Stella-Jones Inc.

Thank you. Good morning everyone.

I am here with Eric Vachon, Chief Financial Officer of Stella-Jones. And 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, 2018.

Our press release reporting 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 will begin with a brief overview of our full year results.

In 2018, we experienced our 18th consecutive year of sales growth. Our sales increased in all product categories, driven by a combination of sales prices, market demand and acquisitions.

Our EBITDA modestly increased to CAD244 million when compared to 2017 as it was negatively impacted by CAD7.9 million non-cash mark-to-market loss on derivative commodity contracts in the fourth quarter. Excluding this nonoperational item, EBITDA would have reached CAD252 million representing a year-over-year increase of about 4%.

Let me provide you with a bit more color on this. We use these derivative commodity contracts to protect our future cash flows from the price fluctuations related to diesel and petroleum.

We have used these derivative instruments for several years. In late 2018, we entered into a new hedge agreement covering diesel requirements for 2019 and 2020, which represents about half of our anticipated needs.

This is the first time we have experienced such a large loss in one quarter as fuel prices sharply declined within a few weeks. What is important to highlight is that this is non-cash and as of today about 60% of the loss has already reversed in the first quarter.

For 2018, total sales reached CAD2.12 billion, an increase of 12.6% over the previous year. Excluding acquisitions and the currency exchange effect, organic sales increased by approximately CAD190.2 million or 10.1%.

Net income for 2018 amounted to CAD137.6 million or CAD1.98 per diluted share, down from CAD167.9 million or CAD2.42 per diluted share in 2017. The year-over-year decrease is primarily explained by a one-off non-cash tax benefit of CAD30 million recorded in the fourth quarter of 2017 resulting from the remeasurement of deferred tax liabilities following a reduction in the U.S.

top federal corporate income tax rate. Turning to the fourth quarter results.

Total sales in the fourth quarter amounted to CAD432.8 million, up 14.7% over the previous year. Excluding acquisitions and the currency conversion effect, sales increased approximately CAD35 million or 9.3%.

Sales of railway ties reached CAD127 million versus CAD118 million last year. Excluding the currency conversion effect, railway ties sales rose 4.8%, driven by price increases.

Utility pole sales amounted to CAD192 million, up 17.9% from CAD162.9 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 15% as a result of greater market reach in the U.S.

Southeast, increased project activity requiring transmission poles, healthy demand for replacement programs and requirements following the California wildfires in late 2018. Residential lumber sales reached CAD60.3 million, up from CAD48.6 million last year.

Excluding the contribution from acquisitions and the currency conversion effect, sales grew 8.0%, reflecting stronger volume in Canada, partially offset by lower selling prices in the U.S. Industrial product sales amounted to CAD23.1 million, up from CAD20.0 million a year ago.

Excluding acquisitions and the currency conversion effect, sales decreased 6.0% as a result of lower bridge and timber demand. Finally, logs and lumber sales totaled CAD30.4 million versus CAD27.9 million last year.

Excluding the currency conversion effect, sales grew 7.9%, driven, in most part, by heightened pole procurement efforts to support the utility pole product category, partially offset by lower selling prices on lumber. Eric will now provide further details about our fourth quarter results and year-end financial position.

Eric?

Thank you Brian. Gross profit amounted to CAD67.0 million or 15.5% of sales in the fourth quarter of 2018, compared with CAD53.5 million or 14.2% of sales in the fourth quarter of 2017.

The increase as a percentage of sales mainly reflects better year-over-year overhead absorption driven by greater production activity. EBITDA for the fourth quarter of 2018 stood at CAD41.8 million or a margin of 9.7% versus CAD38 million or a margin of 10.1% for the corresponding period last year.

EBITDA was impacted by a non-cash loss of CAD7.9 million related to the mark-to-market fair value on diesel and petroleum derivative commodity contracts, as Brian explained earlier. Operating income stood at CAD31.8 million or 7.4% of sales, compared to CAD29 million or 7.7% of sales in the fourth quarter a year ago.

Net income for the fourth quarter of 2018 was CAD20.6 million or CAD0.30 per diluted share, down from CAD51.1 million or CAD0.74 per diluted share in the fourth quarter of 2017. The year-over-year decrease is attributable to deferred tax liability remeasurement following the December 27 U.S.

tax reform. Turning now to liquidity and capital resources.

