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Executives

Henry H. Ketcham (Hank) – Chairman, President and CEO

Gerry Miller - Executive Vice-President, Finance & Chief Financial Officer

(Unidentified Company Representative) [Ted]

Analysts

Paul Quinn – RBC Capital Markets

Pierre Laquerre – Dasar Dan Securities

Daryl [Schefasof] – Raymond James

Jonathan Lethbridge – CIBC

Sean Stewart – TD Newcrest

Richard Skidmore – Goldman Sachs

West Fraser Timber Co. Ltd. (OTCPK:WFTBF) Q2 2010 Earnings Call July 23, 2010 11:30 AM ET

Operator

Good morning Ladies and Gentlemen. Welcome to the West Fraser Timber Company Limited Second Quarter 2010 Results Conference Call.

During this conference we 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 a subject to various risks and uncertainties.

Actual outcome with depend on a number of factors that could affect the ability of the company to execute its business plan. Including those matters described under risks and uncertainties in our annual MDNA, which can be accessed on our website or through [inaudible] as – and as also by our quarterly MDNA’s.

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

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

Henry H. Ketcham

Thank you, Operator, and good morning. And thanks for joining us. Welcome to West Fraser Second Quarter Conference Call.

Gerry Miller our Executive VP and CFO, and I will go over our second quarter results. We also have certain members of our senior management team joining us on the call this morning.

We’ve posted a summary of our Q2 highlights and financial results to our website, which you can access at your convenience.

Earnings for the second quarter were $63 million compared to $20 million in the first quarter of 2010, and a loss of $39 million in the second quarter of 2009.

EBITDA was a $151 million which resulted in a 20% EBITDA margin. All segments contributed to our earnings in the quarter. The significant improvement in our results can primarily be attributed to relatively strong pricing for virtually all of our products in the first half of the year.

In addition, we ran our Canadian saw mills at 98% of capacity throughout the first half of the year, allowing us to benefit fully from the short-but strong rally in lumber prices in the past two quarters.

As a result of our strong cash flow in the quarter totaling $207 million, we were able to significantly reduce our net debt, renew our capital spending program and pay our regular quarterly dividend.

West Fraser is the only publically-traded Canadian forest product company that has paid consecutively-quarterly dividends since we went public in 1986.

Our lumber operations performed well during the quarter. Lumber production at our Canadian mills was up 4%, versus Q1. Production at our U.S. division improved by 32%, versus the first quarter due to dryer weather, which improved log availability throughout our operating areas. This division ran at about 75% capacity in the quarter.

Our lumber division EBITDA was $75 million compared with $66 million in Q1. Our EBITDA margin was 16%. SPF lumber prices were actually down 2% in the second quarter versus Q1, but up 52%, versus the same quarter in 2009. Southern Yellow Pine prices were up 17% in the quarter versus Q1, and up 53%, versus Q2 ’09.

Even with sharply declining lumber prices towards the end of the quarter, we were still able to maintain our inventories close to our desired levels. As a result of relatively high lumber prices in Q1 and early in Q2, the BC lumber export tax rate declined to 10% in May and to 0 in June, versus 15% in the first four months of the year.

In Alberta the tax dropped from 22 ½% in April to 15% in May and 0% in June.

Lumber shipments from our Canadian mills to China increased by 31%, versus last quarter. In the second quarter we shipped 18% of our Canadian lumber off shore, primarily to Japan and China. This compares to 15% in Q1 and 12% in Q2 ’09.

The mountain pine beetle continues to be a very serious issue for our industry in the interior BC. The quality of timber continues to decline, which has an affect on both great outturn and lumber recovery.

The beetle is established itself in certain parts of Alberta as well. Industry and Provincial government are working together to aggressively to fight the spread of the attack in that Province. It’s too early to predict whether our efforts to retire the spread of the beetle in Alberta will be successful.

Our panel operations also ran well in the quarter. EBITDA for this division was $20 million, and the EBITDA margin was 19%, versus 11% in the previous quarter.

