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Executives

Henry H. Ketcham - Chairman, Chief Executive Officer and President

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

Edward R. Seraphim - Chief Operating Officer and Executive Vice-President

Analysts

Sean Steuart - TD Securities Equity Research

Mark Kennedy - CIBC World Markets Inc., Research Division

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

West Fraser Timber (OTCPK:WFTBF) Q1 2012 Earnings Call May 1, 2012 11:30 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. First 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 depend on a number of assumptions, and are 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 are supplemented by the company's quarterly MD&A. 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

Thanks, operator. And good morning, and welcome to West Fraser's 2012 first Quarter Conference Call. Participating with me today is Larry Hughes, our VP of Finance and CFO, and several of our senior management group. As you know, Ted Seraphim was appointed to the position of President and Chief Operating Officer at our Annual General Meeting a couple of weeks ago. Ted will be responsible for the day-to-day operations of the company, which is basically what he's been doing for the past few years. Ted and I will continue to work closely together on all aspects of the company's operations.

In the first quarter of 2012, we lost $16.7 million from continuing operations compared with a loss of $10.6 million last year. EBITDA was $18.3 million compared with $17.9 million last year -- last quarter, excuse me. Our lumber division, which recorded a $6.2 million EBITDA loss, suffered from low prices and production disruptions at several of our mills due to construction projects. In addition, breakdowns on our log and lumber inventories during the quarter reduced operating earnings by $5 million.

Production at our Canadian lumber mills increased by 10% over last quarter. Production was down 3% at our U.S. Mills due primarily to a boiler outage at one mill and capital tie-ins at 2 other mills. We ran at roughly 70% of capacity at our U.S. division in the quarter. While the benchmark SPF lumber price increased by 12% during the quarter, our actual mill nets were flat quarter-over-quarter due to the decline in low-grade pricing relating to sales to China. Chip prices were also down about 15%, reflecting lower pulp prices in the quarter. The effects of the Mountain Pine Beetle epidemic continued to negatively affect results for our B.C. operations through lower grade outturn, lower lumber recovery and lower productivity. Overall, our cost of production is flat quarter-over-quarter.

Log costs at our Canadian operations were up about 4% compared with the fourth quarter and were up 21% versus the same quarter last year. In the quarter, we billed about 50 million feet of lumber inventory due to ongoing capital improvement projects at several of our plainer mills. In contrast to our Canadian lumber operations, our U.S. operations showed improved results quarter-over-quarter due to higher lumber prices in the first quarter. Benchmark Southern Yellow Pine prices increased about 8% during the quarter. Log costs were flat versus the fourth quarter and compared with the first quarter of 2011. EBITDA for our Panel division increased from $3.6 million to $5.4 million, reflecting improved pricing for plywood, as well as higher sales volumes for all products. EBITDA in our Pulp & Paper division increased from $27 million to $30 million quarter-over-quarter.

Benchmark NBSK prices were down roughly $50 versus the fourth quarter and $100 over the same quarter last year. Cost of sales in our pulp division was down substantially, primarily reflecting lower chip costs and the fact that our Hinton pulp mill took a 28-day shutdown in the fourth quarter to complete a major CapEx project funded by the Green Transformation Program. This mill is still experiencing some startup problems, but we expect to be running at full capacity shortly.

We've completed all of our $88 million of Green Transformation Program expenditures and expect full reimbursement from the federal government in the second quarter. When fully operational later this year, these CapEx projects will result in higher production at our Hinton mill, improved energy efficiency at all our mills, increased bio-energy production at our Cariboo pulp and Slave Lake pulp mills, and reduced costs at all mills.

We are cognizant of the issues raised by the tragic explosions at 2 northern interior saw mills over the past 4 months. While we don't know the causes of the accidents yet, we've been working closely with our management team and outside experts to ensure that our plants are clean and safe for our employees. While economic uncertainty continues to cloud the future, we are somewhat more optimistic that the U.S. housing market is close to the beginning of a slow recovery. We are hopeful that the Chinese economy will maintain its growth in order to support lumber and pulp prices going forward. And finally, the coming reduced AAC in the Central Interior of BC will limit the ability of BC producers to respond aggressively to the eventual recovery of the housing market, which should help to drive prices higher.

With that, I'll turn it over to Larry Hughes.

