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Executives

Henry H. Ketcham – Chairman, President and CEO

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

Ted Seraphim - Executive Vice-President and COO

Analysts

Richard Skidmore – Goldman Sachs

Pierre Lacroix - Desjardin Securities

Benoit Laprade - Scotia Capital 

Paul Quinn – RBC Capital Markets

West Fraser Timber Co. Ltd. (OTCPK:WFTBF) Q3 2010 Earnings Conference Call October 26, 2010 11:30 AM ET

Operator

Good morning ladies and gentlemen. Welcome to the West Fraser Timber Company Limited Third Quarter 2010 Results Conference Call.

During this conference call 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 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 plan. Including those matters described under risks and uncertainties in our annual MD&A, which can be accessed on our website, through CEDAR and is supplemented by our quarterly MD&As.

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, good morning and welcome to West Fraser’s Third Quarter Conference Call.

Joining me today is Gerry Miller, our Executive Vice President of Finance and CFO, and several members of our senior management team.

We’ve posted a summary of this presentation on our website at www.westfraser.com for those of you who would like to follow along on that.

Yesterday, we reported the third quarter net earnings after discontinued operations of $45 million compared to $63 million in the previous quarter.

Lower -earnings in the third quarter reflects significantly lower prices for lumber and plywood compared with the second quarter. EBITDA during the quarter was $109 million and cash provided from operations was $116 million. As a result of our strong cash generation of $410 million through the first three quarters of the year, we ended the quarter with a net debt to capital ratio of just 6%. Our strong balance sheet and cash generation has allowed us to pay down our operating line, commit to a more normalized capital program for the next 12 months of at least $150 million in our wood products division and double our quarterly cash dividend from $0.03 to $0.06.

Gerry will more fully discuss the financial position of the company in a few minutes. Before that, I would like to make few comments on the company’s wood products and pulp and paper divisions.

Starting with wood products, our lumber division produced EBITDA of $49 million in that quarter compared to $75 million in the second quarter. The reduction on EBITDA is primarily due to a 16% decline on SPF of lumber prices versus the second quarter and a 34% decline in Southern Yellow Pine prices. As a result of the more precipitous drop in Southern Yellow Pine prices, our U.S. lumber division was a significant drag on earnings in the quarter.

Our Canadian lumber division operated virtually full capacity while our U.S. operation operated at 75% of capacity reflecting the higher cost structure in several of our mills and the collapse of Southern Yellow Pine pricing, particularly for wide woods in the quarter.

In Canada, our well-capitalized and efficient mills performed well. In addition, we benefited from strong exports to Japan and China during the quarter. Shipments to China have been particularly strong and have supported stronger SPF pricing in the North American market.

The beetle epidemic in the interior of B.C. has pretty much run its course. Most of the mature pine in the central interior is dead or dying. In those mills in which we are processing predominantly dead pine, our lumber recovery, productivity and grade outturn continued to suffer.

Our mill personnel have done a very fantastic job of adapting to the declining wood quality through equipment modification and improved processing techniques. Cold weather in parts of Alberta last winter has temporarily retarded beetle activity in some of our operating areas giving industry and the provincial government more time to attack the affected areas.

Subsequent to the end of the quarter, the U.S Government requested consultations with Canada relating to stumpage charge for beetle-killed timber in BC interior. If the dispute is not resolved through consultations, either side may require that the dispute be referred to arbitration. Last week, we reached agreement with the United Steel Workers of Canada on a new 4-year contract covering most of our unionized mills in BC. The ratification process is currently underway. Our panel division performed well in the third quarter producing EBITDA of $20 million and an EBITDA margin of 18%.

Our plywood mills operated at full capacity. Our plywood prices declined significantly towards the end of the quarter as U.S producers ship more heavily into the Canadian market due to the continuing weakness in the US housing market and the strengthening Canadian dollar. Our MDF and LBL operations continue to operate in a reduced-base reflecting the significant oversupply in these markets.

Our pulp and paper division operated at full capacity during the quarter and benefited from continuing strong pricing from BCTMP and NBSK. We’ve built an excess pulp inventory early in the quarter due to reduced purchases from China. But sales volumes have improved recently and we anticipate bringing our inventories into line in the coming weeks. Global pulp inventories are in good shape and while prices have declined recently, we expect them to stay reasonably strong in the coming months.

