Stella-Jones Inc.

Brian McManus - President and CEO Éric Vachon - SVP and CFO

Mark Neville - Scotia Capital Ben Vendittelli - Laurentian Bank Securities Sarah O’Brien - RBC Capital Markets Michael Tupholme - TD Securities

Thank you. Good morning, ladies and gentlemen.

I’m here with Éric Vachon, Chief Financial Officer of Stella-Jones. Thank you for joining us for this discussion of the financial and operating results for the company’s third quarter ended September 30, 2014.

Our press release reporting Q3 results was published earlier this morning. Our MD&A for the third quarter has been posted on our Web site at www.stella-jones.com and will be available on CEDAR.

Let me remind you that all figures expressed on today’s call are in Canadian dollars unless otherwise stated. Stella-Jones experienced a solid third quarter.

Demand remains strong for our railway ties and utility poles. We saw sales growth that reflected increased penetration of our core markets, while the performance of our acquisitions met our expectations.

Steady progress in integrating acquisitions and maximizing the efficiencies of our network also led to further growth and operating income. At the same time, strong cash flow generation allowed the company to reduce debt by $44 million.

The company’s operating margins slightly narrowed as a result of higher year-over-year costs for untreated railway ties. Our response has been to gradually raise our selling prices as permitted in the majority of our multiyear contracts.

The company generated revenue during the quarter of $357.3 million, a 25.2% increase over the comparable period last year. The contribution from the facilities of the Pacific Wood Preserving companies, which we acquired in November of last year, was $11.2 million.

The contribution from Boatright Railroad Products, which we acquired in May of this year, was $12 million. The conversion effect from fluctuations in the value of the Canadian dollar registered a positive impact of $8.9 million on the value of our U.S.

dollar denominated sales. Excluding the contribution of acquired facilities and exchange rate fluctuations, sales increased by approximately $39.9 million or 14%.

Operating income was $45.5 million, an 18% increase over the third quarter of last year. As a percentage of sales, operating income decreased to 12.7% versus 13.5% last year, as higher year-over-year costs for untreated railway ties were partially offset by greater efficiencies throughout our planned network.

We were able to adjust our selling prices in stages, as I’ve already mentioned. Consequently, this has resulted in better gross profit and operating income in the third quarter as a percentage of sales when compared to the second quarter.

Looking at our results by product category, railway tie sales amounted to $148.8 million, an increase of 49.7% over the third quarter of last year. If we exclude the contribution from our acquisitions and the currency exchange effect, railway tie sales rose approximately 34.7%.

As you may recall, there was an approximately $15 million negative effect on last year’s third quarter railway tie sales resulting from the transition of a Class 1 customer from a treating services only program to a full-service black tie program. If we consider this effect in our present comparison, then year-over-year railway tie sales have increased by $19.5 million or 17%.

This strong organic growth reflects two factors; solid market demand on the part of our railroads as they pursue tie replacement programs and increased pricing on our part. Utility pole sales amounted to $127.6 million, an increase of 13.1% over the comparable period last year.

If we exclude the currency conversion effect and the contribution of acquired assets, utility pole sales went up $4 million or 3.5%. The improvement resulted from higher sales of distribution poles as we saw increased demand from replacement programs.

The improvement in sales was partially offset by slightly lower demand for transmission poles due to the timing of certain special projects. Our residential lumber sales came to $43.5 million representing an increase of 10.6% over last year.

This improvement resulted from solid demand in Western Canada and the United States. Industrial product sales amounted to $29.7 million, an 80% increase over the third quarter of last year.

The improvement here resulted from the contribution made by acquisition, as well as by increased sales of rail-related products. Finally, sales of non-pole-quality logs amounted to $7.7 million.

This figure was down from $17.2 million a year ago, as a result of the timing of timber harvesting. During the quarter, we made the expected progress enhancing productivity throughout our organization by further integrating the assets acquired over the last 12 months.

We remain focused on achieving greater efficiencies in our network and as they are realized, we believe they will contribute to an ongoing streamlining of our cost base. In this regard, as the Boatright acquisition provided Stella-Jones with two strategically located facilities in Alabama, we decided to close the Warrior, Alabama facility during the third quarter.

