Stella-Jones Inc.

Brian McManus - President and CEO Éric Vachon - Chief Financial Officer

Mona Nazir - Laurentian Bank Mark Neville - Scotiabank Benoit Poirier - Desjardins Capital Markets Sarah O’Brien - RBC Capital Markets Sara 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. We’re actually doing this call this morning from Lewiston, Idaho.

So, if it may come in a little unclear, that’s the reason, we’re on a plant tour over the next couple of days. So, thank you for joining us for this discussion of the financial and operating results for the Company’s full year and fourth quarter ended December 31, 2015.

Our press release reporting full year and Q4 results was published earlier this morning. It can also be found on our website at www.stella-jones.com and on SEDAR.

Let me remind you that all figures expressed on today’s call are in Canadian dollars unless otherwise stated. I’ll begin with a brief overview of our full year results.

2015 was another record year in terms of sales and net income, the 15th consecutive year of growth for Stella-Jones. Sales totaled $1.56 billion up from $1.25 billion a year ago.

Excluding acquisitions and the year-over-year effect of currency variations, organic sales increased by approximately $80.4 million or 6.4%. Net income for the year amounted to a $141.4 million, a 36.1% increase over 2014 while EPS reached $2.04 per diluted share, up from a $1.50 last year.

We saw sustained demand for our core products and once again expanded production capacity through acquisitions in both the U.S. and Canada.

With strategic purchases of wood treating operations in Ontario and the American Southeast, we improved the scope and efficiency of our network. These factors helped position the Company for further reach into both its traditional markets as new one.

Turning to the fourth quarter results, we saw continued healthy demand in our core market. Total revenue reached $357.5 million, an improvement of 23.3% over the fourth quarter of last year.

An important contributor to the revenue increase was the acquisition on October 1, 2015 of Ram Forest Group and Ramfor Lumber, which I will collectively refer to as Ram. During the fourth quarter, Ram sales amounted to $14.8 million.

In addition, year-over-year fluctuations in the value of the Canadian dollar had a positive impact of $41.6 million on our U.S. dollar denominated sale.

If we exclude the contribution of acquired facilities and the exchange rate effect, sales in the quarter increased by approximately $11.2 million or 3.9%. Looking at Q4 results by product category, railway tie sales amounted to $147.5 million, an increase of 12.5% over the fourth quarter of last year.

If we exclude the currency conversion effect, railway tie sales declined approximately $4.3 million, mainly due to year-over-year timing differences on certain deliveries. Turning to the utility pole category, sales totaled $129.5 million, a 13.8% increase over the fourth quarter of 2014.

If we exclude the currency conversion effect, sales increased approximately $1.4 million. We saw higher sales of distribution poles due to regular replacement programs.

That increase was partially offset by lower sales of transmission poles as a weakness in natural resource sectors affected the demand generated by special projects. In the residential lumber category, sales reached $40.1 million versus $17.9 million last year, mainly reflecting the contribution of the Ram acquisition.

Industrial product sales amounted to $23.6 million, a 26% increase over the previous year. The improvement resulted from increased sales of bridge related product.

In the logs and lumber category, sales reached $16.7 million during the quarter versus $8.4 million last year. This increase was mainly due to the purchase and resale of lumber as well as the timing of timber harvesting.

In regard to the latter category, Stella-Jones enlarged its procurement department to support increased residential lumber requirement. We now purchase a greater volume of lumber to compete on pricing.

We then resell excess product into local homebuilding market. Margins on resold lumber are nominal as they are carried out at a value close to the cost of sales.

These sales along with log sales make up the logs and lumber product category. Turning to our network expansion strategy, in addition to completing the acquisition of Ram at the beginning of the fourth quarter, we also acquired on December 4th, the operating assets of United Wood Treating Company, Inc., a manufacturer of treated wood utility poles and marine pilings located in Whitmire, South Carolina.

These acquisitions further enhanced our status as a leading supplier of treated wood products in North America. The acquisitions have also contributed synergies as we have since made progress in integrating this facility and in leveraging the benefits of a larger network.

Subsequent to year-end, we signed a non-binding letter of intent to acquire Lufkin Creosoting, a producer of treated poles and timbers in the state of Texas. We also signed a similar letter to acquire the parent Company of Kisatchie Treating and Kisatchie Pole & Piling, producers of treated poles, pilings and timbers in the state of Louisiana.

The combined 2015 sales of these potential acquisitions were approximately U.S. $86 million.

We expect both transactions to close in the second quarter of 2016. Éric will now provide further details about our fourth quarter results and year-end financial position.

