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Good morning. My name is Jenney, and I will be your conference operator today. At this time, I would like to welcome everyone to the Potlatch Fourth Quarter 2017 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] .Thank you.
I would now like to turn the call over to Mr. Jerry Richards, Vice President and Chief Financial Officer for opening remarks. Sir, you may proceed.
Thank you, Jenney, and good morning. Welcome to the Potlatch’s investor call and webcast covering our fourth quarter 2017 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 Web site at www.potlatchcorp.com.
This call does not constitute an offer to sell or a solicitation of an offer to buy any securities or a solicitation of any vote or approval in connection with the proposed merger between Potlatch and Deltic. Stockholders of both companies are urged to read the joint proxy statement prospectus together with other important information that was filed by Potlatch and Deltic with the SEC, including a Registration Statement on Form S-4.
I will now turn the call over to Mike for some comments and then I will cover Potlatch’s fourth quarter results and outlook.
Thank you, Jerry. 2017 was a banner year for Potlatch. We generated $189 million of EBITDA, an increase of $64 million compared to 2016, resulting from strong lumber prices, record Idaho sawlog prices and solid execution by each of our three businesses.
Our Resource segment harvested 4 million tons, proactively locking in record cedar sawlog prices earlier in 2017 and the effect of strong lumber prices on our index log sales resulted in over $100 million of EBITDA in our Northern Resource business. Although, Southern Pine sawlog prices remained well below trend levels this year, we are encouraged by the increased pace of capital being invested in manufacturing operations in our southern wood baskets.
While it'll take time for these capacity additions to absorb the oversupply of sawlogs, the outlook for sawlog price improvement in our wood baskets is improving over the long term. As a reminder, our integrated model provides a natural hedge in the south. That's because our Warren, Arkansas sawmill consumes approximately the same volume of sawlogs as we sell from our timberlands in the south, and Warren's margins benefit from low sawlog prices.
Our wood products mills are operating very well and generated EBITDA of $80 million this last year. Our sawmills set production records in 2017 and did so with some of the best safety performance that we've ever recorded. We are seeing the benefits of capital investments made at each of our mills over the past few years, as well as productivity and cost initiatives driven by an outstanding workforce. Also our industrial grade plywood mill continues to generate good returns.
Our real estate segment continues to pursue opportunities to drive shareholder value beyond our regular recurring sales of rural recreational real estate. As an example -- an example was a large HBU conservation sale in Alabama for almost $2,600 per acre in the first quarter of 2017. The Minnesota rural recreational real estate market, which is the core of our recurring sales, remained very strong in 2017.
Turning to the balance sheet. Our cash balance increased almost $40 million this year due largely to strong lumber prices and we closed the year with $120 million of cash. We successfully closed $22 million of bolt-on timberland acquisitions and repaid $11 million of debt. We also returned $62 million to shareholders in 2017 in the form of dividends and we increased the dividend 7% in the fourth quarter.
Looking ahead to 2018, we anticipate U.S. housing starts to be approximately 1.3 million units and we expect repair and remodel markets to remain strong. With the favorable demand backdrop and duties on Canadian lumber imports to the U.S., we expect lumber prices to remain strong in 2018. Low lumber inventories in the field, challenges faced by customers due to transportation delays, improved weather in the south and a strong demand outlook have led to higher lumber prices to the start of the year.
We are also looking forward to closing the merger with Deltic Timber. We received antitrust clearance in the fourth quarter and the shareholder votes are scheduled on February 28th. We expect to close the transaction within a day of the vote.
As we've discussed previously, the combination will significantly increase the scale of the company. We will own nearly 2 million acres of timberland and we'll have about 1.2 billion board feet of lumber capacity, including the addition of two Southern Yellow Pine sawmills in Arkansas. We'll also add an MDF facility and a real estate development business to our portfolio. When the merger is completed, we will still be the timber REIT with the most leverage to lumber prices and we will be positioned well to benefit from improving U.S. housing market.
Potlatch will issue approximately 22 million common shares to complete the merger. To complete the conversion of Deltic to a REIT, we will also pay a special dividend in the fourth quarter of 2018, estimated to be $250 million. Of this amount, 20% will be paid in cash and the balance will be in the form of additional common shares. Excluding one-time cost needed to achieve synergies, we expect cash available for distribution or CAD per share will be modestly accretive in year one and we expect accretion of approximately 5% in year two.
We have identified operational improvements in synergies that will result in an increase in CAD of $50 million. These include increasing the harvest on Deltic timberlands, significantly increasing the capacity utilization of Deltic’s two sawmills, converting Deltic timberland into a tax efficient REIT structure and reducing SG&A. We remained confident in our ability to achieve these synergies. I’m excited about Potlatch Deltic’s prospects and expect 2018 to be another very good year.
