Winston Plywood mill in Louisville, Mississippi is anticipated to start in mid-August, and that will consume about 750,000 tons per year of incremental sawlog. So you're seeing a lot of projects across the south, and they are all in various stages of development, but make no mistake, 12 million tons of incremental demand across these three states is very meaningful.

Okay. And just switching gears a little bit, the comments on cedar pricing, I just want to make sure that's underlying actual prices for cedar going up and it's not really a mix issue?

No, our cedar production across the year, really it varies very little as a percent to mix in the north. It's roughly 8% to 9% every quarter. And just to give you a feel for it, it was roughly a little over $200 a ton in the first quarter, and it hit $250 a ton in the second quarter, so mix didn't change, more or less, about 8% each of those quarters, but the price went up significantly.

Okay. Thanks very much.

Thank you. Your next question comes from the line of Ketan Mamtora with BMO Capital Markets.

Good afternoon, or good morning. Thanks for taking my question. First question, just coming back to the projects in US South. It seems like, at least what we are hearing, is there is some delay in the Sun Paper fluff pulp mill. Are you guys hearing anything on that? It seems like they are still doing feasibility and engineering study.

Yes. Ketan, I think we are reading the same press releases, so we have heard the same thing. I think what we had read was it's just taking longer for them in the permitting and the engineering, and I think the estimate that I recall is it might not start up until 2020. But I think the positive there is it certainly will be a pretty large consumer of pulpwood and is approximate to our Arkansas Timberland holdings, so still a very positive development, but certainly as we mentioned in the past, a long term development.

Okay. That's helpful. And then switching to cedar prices, you mentioned there was a pretty big jump in pricing from Q1 to Q2. What drove that? Is it something that's seasonal or is something else going on from a demand standpoint?

There could be a little bit of seasonality in that that cedar product is used for a lot of high-end second homes in the inner mountain region, and there probably is more building activity in the summer months than there are, say, in the dead of winter. So my gut tells me it's more fundamental demand that's driving those prices higher. Cedar is a relatively scarce product and it's in limited supply and as you see strong high-end second homes being built, as you see demand for cedar go up alongside demand for those homes, you'll see pricing move up right along with it.

Okay. That's very helpful. I'll turn it over. Good luck in the second half.

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

Hi, good morning guys.

Good morning.

First question for me, we discussed how the indexing of your log pricing in Idaho works at length on prior calls. I'm curious, maybe you could remind us given just the portfolio changes, how much of your northern harvest pricing on sawlogs is driven now by lumber pricing?

Yes. It's roughly 70%, Collin.

And then maybe just remind us, or I don't know if you can give us a split of how much of that is a full quarter lag versus more of a monthly lag?

Yes, I don't have that data right in front of me.

Okay. And then, Jerry, just a housekeeping question. Just making sure I understand the guidance and some of the moving pieces going forward on the interest expense, call it a $7 million quarterly run rate once you get done with the refinancing and factoring in the recent debt repayment, is that fair?

That's fair, Collin.

Okay. And then, Mike, just to clarify the comments from the beginning opening remarks, and just maybe walk us back through the current thinking given that clearly you're taking advantage of some of the opportunities on the debt refinancing and debt paydown side, just as far as capital allocation, particularly given the fact that the wood products business has turned back to profitability this year, as you think about the stock here again at, call it $37/$38, priorities as far as continuing to execute on the share repurchase plan versus, I know towards the end of the year typically the Board takes a look at the dividend, again recognize you don't want to get out in front of the Board too far, just walk us through capital allocation priorities.

Well, we've had a lot of options recently with the proceeds from the central Idaho sale, and I think what we've talked about with debt repayment and debt refinancing are important. We lost our investment grade rating earlier this year, largely because we levered up for the large southern acquisition we did a year and a half or almost two years ago. We would like to get that back so a little stronger balance sheet is helpful. We'll also gain traction with that as debt to EBITDA interest -- or ratios come down with stronger earnings in our wood products business.

We continue to believe that most large timberland transactions that are in the market are fully valued with very little opportunity to create returns for shareholders, and so our focus has been on very small bolt-on acquisitions that are quite small where we think we can get outsized returns and the best deal on timberland is to buy our own stock back, which we did in the first quarter or second quarter. And as we said in our prepared remarks we'll continue to look at that opportunistically.