Larry S. Hughes

Thank you, Hank. Thanks to everyone joining us today. Please refer to the advisory contained in our quarterly MD&A concerning our use of terms such as EBITDA, adjusted earnings or loss and adjusted basic earnings per share. As Hank noted, for the first quarter, we reported a loss from continuing operations of $17 million, resulting in a basic loss per share of $0.39. The table on Page 3 of our MD&A describes and quantifies several nonoperational items which affected our results.

If we adjust the $17 million loss from continuing operations, then add back the $12 million charge on equity-based compensation, then reverse the $6 million gain related to the translation of U.S. dollar-denominated debt, the result on an after-tax basis is an adjusted loss of $11 million or an adjusted loss on a per-share basis of $0.26 for the quarter. The equity-based compensation loss reflected a strengthening of the company's share price over the quarter, as well as the issuance of share options and units during the quarter. The gain on the U.S. debt resulted from the strengthening of the Canadian dollar against the U.S. dollar in the period.

Results of this quarter were generally consistent with those of the previous quarter. From an operating, earnings and EBITDA perspective, each of our operating segments showed slight improvement from the previous quarter. Inventories were adjusted at the end of the quarter, the lower of cost and net realizable value and a write-down of $20 million was recorded. This compares to $15 million at the end of the fourth quarter, so the result was a reduction of operating earnings of $5 million. Our defined benefit pension plans were revalued as at the end of the quarter, resulting in a charge to comprehensive earnings net of income taxes of $14 million. This actuarial gain or loss will fluctuate with changes in long-term interest rates and the return on plan assets.

For this quarter, the main contributor to the adjustment was a lower discount rate as described in Note 5 of the quarterly financial statements. Cash used by operating activities during the quarter after working capital changes was $77 million, which included a substantial buildup of log inventories at our Canadian solid wood operations. Capital expenditures for the quarter totaled $42 million. During the quarter, as Hank mentioned, we completed the balance of our Green Transformation Program expenditures and received reimbursement of $16 million. That leaves $34 million still to be received. Our balance sheet remains strong, with a net debt to capital ratio of 19% at a time when our log inventories are peaking.

Hank, that concludes my comments

Henry H. Ketcham

Thank you, Larry. Operator, we'll open it for questions, then.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question is from Sean Steuart from TD Securities.

Sean Steuart - TD Securities Equity Research

Just a few questions. I guess a question for Larry or maybe Ted. When you think about the Green Energy Transformation program and all the capital you guys have been allocated under that, can you provide an overall incremental EBITDA contribution you're expecting from all that capital?

Edward R. Seraphim

Sure, Sean, it's Ted. Yes, I think when we talked about this in prior calls, we basically said we were looking at somewhere about a 3 to 4-year payback range on the capital. I think we're still very confident that we'll achieve those results.

Sean Steuart - TD Securities Equity Research

And then Ted, maybe if you can just -- can you give us an idea of what the pulp mill maintenance schedule looks like through the remainder of 2012? Should we expect it to be Q4 weighted? Is that a safe assumption?

Edward R. Seraphim

No. We have a small shutdown that we've just concluded at our Cariboo joint venture mill and we'll lose 3,000 tons through that. And we have no other major maintenance plan this year.

Sean Steuart - TD Securities Equity Research

Okay. And then Hank, just one question for you. I'm wondering if you can speak to, I guess, M&A opportunities in the U.S. South on the Solid Wood side. You get asked about it a lot, but can you speak to the current opportunities out there and maybe the IP assets that are presumed to be available post the Temple Inland deal?

Henry H. Ketcham

I can speak to what we're doing in the U.S. South, which is really concentrating on modernizing the mills that we acquired in 2007 from IP. Sean required 12 and there's a lot of work to be done on some of them. So that's where our focus is. Certainly, like everybody else, we always look at everything going on, but our focus right now is to make sure that the base we have in the U.S. South is modernized and efficient.

Operator

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

Mark Kennedy - CIBC World Markets Inc., Research Division

I'm not sure who's best to answer this, but Hank, I had a question, I guess, on the beetle-killed wood you're processing in B.C. Do you have a guesstimate of the average age of that wood and is that going to be a factor in your lumber recovery factors for the balance of this year? Because my understanding is, is that if you're dealing with, wood that's sort of less than 5 years dead, you get one level of recovery. If it's 8 to 10 years dead, your lumber recovery drops again. So just wondering if you can comment on that.