Ply wood production was up 8% in the quarter, and prices increased 14%. We experienced a fairly serious fire at of our MDF mills in the quarter, which resulted in a 23 days of down time at that facility. As a result MDF production was down by 2% for the quarter. MDF prices were up by 13% in the quarter.

In our Purple Popham Paper Division, EBITDA was $49 million, versus $40 million in the first quarter. Our EBITDA margin was 22%, versus 19% in Q1.

Pulp production was down 9% in the quarter. We lost 36,000 tons of production due to regularly scheduled maintenance downtime at three of our pulp mills. Benchmarked pulp prices were up 13% in the quarter and 54% versus Q2 ’09.

As we’ve reported previously, we’ve been awarded $88 million of green transformation fund credits. We have approved certain high payback projects for these funds and will approve good pay back projects for the remainder of these funds in the coming months.

Our Eurocan Linerboard and Craft Paper Mill was closed in the first quarter of the year. We’re in the process of disposing of the assets and cleaning up this sight. The major expenses for this operation are behind us. Lumber prices have declined sharply from the levels achieved in the second quarter.

Housing starts are still at very depressed levels and the inventory of unsold homes in the U.S. is very high. Until the housing inventory is worked down to more normal levels, we should not expect a sustained improvement in lumber prices.

Chinese pulp demand is weakening and this will cause pulp prices to be under pressure in the third quarter. Worldwide pulp inventories are still quite low, so if the world economy continues to improve we could see renewed strength in pulp pricing in the, not-too-distant, future.

Now I’ll turn things over to Gerry Miller to discuss our financial results.

Gerry Miller

Thanks Hank. And good morning.

I’ll refer, firstly, to the earnings statement. Sales increased 12% from the previous quarter with sales in each of the three segments recording increases as results of higher prices and increased shipment volumes.

Selling general administrative expense was $17 million in the quarter, compared with 38 in the previous quarter, and 28 – or 24 million in the second quarter of last year. The reason for the lower swing is mainly, related to our equity-based compensation plans, which as a result of changes in our share price quarter to quarter, resulted in a large recovery in this quarter, compared to a large charge in the previous quarter.

We incurred an exchange lose on long term debt, which results from the translation of our $300 million U.S. denominated debt being translated at a lower valued Canadian dollar at the end of the current quarter, compared to the beginning of the quarter.

The majority of other income in the quarter relates to a foreign exchange gain on accounts receivable. In the previous quarter we had a $4 million foreign exchange loss on accounts receivable as well as a loss on a pulp hedge contract.

In Q2 last year the loss was mostly foreign exchange – foreign exchange on accounts receivable.

Discontinued operations relates the closure of the Eurocan Linerboard and Craft Paper Mill. Earnings from discontinued operations in the quarter relate mostly to the sale of inventories with some minor adjusts to the shut down costs. At the end of the quarter we had sold the majority of our finished product inventory. What we have left almost all was held for customers who have made commitments to purchase. This should all be liquidated in the third quarter.

As far as the closure costs are concerned, we are not seeing anything at this time that would result in an increase in our previously estimated closure costs. We are in the process of negotiating the sale of selected assets and we expect that we will make progress on the assets sales in the next couple of quarters.

I will turn now to cash flow. Cash flow from operations was $213 million including $83 million from working capital, which was largely the drawdown of our break up log inventories.

Cash flow in the quarter allowed us to repay essentially all of our operating loans. Capital spending was $5.5 million in the quarter. You will recall that we received $88 million in credits that’s under the Green Transformational Program, as Hank said. These credits can be used to fund qualifying capital projects in our pulp and paper mills.

To the end of the quarter, we have two projects which have been approved by Natural Resources of Canada, and we have two that are in the approval process. A significant portion of our capital spending in our pulp and paper segment this year and next will be funded from this program.

Cash from discontinued operations relate to mainly to recovering the working capital, accounts receivable, inventory that was invested in the Eurocan Linerboard and Craft Paper business.

Overall after dividends and capital spending, we generated about $207 million from continuing our operations and an addition $25 million from discontinued operations for a total of approximately $230 million in the quarter.