This initiative will optimize capacity utilization and provide Stella-Jones with greater cost efficiency. Éric will now provide additional details on our results and financial position.

Éric?

Thank you, Brian. Third quarter operating income reached $45.5 million or 12.7% of sales versus $38.6 million or 13.5% of sales a year earlier.

As Brian mentioned, the decline as a percentage of sales mainly reflects higher year-over-year costs for untreated railways ties partially offset by greater efficiencies across our network. As Brian also mentioned, we closed the Warrior, Alabama facility during the third quarter, which resulted in an asset impairment charge of $1.7 million recorded in other net losses.

We also incurred closure costs of $502,000 that were recorded in selling and administrative expenses. Also, of note, our tax rate in the third quarter of 2014 was 30% compared with 23.1% in the third quarter of 2013.

This important variation results from the favorable impact of the U.S. tax true-up adjustment on last year’s tax rate whereas this year’s Q3 tax rate allows for more representative year-to-date income tax provision.

We believe the year-to-date tax rate of 28.2% gives a better indication of Stella-Jones’ effective annual tax rate. As a result, net income amounted to $29.5 million or $0.43 per share fully diluted, up from $27.7 million or $0.38 per share fully diluted last year.

Cash flow from operating activities before changes in non-cash working capital components and interest and income taxes paid stood at $54.8 million compared with $43.5 million a year ago. For the first nine months of 2014, sales totaled $959.6 million, up 21.7% from $788.8 million in the first nine months of 2013.

Excluding acquisitions and the currency conversion effect, year-to-date sales increased approximately 9.6%. Operating income was $121.8 million or 12.7% of sales, up from $109.2 million or 13.8% of sales last year.

Net income reached $80.9 million or $1.17 per share fully diluted compared with $72.8 million or $1.05 per share fully diluted a year ago. Cash flow from operating activities before changes in non-cash working capital components and interest and income taxes paid amounted to $143.6 million, up $126 million a year ago.

Turning to our financial position, Stella-Jones’ long-term debt including the current portion stood at $433.6 million as at September 30, 2014, down from $456.8 million three months earlier. The decrease reflects 44 million in debt repayment during the third quarter, as a result of our solid operating cash flow partially offset by the currency conversion effect on our U.S.

dollar denominated debt due to the appreciation of the U.S. dollar over the period.

As a result, Stella-Jones’ ratio of total debt to total capitalization was 0.4 to 1 as at September 30, 2014, down from 0.43 to 1 three months earlier. Finally, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.07 per common share payable on December 18, 2014 to shareholders of record at the close of business on December 2, 2014.

I’ll turn the call back to Brian for the outlook.

Thank you, Éric. Looking ahead through 2015, we expect demand for our core products to remain strong.

We see sound fundamentals motivating our customer base, as economic growth continues. We also expect the increase in efficiency of our network to go on improving our margins while those same efficiencies help us further penetrate our core markets.

In the railway tie category, as the North American economy relies more heavily on rail transport, we believe the industry will maintain or increase its investment in track upgrades and new lines. In the utility pool market, regular maintenance projects and a gradual acceleration and the replacement of aging poles should provide a steadily growing business flow.

Network expansion remains an ongoing objective. We will study all opportunities for strategic acquisition as they arise.

In the quarters immediately ahead, we plan to continue adjusting our selling prices in response to higher untreated railway tie costs and over the longer term, we will maintain our constant focus on enhancing productivity. All these factors should allow Stella-Jones to build additional shareholder value.

Éric and I would be pleased at this point to answer any questions you may have.

Hi, guys.

Good morning, Mark.

Good morning, Mark.

The 17% growth in the ties just [sneaked] (ph) above GDP this quarter, just trying to get my head around that. How much of that is pricing or how much is volume?

Was there any sales moved from Boatright to your own assets? Just trying to get a feel for that.

Good question in terms of recognizing sort of the volume price at play. I would say probably a little over half of it is related to price increases and the other would be volume.

Some of it is timing as well. During the earlier part of the year, some of the business got pushed out to the third quarter, but it’s just generally been a good quarter.

Okay, so it’s a rail number. But the Boatright sales 12 million this quarter.

When you bought it, it was around an $80 million business, so I’m just curious as to what happened there and if that had any effect on the 17%?