I’ll now pass it back to Jerry to discuss the quarter and then we’ll take questions.
Thanks Mike. Beginning with page four of the slides accompanying this call, this morning we reported GAAP net income of $11.6 million or $0.28 per diluted share in the fourth quarter. Excluding amounts related to tax legislation and Deltic merger related costs, our net income was $25.7 million or $0.62 per diluted share. This compares to net income of $38.7 million before special items or $0.94 per diluted share in the third quarter.
Adjusted EBITDA was $49 million in the fourth quarter compared to $60.6 million in the third quarter. The sequential decline in earnings and EBITDA is normal in the fourth quarter and is primarily due to seasonally lower harvest volumes.
I’ll now review the results of our operating segments. Information for our Resource segment is displayed on slide six through eight. Operating income for the segment was $29.9 million in the fourth quarter compared to $41.8 million in the third quarter. While down sequentially due to normal seasonal factors, this was a very strong fourth quarter for the segment. To put that into context, Resource’s fourth quarter 2017 operating income was 32% higher than fourth quarter 2016. I will provide more color as I cover each region.
Turning to slide seven. We harvested 464,000 tons of sawlogs in the North in the fourth quarter. Northern sawlog prices declined 9% on a per ton basis in the fourth quarter. This was the result of heavier logs due to higher moisture content and a seasonally lower proportion of cedar’s logs in the sales mix. Sawlog prices were flat sequentially on a dimensional basis relative to record third quarter prices.
I will now turn to south on slide eight. We harvested 581,000 tons in the quarter. Sawlog prices in the south increased 6% due primarily to a more favorable mix of hardwood logs. The price of Southern Pine sawlogs remained flat quarter-over-quarter. Results for the Wood Product segment are displayed on slides nine and 10. Excluding mark-to-market amounts related to a lumber price swap, operating income was $19.6 million in the quarter compared to $21.4 million in the third quarter. The lumber price swap is now complete and we received $1.1 million of cash settlements in the second half of 2017. Our average lumber prices increased 4% in the fourth quarter, which partially offset the effect of 6% lower lumber shipments.
As Mike mentioned, our lumber mills set new production records in 2017. Total lumber shipped for the year increased almost 50 million board-feet to 737 million board-feet, and the segment generated $80 million of EBITDA.
I will now shift to our real estate segment on slides 11 and 12. Real estate’s operating income was $2.8 million in the fourth quarter compared to $1.4 million in the third quarter. The segment sold more acres in the fourth quarter as compared to the third quarter. The current quarter sales mix was more heavily weighted to recurring sales of Minnesota Rural Recreational real estate than the third quarter, which is reflected in the increase in the segment’s margin percentage.
Turning to financial highlights on slide 13. We ended the quarter with cash of $120 million. We have $249 million available on our existing revolver. We expect to close on a new $380 million revolving credit facility in a couple of weeks. Capital expenditures were $7 million in the fourth quarter. Total capital expenditures, excluding acquisitions, were $28.1 million for the year.
Now, I would like to comment on our outlook, which is summarized on slide 14. Note that these comments do not include any amounts related Deltic or the merger. We plan to harvest a little over 4 million tons for the full year with slightly more than the half of the total harvest volume in the South. Approximately 90% of the harvest in the North and 45% of the harvest in the South, including stumpage, is expected to be sawlogs.
We anticipate harvesting between 850,000 tons and 950,000 tons in the first quarter. We believe northern sawlog prices will be flat in the first quarter compared to the fourth quarter. Higher prices for hem-fir and Douglas-fir sawlogs, coupled with a slightly higher proportion of cedar sawlogs, are expected to more than offset the effect of seasonally heavier logs. We think southern sawlog prices will decline 20% in the first quarter due to a significantly lower percentage of hardwood sawlogs in the mix and a higher percentage of pine sawlogs in weaker markets. Note that the price of Southern Yellow Pine sawlogs remained flat in our wood baskets. Southern and pulpwood prices are anticipated to be flat in the first quarter relative to the fourth quarter.
At these volumes and prices, we expect resource operating income to be $20 million to $25 million in the first quarter. This will be meaningfully higher than the first quarter 2017 when the segment’s operating income was $15 million.
Turning to wood products. We believe lumber shipments will be just under $180 million board-feet in the first quarter. For the year, we expect lumber shipments for the four Potlatch sawmills to increase about 1% from the record level achieved in 2017. Lumber prices have gotten off to a stronger than anticipated start this year. Our forecast assumes that the average lumber price realized will be modestly up in the first quarter compared to the fourth quarter.