Most of the closure cost of our Eurocan operation are now behind us. We’re in the process of selling whatever equipment we can and should sell all our remaining product inventory by the end of the year. Looking forward, we believe wood product markets will remain depressed for the foreseeable future due to overbuilt housing market in the US. However, the growing strength from the Chinese market combined with our low-cost structure and our commitment to invest significant capital in our facilities in the coming months will we believe allow us to outperform the industry. In addition, the continuing strength in the pulp markets and improving cost structure of our kraft pulp mills will drive further earnings improvements in this division.

Now, I will turn you over to Gerry to discuss our financial position.

Gerry Miller

Thanks Hank and good morning everyone. For the quarter we earned $45 million after discontinued operations on sales of $707 million. EBITDA in the quarter was $109 million representing an EBITDA margin of 15%. Sales, EBITDA and earnings were lower in the quarter compared to the second quarter mainly the result of lower prices for both SPF and Southern Yellow Pine lumber. Our EBITDA and EBITDA margin this quarter, compared to the previous quarter were lower in the lumber segment, similar in our panel segment and higher in our pulp and paper segment.

Our lower consolidated EBITDA and earnings compared to the second quarter are partially the result of higher selling, general administrative expenses which relate mostly to an increase in share-based compensation cost. The change in share-based compensation cost was $18 million in the quarter compared to the previous quarter and expense of $8 million in the third quarter and a recovery of $10 million in the second quarter. The higher expense in the current quarter relates to an increase in our share price which closed the quarter up 15% from the beginning of the quarter. Interest expense was slightly lower from the previous quarter as average debt levels were lower in Q3 than in Q2.

Also, one of our three rating agencies, Standard & Poor’s, increased its debt rating to BB+ in September. This rating increase only marginally reduced our interest expense in Q3 as the rating change was made late in the quarter. The change will reduce the future borrowing rates and stand by charges on our operating line. In the quarter, we recorded a foreign exchange gain on a long-term debt of $11 million. The gain is a result of the strengthening of the Canadian dollar by nearly $0.035 from the beginning of the quarter to the end of the quarter and the translation effect on our US denominated $300 million debt.

The income tax rate in the current quarter was slightly higher than in the previous quarter, mostly due to the earnings mix across the various jurisdictions in which we operate. The resulting diluted earnings per share after discontinued operations was $1.04, in the quarter compared to a $1.46 in the second quarter, Diluted earnings per share for the three quarters of the year was $2.95. Our earnings from continuing operations resulted in a positive cash flow from operations of $79 million in the quarter down from $130 million last quarter. Working capital was reduced in the quarter providing cash of $38 million.

Maintaining optimal working capital levels remains our key focus across our company. In the quarter, we increased our dividend to $2.5 million per quarter. In the current quarter, we invested $10 million in property, plant and equipment. This compared to about 6 million in capital investment in the second quarter. In September, we announced an additional capital that would be directed to strategic profit improvement projects in our lumber business over the next 18 months. This capital is in addition to the green transformation capital which has been allocated in our pulp and paper business.

Overall, we generated a $113 million in the quarter from continuing operations. From discontinued operations, the closure of the Eurocan mill and the associated linerboard and kraft paper business, we generated $6 million from a reduction of inventories and the collection of accounts receivable. The closure of that operation is proceeding as planned with the expected total cost of the closure to be less than the guidance we provided in Q4 2009. In addition, we are moving on selling various assets of the site and these asset sales will continue to next year. On the balance sheet, with our positive cash flows, we have been able to increase our cash balance and reduce our net debt position. At the end of the quarter the net debt to capitalization ratio was approximately 6% down from 12% at the end of the last quarter.

And as I mentioned earlier, one of our ratings agencies, Standard & Poor’s increase debt rating from BB- to BB+ near the end of the quarter. This upgrade puts our rating by each of the 3 rating agencies one notch below investment grade where our credit rating was before the downturn.

Henry H. Ketcham

That’s it from us. Operator, we will now be ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Richard Skidmore of Goldman Sachs, please go ahead.