Éric?

Thank you, Brian. Fourth quarter gross profit reached $69.3 million or 19.4% of sales, up from $51.4 million or 17.7% of sales last year.

The increase in dollar reflects higher business activity, the contribution from Ram as well as the favorable impact of conversion effects resulting from currency variations. The increase as a percentage of sales is attributable to adjusted pricing for railway ties and greater efficiencies throughout Stella-Jones’ plant network.

As a result of higher gross profit, operating income amounted to $48.3 million or 13.5% of sales versus $33.9 million or 11.7% of sales a year ago. Net income for the fourth quarter rose 43.7% to $33 million or $0.48 per diluted share compared with $23 million or $0.33 per diluted share last year.

As Brian mentioned, net income for 2015 was $141.4 million or $2.04 per diluted share, up from a $103.8 million or a $1.50 per diluted share in 2014. With this significant improvement in net income, Stella-Jones generated cash flow from operating activities before changes in working capital components and interest and income taxes paid of $254.3 million in 2015, up more than 40% from the previous year.

This solid cash flow generation allowed Stella-Jones to conclude the year with a healthy financial position. As at December 31, 2015, total long-term debt including the current portion stood at $670 million while the ratio of total debt to total capitalization was 0.42 to 1 versus 0.39 to 1 a year earlier.

The slight increase is mainly due to the Ram acquisition being completed in the last quarter of the year. Subsequent to year-end, on February 26, 2016, Stella-Jones amended its credit facility with its banking syndicate to increase its committed revolving credit facility from US$450 million to US$500 million over the next two years.

The amended agreement also included an accordion option allowing the request for an additional amount of up to a total of US$200 million. We also entered into demand loan agreements with two banks participating in the syndicate to make available financing up to US$500 million under the same conditions, as our committed revolving credit facility.

Finally, the board of directors declared a quarterly dividend of $0.10 per share payable on April 29, 2016 to shareholders of record at the close of business on April 1, 2016. This dividend represents an increase of 25% over the prior quarter.

I turn the call back to Brian for the outlook.

Thank you, Éric. Just a slight clarification on the demand loan, demand loans were 50 million.

I’m sorry.

Thank you, Éric. Looking ahead, although certain sectors of the North American economy have softened, we expect demand for our core products to remain healthy.

In the railway tie category, we expect sustained demand as operators continue to invest in network maintenance and pursue peak efficiency for their line. In the utility pole category, while lower resource prices are reducing demand for special projects, we expect demand from regular maintenance and replacement programs will hold.

Over the midterm, we expect demand will pick up as increasing numbers of installed poles reach the end of their service life and will need to be replaced. In the residential lumber category, the Ram acquisition will allow Stella-Jones to broaden its reach and product offering.

We’ll leverage our wood treating expertise in this market. And we are confident to achieve a significant increase in sales in this growing product category.

In the short-term, we will aim at achieving synergies from our 2015 acquisition. We’re also looking to complete the proposed acquisitions of Lufkin Creosoting and Kisatchie in the second quarter.

As we have done for many years with previous expansions, we will strive to identify further means to enhance network productivity. In the year ahead, we expect our cash flow to remain solid.

It will be used to reduce debt, invest in working capital and in network enhancement initiatives, as well as to maintain an optimal dividend for our shareholders. We will also continue to study any opportunity to further expand our network and market reach as we remain committed to building additional value for our shareholders.

Éric and I will now be pleased to answer any questions you may have.

Good morning. Just a couple of questions from me, firstly in regard to the Ram acquisition.

The sales figure that you provided was about 16% of the annual sales, based on the 90 million. I’m just wondering if you could speak a little bit about the seasonality of this business and specifically the profitability quarter-to-quarter just given it’s still early on since you purchased it?

Sure, a good question Mona and actually it allows us to explain a bit the residential lumber product category, as it relates now to our expansion. It is much more seasonal.

And so, the second and third quarters will be our strongest quarters. First and fourth quarters are softer, just again people are not installing decks or building fences in the month of February in most parts of Canada.

And at the same time, we are still supporting a larger selling team right now such as in-store service reps that are part of the business. So, you will see again the seasonality in those costs.

Well, they’re flat throughout the year, the profitability of the residential lumber category picks up in the second and third quarter. I hope that answers your question.

Yes, that answers my question. And then just secondly from me on the tuck-in of United Wood; it’s the sixth acquisition you have made in a 12-month period.

