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Executives

Henry H. Ketcham - Chairman and Chief Executive Officer

Edward R. Seraphim - President and Chief Operating Officer

Larry S. Hughes - Chief Financial Officer and Vice President of Finance

Rodger M. Hutchinson - Vice President and Corporate Controller

Analysts

Mark Kennedy - CIBC World Markets Inc., Research Division

Sean Steuart - TD Securities Equity Research

Stephen Atkinson - BMO Capital Markets Canada

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Daryl Swetlishoff - Raymond James Ltd., Research Division

West Fraser Timber (OTCPK:WFTBF) Q4 2012 Earnings Call February 15, 2013 11:30 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. Fourth Quarter 2012 Results Conference Call.

During this conference call, West Fraser's representatives will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, but the accuracy of these statements depends on a number of assumptions and is subject to various risks and uncertainties.

Actual outcomes will depend on a number of factors that could affect the ability of the company to execute its business plans, including those matters described under risks and uncertainties in the company's annual MD&A, which can be accessed on West Fraser's website or through SEDAR, and is supplemented by the company's quarterly MD&As.

Accordingly, listeners should exercise caution in relying upon forward-looking statements.

I would like to turn the meeting over to Mr. Hank Ketcham, Chairman and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Henry H. Ketcham

Okay. Thank you, operator, and thank you, everybody, for joining us for our fourth quarter conference call. I just have a couple of comments to make.

First of all, as you noticed, the Board yesterday appointed Ted Seraphim to be our Chief Executive Officer and President effective March 1. I'll become Executive Chairman of the company. And what that involves basically is less day-to-day -- well, actually, Ted will be running the company on a day-to-day basis as a CEO would, and in fact, has been doing that over the past year or so since he was appointed President and Chief Operating Officer. So this transition has been in the works for a fairly long period of time, as has transition of our whole senior management team. So Ted has taken over a great team and my job in the future is going to be less day-to-day involvement. But the family and me are as committed as ever to continuing to help build this company and develop it. And most importantly, to continue to -- for, in my case, work with -- in fact, have an opportunity to work even closely with the employees in our divisions who have really built this company over the years. So my job will be more working with Ted on long-term strategic issues and hopefully, getting around to the mills more than I have been and reconnecting with our employees.

So with that, I simply want to turn the call over to Ted, who is going to handle it from here on.

Edward R. Seraphim

Thanks very much, Hank. Good morning, everybody. Joining us this morning is our CFO, Larry Hughes and that rest of our senior management team.

West Fraser earned $22 million or $0.51 per share in the quarter. EBITDA in the quarter was $76 million or 10% of sales. Adjusted earnings for the fourth quarter were $53 million as compared to $55 million in the third quarter.

Our lumber business generated $75 million in EBITDA, up 29% from the third quarter. Higher selling prices were the primarily contributor to the increase in earnings.

During the second half of the year, we completed a number of major capital projects in Alberta and the U.S. South.

On October 31, we completed the acquisition of a sawmill in Edson, Alberta for $30 million. We plan to build a planer and rebuild the sawmill in Edson this year. We have a significant capital plan for 2013, which includes a construction of 2 bio energy plants at our Chetwynd and Fraser Lake sawmills in British Columbia, the rebuild of the Chetwynd sawmill and the Williams Lake planer, as well as a number of large projects in the U.S. South.

Our panels business generated $12 million in EBITDA, down 52% from the third quarter. Lower plywood pricing in the quarter was the primary reason for the decrease in earnings.

The plywood market strengthened towards the end of the year. Our pulp and paper business generated $24 million in EBITDA, down 14% from the third quarter. Improving results in our NBSK business were offset by declining selling prices and higher power cost in our BCTMP business.

Capital expenditures in 2012 were $150 million. As mentioned, we have an ambitious capital spending program for 2013. We appear to be in the early stages of a U.S. housing recovery, as housing starts in 2012 were up 28% from 2011.

Our shipments to China remain strong. Our outlook for plywood and MDF markets is fairly positive, as demand for these products continues to improve. Pulp markets are expected to be under continued pressure, as new capacity ramps up this year.

I'll now turn it over to Larry Hughes.