No. Actually – part of it had to do with the Boatright acquisition was at the time we recognized that it was undercapitalized in terms of the amount of ties that they had stacked and ready for future orders.

So we’re playing a catch-up on that with the Boatright acquisition. We actually didn’t move business out of the facilities.

If anything we’ve moved into the facilities.

Okay. And the facility that was closed, so was that a Boatright?

I missed that.

No, that was our own – it was a smaller offline facility. When I say offline, it didn’t have rail access but it was also in Alabama and very close to the two existing acquired assets of Boatright.

Okay. And the industrial, the 13 million for acquisition, just curious where that’s from?

Is that the Boatright to switch ties, that kind of stuff?

Yes, a good part of that would also be some of the PWP assets that we acquired, some of the industrial there as well as just a general increase in bridges, as an example, bridge timbers.

Okay. And I guess last one, just the asset impairment, I assume that’s related to the facility closure?

That’s correct.

Okay. All right, thanks a lot guys.

Thanks, Mark.

Good morning.

Hi, Ben.

Hi, Ben.

Just to continue on the organic growth on the railway tie side, how sustainable is that and how much of an impact in the quarter have you seen so far some your increased pricing due to increased raw material costs?

In regards to the first part of your question, Ben, we continue to expect to see strong demand going forward. I think there’s some timing that we’re seeing in the third quarter in terms of just the general good demand overall, possibly some additional market share we’re capturing.

In terms of the second part of your question, I’m a little unclear on exactly what you mean?

Okay. So basically you’re passing on or trying to pass on some of the increased raw material costs, right?

That’s correct.

How much of that have we seen in Q3 and how much can we expect in Q4? And is it still a Q3 through Q1 type of timing or are we expanding beyond that?

There’s still some adjustments to come through. Most should be realized by the beginning of next year.

Of course, any other movement in raw material would again create a bit of a lag and would also have to be pushed through later on. But certainly by the beginning of Q1 all adjustments would have taken place.

Okay. And from the raw material side of the story, are you – one of your competitors mentioned that they’re starting to see that price escalation or cost escalation starting to abate.

Are you starting to see the same market dynamic on your end?

Certainly what we’ve seen over the last couple of months has been good from two fronts. One we’re seeing increased supply.

We’ve had some good procurement activities over the last little while. And while we’re not seeing the prices go down for the most part, they have remained relatively steady.

I mean in certain regions where we’ve seen some movement, but in general it’s remaining constant.

Okay. And I apologize if you guys already discussed this and I might have missed it, but on the cash flow statement there is a $2.2 million impairment.

What line of the income statement did that flow through?

Other losses.

Yes, other losses.

Okay. And lastly, you discussed on the pole side 3.5% organic growth, you discussed some mixed changes there where you’ve got an increase in distribution pole volumes and a decrease on the transmission side.

Can you give us any color on how much of that increase or decrease from one side to the other, and if the timing on the transmission side is really in the quarter and we should see it in the next quarter too or if there’s something that’s changed there that we might now see it flow through into the subsequent quarters?

In regards to the transmission, no fundamental changes there at all. Demand remains still very strong.

Like we always say, it is a lumpy part of the pole business in terms of when orders are actually shipped. I would argue that the growth of 3.5% is probably very conservative in that assets that we acquired, which we [call out] (ph) as acquisitions are actually performing very well with increased volumes than you would have before we acquired them.

So the way we just calculate the growth outside of the acquisitions is we actually take sales that have flowed through that facility out of the equation. The example will be in PWP when we acquired, they were probably at about a 60% capacity utilization.

We’ve now got that they’re near 100%, so we’ve seen good growth there. And I think if that was added in, the organic number would look even better.

Okay. So if I understand correctly, PWP has grown organically but it’s not reflected in the 3.5% or any of the acquisitions…?

Exactly, that’s correct.

And if you adjust for that, what would have been the organic growth number in poles in an all encompassing type of scenario?

Difficult to say, Ben, because of the fact that how we shift our orders around. I mean I would say we probably would have seen high single digit growth.

Okay. And lastly, does the mix change effect – is the organic growth from a volume perspective much greater than the 3.5% that you’re showing from a broader perspective, because of the shift from transmission to more distribution?