Richard Skidmore-Goldman Sachs

Good morning Hank. Hank, can you talk about the capital spending program, how much of that is targeted to the U.S. South Lumber operation, specifically increasing capacity there to potentially offset reductions that may come out of BC in the future?

Henry H. Ketcham

Yeah, Rich, so you know the capital that we announced in September was reflective of our confidence that these cash flows were going to allow us to make capital decisions part way through the year rather than waiting till our normal December annual capital review.

So, we’re going to be spending around $125 million. We’ve approved at the board level about a $125 million of capital to be spent in B.C, Alberta, and the U.S. South. I can’t give you a breakdown on the percentages in each area but they are high payback items on trend earnings, or trend lumber prices. These would be two year or less payback items and there is going to be some spent in all three of those operating areas.

Richard Skidmore

Okay. Maybe just along those same lines, how do see the industry or specifically West Fraser’s lumber capacity in the beetle impacted region changing over time and what would be the time frame that you think that that starts to actually happen in B.C.

Henry H. Ketcham

Well, I think its the recessions already caused it to happen fairly significantly in B.C but based on future lumber prices, it is hard to predict the shelf life of the dead and dying pine but we are getting closer to fairly significantly downfall and that could begin to happen maybe in 5 years and proceed over a 5 to 10 year period.

Richard Skidmore

So the standing timber that is dead and dying in B.C., some of that at least can still be utilized for anywhere between 5 and 10 years and any meaningful step down in the lumber capacity probably happens in that 5 to 10 year time frame as supposed to the zero to 5 year time frame?

Henry H. Ketcham

Yes, that’s right.

Richard Skidmore

Okay, great. Thanks Hank.

Operator

Thank you. The following question is from Pierre Lacroix of Desjardin Securities. Please go ahead.

Pierre Lacroix - Desjardin Securities

Thank you. Good morning. The first question I have is on China. Can you give us what was the breakdown of the Chinese shipments in the quarter and what is the approximate percentage of your shipments going to China?

Henry H. Ketcham

Well, we shipped about roughly 15% of our Canadian production off shore to Asia and it’s probably -- somewhat more than half of that would be China. You know, Japan and China are two big markets and more than half that would be China.

Pierre Lacroix - Desjardin Securities

Ok, good, and Hank maybe you can give some indication how is the pricing situation going for China? What is different from North America on the pricing side?

Henry H. Ketcham

We’re selling predominantly low grade and there is not a significant difference in pricing in China versus our North American markets.

Pierre Lacroix - Desjardin Securities

The pricing, is it determined on a weekly basis, on a daily basis, or it is quarterly or is there any kind of concept like that?

Henry H. Ketcham

Well, it’s different for different customers but it would be all of the above probably.

Pierre Lacroix - Desjardin Securities

Ok. Thank you very much.

Operator

Thank you. The following question is from Benoit Laprade of Scotia Capital. Please go ahead.

Benoit Laprade - Scotia Capital

Thank you. Good morning. Just a follow up on Pierre’s question, can you compare this quarter’s shipments to China from last quarter and from the same quarter last year?

Henry H. Ketcham

I can. They are up significantly. Certainly up significantly from the quarter of the previous year, and up significantly from the previous quarter in this year as well.

Benoit Laprade - Scotia Capital

Is there anything in particular that is driving that change specifically in Q3? Is it a particular effort on your part? Is it the market that is changing over there? What is the catalyst there?

Henry H. Ketcham

I think it’s just increasing acceptance of SPF over the market and the ability of the -- the economy is moving ahead and I think they are getting more comfortable buying form us, using our product and I guess that is the only thing I could say.

Benoit Laprade - Scotia Capital

Thank you.

Operator

Thank you. (Operator instructions). The following question is from Richard Skidmore of Goldman Sachs. Please go ahead.

Richard Skidmore – Goldman Sachs

Thanks. Maybe just, Hank, follow up on that last question, is the increase in volumes to China related at all to the amount of lower quality lumber that you’re producing because of the beetle kill.

Henry H. Ketcham

I don’t really know the answer to that, Rich. We’re not selling all of our low-grade to China obviously. I just think, the economy is going well over there. You know, their factories are geared up and they need our wood.