Cash flow from operating activities before changes in non-cash working capital components and interest and income taxes paid or recovered was CAD262.3 million for the years compared to CAD248.2 million for 2017. However, given unfavorable working capital variations, primarily linked to increases in inventory, we generated cash flow from operating activities of CAD128.1 million in 2018, compared to CAD301.1 million for 2017.

In 2018, we used our cash to make acquisitions for CAD54.5 million, invest in property, plant and equipment for CAD51.6 million and provide a return to shareholders in the form of dividends for CAD33.3 million and share buybacks for CAD4 million. Stella-Jones concluded 2017 with a healthy financial position.

As at December 31, 2018, our long-term debt, including the current portion, was CAD513.5 million versus CAD455.6 million as at December 31, 2017. The increase mainly reflects higher working capital requirements, financing for acquisitions as well as a currency conversion effect.

As a result, our total debt to EBITDA ratio was 2.1 versus 1.9 as at December 31, 2017. Finally, the Board of Directors of Stella-Jones yesterday declared a quarterly dividend of CAD0.14 per common share, representing an increase of 16.7% over the previous quarterly dividend, payable on April 26, 2019 to shareholders of record at the close of business on April 5, 2019.

This represents the 15th consecutive year of dividend increase. I will now turn the call back to Brian for the outlook.

Brian?

Thank you Eric. For 2019, based on current market conditions and assuming stable currencies and the current level of lumber prices, we expect higher year-over-year overall sales for Stella-Jones, driven by stronger pricing for railway ties and utility poles as well as increased market reach for the residential lumber and the utility pole product categories.

We also expect improved year-over-year margins across all our product categories. Higher margins will be primarily driven by increased pricing and volume for railway ties coupled with improved product mix for utility poles.

In the railway tie product category, sales and margins for 2019 are expected to increase year-over-year, primarily driven by pricing. In fact we believe the increasing cost of untreated railway ties combined with a tighter supply market will lead to continued upward selling price adjustments for the quarters ahead.

In utility pole product category, sales and margins for 2019 are expected to increase year-over-year, driven by both pricing and strong demand for replacement programs and increased project-based sales. In the residential lumber product category, sales for 2019 are expected to be stable year-over-year as higher market demand and reach are expected to be offset by lower selling prices to customers as a result of the lower lumber cost.

Finally, it is important to highlight that sales for the logs and lumber product category, an activity used to optimize procurement and which does not generate margin, is fairly tied to the price of lumber. Therefore, a decrease in the price of lumber will lead to lower sales but higher overall margins when taken as a whole with other product categories and vice versa.

Two points to keep in mind for 2019. First, the 2019 EBITDA will be positively impacted by the implementation of IFRS 16 while net income will be negatively impacted by higher financing expenses.

We will provide you with more information on this with our first quarter results. Finally, we plan on spending a similar level of capital expenditures in 2019, as compared to 2018 and it will include a plant expansion in Cameron, Wisconsin.

As always, we will continue to remain focused on optimizing our operations across the organization while diligently seeking market opportunities in all product categories. Eric and I will now be pleased to answer any questions you may have.

Thank you very much. Good morning everyone.

Hi Walter. Good morning.

So first question, I guess, Brian, your margin outlook for 2019 is fairly consistent with what you had been saying before but I think it's fair to say that the improvement in margin has come a lot slower than we were expecting. And I am wondering, is there any what you could provide in terms of color as to what occurred over the last, let's say, year or two with regards to perhaps the lack of margin improvement?

And if there is any additional comfort that you have that you can provide investors that margin improvement is more likely to be more meaningful going into 2019?

Sure Walter. I think really when we look back over the last 12 to 18 months, what we have really faced is increased raw material costs, particularly as it relates to railway ties but we also saw the same thing happen on our lumber.

So we have been chasing an increased raw material cost, which makes up substantially a good part of our input cost. And as a result, while we were continuing to adjust pricing up, the impact on our margin percentages we continue to kind of get squeezed over this period of time.

I think what we have seen is some stabilization in most areas. We have actually seen some declines, for instance on the residential lumber side.

So that is giving us more confidence in terms of seeing some margin expansion. We are also, in certain markets because of the tightening of supply we are realizing higher selling prices as well that are further helping our margins overall.

And so we are certainly entering 2019 with more confidence of increasing margins. But as you recall last quarter, I think the lesson learned is the volatility in the lumber pricing that can happen particularly on our residential lumber side, we are more looking towards a number as opposed to a percentage which tends to be a little easier for us to guide towards, if you want to say.

And that's going to be sort of our move going forward because once again, if lumber prices spiked then it can push a bit of pressure on our percentage margins, but yet our dollar margins will hold to where we anticipate they will be.