And did you mean by per piece or if you mean by per cubic foot, I mean per piece definitely volume because of the fact that transmission poles are larger. On a per cubic foot basis, I would say it’s pretty equal both pricing and volume.

Perfect. Thank you very much.

Thanks, Ben.

Hi. Good morning.

Good morning, Sarah.

Good morning, Sarah.

Can you comment the tie volume, I guess, more on the pricing side? I mean if some of your contracts have been re-priced but the majority are still out there to be re-priced, what kind of price escalation should we expect on the top line going into F'15?

I would say the majority are left to adjust, Sarah. There are still some left to adjust.

There’s also as examples where we would have taken purchase orders even outside of contracts earlier in the year at a certain set price that only got delivered in Q3 as an example. We hold to what we have originally had in place, so those are getting delivered and sort of work through the system.

But there’s some adjustments to come, but certainly not the majority left.

Okay. I just wondered if pricing was 10% of the organic growth in the quarter, I mean are we looking at something more like 20% or more like 15% just from the pricing impact going into next year?

Compared to year-over-year for the entire year, you mean or…?

Maybe for the first half, let’s call it.

First half I would say probably under 10 would be the – I’m just trying to weight it in my head as the effect. I know what you’re asking and I don’t have a specific number, but I would say a little less than 10%.

Okay. And then I wondered, what’s the client take-up like?

What’s the mood like on accepting more [boltenized] (ph) ties going to next year versus the traditional?

I think because everybody is in the same position, it’s accepted. Many of our customers prefer a dry tie program, if you want to call it, but given the tight supply we had particularly in the earlier part of the year, there is the acceptance.

We don’t have much of a choice.

Okay. And just impact on margin going into next year, I just wondered given the logistics and maybe a little bit of additional input costs for that, how that might affect your margin?

I think it will have a bit of a negative effect on it, Sarah. Longer cycle times, higher energy costs, things like this will certainly affect the margins.

But I would certainly not agree that they were impacted this year with the weight tie movements.

Would you expect a pretty important improvement year-on-year on margins?

Yes, I suspect that particularly on the dollar margin, I think the margin percentage will be not as dramatic because the weight cost is just a pass-through in the numerators, increase in denominators also increase, which would result in a slightly not quite the same change on the margin percentage.

Okay. And I just wondered on the tie side also if you’d seen steel ties taking market share?

I know it’s a very small percentage of the market, but what’s been happening in the past few quarters there?

We’ve seen steel ties being used by some of the railroads in terms of some of their switchyards as an example, but I would not say it’s moved any major shift of any kind.

Okay. Would complementary products like that be of interest to Stella at this point?

Perhaps in the future. We certainly would contemplate it.

We’ve had certain customers mention it to us that it would be a nice fit with us. So something we could potentially look at.

Okay. And then just maybe slipping back to that charge on the closed facility.

What’s the EPS impact? And then the cash flow statement looks like 2.2 million, but then on the other losses it’s only 300,000.

Just wondered what the EPS impact of that closure was in the quarter?

There was an offsetting effect on it, so the EPS effect would have been virtually nil once you look at the offsetting adjustment in a provision we had – environmental provision we had in place that we had some positive news on that we adjusted.

Okay, that’s helpful. Thank you.

Thanks, Sarah.

Thanks. Brian, you were talking about the poles earlier and when I look at the growth you reported this quarter organically, down a fair bit from where it was in the second quarter.

And I understand what you’re suggesting about putting volumes into some of the acquired facilities and that has an impact. Was that something that you started to do in a bigger way in Q3 and is that part of the reason it came down from Q2, or – maybe that was something you would have been doing all along since you acquired it?

Good question. Yes, actually it is something we’ve been doing all along, so you could argue two might have been very conservative as well.

Sorry, what do you mean conservative?

Well, conservative in our organic – what we showed as organic growth, because it comes to the same problem that I’m explaining for this quarter is that we pull out the facilities and count them as an acquisition, part of the equation in our growth. So volume that has increased within those is not counted in the organic growth.

Right. But Q2, if I’m not mistaken, was sort of north of 14% organic growth in the pole side, right?

Correct.

I understand what you’re saying there. It still would have been an issue in Q2 and so the 14.7% I think was perhaps even understated.

Yes.

I’m still unclear why there was a big discrepancy between the two quarters?

