威爾豪瑟 (WY) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Weyerhaeuser Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to Beth Baum, Vice President of Investor Relations and Enterprise Planning. Please go ahead.

Thank you, Regina. Good morning, everyone. Thank you for joining us today to discuss Weyerhaeuser's second quarter 2020 earnings. This call is being webcast at www.weyerhaeuser.com. Our earnings release and presentation materials can also be found on our website. Please review the warning statements in our press release and on the presentation slides concerning the risks associated with forward-looking statements as forward-looking statements will be made during this conference call. We will discuss non-GAAP financial measures, and a reconciliation of GAAP can be found in the earnings materials on our website. On the call this morning are Devin Stockfish, Chief Executive Officer; and Russell Hagen, Chief Financial Officer. I will now turn the call over to Devin Stockfish.

Thanks, Beth. Good morning, everyone, and thank you for joining us today. I hope everyone is staying healthy and is well. This morning, Weyerhaeuser reported second quarter GAAP earnings of $72 million or $0.10 per diluted share on net sales of $1.6 billion. Excluding net charges of $5 million for special items, we generated earnings of $77 million or $0.11 per diluted share. Adjusted EBITDA totaled $386 million in the second quarter, this is approximately 7% lower than the first quarter, but 13% higher than a year ago. Our teams delivered strong operational and safety results despite the disruptions from COVID-19 and the unprecedented volatility caused by the pandemic. In a moment, I'll dive into our business results, but first, let me set the stage with some comments on the housing market. New residential construction activity declined sharply in March and April as the COVID-19 pandemic triggered stay-at-home orders and rising unemployment across the nation. April housing starts were the lowest in over 5 years and over 25% lower than April 2019. The rapid decline in new residential construction activity quickly translated to weaker order files for building products, and significant production curtailments by wood products manufacturers. Over the last few months, demand for housing and wood products have shown unexpected resiliency in the face of broad economic disruption. In late May, states began to reopen their economies and U.S. housing activity rebounded sharply, despite the continued extreme weakness and broader macroeconomic conditions. Housing starts improved sequentially and June starts were only 4% lower than a year ago. Repair and remodel activity has also shown remarkable strength, driven by robust, do-it-yourself demand. Collectively, these factors drove a sharp uptick in wood products pricing and demand as the quarter progressed. As we look to the back half of the year, we're cautiously optimistic regarding a continued improvement in U.S. housing. Mortgage rates are at historic lows, demand for housing exceeds the available supply and societal preferences are shifting in favor of larger single-family homes in less urban areas. The pace of home sales is improving, and June new home sales were 7% above year ago levels. At the same time, the trajectory of the broader U.S. economy remains uncertain in light of rising COVID infection rates and the pullback or pause of many economic reopening plans. Key indicators that we are monitoring have generally plateaued at recessionary levels. Unemployment stands at 11%, with initial claims well in excess of $1 million per week. Mortgage forbearance rates are near 8%, mortgage availability remains tight. Consumer sentiment is comparable to levels measured in April and May, and U.S. GDP has contracted in an unprecedented manner.

Further, the specifics regarding additional federal economic relief packages are also unclear at this point. Our customers are expecting strong demand through Labor Day, but remain cautious of COVID-related economic and operating disruptions. We'll be watching all of these factors closely to see how they influence our markets as we move out of the summertime and into the fall. Turning now to our second quarter business results, starting with Timberlands on Pages 6 through 8 of our earnings slides. Timberlands contributed $75 million to second quarter earnings and $140 million to adjusted EBITDA. In Western Timberlands EBITDA decreased $20 million compared with the first quarter. Log sales volumes and average realizations were comparable to the first quarter as we flexed significant volume out of the domestic market to capture higher-margin opportunities in China. Fee harvest volumes decreased 3%. Forestry and road building costs increased seasonally and export costs were modestly higher. In the western domestic market, log demand and pricing dropped sharply in April as mills curtailed production. In response, many landowners reduced harvest operations or redirected volume to stronger export markets. When demand and pricing for Douglas fir lumber rebounded, mills resumed production and actively sought to replenish log decks. Log supply was slow to respond to the increased demand and pricing trended higher exiting the quarter. On average, our second quarter domestic log pricing was moderately lower than the first quarter.

Turning to our export markets. In Japan, housing starts are down approximately 11% year-to-date as housing demand slowed following the fourth quarter 2019 consumption tax increase. Demand for our logs has generally held up well, enhanced by our strong customer relationships and limited availability of Canadian export logs. However, our second quarter log sales volumes to Japan declined. And average realizations decreased slightly as we've begun to see incremental effects from the COVID-19 outbreak on Japanese construction activity. In China, demand for our logs rebounded sharply in the second quarter as construction and sawmilling activity resumed following the COVID-19 outbreak and sawmills returned to near-normal operating rates. Softwood log inventories at Chinese ports decreased nearly 40% during the quarter and into June at 4.4 million cubic meters. Takeaway was strong in April as mills restocked inventories and then eased as the quarter progressed. Supplies of New Zealand radiata and European spruce logs were also below normal due to COVID-19 disruptions. We flexed significant volume into the China market to take advantage of this opportunity, and average realizations for our China export logs increased modestly compared with the first quarter. Compared with the year ago quarter, log export revenues increased by $18 million due to higher sales volumes.