And in terms of dollar margins then, consensus is shy of just around CAD2.90, I guess. Is any reason why that might be building in some expectations that you would indicate that perhaps should be revisited at all?

Not including the uplift that we will get from IFRS in terms of the benefit on the lease accounting, I would say we are comfortable with that number. That will be the best answer I can give you there.

No, that's a good answer. Okay.

The dividend increase that the Board approved here, fairly meaningful one. I just wanted to make sure, when you look at your M&A environment, it's not that you don't see opportunity and therefore you are hiking your dividend more than normal?

Or maybe walk us through the rationale of this shareholder return decision and touch on whether we are just seeing maybe for longer period where acquisition opportunities are not as prevalent?

Great question. And it's funny that this exact topic was discussed at the Board that would it actually signal that there is not opportunities out there.

And in fact I appreciate you asked the question because that is not the case at all. We actually are seeing some great opportunities.

We do expect to be closing on some within the next 12 months. And so that was certainly not the signal we wanted to send.

I think it was just more a confident signal by the Board of the upcoming year and our future cash flows.

Perfect. That's great clarity.

I appreciate it. Thank you very much.

Thank you Walter.

Hi. Good morning.

Good morning.

Brian, I just wondered if we could maybe clarify your commentary on EBITDA growth for 2019. Excluding the uplift from IFRS 16, is there a range of EBITDA that you would be pointing to for 2019?

Yes. I think, let's call it plus or minus 5% around the consensus number that Walter brought up of CAD2.90.

Okay. And Eric, any sense yet what the impacts of IFRS 16 would be on EBITDA and net debt?

Well, we will be reconciling those numbers in the first quarter. I hesitate to give you guidance.

Ballpark, I think IFRS 16 could add something around CAD23 million to CAD25 million in depreciation to our P&L for 2019. But that again is approximate and an estimate.

Okay. Great.

Not, that's helpful. And Brian, how much of the 15% organic growth in poles was driven by the wildfires?

And what sort of organic growth you expect again in poles in 2019?

I would say that 15%, it would be not quite half. There was a lot of deliveries made in the fourth quarter to help support our customers.

Maybe a third, about a third would be a better answer to that. In terms of growth for 2019, we were looking in certainly the strong single digit on the pole side.

We are seeing a lot of activity, a lot of projects out there. So we are confident on some continued growth into 2019.

Okay. Great.

That's helpful. And related to that, Eric, were there any increase provisions for credit losses in the quarter related to PG&E?

I will say, there was a small adjustment, not necessarily material. And we believe that going forward we don't expect any more adjustments.

Okay. Great.

That's helpful. That's all I had.

I will turn it over.

Thanks.

Thank you.

Yes. Good morning Eric.

Good morning Brian. My first question is on the railway tie.

The RTA is putting a new report that looks at the green tie pricing. So I was just wondering given the increasing pricing for green tie, your ability to pass through those price increases to customers?

And I am also wondering if the lower inventory to sales ratio will bring one some boltanization in 2019 and maybe going forward?

It's going to be simple answers to both of those questions. We will continue as prices continue to move up on railway ties continue to pass them through.

Boltanizing for sure. It's going to be a tight market until we can see the procurement improve.

But we have capacity and we will be responding to the market needs. We are comfortable that our procurement team will succeed in getting us what we need.

Okay. Perfect.

And should we expect any big move on the cost side, given the boltanization? Or it's mostly again another pass-through in terms of pricing, Brian?

Yes. Nothing of material nature and we certainly will be able to pass that through.

Okay. Perfect.

And just in terms of working capital for 2018, there was drag or usage of almost CAD76 million driven by higher inventory. I was wondering if it was mostly related to the transition to black tie model?

And also what we should expect in 2019 in terms of movement in working capital?

Yes. A good question.

You answered part of it yourself. But yes, the transition of black tie certainly had an effect on that for the full year.

I would say also over the year before what we certainly were able to take advantage of was the softer lumber pricing. And so we were in a better position to get ourselves better set for the upcoming lumber season.

So that plays into it as well. So the combination of those items speak to most of that change in the inventory.

As we move into 2019, I think we are going to have just more of a stable effect on working capital from the standpoint of a change in working capital, if you want to say.

Okay. Perfect.

That's very good. And in terms of M&A update, Brian, you mentioned that you are confident to close some in the next 12 months.

Any particular segment that we should see more activities?