That has to do with the transmission more than anything. Again, the transmission because they are high dollar value units and depending on the timing of the orders, Q2 we had a lot go out.

Q3, one that expected to go out didn’t go out as planned, so we’ll see some of that roll into Q4 and into Q1. I believe it was Ben that asked the question earlier on, are we seeing any fundamental changes there and the answer was no.

It’s still very good demand. But the transmission business, especially as it relates to project work, can be lumpy.

That makes sense, I just didn’t realize it was that – had the capability of swinging it that much, but that is the main explanation. There’s no other issues at play here.

No, none whatsoever.

Is there any issue when we go to the fourth quarter with the TSO transition issue back in Q4 for '13 or was that all done by that point?

No, they’ll be still a bit of a…

There’s another 15 million in Q4 of last year. The total I think was close to 30.

If you go back to our Q4 last year, the total effect was described close to 30, so it’s 15 this quarter and 15 next quarter.

But again the comp is easy I guess as a result of that.

Correct.

The closure of the Warrior facility, can you talk about what that might mean in terms of margin improvement opportunity?

There’s definitely an improvement because one, our facilities – the two new acquired facilities are on line which removes the cost we incurred when we had to ship by truck to a line as part of it also increase throughput just economies of scale will help the improvement. And so it’s a combination of those factors.

For the facility of that play, I don’t know, a 1% to 2% operating margin improvement would probably be the flow-through effect. But I mean when you look at it as an overall corporation, it’s going to be hard to see.

All of our efficiency that we always seek, Michael – if we looked at it that way, you’d say, geez, why are you doing these types of things. But obviously every little bit helps and then they all add together for greater efficiencies.

Right, that’s helpful. I just wasn’t sure if this one was maybe a little more impactful, but it sounds like this is sort of your normal – the kind of thing you would normally look at for seeking efficiency improvements.

Exactly.

And then I wanted to clarify on the impairment, so I understand the 1.7 million and the closure costs, but it looks as though you actually mentioned a larger impairment number I think of 3.5 million in the other losses section. So it looks like there is close to another couple of million dollars of additional impairment.

Just wondered what that relates to?

That relates to a multitude of several smaller items that add up. It’s around the 1.5 range, if you want.

And it’s just streamlining some assets or facilities, mobile equipment being adjusted. We also mentioned in the MD&A that we wrote off an office building in West Virginia for some $545,000 which was a donation to the state to be able to – we wanted to get this asset off of our hands, so we got a donation to actually receive an exchange for that.

So if we wanted to look at all of the, what I’ll call unusual items in the quarter as it relates to these impairments and this building and whatnot, is it fair to look at – I mean I guess it’s effectively the net other losses number.

Yes, exactly, because we also mentioned that we had a provision reversal in the quarter of 2.8, so it sort of like nets out for the quarter to $300,000.

But then the closure costs are over and above that.

The $502,000 of closure costs is underwritten.

So if you take all the one-time, you’re looking at about $600,000, $700,000…?

Per quarter, yes.

Yes. Okay, that’s great.

Thank you.

Thank you, Michael.

Thanks. Good morning.

Hi, Frederick.

Hi, Frederick.

Just a question on production capacity I guess relating to your closure in Alabama. As you look at your next quarter more broadly, more globally, what’s your comfort level in terms of your current production capacity in ties and poles?

You think that perhaps further quarters will be required or the opposite? Could you make some investments given your forecast for [LT] (ph) demand in the future?

I’ll separate it because there’s slightly different responses for each product category would be on the tie side, the acquisition of the Boatright facilities provided us with some additional capacity that we needed, and so we’re in a healthy position from that standpoint on the tie side. On the pole side, we are seeing particularly as it relates to the western region capacity constraints in the foreseeable future, so for that reason we are actually investing in some expansion initiatives in 2015.

Okay. And what amount would that be or what’s your, I guess, CapEx number maybe for next year?

Total CapEx number for next year, I mean we’re not totally finalized with our budgeting process, but we’re going to be around the $20 million mark with probably more than half of that related to expansion and efficiency improvements.

Okay. Thank you.

Thanks, Frederick.

Thank you everybody for joining us on this call. We look forward to speaking with you again at our year-end conference call in March of next year.

Have a nice day.