Henry H. Ketcham

Yes, I mean, the whole thing really started in the mid-'90s. So obviously, there's various stages of decay and dryness in the wood we're harvesting. I can't quantify, Mark, the age of the wood would bring into or the age of the beetle-kill we're putting into the mills, I'm afraid. But suffice it to say that it's deteriorating. In general, it's getting worse and in general, that is affecting our -- the 3 things I mentioned, which is lumber recovery factor, productivity, and quite importantly as well, great outturn which affects our mill nets.

Mark Kennedy - CIBC World Markets Inc., Research Division

And just a couple of comments. I think you made a couple of comments in your release that a, you're starting to see the premium on Southern Yellow Pine reestablish itself first as Western SPF, and secondly, you're starting to see the discounts narrow on your economy grades versus number 2. Can you sort of give us updates on where that's looking for the second quarter?

Henry H. Ketcham

Yes. We're seeing lumber prices in the U.S. strengthen. And one of the issues up here or one of the issues down there is particularly 2x10s aren't at their traditional levels. So that pulls down prices. But we're seeing strengthening prices in U.S. South, which is starting to reestablish the more traditional difference between SPF and Southern Yellow Pine. In respect to low grade, for sure we're seeing a narrowing of the difference between high-grade lumber and the lower-grade lumbers. There was quite a drop in the price for the low grade in kind of the third and fourth quarter last year, primarily in the fourth quarter and those prices are coming back.

Mark Kennedy - CIBC World Markets Inc., Research Division

And then finally, just a comment in terms of -- are you able to sort of make a prediction on your export volumes this year? Like, do you see them being flattish to 2011 or up 10% or any guidance on that front?

Henry H. Ketcham

Well, they're pretty strong right now through the first quarter and going into the second quarter. Their strength is very strong. Again, my anticipation would be if the market stays -- the export market stays strong, my anticipation would be that we will export more than we did last year.

Operator

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 following up on Mark's on export. Can you quantify that strength, I mean and what do you expect year-over-year? What are you up quarter-over-quarter or what are you up year-over-year in Q1 on exports?

Henry H. Ketcham

In terms of volume?

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

Yes.

Henry H. Ketcham

In terms of volume, we were back to the levels that we were kind of mid last year. So I think that we're running at a rate that's at least as good as it was early in 2011 and we expect that to pick up a little bit.

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

Can you talk to your change in lumber marketing plans on the export side?

Henry H. Ketcham

Change in the lumber marketing plans? No. I don't think there's any change to our plans. We continue to sell through the channels we've always sold through. Am I getting the question right?

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

I thought that you guys had changed the way that you're going to the market through wholesalers and taking a lot more of that sales internally?

Henry H. Ketcham

We have done more of that but that's been an ongoing thing over the last year or so.

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

Okay. And then just on cost, you mentioned that on the Canadian operations, the costs were up 4% quarter-over-quarter, 21% year-over-year if I caught that correctly. Is that cost pressure a concern? We definitely noticed costs come up at other companies as well in the last couple of years. And do you see that continuing at that rate going forward?

Henry H. Ketcham

Those were log costs, I think, our manufacturing costs were flatter log costs were up and in terms of log costs, that's primarily reflecting the very tight labor market, the fuel -- significant fuel increases and the tightness both in the contract logging side and also in the trucking side. So these cost pressures have been pretty strong there.

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

Okay. And just lastly, you mentioned Hinton down 28 days in Q4 and still having difficulty. Is this something that -- I'm just surprised because we're now in May here in and you're still talking about difficulties on the startup. What's the issue there?

Edward R. Seraphim

Paul, it's Ted. Maybe I should answer that. I think we have a goal of where we want that mill to get to. It's running at a much higher rate than it ran prior to the upgrade. We've seen tremendous potential there. We're just not getting there consistently. So we're pretty demanding in terms of the results we want from that mill and we expect to get there this quarter or shortly thereafter. But the potential is definitely there. We're just not getting it every day.

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

And so there's no maintenance downtime for that mill in 2012?

Edward R. Seraphim

No, none. None, whatsoever. In terms of major maintenance, of course.

Operator

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

Henry H. Ketcham

Okay, well, thank you very much. We appreciate your attendance and we'll talk to you next quarter. Thank you.

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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