The common theme when reading your commentary surrounding these acquisitions is synergies. I’m just wondering what kind of synergies can we expect to see, and can you quantify such, might quite hard but on the cost side; and then on the revenue side, how those synergies come into play and then how the other acquisitions are progressing?

In terms of the synergies, Mona, it is very similar to what we have achieved in previous acquisitions over the years at the SG&A level. We immediately can see some savings that happen there.

We have overlapping markets, both on a procurement side and on a selling side, so that again allows further synergies. Logistics is another big thing.

The ability to immediately shift production to plants that would be closer to the market or shift procurement that would be going to one plant to another plant because it’s closer to receive the white [ph] wood that’s coming in. So, these are very common and where we see these synergies.

Each acquisition varies in what’s available in terms of synergies. But we generally are able to see increases in the margins of those acquisitions that we have done by generally a couple of percent on the EBIT line.

That’s been sort of our historical synergies that we are able to extract out of acquisitions. In terms of the two that we have ongoing that we’ve announced letter of intents on, we expect that those should be closing in the second quarter; they’re progressing one.

And just lastly for me, on that tie side, I am wondering if you could speak about what drove the compression in organic growth in Q4. And then, in light of Class I CapEx cuts, what kind of discussions are you having with clients; has there been a change in tone?

And I know there is still a commitment to maintenance of networks at this point, but do the overall cuts impact you with all at this point in time?

In regards to fourth quarter, first part of your question, that’s primarily just related to the timing of shipping of borders. And fourth and first quarter, on year-over-year basis are always the most volatile in terms of the timing of when those ties are going to ship out of the plants.

So, you will see a pickup in Q1 from -- once it’s [indiscernible] in Q4 on the tie side. In regards to the overall demand for 2016, for the most parts, our customers are still indicating to us that their maintenance programs and their tie demand is going to be maintained throughout 2016.

We had one of our customers indicate a slight softening, a bit of a cut. But then on the other side, we had another larger customer of ours increase their demand.

So overall, we’re cautiously optimistic about a good 2016 on the tie side.

So, just back on the ties for the quarter, it looks like you said about 3.5% roughly organically. But if I’m not mistaken, I guess our expectation of pricing would be a bit of a tailwind this quarter.

So, maybe, just give us some indication on organic volumes in the quarter?

Organic volume -- actually, both pricing and volume would have been -- or pricing and income down remain steady. So, most of that’s related just to bit of a pull back in volume.

And again it’s really just related to the timing of some shipping.

Okay. So, the pricing on a year-over-year basis was fairly consistent?

Yes.

Okay. Is that because…

Makes sense as well depending on what markets it’s going to that would have had a slight year-over-year difference but overall [multiple speakers].

So, I guess on the pricing, it’s our expectation, maybe we were as wrong, but there would be, again, just some I guess residual benefit from the increases that you announced previously. So, was there some softening in prices or did mostly just had already come through by the end of Q3?

Almost everything was through by the end of Q3. We haven’t seen any softening in Q4.

And just on the poles, so to make sure numbers are correct, but roughly flat volumes in that business organically in the quarter?

That’s correct; it was just marginally up, a little over $1 million for the quarter.

And there were some treating materials in there, right, the M&A in Q4?

But quite -- that would be almost about...

Okay, so call flat, all right. And I guess just one last question on the balance sheet.

When you announced the acquisition of Lufkin and Kisatchie, you hinted that potentially tapping equity markets but you’ve obviously significantly expanded your capacity here, borrowing capacity. So does that take the equity potentially off the table or no?

I think it’s really going to depend on what we have in the pipeline as we near the actual date of the acquisition. We certainly don’t have sure mark to do it, but by the [indiscernible] we’d like to keep the healthy balance sheet and I think we’re going to really see what other acquisitions are lining up behind the ones we’ve announced.

Just to come back on the previous question on the debt-EBITDA level, where would you see the ratio ending, once you complete the latest acquisition in Q2 at the peak level?

A lot of it’s going to depend on the exact timing of that acquisition. One of the things getting back to the seasonality of the residential market is the more we push it into the latter part of Q2, the more we’ll have the positive cash effect of the residential market, working capital sort of coming down substantially.

So, I would say somewhere in the range of 2.8 to 2.9 probably.

Okay, very good color. And just with respect to railway ties, Brian, you already provided some good color about the market these days.

But looking at the numbers for the industry, it seems that it has changed in the last few months with purchase down, inventory rising close to a high. So, how do you see those stats in the industry and kind of implication for you and let’s say in the longer term?