As a reminder, our highest quarterly lumber price realized in 2017 occurred in the fourth quarter and was $447 per thousand board feet. At these volumes and prices, wood products’ operating income would be about $20 million, which is more than the double the amount that this segment earned in the first quarter of 2017.
Shifting to real estate. We plan to sell a bit over 20,000 acres in 2018. We expect that approximately 70% will be rural recreation real estate and 30% will be HBU. We estimate that land basis will be between 25% and 30% of revenue for the year. In the first quarter, we expect to sell approximately 5,000 acres at an average price of $1,500 per acre. We believe that land basis in the quarter will be 30% of revenue. We estimate that real estate's operating income will be about $4 million in the first quarter.
Corporate expenses are anticipated to be just under $8 million in the first quarter, excluding merger related costs. We expect interest expense to be $5 million in the first quarter, which includes receipt of our annual patronage distribution related to our farm credit debt. Interest expense on Potlatch debt is expected to be $7 million per quarter for the second through fourth quarters of 2018. We estimate a consolidated annual tax rate of 10% to 15% for both the full year and the first quarter of 2018. This reflects the new lower federal corporate rate, as well as strong wood products’ earnings in our taxable REIT subsidiary. Had the new tax rate been in place in 2017, our income tax expense would have been $5.4 million lower for the year.
Capital expenditures are planned to be $5 million in the first quarter. This year is off to a great start and we expect first quarter 2018 earnings from Potlatch operations, excluding special items, to be meaningfully higher than first quarter 2017. This is primarily because current lumber prices are about 25% higher than they were at this time last year. We are excited to close our merger with Deltic, which we anticipate occurring within a day our February 28th shareholders votes.
That concludes our prepared remarks. Jamie, I'd now like to open the call up to Q&A.
Thank you [Operator Instructions]. Our first question comes from George Staphos with Bank of America Merrill Lynch.
Just a couple of questions in terms of what you're seeing in the supply chain right now. And I guess first, Jerry, you were talking about southern trend. What is driving the higher percentage of pine logs in weaker markets in the upcoming quarter, recognizing that the actual like-for-like pricing is staying flat? And can you comment on log decks in western markets, except that you have visibility on that. Where do they stand relative to what you'd see as a more normal level?
So couple of different ways to think about that. So let me take your last question first, which is log decks in the west. As you know, it was a really tough fire season in the Western half of the U.S. and even up in the DC. Those fires have crimp log supply to mills, and log decks are relatively low at mills. But not all mills are running with low log decks, some mills in northern regions of the U.S. have got log decks that are acceptable. But most log decks in the west are running with low log inventories.
I was going to ask a question, you probably can't quantify or answer specifically, but I'd give it a shot anyway. Would you say Eric that log decks are 5% on average lower than normal, 20% is there any way to size that from your vantage point?
I mean, it's all over the map, George. I mean, some mills -- our own lumber mill in St. Maries is fully wooded and should survive breakup just fine. Some of our Southern Idaho are running with low log decks and are not likely to make it through breakup. So it's really hard to characterize. It's a wide range and it just depends on the particular mill in the particular region.
I guess maybe win in that region, how are lumber inventories as well and then I'll weight on your answer on the southern mix issue as well. Thanks.
So lumber inventories across the supply chain, as Jerry had mentioned in his commentary, field inventories are relatively low. And that's a good part of the reason why you've seen a sharp run up in lumber prices here in Q1. Dealers were caught low inventories heading into the year, and we’ve seen firm demand, firm takeaway and an inability in particular Western mills to provide product to meet that demand response. And so consequently you seen prices run up.
So on your question regarding the mix in the South, what I’d say is that that’s really just due to normal seasonality. Hardwood sands tend to be in lower elevation areas. And when you get into the wetter months, it’s harder to access those sands just because there is a lot of water on the ground. So normal seasonality is a hardwood as a percent of the mix will be in the 3% to 5% range and maybe Q1 and Q2, and then as it warms up it dries up outside, it will turn to 15% to 20% as you get into Q3 and Q4. So really nothing other than the normal seasonality.
Our next question is from the line of Gail Glazerman with Roe Equity Markets.
I guess, can you talk a little bit about the softwood lumber agreement, just how you see current negotiations and litigations potentially impacting the market, as well as maybe any volume patterns you’ve seen out of Canada since the summer when the duties fell off and then since they come back on?