I think I don't want to pinpoint any specific one but it will certainly be in one of our core product categories. How's that?

Yes. Okay.

Perfect. And lastly, you are investing for the plant expansion in Wisconsin.

I was wondering how much does it represent? And what kind of incremental revenues it could add or the rational for the plant expansion in Wisconsin, Brain?

It's a little over CAD10 million, will the total cost roughly. The reason, the rationale behind it is just that we tapped the capacity at the facility.

It will become much more efficient when the second cylinder is in place. And in terms of the potential revenue out of that that could drive, it's somewhere between CAD15 million and CAD20 million a year, once again we reach the capacity on that cylinder.

And I would point out, we actually have room for a third. So if we continue to see the demand, we can add another one.

Okay. Perfect.

Thank you very much for the time.

Okay. Thanks Benoit.

Good morning. Thanks for taking my call.

I just want to go back on the commentary around the California wildfires leading to certain requirements. I am just wondering if you able to elaborate what those requirements are?

And if it was specific to California or more broadly across the states?

The question was relating to the growth we saw in the fourth quarter and around that was kind of what percentage of that growth could have been attributable to the California wildfires? And really what it was, was replacement poles getting sent in for ones that would have come down because of the fires.

And so specifically related to the growth, the rough estimate was about a third of the 15%, if you want to say. Not a third of our overall pole sales.

I am just referring to the growth.

Okay. That's helpful.

Hope that answer your question, Justin. But we did see growth pretty well spread out everywhere but certainly concentrated there was some concentrated growth in the fourth quarter related to the California wildfires as we responded to our customer needs.

Understood. And I am just wondering if the situation there and the major bankruptcy of one of the utilities, is that leading to other unities across the states maybe potentially addressing the liability of end-of-life poles and maybe increasing their CapEx expenditure?

Well, we would certainly hope we could see that. Feel free to give them some call and suggest that to them.

But joking aside, I suspect it's probably discussions that would be happening within those utilities. But I think that's responsibilities remains ensuring the proper maintenance of lines.

I would like to think it's probably a key topic with many of the utilities. So I certainly see that as a potential positive for us or a driver going forward in the years ahead.

Okay. Thank you.

And then just finally on M&A, I am just wondering if you are seeing similar multiple levels than in the past, kind of slightly below the one time sales?

We will continue with our disciplined approach. It is the best way I can answer that.

Okay. Thank you for taking my questions.

Thanks Justin.

Thanks. Good morning.

Hi Michael.

Brian, I think you talked in response to a couple of questions about the impact in the quarter on utility poles as a result of the additional volumes related to the wildfires. But I don't know, did you comment specifically a little more detail on the 2019 outlook?

I know you said sales for poles should be higher year-over-year. But can you provide a bit more granularity?

Sorry. From the standpoint, I said we were expecting sort of a high single digit growth on utility poles in 2019.

But that's going to be pretty well spread out. A lot of projects going on, a lot of maintenance demand and continued market reach as well.

Okay. And this sort of builds on one of the last question, but do you see this as sort of being partly driven by finally tackling the large install base that is nearing end of its useful life?

Or is this more just still normal course type growth?

I think we are starting to se hints of it. Because I know a lot of our customers are referring to pole replacement programs or grid hardening and these types of things.

But I am a little nervous to the point directly to that. But I would say it's certainly a positive sign.

So we are feeling pretty good in terms of what we see the market doing.

Okay. And then I guess similarly to what I just asked about in terms of the 2019 outlook for poles, if we switch over the ties, again you are calling for some growth there.

But can you talk to the sort of the components of that growth, volume versus prices? Prices seem like they is still up in there, maybe still climbing in terms of the pass-through.

But how do we think about the two pieces of volume versus price for ties in 2019?

Most will be price. Volumes, well, we suspect a healthy demand.

It's really going to be ensuring that we can get enough white tie to meet that demand. And that kind of goes back to another question about the need to be doing a lot of boltanizing in 2019 is certainly going to be something we going to be doing.

But I would say, the anticipated growth is going to come mainly from pricing.

Okay. And then I know in the last couple of years, there's even playing some catch-up as far as seeking higher prices to offset the higher untreated tie prices and untreated tie prices are still quite elevated obviously.

But where are you at as far sort of catching up and restoring the margins in that business to sort of more historical levels? I know you don't want to talk about margins as far of the overall 2019, but within that, have you largely restored them now as we get into 2019?

Or is that still happening as you move through the year?