At the end of June our net totaled debt was approximately $235 million, resulting in a debt-to-capital ratio of about 12%. The next significant debt maturity is 2014.

At the end of the quarter, our available liquidity was $690 million.

With that, Hank, I’ll turn it back to you.

Henry H. Ketcham

Okay, thank you. I think we’re now ready for questions, operator, so I’ll turn it over to you.

Question-and-Answer Session

Operator

Thank you, we will now take questions from the telephone line. (Operator Instructions) Thank you for your patience. The first question is from Richard Skidmore from Goldman Sachs, please go ahead.

Richard Skidmore – Goldman Sachs

Good morning Hank, and Gerry. Can you, maybe Gerry – just a couple of quick questions. The tax impact on the translation of long-term debt, is that done at 0 tax rate? Just trying to get an after tax number.

Gerry Miller

It’s about 14% we use for that calculation.

Richard Skidmore – Goldman Sachs

Okay, great, and maybe Hank, could you just give us an update on what you’re seeing currently? Or maybe Ted’s there to, maybe, give us an update on what he’s seeing currently in the pulp markets, and how you think the pace of the price declined might evolve in the third quarter.

Hank H. Ketcham

Okay, I’ll led Ted, who runs our Pulp Division answer that, Richard.

(Unidentified Company Representative) [Ted]

Well, I think the overall situation is still fairly tight when you look at world inventories. At the end of May they were a 27 days and soffit was 22 days. But primarily in China, there’s been a significant slowdown in buying and I think for certain grades and companies that are significantly focused on that market, they’re more pressure than those that are selling their product on a global basis.

I think globally, we’re still seeing fairly balanced markets but prices are going to decline. In terms of the rate of decline, it’s not something I’d really like to comment on at this point because it’s – we’re taking it one month at a time, really.

Richard Skidmore – Goldman Sachs

Maybe, Ted, on the Chinese, are you seeing them with – do you have any visibility on the end market inventories or inventories in the channel to kind of give any indication on how long the buyers strike might kind of last there?

(Unidentified Company Representative) [Ted]

Well I think just to provide some perspective, purchases of pulp in China are down this year. They’re probably down 25% if you look at all grades. So I think these are pretty strong indications that inventories are rather low in China. I think we should anticipate that they’ll be coming back to the market within a few months. That would be my expectations. I can’t expect that they’ll stay out of the market for too long.

Richard Skidmore – Goldman Sachs

Okay, and then maybe just, Hank, shifting back to the lumber business for a few minutes. How do you feel the lumbar business in the third quarter, given the pull back in pricing. Are you still generating cash in the lumber business at current prices and volumes?

Hank H. Ketcham

Yes. But we do believe that, as I said, there’s no fundamental reason to believe that there’s going to be any strength in the market in the next little while for sure.

Richard Skidmore – Goldman Sachs

Operator

Thank you. The next question is from Paul Quinn for RBC Capital Markets. Please go ahead.

Paul Quinn – RBC Capital Markets

Yeah, thanks. Good morning. Actually, a pretty strong quarter. It’s surprising. So congratulations on that.

Just a question on grade mix in offshore markets. Is that primarily low grade for you guys, or can you give us a rough percentage breakdown?

Henry Ketcham

It’s primarily low grade. Yes. Well, sorry. It’s primarily low grade in China. In Japan, it’s high grade.

Paul Quinn – RBC Capital Markets

Okay. So just focusing on China, are we talking like 80% low grade, 20% too and better?

Henry Ketcham

That would be a good mix, but maybe even higher.

Paul Quinn – RBC Capital Markets

Okay. And then just if you could, mention the green transformation program, two approved projects. What are they and can you give us sort of a dollar amount? What are the two in process, just so we have some background on it.

Henry Ketcham

We’ve got $88 million to spend. We will spend it. And so when you look at our capital program, we are going to spend – we’ve got a balance sheet that allows us to spend a good amount of capital this year and next. So you add $88 million to that. So we’ve got a pretty strong capital program going forward.