Richard Skidmore – Goldman Sachs

Maybe another way to ask this is, are you seeing any change in lumber demand aside from the normal U.S. housing impact because of quality issues of the lumber itself coming out of B.C. into the U.S. such that the U.S customers are buying less from the B.C. because of the beetle kill?

Henry H. Ketcham

No. We haven’t noticed that.

Richard Skidmore – Goldman Sachs

Okay. Maybe just shifting topics to the pulp market. Can you just talk a little bit more or if Ted’s there talk a little bit about what you are seeing currently in the China market both on the kraft and BCTMP pulp side?

Henry H. Ketcham

I don’t think Ted’s on the phone.

Ted Seraphim

I just got on the line.

Henry H. Ketcham

Sorry Rich. I guess we all have to listen to Ted then.

Ted Seraphim

On the BCTMP side, we have seen demand come back. Demand has been very strong in the last 45 days. I think NBSK is fairly stable at this point in China. So, I think our outlook at least for the short term is fairly, fairly. fairly strong.

Richard Skidmore – Goldman Sachs

And do you get the sense that the Chinese that they had sort of stepped out of the market in the first part of the year, that this is back more towards the normal level and it is sustainable or is there something that, there’s been some discussion that maybe there were just some timing of some shipments leaving North America to China that is causing the most recently reported data that showed China volumes up materially relative to August or we’re just seeing that September volumes are much better than August into China.

Ted Seraphim

I think basically, our view of it is that the Chinese market, they really took a bit of pause through the first two months of third quarter and now they have been back much more active. So whether that will carry on for the next several months, we can’t say, but I’d say for the last 2 months or so, it’s been fairly back to normal.

Richard Skidmore – Goldman Sachs

Great. Thank you.

Operator

Thank you. The following question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Paul Quinn of RBC Capital Markets

Good morning guys. Just a follow up question on China. Just so I’ve got this -- you’re saying exports to Asia is 15%, I guess almost 840,000 board feet of lumber and China would represent just over half of that, so essentially if I did the math, it’s somewhere -- Chinese shipments are about 6% of your total shipments?

Henry H. Ketcham

That is probably roughly correct. Yes.

Paul Quinn – RBC Capital Markets

When you describe it as significant increase over last year, what is significant, is that 10% or 15% growth, is that a 30% growth?

Henry H. Ketcham

Into Asia it’s 50% .

Paul Quinn – RBC Capital Markets

I just saw Hank that you mentioned the improving cost structure of the kraft mills, I want to be able to try to model that in. How do you suggest I go about that. What are we talking about in terms of the improvement, is it 5% improvement on cost?

Henry H. Ketcham

Ted, why don’t you cover that?

Ted Seraphim

Thanks Hank. I don’t think we usually get into detailed data on our individual pulp mills, so we really can’t go in that much detail, Paul. But I think, significant amount of the improvement in the quarter was in our kraft pulp business, so I guess I’ll leave it at that.

Paul Quinn – RBC Capital Markets

Okay. I guess the question, maybe you can answer in a general way, do you see the cost improvement at your kraft side continuing over the next 4 quarters?

Ted Seraphim

Well, I think that’s our expectation. I think a big part of it is, I think you saw that in our record production and we expect that to carry on definitely.

Paul Quinn – RBC Capital Markets

And just maybe a question, I guess back to you, Hank. Just on capital structure you’ve now got a squeaky-clean balance sheet once again. You’ve opened up sort of the company wallet for some CapEx expenditures, do you start to feel confident about further growth opportunities at this point?

Henry H. Ketcham

I think just like probably everybody else we have no idea what the future holds in terms of the U.S. economy. So, we will continue to be, I would say, cautiously aggressive in terms of our capital spending. So our number one priority is to continue to invest in our existing operations and certainly we are interested in strategic opportunities and we just have to look at whatever comes along on an individual basis.

Paul Quinn – RBC Capital Markets

Thanks guys.

Henry H. Ketcham

Thank you.

Operator

(Operator instruction). There are no further question registered at this time.

Henry H. Ketcham

Thank you operator and thanks everybody for joining our call. And we’ll be around all day if anybody wants to follow up on anything. Thank you.

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