Larry S. Hughes

Thanks, Ted, and thanks to everyone joining us today. For the fourth quarter of 2012, we reported earnings of $22 million or $0.51 a share. As we've done in the past, we adjust those earnings from non-operational items, which for this quarter, were the equity-based compensation charge and the U.S. dollar denominated debt, which on an after-tax basis, produced a $31 million favorable adjustment. As shown on Page 11 of our MD&A, this produced adjusted earnings of $53 million or $1.25 per share.

This result was in line with adjusted earnings for the third quarter of 2012 of $55 million or $1.27 per share. But there was a significant difference in segment contributions to those earnings. On a quarter-to-quarter basis, operating earnings for the Lumber segment increased 40%, while operating earnings for panels were off almost 70% and pulp and paper, off 23%.

We analyzed these changes in the MD&A, but the improvement in Lumber operating earnings reflected a surprising strengthening of lumber prices late in the year, while a weakening of Canadian plywood prices, which had been very strong in the third quarter, was the main contributor to the panels operating earnings decline.

For the full year 2012, our earnings were $87 million or $2.02 per share. As shown on Page 3 of our MD&A, adjusted earnings for the full year were $138 million or $3.22 per share. And that compares to $23 million or $0.54 per share in 2011.

2012 begun fairly weakly, as we recorded a loss of $17 million in the first quarter and overall results with lumber and panel as the main contributors improved as the year progressed. I won't go over the various adjustments, except to note that the equity-based compensation charge for the full year was $61 million, as the trading price of West Fraser shares increased almost 70% from the beginning to the end of 2012.

As at the end of 2012, our earnings sensitivity to $1 increase in our share price is approximately $1.7 million under the equity-based compensation.

Cash flows from operating activities in the fourth quarter were $21 million compared to $108 million in the third quarter, reflecting increased contributions to pension plans, as well as seasonal log inventory buildups in Canada.

Capital expenditures were $44 million. And in the quarter, we completed, as Ted mentioned, the acquisition of the Edson, Alberta Sundance sawmill and related assets for $30 million.

For the full year, cash flows from operating activities were $195 million, which was $110 million improvement over 2011, while capital expenditures for 2012 totaled $150 million.

We are expecting capital expenditures in 2013 to be in the range of $250 million to $300 million, which will include several major energy projects that are in progress and have been announced in addition to the rebuild of the Edson mill.

In Note 19 of our annual financial statements, we described loss carryforwards of $335 million relating to our U.S. operations, which are not currently recognized for accounting purposes. We expect to apply these losses against future U.S. earnings.

The quarterly revaluation of our defined benefit pension plans, which flows through other comprehensive earnings, resulted in a $47 million gain for the fourth quarter, as the discount rate increased from the third quarter and the actual return on plan assets exceeded assumptions.

For the full year, we recorded an after-tax actuarial loss of $52 million, mainly as a result of lower discount rates being applied. The after-tax actuarial loss for 2011 was $104 million.

In 2012, we made contributions to our employee future benefit plans of $64 million. And we expect to make payments totaling approximately $94 million in 2013.

Our balance sheet, as at December 31, 2012, remained very strong, with over $100 million of cash and short-term investments on hand, as we continue to build significant log inventories at our Canadian solid wood operations.

We ended the year with a net debt to capital ratio of 12%. Yesterday, after we had released our results, Moody's Investor Service announced that we had once again achieved an investment grade rating. This is an important milestone for the company from a cost of borrowing perspective and general access to capital, which is a very important issue in our industry. And we'd like to acknowledge the efforts of our over 7,000 employees in achieving this result. And in particular, I'd like to single out our hardworking treasurer, Maureen Kuper, for her work. Ted?

Edward R. Seraphim

Thank you, Larry. And now we're open for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question is from Mark Kennedy from CIBC World Markets.

Mark Kennedy - CIBC World Markets Inc., Research Division

First question, I guess. Just wanted to talk about your lumber realizations in the quarter. Because when I just run the numbers in terms of your lumber revenue divided by shipments, like I was only seeing about a $2 per 1,000 board increase from Q3 to Q4, even though your Edmonton [ph] lumber moved up quite a bit. So I was just wondering, could you just, maybe just give us some insight into what was happening in Q4 and how that might see some further progression as we move into Q1 in terms of the actual lumber price realizations?

Edward R. Seraphim

Yes, sure. Mark, I think when you look at the fourth quarter, I mean, there is a lag when you look at published prices versus the prices we realized. But ultimately, we saw a strong market. And as everybody knows, things continue to improve in the first quarter and we're seeing our realizations go up accordingly. So I think it was really just the lag impact.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then any update or status in terms of where your thinking is on your 2 idled mills in the U.S. South?