Moving to the South. Southern Timberlands EBITDA decreased $8 million compared with the first quarter. As in the West, demand for Southern sawlogs remained weak through April and into May as mills curtailed production and minimized log inventories. As lumber demand and pricing rebounded, capacity came back online. Although log takeaway for June was trending towards normal, some customers remained cautious and log decks were generally below average levels. Demand for our fiber logs remained steady through the quarter, supported by downstream demand for hygiene products. Realizations for our sawlogs and fiber logs were generally unchanged from the first quarter. Average log realizations declined 2% due to mix as we harvested an increased proportion of fiber logs in the quarter. Fee harvest volumes declined 4% compared with the first quarter and 7% compared with the second quarter of 2019 as we began to implement the previously announced 10% reduction in full year Southern harvest volumes. Comparing our overall Southern Timberland second quarter results with the year ago period, EBITDA declined by $16 million due to lower fee harvest volumes and lower average sales realizations. In Northern Timberlands, EBITDA decreased by $4 million compared with the first quarter. Fee harvest volumes declined seasonally as spring breakup limited activity across most of our Northern operations.

Real Estate, Energy and Natural Resources, Pages 9 and 10. Real Estate and ENR contributed $19 million to second quarter earnings and $57 million to adjusted EBITDA. Second quarter EBITDA was $44 million lower than the first quarter and $14 million lower than the year ago period. As expected, real estate sales were significantly lower than the first quarter. We experienced continued steady interest in rural properties, but transactions were slower to close due to delays in title work, financing approvals and recording deeds. Average price per acre decreased an average land basis as a percentage of real estate sales was higher due to the mix of properties sold. As in the first quarter, second quarter real estate sales included low productivity acreage in Southern Oregon that we acquired with the Plum Creek merger. Results from energy and natural resources were comparable to the first quarter. Demand for construction materials has remained steady as infrastructure projects have generally benefited from essential industry designations during the pandemic. Wood Products, Pages 11 and 12. Wood Products delivered its strongest performance since the third quarter of 2018, contributing $159 million to second quarter earnings and $198 million to adjusted EBITDA.

EBITDA increased $14 million compared with the first quarter as higher average lumber realizations and improved manufacturing costs were partially offset by lower sales volumes for most products. In April, we reduced production across our manufacturing facilities to align with customer demand. As demand improved, we increased operating rates, and most businesses exited the quarter at pre-COVID operating levels. Manufacturing costs improved across our operations despite the production volumes -- the lower production volumes. Our lumber business delivered standout performance for the quarter. EBITDA was $24 million higher than the first quarter and $59 million above a year ago levels due to improved realizations and lower manufacturing costs. Lumber pricing began to stabilize early in the second quarter as mills curtailed production in response to lower demand. With inventories extremely lean across the channel, pricing strengthened steadily as demand improved. This was particularly notable in the Southern markets. Benchmark lumber pricing improved by approximately $135 per thousand board feet or nearly 40% during the months of May and June. On average, the framing lumber composite price increased 2% in the second quarter compared with the first. Our average lumber realizations increased by 5% as our mix of production is weighted more heavily to Southern Yellow Pine. Unit manufacturing costs decreased by 2% compared with the first quarter. Our lumber mills delivered outstanding operating performance, achieving the lowest quarterly and monthly controllable manufacturing costs on record despite weekly fluctuations in operating posture. I want to thank our entire lumber business for the commitment to operational excellence that's driving these industry-leading results. In OSB, EBITDA decreased $4 million compared with the first quarter due to slightly lower sales volumes and average realizations. Supply demand dynamics generally mirror those of lumber, but with a more modest uptick in pricing. Our sales volumes decreased 3% compared with the first quarter. Average realizations decreased 2%, in line with the change in benchmark OSB composite.

Manufacturing costs improved compared with the first quarter due to the slightly lower resin costs and focused cost control across the business. Compared with the year ago quarter, OSB EBITDA increased $33 million due to higher average sales realizations and lower manufacturing costs. Engineered wood products EBITDA decreased by $9 million compared with the first quarter due to lower sales volumes. Average sales realizations for solid section products were flat with the first quarter, and average I-joist realizations decreased by 1%. Sales volumes decreased 12% for solid section products and 11% for I-joist in the second quarter. Because over 90% of these volumes are used in new residential construction, these product lines benefited minimally from the strong second quarter repair and remodel activity. Controllable manufacturing costs decreased compared with the first quarter, but this was offset by higher input costs due to the increased cost of oriented strand board. Compared with the year ago quarter, EBITDA for engineered wood products decreased by $22 million due to significantly lower sales volumes, higher input costs and slightly lower average realizations. Distribution EBITDA increased by $1 million compared with the first quarter as we continue to focus on improving product margin and controlling costs. The business also set a new record for June monthly EBITDA. Compared with the year ago quarter, EBITDA increased by $2 million due to higher product margins and lower delivery and warehouse costs.

Turning now to operational excellence. Each of our businesses has remained focused on delivering on its OpEx initiatives despite the disruptions caused by the pandemic, and that commitment is evident in our second quarter results. Halfway through the year, we have made good progress against our $50 million to $70 million full year OpEx goal, and I am confident we will achieve this target by year-end. I'm extremely proud of the dedication and focus of our teams as they have safely adopted business practices, rapidly and efficiently pivoted operating postures and capitalized on operational excellence opportunities while navigating unprecedented fluctuations in market demand. Staying on track to achieve our OpEx goal is a real accomplishment given the rapidly changing environment in which we've been operating. Now I'll turn to a few comments regarding capital allocation. The Board continues to regularly review opportunities to reinitiate an appropriate quarterly dividend. As we said last quarter, this review takes into account a number of variables, including our market conditions as well as the broader macroeconomic environment. All else equal, the Board's preference is to reinitiate a dividend sooner rather than later.