I think a lot of that, Benoit, is related to some catch up that needed to be done. Inventories were for quite a period of time below where they needed to be.

As you know, we’ve been working to build ours up in order to get to a dry inventory and move away from the need to be boltanizing. So, that’s really where you’re seeing those inventories come up.

It’s a conscious effort by the industry to get more dry material available.

And on the free cash flow side, inventory obviously has been putting a pressure on the working capital requirement in 2015. But what should we expect in terms of working capital changes for 2016, given the closing of the latest acquisition and also the procurement, the new procurement department for residential lumber?

You kind of hit it at with your last part of your question. We expect we certainly will not have as large of an effect as we saw in 2015 as we’re getting to a level where we’re more comfortable on the railway tie side as well as our poles are in a fairly good position, I mean there’s certain sizes we’re still chasing.

But the residential lumber will continue sort of build up until the end of the first quarter and then we’ll start to see a positive change there. So, definitely less pull on our cash flow for working capital for 2016, it’s a change in working capital which is…

Okay. And then looking at the numbers, is it something that could be more similar to 2014, so around 50 million in terms of working capital changes?

Sounds about right, yes.

Okay, perfect. Okay.

That’s very good. And utility pole, if you would exclude the special projects, Brian, what would be your organic growth rate?

It would probably be around roughly about the 6%.

And just with respect to residential lumber, you mentioned in the release that you enlarged your procurement department and also the Ram acquisition will broaden your reach in product offering. So, just wondering if you see more opportunities, M&A opportunities down the road, and maybe what’s your timeframe for south of the border?

I think anything south of the border will be pushed out, if we believe opportunities exist, we won’t see anything until 2017, even maybe 2018. Our growth, our ability to leverage off this Ram acquisition is really what we’re focused on for 2016 and into 2017.

We’ve had a lot of positive moves take place and that’s going to come out in 2016.

And last one just in terms of M&A, is it fair to say that 2016 will be more an integration? You will be more under an integration mode or you still see some potential opportunities that could take place?

We certainly are hoping to complete the acquisition of Lufkin and Kisatchie, which would happen in 2016. And I am confident we could have something else starting in 2016.

So, in terms of closing of acquisitions, we have the two that we’ve announced letters of intent that we’re focused on closing those and integrating them, as you pointed out, as well as ensuring the full integration of the Ram acquisition, which is pretty much done. But, we always like to fine tune everything.

And then, again, we’ll see -- we have other things in the pipeline. I suspect that if they could start in 2016 and would be a 2017 book.

Can you talk a little bit about the EBIT margin impact for consumer lumber and the selling lumber portion of that, just any impacts on seasonality there, and maybe in terms of the objective of your target EBITDA range for F16?

Yes. It’s a good question, Sara, because one of the things that this -- the logs and lumber category, if you want to call it, and one of the reasons we did isolate it as a separate category, was essentially because it does run at a very low to almost zero margin.

So, we would expect to see that product category probably adding the two together in the range of around $120 million overall for 2016. So that will create a compression on our -- what we would call, our historical EBITDA percentage margin.

However, we’re still confident that that margin will come in between that 15% and 15.5% that we’ve seen.

Okay, but not -- I think prior -- in previous calls, you’ve commented maybe 16% plus, so this will bring that back down?

Correct, yes.

And then maybe if you can talk about operational efficiency opportunities in a flattish market right now, maybe tied into what CapEx projects you have ongoing and CapEx dollars we might expect to see in 2016?

2016 in terms of our overall CapEx excluding a new plant initiative that we have going on now, we expect it’ll be very similar to what we saw in 2015, so around $35 million, in between let’s say $35 million to $40 million of CapEx. Again, outside of a new plant initiative that we have going on in Wisconsin.

And what is -- can you just remind me what the new plant initiative is and what that cost is?

That cost will be we’re estimating approximately US$27 million to US$30 million and it’s for a full plant.

And once you have this, when is that supposed to be up and running, first; and then, is that kind of the end of special projects or are there others that you can foresee?

I would say that’s probably -- I mean looking at what we see right now but I would say that would be the probably end of a Greenfield operation for us of building new one but that should be operational by the first quarter of 2017?

And then just again on the acquisition pipeline, it sounded like there is still deals you’re looking at. And judging by your debt covenant of 3.5 times, are you still comfortable that you can operate within that range, given the inventory requirement in Q1 and the closings of deals in Q2?

Just trying to get a sense of timing in terms of when you might seriously consider equity and also how comfortable you are up around that 3 times leverage mark?