As you know, the tariffs are in place. Canada is pursuing an appeal process through dispute resolution process under chapter 19 in NAFTA. I take negotiations between the two countries I think really have been sidelined to a large degree, while Mexico, Canada and the U.S. all try to work on a bigger NAFTA deal, which lumber is not part of NAFTA. So I think for the foreseeable future as we see it, we expect the tariffs and duties to stay in place for the bulk of this year.
Having said that, we still support a negotiated settlement based on market share in each country, we think long-term that’s the best outcome. In terms of trade flows, as maybe a result of lumber market not so much the tariffs I think. We seen a little bit more on lumber from Europe, and that’s not an alarming amount, that’s to be expected when pricing gets stronger that typically lands on the Eastern Coast, not so much the Northwest or Inland, U.S. And the supplier response from Canada has been pretty stable. There hasn’t been any big spikes up or down, it’s been pretty steady.
And can you give any perspective on some of the strength in lumber and not your logs of Western logs. How much of that in 2017 do you think was reflective of extreme weather relevant versus just underlying supply-demand than if we had a more normal weather pattern as this year plays out those log decks get stocked. How do you think that would impact lumber pricing?
I’ve been thinking about this question of strength in lumber pricing as we head into 2018. And certainly that’s something we’ve all been thinking about how big of an impact did the fires have on 2017 prices. What I can tell you is that I think about it, there is lots of reasons for lumber prices to move higher. There is firm demand. New housing starts are moving higher and increasingly the mix is towards single family versus multi-family; repair and model is strong; commercial industrial is strong; field inventories are low; the duty issues now been resolved to 21%, continues to be firm Chinese demand in takeaway.
ERA put out a report recently that showed new capacity installs is roughly 2 billion board feet a year whereas demand is growing 2.5 billion board feet a year. Canadian production, frankly looks like its peaked with the pine beetle issue in the west and the allowable cut issues and residual issues in the east, so Canadian production appears to have peaked. So capacity utilization in the industry is, frankly it’s inching higher. So those are all positive factors that support lumber prices. The negative factors are Mike mentioned the increase in imports so we’re starting to see from Europe, it’s still small, it’s maybe a half of billion a board feet a year, but it is starting to show up at these higher prices. And then we get back to a normal fire season.
I look at the positives driving markets higher and I compare issues that could cause prices to move lower. And frankly, the positive factors far outweigh the negative factors. So I think lumber prices are well supported here and our outlook is for modestly higher prices in 2018 versus 2017.
And just can you give any update on the specific new projects or news on any major projects in your wood basket that we should be following this year?
Well, there is Eric can add some more to these, he’s looking at a list. But the ones that are top of mind are certainly in El Dorado, Arkansas in the Conifex mill, there’s a restart of an old GP facility that’s been underway for a couple of months. And that’s important to legacy Potlatch and it clearly is a benefit to the new company going forward, it’s in the heart of the Arkansas ownership. That’s probably number one on the list. We’ve also got saw mill in Newton, Mississippi and other one in Alabama that are fairly new start ups now coming on several months behind us, but those are going well and we’re delivering logs to those facilities. So there is a number of key locations. And Eric I don’t know if you want to add any.
Gail, I would just add Interfor announced that they’re exploring a new mill somewhere in the South GP, the same thing Rex Lumber somewhere in the Southeast. I mean, it’s almost like every other day there is a new announcement of new capacity. And then our three primary wood baskets Mississippi, Alabama and Arkansas, there is a total of 20 projects to 25 projects that are going to increase demand 10 million tons a year over the next few years. So they’re very large, very meaningful and just -- there's just a host of projects underway. So we’re excited and we’re bullish.
And does that 10 million tons include pulpwood and specifically the [Sun] project?
Yes, it does. It includes both of those.
And do you have any sense of visibility into [Sun] as how probability of that will come on in the next few years?
Well, we don’t -- all we get the anecdotal reports like everybody else. And what we hear is that they are definitely moving forward and they’re pushing forward with their permits. They’ve decided to not pursue fluff pulp, but that’s fine. They’re still pushing forward is kind of the word that we’re hearing.
And just to reiterate that 10 million tons that I threw out, that’s roughly 5 million of sawlog and 5 million of pulpwood demand.
Our next question is from Ketan Mamtora with BMO Capital Markets.
There is about 10% reduction in your forecast of harvest at Deltic versus what they were pointing to earlier. Can you provide for us some sense or color on what drove that drop because we’ve been expecting a pretty big ramp up for the next two to three years? Just any color or sense you can provide on that.
Did you say, will the impact of the Deltic harvest to Potlatch?
Yes, but that was in the prospectus they have provided their internal forecast, your forecast of their harvest, are both 10% lower in '18, '19 and '20. So I am just curious what drove that?