While we have been seeing improved business conditions over the last couple of months, we need to get comfortable that those improvements will be sustainable even as the pandemic and other macro headwinds continue. I want to be clear that we remain committed to returning a significant amount of our free cash flow back to shareholders as part of our capital allocation philosophy. Our Board also recognizes the need to deliver on that commitment through a sustainable dividend policy that will drive long-term shareholder value. Some of our businesses generate relatively stable cash flows. Other of our businesses are more cyclical in nature. Our overarching goal is to ensure a sustainable capital allocation framework that will enable us to return a meaningful and appropriate level of cash to shareholders across market cycles.

Our other capital allocation priorities include investing in our business and maintaining an appropriate capital structure. We've deferred discretionary capital for 2020, but we continue to invest in the maintenance expenditures required to sustain and further improve our strong operating performance. And we will continue to consider incremental opportunities to optimize and enhance our assets and operations. Russell will provide more details in a few minutes, but the actions we have taken to enhance our financial flexibility in addition to the better-than-expected pricing and demand environment have allowed us to maintain our financial strength during this volatile period. With respect to our capital structure, we are working to bring down our leverage over time. We have repaid our revolver balance, redeemed the majority of our 2021 debt maturities and earmarked cash for the remainder of our 2021 notes. Going forward, we will continue to review opportunities to efficiently reduce our gross debt balance. I'll now turn it over to Russell to discuss financial items and our third quarter outlook.

Thanks, Devin, and good morning. At the beginning of the second quarter, we anticipated challenging market conditions throughout the quarter and potentially through the remainder of the year as the effects of COVID-19 pandemic were largely unknown. As a result of this uncertainty, we took several steps to enhance our financial flexibility. These actions, coupled with our continued focus on safety and operational excellence enabled us to strengthen our balance sheet and generate solid cash flow during the second quarter. Today, our financial position is solid and improving. We are well positioned to fully capitalize on strengthening markets and successfully navigate the continued economic uncertainty related to COVID-19.

Starting with our key outlook items for the third quarter on Page 15 of the earnings slides. In our Timberlands business, third quarter earnings and adjusted EBITDA are expected to decrease by approximately $20 million to $25 million compared to the second quarter, which is a similar reduction to what we saw in the third quarter of 2019. In our Western Timberlands operations, we expect our third quarter domestic log sales volumes and domestic average sales realizations to be higher than the second quarter. Demand in the West has been favorable for the past several months and log inventories at domestic mills ended the second quarter on the low end of normal levels. However, as July has progressed, mills have begun to rebuild log inventories to moderate level in response to increased demand for finished product and as a precautionary measure ahead of fire season.

Moving to the export markets. In Japan, residential construction activity continues to soften due to the ongoing effects of last year's consumption tax increase and the COVID-19 outbreak. Demand for logs slowed through the second quarter and is expected to decrease as the third quarter progresses. As a result, we expect our third quarter Japanese export log sales volumes to decline with a moderate decrease in average sales realizations compared with the second quarter. Chinese export logs sales volumes are expected to decline in the third quarter as we flex supply to take advantage of improving domestic markets. Additionally, we anticipate slightly lower average sales realizations on Chinese export logs due to seasonally lower demand and increased log supply from the competing New Zealand radiata pine and European spruce logs. Shipments to China from these markets have increased as COVID-19 related disruptions at the East. Additionally, in the West, our road, forestry and per unit logging and hauling spend will seasonally be higher. As is typical during the drier, warmer summer months, we harvest on higher elevation tracks. The favorable weather conditions also allow us to complete many of our silviculture and road activities. In the South, we expect seasonally higher forestry expenditures in the third quarter, which is typical as most of the activity generally is completed during the drier summer months. We anticipate slightly lower average sales realizations in the third quarter due to a higher percentage of fiber mix as we shift to seasonally higher thinning activities. Additionally, we expect lower fee harvest volumes in the third quarter compared to the second quarter as we continue to implement the previously announced 10% reduction in our 2020 Southern harvest volumes. In the North, third quarter fee harvest volumes will be significantly higher than the second quarter as we move past the spring breakup season.

Turning to our Real Estate, Energy and Natural Resources segment. We anticipate third quarter earnings and adjusted EBITDA will be comparable with the second quarter. Although many transactions have experienced longer than usual time lines to finance, close and record property deeds due to COVID-19 related social distancing and other safety measures, we continue to experience solid demand and interest in our real estate properties. Demand for smaller HBU transactions is strong. And although the volume of larger transactions requiring financing has slowed, we have continued to make progress on these transactions throughout the second and third quarters. In particular, we continue to further optimize the Southern Oregon Holdings acquired with the Plum Creek merger. As a result, we now expect full year 2020 adjusted EBITDA of approximately $235 million, which is a $35 million increase from our guidance last quarter.

Additionally, we now anticipate land basis as a percentage of real estate sales will be between 65% and 75% for the full year.

In our Wood Products segment, we have continued to experience a strong repair and remodel market and have seen a favorable rebound in residential construction toward the end of the second quarter and into the third. We're experiencing strong demand across all product lines.

Looking at the third quarter, we expect earnings and adjusted EBITDA for wood products will be significantly higher than the second quarter, primarily due to stronger average sales realizations for lumber and oriented strand board as well as increased sales volumes across most product lines. Entering the third quarter, benchmark pricing for lumber and OSB has continued to increase with lumber reaching record highs. For lumber, our quarter-to-date average sales realizations are approximately $110 higher, and current realizations are approximately $130 higher than the second quarter average. For oriented strand board, our quarter-to-date average sales realizations are $35 higher and current sales realizations are $50 higher than the second quarter average.

As a reminder, at typical operating rate for lumber, every $10 change in realizations is approximately $11 million of EBITDA on a quarterly basis. For OSB, at typical operating rates, every $10 change in realizations is approximately $8 million of EBITDA on a quarterly basis.