Comfortable close to the 3, but I think really again it’s going to be where we see the timing of other acquisitions that are in the pipeline happening. So, I think that decision would look to happen sometime in early Q2.

I just wanted to clarify the overall organic growth in the quarter. It sounds like if you strip out the impact of Ram plus the FX, you are talking about $11.2 million increase on the top line, which is 3.9%.

Is that all organic or is the organic number actually something a little bit different than that? Is there anything else flowing through there?

It’d be primarily organic. You have a bit of the treated materials in there, but it’s a small amount.

We were doing some plant improvements, so there wasn’t a lot of production going through that facility. And as is the case with all of our acquisitions, we will often be shifting production around, so to target the exact organic number is always a bit of a challenge for us.

But, I would say it’s fairly accurate number.

And then just back on the railway tie, so you were asked about the outlook there and it sounds like some puts and takes in terms of some customer or one customer increasing and other decreasing, but overall sounds fairly healthy. Should I interpret that to be then flat organic growth in ties in ‘16 for the full year or you think there is actually possibility of seeing a little bit of positive growth?

We’re taking a cautious approach at this point in time, Michael. I think it will be flattish.

And if we can see -- is there potential for a bit of upside? There is.

But at this point in time with the visibility we have, we’re guiding towards a more flattish on the tie side for 2016.

And then with respect to utility poles, I understand the specialty project has acted as a bit of a drag. At what point do you see the comps within that segment getting easier such that we might start to see in the reported numbers something closer to some of the organic growth numbers you were talking about when you ex-out the specialty projects?

Good question. And I would say towards the end of Q2 and definitely Q3.

And then, I just wanted to clarify, the comment you made about I think it was non-pole quality logs and then the lumber resell category, between the two of those, you are talking about $120 million of sales for full year 2016?

That’s correct.

Okay, excellent. And I think that’s all, great.

Thank you.

Thanks Michael.

Good morning, Brian. Congratulations on a wonderful year.

I have one question. I was wondering if Stella-Jones has any pollution or environmental liabilities with the public growing very sensitive to environmental situations.

And when you manufacture those treated poles and ties, if there is anything that we need to worry about, moving forward; are we well-protected in that area?

Well, all of our preservatives that we use are registered preservatives. We treat to the required industry and governmental specs.

And then in terms of any of the sites that we own or acquired, any impacted soil that would need to be cleaned or things like that have been provided for on our balance sheet when such acquisitions are done. So, we’re very comfortable operating in this environment.

And we have a very solid team on our environmental health and safety that is very focused on ensuring that we not only are at the requirements but work above it, so it’s a risk that we’re very comfortable with.

I just wanted to hopefully clarify a few points. The 15% to 15.5% consolidated EBITDA margin for ‘16 that you referenced, that does include the 120 million of sales at let’s call it essentially no margin?

Yes.

And so on the resale lumber, it doesn’t sound -- I am just curious, it sounds like -- how long do you hold that product? It doesn’t sound like it should be a major drag on working capital.

It’s not. That’s actually very good point, probably should have brought that up.

If we carry a very minimum working capital forward, it’s essentially back to back trade.

And just on the residential business, I mean the business, it seems like you’re doing quite well there. I am just curious, can you just talk a little more.

I mean obviously the market is maybe doing a bit better, but just talk about what you’re seeing there or what you’re doing to drive the growth that we’re seeing.

What’s that on the -- I am sorry I just didn’t hear…

The residential.

In terms of why we’re seeing growth there, or…

We’re seeing a lot of it, I am just curious as to what are you doing with the business. I mean sales were up I think 25% organically and look like, anyway maybe I had some wrong numbers there.

But I am just curious what you’re doing with that business, and what’s really behind all that?

Really what’s behind it is I would give a lot of accolades to our great sales team and service team, what we’re providing to our customers and our ability to frankly outpace the market on the residential side. So, I don’t want to get into too much of our trade secrets, but we’re doing the right things.

Éric, just to clarify, can you tell us what we should be thinking about in terms of effective tax rate for 2016?

Probably along the lines of what we disclosed for our Q4 2015. The increase that you observe is essentially view as a higher taxable income in the U.S.

jurisdiction where tax rate is just slightly higher. So, the percentage trended upwards.

So, the 32% to 33% would probably be a good indication.

Okay, thank you.

Thank you. Well, thank you everyone for joining us on this call.

I would like to invite you to our annual meeting of shareholders to be held on April 28th at the Ritz-Carlton Hotel in Montreal. We also look forward to speaking with you again at our next quarterly call.

Have a nice day.