In our Pulp Division, it’s going to be primarily spent in our two craft mills and some in our mechanical mill. Our mechanical mills are going to be relatively high payback items, and we’ve got three approved.

Gerry Miller

We’ve got two approved and the paybacks are things that look very good. Sorry.

Paul Quinn – RBC Capital Markets

What areas of the pulp mill are you focusing in on? Is that energy, or is that environment?

Henry Ketcham

They’re mostly energy projects.

Paul Quinn – RBC Capital Markets

Okay. That’s all I had. Thanks, guys.

Operator

Thank you. (Operator Instructions) The next question is from Pierre Laquerre from Dasar Dan Securities. Please go ahead.

Pierre Laqueere – Dasar Dan Securities

Thanks. I just want to ask some clarity on the inventory level that we had at the end of the quarter at the $235 million. And that level is pretty much the lowest level of the last several years, which have an impact on the working capital.

What do you see in terms of the levels going forward for that, and by the same token, you can maybe comment on the direction of the working cap for the rest of the year. And is there any relation with the Eurocan being closed and that no longer being on the balance sheet?

Gerry Miller

Pierre, this is Gerry. You’re right. The inventory levels are rather low. I mean, part of that is the fact that we have shut down Eurocan and liquidated inventories. I mean, that’s part of it.

And of course too, we have been focused over the last many quarters on working capital. So as far as what the working capital levels are going forward, it’s going to depend largely on how we’re operating, and what the cost of getting inventory is.

But we’re intent on keeping our investment in working capital as low as we can.

Pierre Laqueere – Dasar Dan Securities

I see. Do you have a target there in terms of total working cap versus sales or something like that?

Gerry Miller

No.

Pierre Laqueere – Dasar Dan Securities

No? Okay. Thank you very much.

Operator

Thank you. The next question is from Daryl [Schefasof] from Raymond James. Please go ahead.

Daryl [Schefasof] – Raymond James

Thanks. Good morning, guys. These questions are probably more for Wayne and Hank, but on the beetle, you made some comments and recently I’ve heard the Ministry of Forrest a couple of times talk about shelf Life and some of the recent work they’ve done where they think the shelf fite could be longer. Perhaps as long as an average of 12 years. And that the infestation on the mature pine is less than they originally expected.

What’s West Fraser’s view on this?

Hank Ketcham

Well Daryl, Wayne is not on the call so you’re going to have to listen to me. I mean, throughout the region, you can see different – shelf life is going to depend on primarily on lumber price because we are seeing serious deterioration worse in some areas than others.

But a grade percent is declining. LRF is declining. Productivity is declining. So what keeps you in the game in these logs is lumber price. And I don’t think I can predict the shelf life really. But we’re dealing with some pretty old wood right now in our mills.

It is having a significant impact throughout the organization.

Daryl [Schefasof] – Raymond James

Thanks. I was up north recently and I was taken with how dry it is. On the lands that you operate, what’s your sense of the condition of the forrest, especially with respect to as we enter the fire season?

Hank Ketcham

Yeah. I know it’s very dry. It’s very dry up there, and we’ve been very lucky up to this point in time not to have any serious problems. And again, just like every year, hopefully we’ll get some rain one of these days.

Daryl [Schefasof] – Raymond James

Okay. Thanks, Hank.

Operator

Thank you. The next question is from Jonathan Lethbridge of CIBC. Please go ahead.

Jonathan Lethbridge - CIBC

Good morning. I was just wondering if you could provide some color on the pricing dynamics affecting the spread between Seven Yellow Pine and SBF?

Gerry Miller

Well, I guess the only anomaly – there’s kind of a regular price difference which relates to trade and so forth, but the anomaly in the second quarter basically was that there had been a serious shortage of timber availability to our mills in the U.S. South, kind of in the first quarter.

And that related primarily historically to weather down there. We just couldn’t get into the bush. Also, the pulp mills were stocking up on logs because they also were short. So they were buying saw logs that in many cases would normally come to us. So there was a significant shortage, lots of mill down time, and so there’s a Seven Yellow Pine price spike in the second quarter just to reflect that shortage. So that’s come back into line now.