For engineered wood products, we expect third quarter average sales realizations will be generally comparable with the second quarter.

Page 13 outlines the major components of our unallocated items. The $37 million favorable variance in earnings before special items compared with the first quarter is primarily the result of an $18 million noncash benefit from elimination of intersegment profit in inventory and LIFO in the second quarter compared to a $13 million charge in the first quarter. The benefit recorded in the second quarter was primarily driven by reduced log and lumber inventories across our businesses. Second quarter also saw a benefit related to foreign exchange rates resulting in $11 million noncash increase over the first quarter. These favorable fluctuations were partially offset by a $14 million noncash fluctuation in the valuation of our liability classified share-based compensation. This increase reflects the improvement in our stock price from first quarter to second quarter. Our second quarter noncash nonoperating pension and postretirement benefit costs remain comparable to the first quarter. We continue to expect approximately $40 million of expense for the full year 2020.

Turning to our key financial items, which are summarized on Page 14. We ended the second quarter with a cash balance of $643 million. Cash from operations during the second quarter was $391 million, an increase of $305 million over the first quarter, which is typically the lowest cash flow quarter of the year. Capital expenditures for the second quarter totaled $66 million. We continue to expect total CapEx for 2020 will be approximately $270 million.

Moving on to financing. We ended the quarter with approximately $6.3 billion of debt outstanding. During the quarter, we redeemed our $569 million 4.7% notes that were due March 2021 and incurred an $11 million pretax charge due to the early redemption. This charge for early extinguishment of debt is included in our results as a special item.

Additionally, during the second quarter, we repaid the $550 million precautionary revolver draw taken at the end of the first quarter. Currently, we have the full $1.5 billion capacity available on our revolver. As indicated last quarter, we intend to repay our $150 million 9% note when it matures in the fourth quarter of 2021 and we will continue to review opportunities to reduce our gross debt balance. As part of this, we've begun evaluating our 2023 debt maturities and are assessing options and timing to efficiently refinance and repay this debt. Including our $11 million special item related to the early extinguishment of debt, second quarter interest expense was $103 million. We continue to fully expect full year 2020 interest expense will be approximately $360 million, excluding special items.

I'll wrap-up with taxes. In the second quarter, we recorded an income tax expense compared with an income tax benefit in the first quarter, as we recalibrated our annual effective tax rate to account for better-than-anticipated wood products pricing and sales volumes. We continue to expect our full year effective tax rate reflect an expense of approximately 20% before special items.

However, the tax rate will be sensitive to the level of mix of earnings between our REIT and taxable REIT subsidiary. With respect to cash taxes, we now expect our full year cash taxes will be generally comparable to our overall tax expense. I'll turn the call back over to Devin, and I look forward to your questions.

Thanks, Russell. Before we open the line for questions, I do want to touch briefly on sustainability. Weyerhaeuser has just recently launched our new sustainability strategy, and it builds on our solid foundation of environmental stewardship, social responsibility and strong governance. A core part of this new strategy is what we're calling 3 by 30 and it's intended to drive increased focus in 3 key areas where we, as a company, can make a unique and meaningful contribution over the next decade. These include contributing to climate change solutions, meeting the need for affordable and sustainable housing and helping rural communities thrive. For over 100 years, we've been committed to managing this company sustainably and for the long term. And that focus remains today as we navigate these unprecedented times.

In closing, we believe our company is well positioned with unrivaled assets, industry-leading operations, a strong safety culture and a solid financial position. The underlying thesis for U.S. housing remains strong and evolving societal preferences are further bolstering demand for single-family homes and wood-based construction.

Looking forward, we remain focused on operating safely and efficiently, effectively capitalizing on opportunities across the full range of market conditions and driving long-term value for our shareholders through industry-leading performance and disciplined prudent capital allocation.

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

(Operator Instructions) Our first question will come from the line of Mark Wilde with Bank of Montreal.

Devin, I was thinking you must feel like a personal injury lawyer dealing with whiplash right now, given what's happened in the last 3 months.

It's been a interesting dynamic. That's for sure.

Yes, I've never seen anything like this. I wondered if you or Russell could help people in just thinking about how these higher lumber and OSB prices that we see in the trade publications, how that flows through to your results? Because I'm sure this is going to be a big topic over the next couple of months.

Yes, sure. And so I think as we've mentioned before, we do have a little bit of a lag between what you see in the print and when that hits realization, just because of the length of our order files. And for, I think, this particular period, the order files are extending out a bit, as you probably heard from some other companies. With the strong market dynamic and low inventories, we have extended our order files out a bit. So it will flow through. But when you look at our realizations, it takes a few weeks for that to actually hit our realizations.

Okay. And are there any other kind of qualifiers that we should think about? It's always easy to think about the good news, but there may be other things that we're overlooking as we try to model out the third quarter?

Yes. So I guess just how I'd respond to that is more in terms of the broader environment and what the key demand drivers are. And so when we think about what's really driving the strong demand for wood products right now, it's really a couple of things. Obviously, we've seen housing improve. And our customers, the builders, you've probably heard this on various earnings calls, the demand for housing has really picked up a lot faster than we had anticipated. You saw that in the June new home sales numbers. And so I think, generally, the overall view on housing over the next several months is pretty positive. And so that's obviously a key driver for us. I mean, it is important to remember, though, you look at the June starts numbers, that was still not overwhelming relative to what we were seeing earlier in the year. But I do think that the momentum is building around that. So that seems like a positive, at least for the next several months. But I'd say the other thing that's really been driving the wood products demand has been the repair and remodel market, and in particular, the home improvement do-it-yourself segment. And that has just been remarkably strong.