We'll have to get back to you and compare the numbers offline, I think off the top of my head, Deltic had a more optimistic outlook for pulpwood production and sales, and it's a very low margin product as we know. We are not as optimistic about that as they were in. So I think that's probably the key difference that you're going to see in the pro formas.
And then just turning to real estate. I mean are you seeing the stronger economy and stronger financial markets are creating any increase in interest for rural recreational land. And if that's the case, where is the interest strongest?
Well, I would say Ketan to address the second part of your question first. The interest is the strongest in Minnesota. You've got the twin cities with relatively high household income levels and the relative inaccess or inability to access lands to recreate on compared to the west. For example out here there was a lot of open land for people to recreate on, that’s government owned land that doesn't cost too many thing. So the demand is the strongest in Minnesota.
And to answer the first part of your question, yes I think at these higher consumer confidence levels with people's 401(k) running sharply higher, I think demand for rural real estate is very strong. That said, we're going to continue to meet it out over time. We don't want to flood the market with property and compete against ourselves. So that's how we think about it.
And then turning to cedar market. Any thoughts or color on what you're seeing there and thoughts on 2018 prices?
Yes, so cedar prices have softened a little bit from the sharp run up that we saw last year, prices have rolled over a little bit, Q3 to Q4 they were down 3%. We expect a little bit further softness as we move into '18. And it's pretty clear to us that at these higher prices, cedar is coming out of the woods, so to speak, these higher prices are stimulating additional supply and it is putting some pressure on prices. I wouldn’t say its material, because these are still incredibly high prices that we're enjoying, but they have rolled over a little bit.
And then just one last question on lumber production over at the Deltic sawmills and correct me if I’ve got my numbers wrong. But I have been thinking that the target is to increase production from 275 million to 375 million board feet. And so what is the timeline that you have in mind on that? And in your view, how difficult will it be to prove that because we've been hearing reports on availability of skilled labor, regional preferences and those kind of things. So just any color around that.
So you're correct. Our goal is to get their mills up to 375 million feet and we expect to get them there by 2019, we don't see any issues with that. As it relates to 2018 levels, we'll probably be in the 360 million feet range, so we'll be just a little bit under our goal for where we expect to get in 2019. Part of that increased production is simply the installation of new equipment and new kiln going in at their Waldo sawmill.
And certainly part of it is more man hours of labor, more hours running the mills. And so far if you look at Deltic’s historical results, they frankly were on a path to increase their production themselves. And they went from about 270 million feet in 2016 to roughly 300 million feet in 2017. So they are finding the labor, put it that way, and we expect to find the labor as well.
One other thing Ketan that you touched on was substitution of CCs. And we certainly have read reports and are seeing anecdotally through our sales force. In fact, I heard a story from our VP of sales within last week that we’re shipping Southern Yellow Pine into LA. So we’re certainly seeing what being shipped more broadly than it would have been traditionally.
Our next question comes from the line of Chip Dillon with Vertical Research.
First question is just on the Northern log prices. When I look at the slides, I mean, it was a really good year last year and I know for a variety of reasons. But could you give us some help as we look out to ’18 and ’19, it would seem like some of the forces that have helped you are going to continue, especially with Canada having peaked perhaps for a very long time. And I suppose even some influence from Asia is impacting that. Notwithstanding the fact that you are on the Far West Coast, but it probably had some ripple effect. Could you talk a little bit about what do think what you saw in ’17 is sustainable?
As I spoke about a minute ago, we’re still bullish on lumber prices in 2018, modestly higher prices, that’s particularly true in the west where especially you’re seeing mills have to curtail production volumes due to low long decks. So we do think western prices are well supported here. As you know, our Northern sawlogs are by enlarged indexed to lumber prices. So those higher lumber prices should translate to higher sawlogs prices. We will see a little bit of mix effect in 2018, little less cedar production and a little bit more hem-fir doug-fir production. Those two factors will offset each other, but we do expect slightly higher prices.
And on that indexing, any time point we should be aware of as to when those contracts might get renegotiated, not that you should tell us how they get renegotiated on an open line. But is there any date where the preponderance of them getting renegotiated or are they very, very long term?
Well, three years generally is the term of the agreement. There is an evergreen clause that after when one year goes by and there is two years remaining on the contract, it’s an evergreen renewal. Each parties allow to approach the other and discuss the terms of the contract, and if both parties disagreed then the contract expires in two year. But it comes up every summer I believe and we’ve had no issues renewing it.