We continue to trade at a pretty deep discount to most analysts estimates of net asset value. Yours is a little bit low, but some of the others are higher. And I think our best use of capital allocation is to buy our own shares in this market.

Regarding the dividend, it's nice to have a little more coverage with the improvement in our wood products business, but that business, as we have certainly seen, can be very lumpy and we really look to improvement in southern log prices I think to be a real catalyst for further discussions with our Board about raising the dividend. And we'll see what happens in the second half.

Appreciate that very detailed response. Just one other part of that, just as you think about potential capital projects, particularly given the commentary and outlook about lumber pricing not only for the remainder of this year but also into next year depending upon what happens with the lumber dispute when the US and Canada, how do you think about opportunities to continue to put more money into your mills, maybe ratchet up some production capacity?

Well, last year we spent roughly $15 million to $17 million of incremental discretionary capital to increase production and grade recovery at each of our four mills. Those projects have been successful. We're going to produce another 25 million board feet this year because of those.

We felt they all had 20% kinds of returns or better. Same with our project that we executed in Warren, Arkansas this year. We felt the returns were in that same zip code and our mill managers have no shortage of projects that have those kind of projected returns, and we'll continue to do a small number of those each year, but I think our capital spending is going to continue to fall in this range of roughly $20 million to $25 million going forward with select projects each year.

I really appreciate the color, Mike. Thanks.

Thank you. Your next question comes from the line of Chip Dillon with Vertical Research.

Yes, good morning, Mike, Eric and Jerry.

Hi Chip.

First question is with the -- just to piggyback the last one, what would you describe as a range of what the lumber system could do if the demand were there for it? I know there's some flex always in these situations with the potential to run extra shifts and overtime, but how should we think of what the range in the annual output could be in a really good market?

Well, Chip, this is Eric. The simplest way to answer that question is to look at where capacity utilization is in the industry right now. It's roughly 85%, which means there's roughly 15% spare capacity that's out there. Now I think the real question is at what price will it take to get that 15% to come online and produce, because you have got to believe that over the last few years -- maybe not last year, but the prior couple of years were really strong markets and I think a lot of the easy capacity has come online. So what's left is high-cost expensive capacity, but that's roughly 15% is what's out there and what's available, according to RISI anyway.

That's helpful, but I was talking about your own system.

In our own system. Well, we're running our mills about as hard as they can be run. So there's not a lot more room for incremental production there.

Okay. That's helpful. And second question has to do with the -- I just want to make sure I heard you right. I know since the Clearwater spinoff, eight or so years ago, there have been two instances when I know there was one dividend decrease and there's been two instances where it has gone up. Would there be any reason why the timing of another dividend move, if you do decide to do one, would be different than the last two? When looking at the calendar?

Well, typically our Board has always reviewed the dividend in the fourth quarter of each calendar year, not that they can't change that schedule, but we increased the dividend from $1.24 to $1.40 in the fourth quarter of 2013, and again to $1.50 in the forth quarter of 2014. And so our pattern has been to review that in the fourth quarter. I expect that will continue.

Okay. And then on the -- looking at the real estate segment. I guess I have in my model, rightly or wrongly, somewhere around 20,000-or-so acres a year is the normal divestiture program, and I just was wondering if that still is a place, or if it ever was the right place to be, in light of the Idaho land sale?

Yes, Chip, this is Eric. Yes. The majority of our acres that get sold each year are coming out of Minnesota, but we still have plenty of acres left in the state to sell, so, yes, I think 20,000 to 25,000 acres continues to be the run rate there.

Okay. And last question is on the -- when we think about the Idaho lands and the potential projects that are being talked about and various products, I just wanted to clarify, you would by far benefit more from wood products that use sawlogs, I guess, or other -- yes, basically wood products facilities more so than a pulp facility?

If there were an expansion -- is your question specific to Idaho, Chip?

Oh, no, I'm sorry. I mean Arkansas.

On Arkansas. Yes, well the margin on sawlogs is roughly 3 to 4 times what it is on pulpwood, so additional sawlog capacity, whether it comes from a plywood plant or a sawmill, is always more attractive than pulpwood just because the margin is 3 to 4 times different.