And I think as we think about that in retrospect with everyone being stuck at home, folks not traveling, no sports, nothing else to do, everybody's doing home remodeling projects. And so that's just been a really key part of what's been driving this overwhelming demand of late. So I think as you're modeling out the third quarter, we have pretty good visibility through August. I think with the order files and what we're hearing for customers, I think August should be pretty strong. I think the big question really is, as we get through Labor Day and head into the fall, what is that repair and remodel market going to look like. And so to us, that's really the big open question, what happens to that segment of the demand signal as we progress through fall. Ordinarily, as the weather starts to cool, you'd see a little bit of slowdown there. But again, this year has been a little different than most years, and so we'll see how that plays out.

Okay. And then just as a follow-on, Devin, I wondered if we can get some thoughts from you on where you see kind of inventories in the distribution channel? Because it feels like part of what we've got right now is just a bit of a short squeeze because so many people liquidated inventory early in the second quarter, and then demand has come back much, much more sharply than people anticipated.

Yes, there's no question. The inventory channels are lean. And that's almost universally true. And like you say, Mark, what really happened is when you saw so much production come out and demand picked up more quickly, nobody had inventory in the channel, and it's just been a scramble ever since. So I think that's been part of the driver. People have -- they have customers that have needs. There are projects that are being built, and they're just out scrambling for product, trying to find that. And the production and the capacity has come back online for the most part. I would say around the margins, I do think, particularly in the South, you're probably seeing a little bit of production that's being lost to producers struggling to keep up with COVID-related downtime. For us, we haven't had a meaningful amount of downtime related to COVID. But if you think about where a lot of the production capacity is for the Southern Yellow Pine in particular, they're in regions where the COVID rates are really spiking up. So I suspect there's probably a little bit of production being lost to that dynamic. And so we just, as an industry, haven't been able to keep up with demand, and that's really what's driving the pricing dynamic.

Your next question comes from the line of George Staphos with Bank of America.

This is actually John Babcock on for George. First and actually just somewhat follows too with what Mark Wilde was asking. But I just want to get a sense. I mean, as you -- we've clearly seen a sharp rise in prices here. And so I wanted to kind of get your sense. I mean you talked a little bit about potentially repair and remodel demand slowing as we get into the fall. And obviously, maybe as we get beyond this jump in COVID cases, maybe that has an impact on supply, but wanted to kind of get your read on how you expect the market to move from here, particularly kind of given these factors?

Yes. So what I would say at the outset is predicting commodity prices is extremely difficult under any circumstances. And I would say, given what's going on in the market today, that's even more so. Again, I think we have a pretty good line of sight on August. So I do think that the August time frame should be pretty strong. With each week that we continue to see strong pricing and strong demand, that probably moves incrementally into September. Honestly, beyond that, it's very difficult to tell. I do think that the housing market will continue to grow the slope of that curve, I think it is very hard to say, particularly given the offset that you may see ultimately with high unemployment. That hasn't seemed to really impact housing demand of late. Historically, that's been a pretty strong correlation between unemployment and housing demand. So as we get deeper into the fall, I think that's an open question. But sitting here today, it certainly seems based on what we're hearing from our customers that the demand for new homes is really strong and building. And so, again, it's difficult to predict how all of those different puts and takes are going to play out over the course of the fall. But certainly, we are in a lot better space now than we had anticipated 3 or 4 months ago. So it's positive from that respect.

And then with regards to fee harvest volumes, what are the primary drivers for your expectation for lower volumes in the South? I mean I know you talked about, for the year, decreasing the harvest volumes, and that's consistent with what you said last quarter. But particularly with the strength in wood product markets, why are those fee harvest volumes expected to go lower?

Yes. So again, I think it's just -- it's the dynamic across the Southern markets. And so we talk about the South as though it's a market. It's really a combination of submarkets. And notwithstanding the fact that wood products pricing and demand has been reasonably strong, I think on balance, across the South, you're probably still not up to full running capacity from a manufacturing and sawmilling perspective, partially because of COVID, I suspect, partially because there's still a little bit of caution around bringing back shifts, if you've taken a full shift out before you hire people back, you want to have some certainty that this run is going to last. So I don't know that production has fully come back. And then the other piece in the South is, as we've talked about, there's just a lot of log supply in the South. And so we made a decision to reduce the harvest volumes in the South by 10% just based on our projection of what that overall log demand is going to look like, the supply demand dynamic. And as we think about that going forward, that's obviously something that can change depending on what market conditions are doing. But bringing back volume and pushing it into a market where pricing is a little soft or the market just doesn't need it, you got to be really thoughtful about that. So at this point, we're still contemplating that 10% reduction, which will largely be taken in the back half of 2020.

Okay. And then just last question before I turn it over. Just with regards to China and the volumes you're seeing there, how did radiata and spruce logs or spruce volumes trend during the quarter?

Yes. So really, you saw a pretty dramatic drop-off in the log flow into China from New Zealand and in the European salvage logs related to the COVID-19 disruptions there. It was basically a full shutdown in New Zealand for a period of time. There were some supply chain disruptions coming out of Europe. And so Q2 really, you saw that volume drop off pretty dramatically. That started to come back. And I think the demand signal in China is holding up pretty well. Takeaway is pretty good, but the supply going into that system has increased with the radiata and the European salvage logs coming in. So there's still demand. I suspect, as we mentioned, we're probably going to swing more of our western volume back into the domestic market, pricing is better, margin opportunities are better, and that's really 1 of the advantages of our system in the West. In that, we have 3 key customers between the third-party domestic, our own internal mills and the export market that we can really swing volume across those customer bases to really go after whatever the highest margin opportunity is. So I think China will obviously continue to be a good market for us. But at present, we have better pricing opportunities in the domestic market. So you'll see our volumes to China in Q3 go down a bit.