And then I know you gave us an 8 million number for corporate expense, but there is I believe some volatility around where the stock goes for incentive compensation, executive comp. And the stock is up a bit from the beginning of the year. And so I don’t know if you incorporated where it moved to say through yesterday? And maybe just remind us that is that 8 million sustainable once you close on Deltic? And if not, what a good run rate to use along with what should we think about the sensitivity in the new regime with the stock price on compensation front?
In terms of that 8 million, we have factored in the recent move in stock price it has to be a more significant move before that dollar effect was more significant. I think the reason -- so we had $10 million of corporate expenses in Q4 of ’17 versus the 8 guide for Q1, large reasons why that’s down is we were at the maximum on our bonus in 2017, given our very strong performance. And we don’t adjust that, we accrue at target if you will until we get enough of the year under our belt and then we potentially adjust that later in the year. So that’s probably the biggest delta.
The other thing I’ll comment on is that $8 million is probably a reasonable Potlatch standalone run-rate. We’ll come back and provide combined company guidance once we close this merger, and probably do that on our first quarter earnings.
And then last question, I guess for all three guys. When we look at -- I know it’s very early days, but we’ve seen a pretty meaningful lease off the base move in the 10 year long-term treasury rate. I don’t know if that’s having any influence, I mean 50 basis points isn’t huge. But is it had any influence in terms of what you see in terms of what private timberland transactions are going for at least in terms of the discount rates you used?
There have been so few transactions in the market certainly since we’ve seen a increase in the 10 year that we don’t have any evidence to answer your question either way. I wouldn’t -- you’ve got a mismatch there of maybe a little bit. This is very long-term asset class and I suppose there could be some pressure on discounted rates. But I think it’s pretty small.
And on that point, just could you tell what the supply situation is in terms of lands for sale. Do you find it to be as you look back over the last 10 years, Mike? Is the amount out there for sale tend to be more dried up or is it more increasing or about how do it normally is?
I would characterize it as the larger transactions that have been happening, I think have been lower quality transactions in terms of -- there has been complex supply agreement surrounding the deals or geographies that aren’t as attractive. The smaller transactions that are in the 25,000 to 50,000 acre range, I think have been very good and price as well, just speaking largely of the south here. So there hasn’t been as much for sale recently as maybe there -- I think the market expected originally, so I think it’s been fairly quiet.
Our next question is from the line of Mark Weintraub with Buckingham Research.
Just following up first on the last question that Chip was asking, there really doesn’t seem to have been all that much activity in terms of the markets at least relative to some of the talks that there’d be a number of key modes where their funds were coming through the end of their 10 year lives or what have you. Do you have any color as to what maybe going on and why there have been it seems fewer parcel or larger parcels coming on?
Well, there is a number funds that have matured, Mark, or are maturing. I think the team I was typically carving off 25,000 and 50,000 acre pieces and selling them rather than selling 250,000 acres at a time. That seems to be a trend that has occurred. But beyond that, I really don’t have insight to offer.
And then second, you have experienced much stronger earnings growth than any of your timber REIT peers, I mean in no small part because of your exposure to lumber. You did raise the dividend 7%, which is certainly consequential but it tails in comparison to what your earnings growth has been. You talked about how at least in the year ahead the dynamics for lumber remain very favorable. At a certain point in time, how do you think about when you get more comfortable using the manufacturing profitability to justify perhaps getting more aggressive on the dividend?
Before I answer that, maybe let Jerry just briefly step through the capital allocation steps this year. There's a number of important outflows that are going to happen.
So to pick that up, Mark, as you know, we closed the year with $120 million of cash on the balance sheet. And in terms of these outflows that Mike is touching on first, we have about $20 million of merger costs that we're going to pay and then about half of that is transaction specific and the other half is cost to achieve synergies. We also have a special distribution that we expect will be paid in the fourth quarter of 2018. Total amount is $250 million, of which $50 million or 20% is cash, so that's cash that we'll go send out. And then we also have $14 million of debt that’s maturing this week actually that we are planning to pay off.
So when you add that up, that's a chunk of the existing cash that earmarked for specific purposes. And to your point, cash generation remains strong given robust lumber prices. And certainly our platform increases when we close this merger, but that's probably well. I'll turn it back to Mike and let him comment on dividend and how we think about that.
The takeaway or the summary I’d offer you Mark and we'll revisit this later in the year after we get some of the Deltic's merger issues under, behind our belt. I think it's fair to say the southern log prices are going to be lower for longer. I think there's a plethora of information and data that supports that. Fortunately, I think and one of the strategic issues that we did the merger with Deltic was we've got a natural hedge with Southern Yellow Pine Manufacturing between whether the trees go to a sawmill or the trees are sold in the open market. And we can capture the return, not only in the Warren sawmill but the additional two Deltic sawmills at Ola and Waldo.