And I guess to ask more directly, if the Sun mill gets delayed further or never happens noting that our research indicates there hasn't been a pulp mill permitted since the 1980s, Marlboro, South Carolina, would that be a real -- would that be a big disappointment or do you see, so to speak, enough on the wood products side, which is of course much more easy to permit, as being satisfactory to helping that market?

Well, Chip, as I look at the outlook for pulpwood demand in Arkansas, from these projects that are coming online, whether it's the Sun paper mill or it's pellet mills, there's roughly 7 million tons of incremental demand that's on the horizon in Arkansas, and our view is roughly 3 million of that, more or less, is going to come from Sun. So would it be a disappointment? Perhaps, but I think in the grand scheme of things there's still another 3 million, 4 million tons of demand coming online in the state.

Gotcha. Very clear. Thank you so much.

Thank you. Your next question comes from the line of Steve Chercover with D.A. Davidson.

Thanks. A couple late questions please. First of all, you specified that the work at Warren hit income by about $3 million. I was wondering, is that due to foregone production or does that include some capitalized expenses?

Yes, Steve, so this is Jerry. That actually is a combination of foregone production as well as we also did some annual maintenance there, so it includes some dollar expenditures as well.

Okay. And -- well, I guess we've already got the income target for the second quarter. And then, I guess, following on Chip's question. I was kind of wondering why sawmills can't invoke the easiest capacity expansion which is to add shifts or second or third shifts in the US? I mean, just to get some instant incremental capacity if we really think prices are going to be up substantially in 2017.

I think, Steve, the second shift is not terribly, terribly difficult to do. I would guess that probably the majority of mills today are running a second shift. The third shift is overwhelmingly challenging. You're talking about running in the middle of the night. You're talking about not giving adequate time for repair and maintenance of equipment. And I would guess very few mills are willing and able to run a third shift, even in a really strong pricing environment.

Got it. And do you think it would have an impact if some were configured to do a third shift or second and a half shift, would it impact log prices in the vicinity of the mill?

Sure, if it's incremental demand for sawlogs it would definitely have an impact on pricing. I guess it all comes down to what does that incremental demand look like relative to the base case?

All right. And the outlook for $30 higher prices for lumber in 2017, do you believe that incorporates the Canadian share of the market going back below 1/3, like is it back around 25%?

What I gave you, Steve, was what the pundits think, which is the average of the five experts that are out, they're looking at a $30 price increase. So I don't know what each and every one of those are thinking as it relates to where we shake out on the softwood lumber agreement. I guess my gut tells me depending upon what comes out of that arrangement there could be more upside.

Got it. Thanks. And then finally just one last clarification on the Tamarack sale. So that land had annual EBIT contribution of about $4 million was actually negative EBITDA, so we really shouldn't be thinking of that as having significant impact on your full-year Timberland results?

Steve, this is Jerry Richards. In terms of the property, it was approximate to Tamarack, but we certainly didn't own that ski resort. But in terms of EBITDA contribution, you're correct. It actually -- and I think you meant to say actually slightly negative from an earnings standpoint once you factor depletion in, so really not a meaningful change in terms of our GAAP results going forward.

Yes, I was just referring to the land -- the Tamarack land, but the 172,000 acres. Okay. Thanks.

Thank you. Your next question comes from the line of Paul Quinn with RBC Capital Markets.

Hi, thanks. Good morning, gentlemen. Just a question on -- just trying to reconcile wood products here. So what was the capital spend at Warren and then it sounded like you guided $8 million to $10 million in wood products in Q3, and I'm just trying to reconcile that with the $6.4 million you did in Q2, plus the $3 million incremental hit from the Warren 12 day outage?

Yes, Paul, this is Eric. So the first part of your question was the capital spend at Warren. That was a little over $2 million for a log booking optimization project. Now when you talk about sequential earnings in wood products, and Jerry indicated, we'll get to roughly $8 million to $10 million of earnings in Q3 in wood products. And by the way, we're about halfway through the quarter now, so we feel pretty good about that number. Part of that is going to come from what we believe will be a lumber price increase.

The pundits are talking about, more or less, a 2% price increase. That should drive incremental earnings of a few million dollars. We've also got the Warren issue that we had to deal with in Q2 that will not repeat in Q3, and that ought to provide, as well, a couple million dollars of incremental earnings. So those three factors combined gets you to $8 million to $10 million.