Your next question comes from the line of Mark Weintraub with Seaport Global.

First, on the gross debt balance you indicated you want to bring that down over time. Can you give us a sense as to where you'd like to bring it to?

Yes. I'm not going to give you a specific gross debt number. What I would say is we've been elevated relative to our 3.5x net debt-to-EBITDA target. And so we're bringing that down over time. As Russell mentioned, we've got a fair amount of debt coming due in 2023, and Russell and the treasury team are looking at opportunities around that. We also have some term debt. We have some opportunities there, maybe even more so in the near term. So it's something directionally, Mark, that we're looking to take down so that we're more in line with that 3.5x target over the course of the cycle. I think what you saw really in 2019 was, when we're on the bottom end of that cycle, it starts pressing up pretty hard against the upper ranges of where we're comfortable going. So directionally, we're bringing it down. I don't know that we're prepared to give a specific number. Anything to add to that, Russell?

No. As Devin mentioned, yes, we were elevated in the first quarter, obviously, because we had issued that $750 million bond in the first quarter, and then we paid down the $569 million. So we're at about 6.3 right now. And our ratios have improved a little bit. We're at about 4.1x on our net debt-to-EBITDA and our net enterprise value has improved, obviously, with the increase in the share price. So, yes, we have opportunities to start looking at that 2023 tower, and we'll figure out the best way to refinance or repay that.

Okay. In the past, Weyerhaeuser has talked about paying out 85% of its average cycle free cash flow in the form of dividends. Is that still a good starting base to think about? Or has that evolved?

Yes. So I think that's in the process of evolving, Mark. And what that 85% target was really a reflection of is a commitment by the company to return a significant amount of our free cash flow back to shareholders. And that broader commitment remains intact. I think as we consider reinitiating the dividend going forward, we're looking at a number of factors. And I think as the Board considers that opportunity, we want to make sure that the dividend is sustainable and appropriate for our portfolio of businesses, our business conditions, the free cash flow that we can generate from our businesses over a cycle. And as I mentioned, some of our businesses have generally relatively stable cash flows. Others have more cyclical cash flows. And so as we think about that, our capital allocation approach, I think, has to account for that variability. And so ultimately, the overarching goal is to ensure a sustainable capital allocation framework that enables us to return significant but appropriate levels of cash back to shareholders over a cycle. So it's evolving, it's part of the conversation that we continue to have as a board.

And so if I were to hypothesize that, that means, given that there is some cyclicality maybe that percent potentially evolving to a lower level, but then being more opportunistic with a certain portion as well? A, is that an appropriate way to think about at least the directional conversation? And any color as to what that -- the use, if that is indeed the case, what would be contemplated as the use of that more opportunistic cash flow?

Yes. So what I would say is that's obviously part of the conversation. It's a decision the board will ultimately make and a discussion that we continue to have. So I can't give you a specific answer on that. As I said, it's part of the dialogue. With respect to the uses of additional cash, I think it would flow through the same framework, right? So obviously, we are intent on returning a good percentage of that back in terms of a quarterly cash dividend. Over and above that, we have opportunities, I think, to return cash to shareholders and create value through share repurchase. And so I think that basic framework would remain intact.

Okay. Great. And then just lastly, if I could, following up on some of the prior questions. I believe you said that the OSB price, your current OSB price is about $50 higher than what you registered in the second quarter. And you've indicated there is a lag, and so that must be capturing. But it's very, very substantial if you look at the Random Lengths OSB prints. I mean, they are north of $200 higher...

Yes.

Than where the second quarter average was. So not wanting to recognize predicting commodity prices is dangerous at best. But if we were to assume that the commodity prices stayed where they are for the next period of time. For the third quarter as a whole, can you tell us how much higher as the flow-through and the lag impacts effect where the OSB price and possibly the lumber price, where you might expect them to end up relative to the second quarter? So again, not trying to have you predict. But if we were to just keep the price where it is today, how that flow through would end up?

Yes. So without giving you a specific number, Mark, I think just the way to look at that is when we see the composite go up by that amount, our order files are out, particularly in OSB, a fair amount. So it typically takes -- it can take up to 3 to 4 weeks for that really to flow through to realization. So it's slower on the upside for that to hit the realizations. We eventually get it, of course. But on the same token, it's also slower on the downside. So I think as you think about our realizations relative to what you're seeing in terms of the jump in print, it's just -- it's going to be a lag of several weeks. There's also a lag in lumber, but that's going to be shorter just because the order files in lumber are typically shorter than OSB.

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

It's Derrick Laton on for Brian. Maybe just to build on a couple of the earlier questions on wood products. Certainly, with lumber prices at all-time highs, even mills, at the high end of the cost curve are profitable there. If I could just get your sense for -- your expectations for the supply response in lumber and even in OSB? We've seen a lot of curtailments in the last 6, 12 months. Are you expecting some of those to come flying back into the market now or maybe stay on the sidelines for a bit?

Yes. I mean, obviously, that's hard for us to say because each individual company has a better view on their individual cost structure. What I would say, just generally, and I'll speak from our standpoint, when you think about bringing lumber capacity back on, that's usually a much easier decision because you can bring that on incrementally. And you can sort of layer it in, depending on what's going on in the market, adding shifts, taking a few shifts out. That decision with respect to OSB is a bigger decision. Once you've decided that you're going to curtail a mill, from our standpoint, I think the way we would look at it is you're going to have to have more visibility on the sustainability of this improvement when you make that decision. But obviously, each individual company will make their respective decision. But I think, certainly, on the lumber side, most of the capacity has come back on to take advantage of this good environment for lumber pricing.