Jonathan Lethbridge - CIBC

Okay. So there’s no changes in terms of substitutability between them?

Gerry Miller

No, not really.

Jonathan Lethbridge - CIBC

Okay. And the other question I have is just on the pulp side, and what you’re seeing in terms of pressure on the BCT and B pulp?

Henry Ketcham

Well, we are seeing pressure on BCT and B pulp because there’s pressure on hardwood craft. So there is real pressure on BCT and B prices right now.

Jonathan Lethbridge - CIBC

Okay. Thank you.

Operator

Thank you. The next question is from Sean Stewart – TD Newcrest. Please go ahead.

Sean Stewart – TD Newcrest

Thanks. Good morning, guys. Just one question. Hank, I’m wondering if you can speak to the margin differential in terms of profitability on the lumber you’re shipping to China versus what you’re getting in the typical North American market.

Henry Ketcham

I think the margin would be very similar.

Sean Stewart – TD Newcrest

Okay. And as you said, it’s primarily low-grade stuff, so you’re still going to get margins on that?

Henry Ketcham

Yeah. Well, we got reasonably good margins in the second quarter. It’s a little different in the third quarter.

Sean Stewart – TD Newcrest

Okay. That’s all I had. Thanks.

Operator

Thank you. We have a follow-up question from Richard Skidmore of Goldman Sachs. Please go ahead.

Richard Skidmore – Goldman Sachs

Hank, if we could just maybe spend a little bit of time on the lumber business for a second. How do you see the mix of your business as you go forward over the next one to two years with regards to how much comes out of the U.S. South and how much comes out of Western Canada give the pine beetle situation?

Henry Ketcham

Well, at full capacity, I guess the only way I can answer that is, at full capacity, we’re about 2 billion trees in the U.S. and 3 billion trees in Canada. So we would expect that to be the mix.

Richard Skidmore – Goldman Sachs

So as you go forward over the next couple of years, you wouldn’t expect that the beetle kill would reduce your capacity in Canada over the next couple of years? You’ll be able to run pretty full up there? Again, assuming that demand is there?

Henry Ketcham

Yeah. I mean, yeah. Whatever fall down you get, you try to make up with through put. And so currently, that’s what our plan would be.

Richard Skidmore – Goldman Sachs

And then just, maybe just asking a follow up to that, is as you think about the margin – the profitability differential between Western Canada and the U.S. South, and the declining productivity in Western Canada, do you see those crossing over at some point where the U.S. becomes more profitable on a per-unit basis as you go forward? And are you close to that level such that you’d be ramping up production in the U.S. South relative to Western Canada?

Henry Ketcham

Well, let me just put it this way. Non-pine build is affecting productivity, but we’re improving our productivity because we’re making capital investments and every year trying to offset the affects. So I mean, I think that we’re still doing a pretty good job in Canada. And our job in the U.S. is to – we have quite a few assets there that we have not modernized yet. So we’re going to be spending capital there to improve productivity there as well too. Canada is still a good business for us, and our job is to really start to improve our U.S. operations, many of which have not had capital to spend on them for quite some time.

Richard Skidmore – Goldman Sachs

And lastly, does that capital spend in the U.S. South, as you look out over the next couple of years, do you have visibility on when that starts to take place, or is it more a function of your profitability, or is it a function of the demand coming back in the U.S.?

Henry Ketcham

With respect to when do we spend the capital?

Richard Skidmore – Goldman Sachs

Correct.

Henry Ketcham

We’ll start spending capital in the second half of this year. But we are not out of the woods yet in terms of this recession in our industry. And so we’re going to be very careful to make sure we have a strong balance sheet, but at the same time, we will be spending whatever capital we can while maintaining a strong balance sheet.

Richard Skidmore – Goldman Sachs

Thank you, Hank.

Operator

Thank you. There are no further questions registered throughout this time. I’d now like to turn the meeting over to Mr. Ketchum.

Henry Ketcham

Well, thank you, Operator. And again, I have nothing further to add. So thank you very much for joining us, and we’ll talk to you in a quarter. Bye.

Operator

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

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