Edward R. Seraphim

Well, I think, we continue to review those operations. And as conditions warrant, we will consider whether we start up one or the other mill or both. But we're still looking at that and we continue to review it on a weekly basis.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And, Larry, just on the cash taxes front with some of these loss carryforwards and stuff in the U.S., what's a good sort of cash tax expectation for us to use for 2013?

Larry S. Hughes

I'm going to ask Roger. Roger Hutchinson's here, Mark. Maybe he can comment on that.

Rodger M. Hutchinson

Yes. Mark, we continue to estimate a cash tax at the B.C. statutory rate of 25% for the company. I think that's a reasonable estimate at this point.

Mark Kennedy - CIBC World Markets Inc., Research Division

Just before I go, Hank, I just want to say congrats on the transition. 28 years in the CEO role. You've done an excellent job and you've left some pretty big shoes for Ted to fill there as well.

Henry H. Ketcham

Mark, Ted is not going to have any problem filling those shoes, I can tell you.

Operator

The next question is from Sean Steuart from TD Securities.

Sean Steuart - TD Securities Equity Research

A couple of questions. Ted, I'm wondering if you can -- I just want to follow up on the mill net realizations at the sawmills. Can you speak to -- was there any hold back of shipments to the states at all towards the end of the year? I guess in anticipation of the export tax falling off in January and February. Did that factor into it at all?

Edward R. Seraphim

No, not at all. I mean, we run our business irregardless of our view towards export tax. I mean, we produce and ship every day, and so there was really no anomalies there.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And then on the CapEx program for 2013. I guess, the discretionary component of the big spend you're guiding to. Can you remind us of what return hurdles you're looking at for these projects, whether it be the energy projects or the rebuilds of the Sundance sawmill?

Edward R. Seraphim

Sure. I think our typical guidance for CapEx is about $150 million to $225 million, and our plan this year is to spend well in excess of that. And typically, if you look at our average paybacks in terms of projects that we talked about for the last couple of years and this year, we're really in the 3-year range on average. Some are lower. The energy projects are slightly higher in terms of payback, in terms of number of years. But on average, 3 years, I think, is good guidance.

Sean Steuart - TD Securities Equity Research

Okay. And then just finally, I'm wondering if you or Hank can comment on, I guess, what the acquisition landscape might look like for sawmills in the U.S. South in light the couple of deals we've seen in recent months. Is there much coming up for sale? Are you knocking on doors? How has that landscape changed at all?

Edward R. Seraphim

Well, I think, first of all, Sean, our company's goal is to continue to grow. We've got a lot of work to do with our -- the assets we've got here in terms of adding value. But we continue to look at growth areas. We're comfortable with the U.S. South. But we can't really speak about any -- what others have done or what we're looking at or not looking at. But we do want to grow the company, and we like the U.S. South. I think that's all I can say.

Sean Steuart - TD Securities Equity Research

Got it. And I'll echo Mark's comments. Congrats to both Hank and Ted.

Operator

The next question is from Stephen Atkinson from BMO Capital Markets.

Stephen Atkinson - BMO Capital Markets Canada

Question one, can you talk about the fiber mix in B.C., what's your fiber -- like how much beetle versus non-beetle and the status of the beetle? Or the beetle wood, I should say.

Edward R. Seraphim

Sure. I think, in British Columbia, I mean, we continue to face this challenging issue. And we are moving slowly into some greenwood, but we're still predominantly beetle kill in British Columbia. I'm not sure if that answers your question, but one of the benefits that we have of being -- over 50% of our lumber today is outside of British Columbia, and I think that's going to bode well for us as we go through these challenging times.

Stephen Atkinson - BMO Capital Markets Canada

In terms of the -- like I know you're doing a lot of work in the mills in the U.S. South, are you where you want to be? Or is there still a lot of work to do to optimize them, this being the existing mills?

Edward R. Seraphim

Well, we just started this capital program late in 2011 and we see this as really being probably a 3.5-year program. So by the end of this year, we'll be halfway through. The projects that we've done, we've been very, very pleased with them and that gives us the confidence to continue down that path. But we're still a few years away from being where we want to be, which is to have all our mills first, third top [ph], second quartile. But we think we'll get there in a couple of years.