Understood. Okay. And then switching back to the Western logs. I appreciate your ability to be able to flex into the domestic market and take advantage of some better pricing there. I guess looking at the outlook for the third quarter, I guess my expectation would have been that you're expecting the realizations to be higher, just given flexing into the better domestic market. But I think it was expecting to be down a little bit. Maybe you could just help me kind of square that? And any other dynamics I might not be thinking about there?

Yes. And that's really just -- it's a mix question. So the domestic log prices in the West, we are expecting to go up in Q3. But just given that the Japan market is softened a little bit because their home sales has really declined a bit this year. So that's just creating a little bit softer market. So we won't be shipping as much to Japan. Similar statement with China, with the New Zealand and European salvage wood going in there, that's putting some pricing pressure there. So we will see better realizations for the domestic logs, but it's just the overall western business as a whole, you'll see realizations go slightly down just because we'll have less export volume in the quarter.

Your next question comes from the line of Anthony Pettinari with Citi.

You talked about the very strong demand in wood products and obviously curtailments coming off. I'm just wondering in lumber, OSB and engineered products, if it was possible to say kind of where your operating rates are currently? And to the extent that you have places where you're maxed out, are there opportunities for debottlenecking or maybe even more kind of extensive capital projects that might show up this year?

Yes. So in terms of operating rates coming out of Q2, we were in kind of the mid- to upper 80s, somewhere in that range, maybe even low 90s. OSB generally in the upper 90s; EWP, low to mid-70s. I'd say as we head into Q3, kind of going business by business. On the lumber side, there's a little bit that we can do here in the near-term, a few percentage to take advantage of the good markets. And we're looking to do that. In terms of the longer time horizon and debottlenecking, I mean, that's certainly part of every mill's road map is finding what bottlenecks you have in the mill and trying to eliminate that. So every year, we do pick up a little bit of volume, just through those efficiency and debottlenecking efforts.

On the OSB side, again, when you're operating in the high 90s, there's really not a whole lot left there, maybe low single digits in terms of opportunity in the near term. You don't have as many debottlenecking opportunities in an OSB mill. Oftentimes, it's the press or something right around the press that's the bottleneck, and that's a pretty large capital investment to really do that. So not a whole lot more upside on the OSB side. EWP, I do think that there's opportunity for a little bit more pickup there. And so we're looking at that. But again, that's really going to be dependent on what market conditions look like.

Okay. That's very helpful. And then just switching to the sustainability initiatives that you've outlined. Understanding it's a very long-term undertaking, could you just talk broadly about maybe the potential kind of financial opportunity for Weyerhaeuser if we actually had kind of a functioning carbon market? And just maybe more broadly, the importance of ESG for Weyerhaeuser?

Yes. So this is really exciting for us. We've had a lot of internal work going on around putting out this new strategy. I think it really reflects a commitment on behalf of the company to really double down on our sustainability efforts. And so I'm really excited about this. I think there are opportunities really across the board with this new sustainability strategy in terms of how we deal with our employees, our workforce, our communities. And so there's a lot more there than just the economic side. But on the economics and business side, certainly, I think as we look forward, there are couple of opportunities I would highlight, the first of which is mass timber/CLT that's a market that does seem to be picking up momentum. We've seen a number of projects come out. It's moving quicker than I had anticipated even 12, 18 months ago. And so that's a market, I think that will benefit the industry as a whole. More wood demand is obviously good. And I think there's a growing appreciation for the value of wood-based construction relative to other materials and building materials from an environmental standpoint. But specifically to the carbon market, I do think that this is an opportunity. You just have to look around the corporate landscape and most big companies have announced some initiative or another to be carbon neutral or even some trying to be carbon-negative. There really aren't any technologies out there that are better suited to take carbon dioxide out of the atmosphere than trees and forests. And so I think there is an opportunity over time. But the one thing I would caution is we're in the early stages of this. We need to figure out the mechanics for developing these markets, either private or public. It needs to be something that's beneficial to everyone involved in the process. And so we're looking at that. It's something that we're actively assessing to determine how are we going to create these markets. So I think we're in the early stages. But over the long term, I absolutely do believe this is an opportunity for us. And I think Weyerhaeuser has a role to play and something that we can really develop a nice business around.

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

You had some big changes, obviously, in market conditions this quarter. And I'm curious if the speed of those changes led you to find anything that you want to approach differently in operational excellence or new opportunities or shortcomings in IT, that sort of thing, whether there's opportunities to get more nimble or more efficient?

Well, I think in terms of how we've dealt with what is really an unprecedented level of volatility in our markets, I would say I'm just extremely pleased with how nimble the organization has been. Certainly, I think the investments that we've made over the last 5 to 10 years in information technology has made this whole transition to more remote working and changing business practices doable. I think if this had happened 10 years ago, this would have been a very much different and more challenging environment. So I think the organization has done...

And that spend wasn't very popular when you made it.

Well, IT spending never is, but I think for most people that have ever run a business, you know that if you don't have that infrastructure, it's very hard to be successful in a lot of different areas. So it's necessary, it's important. I think we're seeing the benefits of it as we speak and we'll continue to as we go forward. In terms of OpEx specifically, to my mind, the silver lining here is we have really, I think, demonstrated the importance of OpEx. I think the strategy is being further appreciated across the workforce, just the ability to continue to operate well, the cost structure, it gives you so much more flexibility when you have these market disruptions. So my sense is that there's an even greater appreciation for all of the OpEx work that we've been doing and the importance when you're going through some of these market swings.

That's super. And just a broader question. In the past year, we saw homebuilders struggling to find enough labor. Now you've got big markets like Houston with COVID issues. Are you seeing any of that sort of issue start to creep up? Is that part of the caution that you're thinking about?