Okay. And then taking a look at -- maybe you could comment on the overall US timberland market itself. Mike, you said most of the large transactions out there are fully valued, but are you seeing the volume of transactions you expect, it seems light in my mind, and what do you expect going forward?

I think there's a number of packages that are on the street being valued by parties, so it's been kind of quiet about the announcements on those. I think when those come to closure it will seem like a normal level of deal activity by the end of the year. That's our feeling. I agree that maybe it's a little bit light so far, but I think there's still a number of TMOs and, certainly, REITs that are competitive on these things. Interest rates are low for the REITs that are borrowing money. I think we'll see the projects clear and I think they will continue to be at prices that are quite strong.

Okay. And then just flipping over to softwood lumber and the dispute. I appreciate the color on current situation. Your expectation post October 12 is for CBD and [ABDD] to come in and do you expect them to be similar to 2001 the last time this occurred?

We don't have any expectation about what they're going to be or if there will be any. I think the only thing that we know with certainty, through the softwood lumber coalition we're a part of, is if we get to October 13 and there's not a negotiated settlement, the US is free to file a trade case, and I fully expect that will happen if we aren't making progress.

Okay. And last question I had, just on US south sawlog prices, it seems if we follow Timber Mart-South closely prices are down on the softwood side. Any indications, I mean, it sounded like inventories are high on the sawmill side for logs, so it doesn't seem like a price recovery in the short-term, but do you see a point of inflection 2017, 2018?

Yes, people have been talking, Paul, about a point of inflection for a number of years now and we have yet to see it, although some of the major consulting firms that are out there covering in the industry, they believe that we aren't too far from where that inflection point is. It could be with an extra 100,000 or 200,000 housing starts we could start to see prices move. One actually thought -- that I spoke with recently, said we would see it move by the end of the year. So our fingers are crossed and at some point it will happen, but we haven't seen it yet.

All right. That's all I had. Best of luck in Q3.

Thanks.

Thank you.

(Operator Instructions)

Your last question comes from the line of Mark Weintraub with Buckingham Research.

Thank you. I understand the thought process, vis-a-vis, the dividend, wanting to focus on the timber profitability recognizing the cyclicality in wood products, but you've done a lot of work to improve the profitability of your lumber system. Does that get factored in -- and fairly recently -- does that get factored into what you might think is sustainable in the right dividend level and how do you factor that in?

Absolutely. We wouldn't have -- the incremental capital that we spent last year of the $15 million to $18 million that I mentioned with a 20% return threshold or higher, I think that's kind of money we can take that bank. And I absolutely think that gets factored in when we think about dividend coverage and how much head room we have to raise the dividend on a long term sustainable basis.

But nevertheless, I think you can never forget about what happened in the wood products business last year where we had our EBITDA fall by roughly $50 million to $60 million in one year as lumber prices weakened for a variety of factors. So I think the Board will factor in the improvements that we've done in our lumber business, but fundamentally we need to see southern log price improvement to have a meaningful impact.

Okay. And maybe -- the color you gave on the southern markets was very helpful. Could you kind of run through what you're seeing in the Pacific northwest in a little bit more detail, as well, on the timber side?

You're talking about from a log pricing --?

Exactly.

Well, we're seeing strength as we talked about, Q1 to Q2 our sawlog prices were up 14%, and I think as we indicated in our call, we'll see them up again in Q3 another 4% or 5%. At these lumber prices and with the outlook being for continued strong lumber pricing, and with the fact that 70% of our northern sawlog production is indexed to lumber, we'll see continued strength in sawlog prices in the north. That's our expectation.

Fair point. And the part that isn't indexed to lumber, what are you seeing in the market for that part of the business?

Oh, it tends to go up right alongside the index pricing. Any given quarter it may vacillate plus or minus a little bit, but it will move in tandem.

Okay, thank you.

Thank you. At this time I would like to return the floor to management for closing remarks.

Thank you, Latonya, and I certainly appreciate everybody's attention and interest in Potlatch, and we look forward to catching up with you on next quarter's call.

Thank you for your participation in today's Potlatch second quarter 2016 conference call. You may now disconnect.