The only leakage we really have from that is just tax leakage in the TRS. I think as we get more comfortable with that, have more capacity in the south, I think the board will gain confidence that the dividend doesn't have to be just to be supported by timber prices, it can also have a leg that supported by manufacturing because the southern manufacturing is very different than the western manufacturing where we're more hedged in the south.
And then I possibly should know this, but when you do the Deltic transaction, does that change your integration level from saw timber through lumber meaningfully or are you still fairly integrated in the south of Deltic?
No. So Mark, this is Eric. So we'll still be -- we'll still have that natural hedge. Post closing with Deltic, we'll consume about 2.4 million tons a year across our three southern sawmills and we'll be producing about 2.1 million tons more or less sawlogs across our combined ground. So we'll be pretty naturally hedged, going forward.
And so actually a modest net buyer of sawlogs, if I understood correctly?
That's correct.
And just one -- just follow-up. I think you’d also mentioned that Deltic sawmills that produced 300 million board feet in 2017. And did you say you're expecting about -- I guess at this point they were expecting about 360 in 2018?
That’s our plan is to get them up to roughly 360 million feet for the year.
And then just lastly, on the $50 million of improvements in synergies, et cetera, you had highlighted the sawmill optimization as a part of that. So clearly, you get some benefit from increased production. Is there also meaningful cost reduction related to the equipment that you’re putting in. And if so, can you quantify how much of that $50 million is related to the cost side of the sawmill optimization?
What I would tell you Mark is that, while certainly there is going to be opportunities for us to save cost across a variety of areas, whether it’s purchasing supplies or implementing safety programs or implementing capital projects, there is going to be opportunities for us to leverage our greater size. We have not tried to capture those benefits into the $15 million number.
Our next question comes from the line of Steve Chercover with DA Davidson.
My first question is on plywood. And I recognize that you’re not huge in it, but I was hoping you could give us some perspective on the strength and whether perhaps you’ve seen an abatement in the amount of volume coming in from South America?
Steve, this is Eric. Our industrial plywood business is showing signs of strength. One of our competitors is having issues and demand is very firm across all of our markets, whether its furniture, RVs both, you name it. They are doing good business, so demand is firm and pricing is good. The fire is in the west, have curtailed production from some of the Western mills further enhancing the opportunity. So markets are good. And I’ve not heard anything notable about an increase of imports from South America. But given these higher prices that we’re seeing, I wouldn’t be surprised if it has been creeping higher.
And then I recognize you don’t really want to talk about Deltic. But for modeling purposes, is the best way to view the real estate component of Deltic as flat to up. Or was there anything we should be aware of down in Arkansas that local might not know?
The only thing that I would say, Deltic has been doing a solid job with its Chenal Valley development. The one opportunity that we saw in all of our due diligence work was that Deltic historically is not stratified its acreage like us and the other limber REITs have been stratifying and hiding off acres out of a timber state over to a real estate play. We will be implementing that program across the Deltic acreage. So we do expect to see some amount of real estate sales that we classify as rural or HBU that they have not been doing historically.
There is no holding period or anything that is part of equation as it comes into the REIT. I guess it’s just sold off through the TRS at the new lower corporate tax rate?
Yes, you are correct, Steve in that, that when we stratify acres, they’ll be in the TRS and it will just be normal TRS business. So there is no constraint or built in gains or other holding period requirements.
And final question from me. Is it safe to assume that Deltic’s two saw mills in Arkansas are similar to what you’ve got at Warren in terms of margins and product?
Well, they’re all a little bit different. Their Waldo mill is probably the most similar to our Warren mill. Their Ola mill is really not quite same, it’s more timbers than anything else and we don’t produce timbers today. So they’re a little bit different but they’re all in good wood baskets and producing healthy margins.
And to add one thing to that Steve, the one thing it does it really rounds out our product line as well. So Eric talked about timbers but also MSR. And so I think that’s something that I think will be very attractive as we go to market.
Yes, Waldo does produce a higher MSR -- well they produce MSR, we don’t produce MSR today, but we have comfortable product called select struck. But it will run our product offering, which should be good for our customer base.
Our next question comes from the line of Paul Quinn with RBC Capital Markets.
Just had a couple of questions, starting on the timber side. Trying to understand the effect of the higher log weights, and it sounds like it’s offsetting the price increase that you’re seeing quarter-over-quarter. So how much of an effect is that have to your logs in Q1?