Yes. I mean, I -- the labor issue hasn't gone away for certain. I think, obviously, the demand side has picked up over the last several months. And so I think the builders are trying to build as many homes as they can. But the labor issue that we've been dealing with for many years didn't disappear. It's still out there. I haven't heard the builders really talk much to us about COVID-specific labor concerns. I would imagine there must be some around the margins. It's not something that we've heard a lot about. But I think that is something that will continue to be a struggle is just finding enough labor to put up houses as quickly as the builders want to build them.

Our final question will come from the line of Paul Quinn with RBC Capital Markets.

Maybe just starting on Timberlands. Just wondering a couple of years ago, U.S. log exports out of the South to China were really picking up. Where is that market sitting? And then flipping over to the West, when do you expect that Japanese market and China, I guess, now to rebound?

Yes. So out of the South, we had been growing that market. I mean it was a really small piece of our overall business, but we had seen pretty strong growth on Southern exports of Southern Yellow Pine into China. When the trade war broke out and the 25% tariff came into place that really put a pretty hefty headwind in there. And so we had kept that market open just really at levels low enough that we could keep or levels that could keep the supply chain open. When the tariffs came off and when you saw radiata and the European salvage wood back off in Q2, we did ramp that back up again. Those logs do compete with radiata pine. They compete with the salvage wood to some extent. And so I think for the next few quarters, as we see those volumes kind of spike up again, we'll probably take our foot off the gas a little bit, but we're still shipping wood into that market. We anticipate continuing to do that. We're shipping into India again in small volumes, but those are markets, I think, in the near term, might be a little stressed from a Southern export standpoint just because of the European salvage wood. But over the long term, those markets are going to be good for us. I think there's a home for Southern Yellow Pine. We continue to develop a customer base. So good long-term market for us. Out of the west, I think the Japan market, the softness that we're seeing, it's really 3 things. It's the demographics. The population is shrinking in Japan. And so over the long term, that's not ideal for housing. But it's been a slow decline and our customers have held market share. So that in and of itself, I think we managed through. This year, it's just had the extra stresses of the increase in the consumption tax and obviously COVID-19 related disruptions. So I think it's going to be a tough year from a housing standpoint in Japan. I'm hopeful you'll see that start to come back similar to other economies as we move past the COVID pandemic. But again, it's still a good market for us. We're still going to ship logs there. It's just a little bit softer as all.

Okay. And then just on wood products. I mean you guys signaled that you exited Q2 back at pre-COVID levels of production. What do you think the volume pickup will be in lumber and OSB from Q2 to Q3?

Yes. I'd say in lumber and OSB, it's probably low single digits. As the quarter progressed, we brought that production back. And I think importantly, the mills ran remarkably well. The reliability that they -- reliability work that they've been doing over the last year or so is starting to yield real benefits. And so we were getting a lot of good production for every hour that we are operating. So I think it's low single digits. We'll try to take advantage where we can, but there's not a whole lot left there. I think on EWP, it's probably slightly more than that. But again, that will depend on what market conditions look like over the back half of the year.

And our last question will come from the line of Steve Chercover with D.A. Davidson.

I got booted off the call, so I was also out of the queue. So you did do a remarkable job on the cost side and manufacturing. So the first question is, do you think you can hold that progress stable in Q3?

Yes. I mean, the whole essence of our operating strategy, and it's wood products, but it's also timberland, it's the company as a whole, is we are working on OpEx in every nook and cranny of the entire company. And so it's become cultural. It's become the expectation. People throughout the company, whether you're in a leadership role or whether you're operating equipment in the mill, are looking for opportunities to improve. So I have every expectation that we will hold and continue to improve our cost structure going forward.

Terrific with -- that's what I was hoping to hear. So with that in mind and with the expectation of lower log costs and record high lumber and OSB, they're pretty much booked through the end of the quarter, I think. Do you think you can approach, meet or exceed the results you did in Q2 '18, which is the best of the modern era?

Yes. So I think it's a little early for us to offer that specific of guidance. I agree with you, we have pretty good visibility through August. I think September, we'll see. We're hopeful, but I think we're watching what happens post Labor Day pretty closely. So ultimately, I think we are going to have a good quarter, we're running the business well. The pricing and demand environment on wood products is strong. So that -- I think that bodes well for Q3 for sure.

Yes. Well, even the longest home run ball eventually comes back to earth. Okay. And then when we last chatted, we were discussing the risk of an air pocket in Q3, which is obviously not going to materialize. So I'm just wondering, do you think that fear gets pushed into Q4 or does the net benefit of pent-up demand and low housing inventory, low rates and recovering economy outweigh unemployment and produce net-net optimism?

Yes. So I think the air pocket that we were concerned with never materialized. I think just the really, really strong repair and remodel demand, followed by a quicker than expected recovery in housing, dealt with that air pocket. I think as you get into the back half of the year, the question is, one, what's going to happen with repair and remodel demand? How is that going to hold up? Is it going to hold up reasonably strong? Is it going to fall off? That's something that we're watching closely. And then I think as we think about housing into the fall and really even into next year, at some point is the high unemployment level going to start impacting home -- new home sales demand. And so that's an open question. Certainly, what we're hearing from the builders is there's a lot of demand there. So we're watching that closely as we're watching the macro conditions. But I think it's -- frankly, it's a little uncertain as to how that's going to play out later this year and into next year.

All right. Well, I think that was our final question. Thanks, everyone, for joining us this morning, and thank you for your interest in Weyerhaeuser. Please stay safe and healthy, everyone. Thank you.

Ladies and gentlemen, that will conclude today's call. Thank you all for joining, and you may now disconnect.