Well, as long as we still see pressure on the supply and still see pressure on the raw material cost, we are still going to be chasing it slightly. But I would say, the pace has at least slowed down.

So we are closer to grabbing hold of it, maybe is the best way to express it. So we are getting there and I think outside of the contractual obligations, that's been able to be adjusted much more quickly.

So we are seeing improvement, for sure.

Okay. And then I apologize if I missed this.

But I think there was a question earlier about changes in non-cash working capital. Eric, did you provide some outlook or guidance for that for 2019?

Or if you didn't, could you?

Actually I provided it, but Eric can repeat it.

Exactly. So Mike, to reiterate what Brian mentioned, we think it's going to be relatively stable for the remainder of the year.

Got it. Okay.

And then just one last one for you, Eric. I think in the context of IFRS 16, you were talking about the expected increase in EBITDA but you were suggesting net income would be lower due to I think higher finance expenses.

Sort of my understanding of IFRS 16 was that there was typically relatively little impact on the bottomline. Are you simply pointing out that there is going to be some incremental interest expense?

Or is net income actually going to decline?

No. Essentially the message is that there is going to be some interest expense related to the accounting approach.

But from a neat earnings perspective, it should not have the offset as I guess the rent expense that you won't be incurring in the SG&A line.

Right. It could have a slight impact.

I don't expect anything too significant. But it could have a slight impact, Mike.

I see. Okay.

All right. That's all for me.

Thank you.

Thank you Mike.

Yes. Just to come back on the high single digit growth expected for utilities, Brian.

Were you mostly referring to volume or overall revenues?

A combination of the two, Benoit.

Okay. And mostly driven by volume, I would assume?

In the case of utility poles, I would agree with that, yes.

Okay. Perfect.

And for residential lumber, you mentioned some color about kind of a flattish revenue but driven by lower pricing and strong demand. What type of volume growth should we be looking for, for residential lumber in 2019?

And is it mostly driven by market share gain from your customer?

It will not only from our customer, but also just from additional customers that we are taking on as we continue to expand our market reach. You will remember that we did an acquisition last year that expanded our geographical footprint and has allowed us to further expand in that market as well.

So a combination of hooking our wagon to the right horse as well as just our ability to expand our market reach. So I would say, on the volume side, we are probably low mid single digit, I would say, on the volume side.

Okay. That's really, really great color.

And just in terms of cash deployment opportunities, obviously the balance sheet $2.1 billion is strong, especially the working cap is going to be more flattish this year as opposed to usage similar to last year. So I am just wondering as you build up EBITDA, free cash flow, any thoughts about the cash deployment opportunities or given the M&A pipeline is still there, that it will still be the first usage to make, Brian?

Absolutely. That's always our best return for shareholders is the acquisition pipeline.

And that's, I certainly hope that's going to be my number one use of cash this year.

Okay. Perfect.

Thanks again for the time.

Thank you Benoit.

Hi. Thanks.

Just one follow-up. In terms of the incremental volume you saw on the pole segment due to the wildfires, would the margins on that business have been consistent with the rest of your poles sales?

Or was there any difference in the margin profile of that incremental work?

It would have been consistent.

Okay. Thank you.

Hi. Good morning guys.

Hi Mark.

So I just want to clarify just two things, I guess. Just on the working cap, is that neutral for the year?

Or it sort of grows with sales? Because it sort of sounds like you will some pretty good growth in sales this year.

So I would assume some investment in working cap?

There will be some, yes. it's more of an effect that we, if you look at it on a year-over-year form 2018 to 2017, we had quite a bit a swing on the working capital and it was related to some timing events on stocking up with inventory.

It would just more point to more of a neutral affect. But you are absolutely right.

There will be some use to respond to increased sales.

Okay. And just on the guidance, again the $2.90, the plus or minus 5% around that, again that could be reasonable sort of, it could be a pretty material difference either way.

So I sort of curious as to some of the puts and takes and some of the things that may lead to plus 5% or the minus 5% as sort of some of the things you are looking at?

I think really it's just we are early in the year and hedging my range at this point in time, I would say, I would tend to lean at this point in time, we are fairly bullish for the year ahead. All indications are that we are going to have a healthy year.

But there's things beyond our control. We have certainly learned that lesson well over the last few years.

So giving a tight number, there're certain things beyond our control. So I just wanted to provide a bit of a range.

Okay. No, that's fair.

All right. Thanks.

Good. Well, thank you everybody for joining on this call and we look forward to speaking with you again on our next quarterly call.

Have a great day.