Yes, it’s roughly 6% to 7%, Paul, Q3 and Q4 are the heaviest months where the logs are the most dense. So all things equal, it has a 6% impact on Q4 and another 8% in Q1. So you’re in that zip code. And then you see a reversal of that as you get into Q2 and Q3 as you get into the dryer month. So the swing should be in the 6%, 7%, 8% range.
And then when I look at the guidance on timber harvest for 4 million tons in ’18, that’s pretty much flat over ’17 but you did 42 in 2016 and 44 in ’15. So I’m just wondering why the harvest is coming down? And is that because you’re going to I guess maybe be a little more aggressive in the Deltic and you’re trying to see some management for that side, or do you just not have the trees?
Paul, so it’s not an issue of not having the trees. When we were at 4.4 million tons, recall we had Central Idaho in the mix. So we sold Central Idaho so we lost about 200,000 tons a year from that. We did plan on harvesting about 4.15 million tons in 2017 and we did come in a little late, a little over 4 million tons. And what’s happened to us in particular in the north is trucking has gotten pretty tight. And today we’re hallowing pulpwood at virtually no margin and we’re hauling chip in saw at maybe $10 ton margin.
We’ve decided to take those trucks that we’re hauling no margin pulpwood and low margin chip and saw, and have them haul high value saw logs. So that effectively has cost us 750,000 tons more or less from northern production. And I think you’d agree at these strong margins we’re seeing in our sawlog business that that was a wise decision to do that.
Now in the south we’ve got cost with mills being relatively full towards the end of the year. And as we’re in Q2 and Q3, there is pretty wet weather in the south, as you may recall. So we got behind on logging. And then as we got into Q4, we were going to make that volume up, and we got caught with mills being full and we decided do not show logs into an oversupplied market. So we kept volumes held back a little bit. But if you think about it, our guidance range has always been 3.8 million to 4.2 million tons per year since we divested the Central Idaho timberland. So at 4 million tons or 4.1 million, we're in the zip code of where we want to be.
It sounds definitely like you're in the zip code, but it sounds like the way you described that you're constrained in the upside. I think I was at a conference last week in the most of the timber owners in the Pacific Northwest just sitting down and we’re describing the potential of the rates harvest, 5% to 10%. You still got that ability, right, it's just -- is it manpower that's constrained right now?
No, I mean I think we just don't want to jerk our volumes around, it's tough to manage the business, it's hard to manage the loggers and haulers when you're plus 10% minus 10% year-over-year. We like our volumes to be relatively steady year-to-year. And we have a long term harvest plan, we want to operate sustainably, and that's how we run the business.
And then just a question on the -- I think Jerry, I think you were saying that lumber income would be 20 million in Q1 if lumber prices stayed at what you forecast or at current pricing?
So the clarification Paul would be at Q1 forecast.
And how high -- how much higher are current prices in Q1 forecast?
Well, to give you a sense of it, we had a modest improvement quarter-over-quarter, Paul, in the single-digit -- very low single-digit percent range. So random lengths finished Q4 at $436 and last print I saw was $471, so it's 8% higher than the Q4 average. Now that's just one point in time, right, I mean random lengths bounces around a lot, it's incredibly volatile as you know. So our own forecast is not for an 8% increase, which is where random lengths is today relative to Q4, but for something more like 1% or 2%.
So if we look at a benchmark for – or one of the benchmark prices in random length, what fits well with you guys? Does that benchmark actually -- the comp composite, does it fit your lumber profile overall?
I don't know that there's any one deposit that you can look at. I mean, random lengths is probably as good as any, because it captures a broad mix but random lengths won't have the heavy component to studs that we have and random lengths won’t have economy, which we have. There really isn't one index. And I suppose if you want to get your hands on western, you can look at the -- WWPA has an index for western and hem-fir you could look at, but that's just western. And you could look at, I suppose, Great Lakes studs, SPF to get your arms around that and then maybe Southern Yellow Pine two by six might be the benchmark.
I am looking at all that stuff and it all seems to be up a lot higher, do I ask the question. Maybe the other question I’ve got is that given that you’re about to acquire Deltic, do you think you move closer to that random link composite that seems like something that would be with the addition of two more mills in the south?
That could be the case. One of the things, it's a real drag on us compared to these benchmarks that you referenced. Our stud mills produce a lot of economy grade lumber and it has not moved up in price over the last several months. And so that's a drag on our results compared to the broader market. So adding the Southern Yellow Pine mix from the south into it will mute that effect a little bit. So we ought to approach the benchmarks a little closer.
There are no further questions, at this time. Gentlemen, are there any closing remarks?
Well, I just want to thank everybody for your time today and look forward to catching up as we move forward and close this merger. So that is it Jenney
Ladies and gentleman, this concludes today's teleconference. You may now disconnect.