Stephen Atkinson - BMO Capital Markets Canada

Okay. In terms of the U.S. South last year 2012, was the downtime taken? And I'm assuming that you'll be running virtually flat out this year.

Edward R. Seraphim

Well, our capacity in the U.S. South is about 2 billion feet. So we ran at about 75% of that last year, with 2 mills being down, as was discussed earlier. The rest of our mills pretty much ran full hours, with the exception of a few places where we had some minor log shortages during the year. And remember, we were doing a fair amount of capital spending last year, so that impacted our production as well last year. So we expect to incrementally improve our production in the U.S. So this year with our existing mills and, as we said earlier, we are continuing to review what our plans are for the other 2 mills.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And in terms of the pulp mills like, obviously you've done a lot work at Hinton, are you where you want to be?

Edward R. Seraphim

Well, I think, we've just completed all our Green Transformation Projects overall. We just completed the -- we just started up the cogeneration plant at Cariboo Pulp in the fourth quarter and also, our new chlorine dioxide generator started up early in January, and that was another good project for our Cariboo Pulp mill, our joint venture pulp mill. In terms of Hinton, I think we've talked about Hinton quite a bit. And we started to develop some confidence in terms of how that mill is running. That mill has run very well, really just from the middle of December until through February. So we believe we're going to get the results that we expected to get, but it's -- 2 good months of production is not a track record yet.

Stephen Atkinson - BMO Capital Markets Canada

No, but better than 2 bad ones.

Henry H. Ketcham

Yes. [indiscernible] Yes.

Operator

And the next question is from Paul Quinn from RBC Capital Markets.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Just a couple of questions. One, just on log pricing pressure that you're seeing, specifically whether that's showing up at all in the U.S. South? And then how that is affecting your operations in B.C. and Alberta?

Edward R. Seraphim

Sure, Paul. I think, we'll talk about the U.S. South first. Basically, log costs in the U.S. South are -- have really been flat for the last year, 1.5 year, and they continue to be that way. In terms of Alberta, log costs really -- our stumpage is based on the price of lumber. And really, until you're well over $400, $1,000, there's really no significant movement in log costs in Alberta in terms of stumpage. Of course, we're seeing higher contractor cost as -- throughout the industry. In terms of British Columbia, I think every quarter, there's an adjustment based on the market price and CPI and exchange rate, and we expect that to be about $2 in April. And then every July, there's a review of pricing based on B.C. timber sales. So we expect another increase in July as well in British Columbia.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay, that's great. And then just the plans for your new Alberta mill in terms of eventual capacity that you want to run there? And then a timeline on when that will come up.

Edward R. Seraphim

Sure. So we're looking at putting in a new planer, and that should be up and running early in the summer. And then we're going to rebuild the saw mill and that will be complete probably late third, early fourth quarter, or at this point, that's what we're looking at. And we'll -- our capacity that we've announced at that mill, we expect to be at about 180 million feet.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Great. And then just on China in 2012, it looks like Canadian industry stats would show that 2012 was pretty flat versus 2011. I wanted to know what that specifically, was that a volume gains for you in 2012? And what's the expectation for 2013?

Edward R. Seraphim

Well, I think just overall, yes, China was flat last year. Remember, it started out slow in the year. The first part of the year was fairly slow. So the second half of the year was quite strong. And Chris McIver could probably give you a better answer than I could, and he's on the phone if you want a bit more detail. But as we look at it, we see growth in China not growing at the rates that it did for the first 4, 5 years of our efforts in China. But we still see it growing at kind of a GDP rate. And the market continues to be strong for us. Our -- we did see growth in our shipments to China last year and we continue to see growth.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay, just a comment. Congratulations, Hank, on your retirement. And best of luck, Ted.

Edward R. Seraphim

Thank you. Thank you, Paul.

Operator

Next question is from Daryl Swetlishoff from Raymond James.

Daryl Swetlishoff - Raymond James Ltd., Research Division

Actually, all my questions have been answered. I will just pile on and congratulate Ted on his promotion and Hank on his retirement. Although Hank, it does look like you're tapping out just when things are starting to get fun.

Henry H. Ketcham

You're right about that. I'll be around.

Operator

There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Seraphim.

Edward R. Seraphim

Well, thank you very much, everybody, for joining us today and we'll talk to you next quarter.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.

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