Stella-Jones Annual Report 2017

Plain-text annual report

2017 ANNUAL REPORT S T E L L A - J O N E S 2 0 1 7 A N N U A L R E P O R T 167.9 73.1 25.7 2007 2012 2017 NET INCOME GROWTH SINCE 2007 $1,886.1 M IN TOTAL SALES $207.4 M OF OPERATING INCOME $167.9 M OF NET INCOME A Quarter Century Building On Our Expertise of Railway Ties Stella-Jones is a principal supplier of the more than twenty million ties purchased annually by the railroad industry in North America. 94.4 34.5% OF SALES 651.5 404.5 $651.5 M 2017 SALES 2007 2012 2017 SALES GROWTH SINCE 2007 34.7% OF SALES 654.0 Utility Poles Offering an unparalleled security of supply, Stella-Jones is one of the continent’s largest producers of 129.8 pressure-treated poles. 218.5 $654.0 M 2017 SALES 2007 2012 2017 SALES GROWTH SINCE 2007 1 2017 Annual Report Stella-Jones Inc. 19.4% OF SALES 5.0% OF SALES 6.4% OF SALES 366.2 Residential Lumber Diversifying within its core competence, Stella-Jones has made residential lumber a rapidly growing component of its core product offering. 29.6 35.5 $366.2 M 2017 SALES 2007 2012 2017 SALES GROWTH SINCE 2007 Industrial Products Stella-Jones generates additional revenues by pre-plating ties for railway clients, and by manufac tu ring marine pilings, bridge timbers, highway guardrail posts and panelized railway crossings. 15.9 94.5 59.0 $94.5 M 2017 SALES 2007 2012 2017 SALES GROWTH SINCE 2007 Logs and Lumber 119.9 Untreated lumber, as well as logs unsuitable for use as poles, are marketed by Stella- Jones as signiﬁcant sources of ancillary revenue and key to ensuring reliability and minimizing costs for our poles and lumber. $119.9 M 2017 SALES N/A 2007 N/A 2012 2017 SALES GROWTH SINCE 2007 2 2017 Annual Report Stella-Jones Inc. 5-Year Financial Performance For the years ended December 31 (millions of dollars, except per share data and ratios) 2017 $ 2016 $ 2015 $ 2014 $ 2013 $ OPERATING RESULTS Sales Operating income 1 Net income FINANCIAL POSITION Working capital Total assets Total debt 2 Shareholders’ equity PER SHARE DATA Basic earnings per common share Diluted earnings per common share Book value Dividend per share Average number of shares outstanding (000’s) Average number of diluted shares outstanding (000’s) Shares outstanding at year end (000’s) FINANCIAL RATIOS Operating margin Return on average equity Total debt 2 to total capitalization Total debt 2 to trailing 12-month EBITDA 1 Working capital 1,886.1 1,838.4 1,559.3 1,249.5 1,011.3 207.4 167.9 233.2 153.9 220.1 141.4 155.7 103.8 138.7 92.5 779.4 1,786.0 455.6 1,115.5 2.42 2.42 16.09 0.44 69,324 69,333 69,342 928.0 854.4 615.1 517.0 1,960.9 1,778.9 1,289.0 1,071.9 694.0 1,026.4 669.9 913.5 444.6 692.3 372.9 572.2 2.22 2.22 14.81 0.40 69,215 69,231 69,303 2.05 2.04 13.21 0.32 69,018 69,153 69,137 1.51 1.50 10.04 0.28 68,802 69,027 68,949 1.35 1.34 8.33 0.20 68,681 69,053 68,697 11.0% 15.7% 12.7% 15.9% 14.1% 17.6% 12.5% 16.4% 13.7% 17.8% 0.29:1 0.40:1 0.42:1 0.39:1 0.39:1 1.89 7.04 2.62 8.58 2.75 6.36 2.52 8.33 2.41 8.97 1 These items are ﬁnancial measures not prescribed by International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board and Chartered Professional Accountant Canada Handbook Part 1 and are not likely to be comparable to similar measures presented by other issuers. Please refer to the Non-IFRS ﬁnancial measures section in the management’s discussion and analysis. 2 Including the current portion of long-term debt. 3 2017 Annual Report Stella-Jones Inc. Continued Strength As we mark the 25th anniversary of Stella-Jones’ founding, and in line with the pattern of decades of success, we remain singularly devoted to the pressure treatment of wood, and the manufacture of high-quality railway ties, utility poles, residential lumber and ancillary treated wood products. Following that same historic pattern, the efﬁciency of our Company’s network in 2017 once again improved, and our market reach and sales also grew. These are the effects of our disciplined approach of adhering strictly to our core competence – and increasingly leveraging that specialized expertise to beneﬁt our clients and shareholders. For Stella-Jones, 2017 was a year of Company-wide integration, with negotiations leading to the smaller-scale, yet synergistic, early 2018 acquisition of the operations of Prairie Forest Products, a treated lumber and pole producer. This purchase also represented the extension of our treating facility network into the province of Manitoba for the ﬁrst time. It was also a year during which we faced strong commercial headwinds, particularly in the railway tie sector which I referred to in my report last year. 4 2017 Annual Report Stella-Jones Inc. The Stella-Jones Advantage High inventory levels, which started to build across the industry in the fourth Our Team: Stronger Together quarter of 2016, put pressure on prices and margins. These inventories only Numerous strategic acquisitions have reached more normal historical levels during the latter part of 2017. Margins brought assets, systems, market intelligence also came under pressure in the utility pole product category, although this and seasoned personnel to Stella-Jones. situation mainly reﬂects our greater reach in the U.S. southeast, where the With the resulting economies of scale, predominant wood species gives rise to a different sales and margin mix for leveraged network efﬁciencies, and ever- the Company. Finally, our residential lumber activities had to cope with steep increasing reliability as a supplier, our rises in lumber prices in Canada and the United States, but the strength of continent-wide team has consistently Stella-Jones’ network still produced solid growth. expanded the Company’s market reach. Despite these challenges and without any boost from large-scale acquisitions, Stella-Jones achieved a 17th consecutive year of sales and net income Well-Positioned Network growth. Consolidated sales and net income in 2017 reached $1.89 billion and The network of Stella-Jones facilities $168.0 million, respectively, compared with $1.84 billion and $154.0 million spread across Canada and the U.S. reﬂect in the previous year. Once again, the Company’s overall ﬁnancial strength was a methodical expansion strategy that has demonstrated by a net reduction in total debt of more than $200.0 million. achieved unrivalled continental coverage in the wood-treating industry. As Stella-Jones begins its second quarter century, we are optimistic about the prospects for 2018 in all sectors of our business. The essential need both in Canada and the United States to upgrade the infrastructure of the rail and utility networks will underpin demand for our ties and poles, and strong Expanding Possibilities with Our Expertise economic growth in both countries will provide support for our residential Adhering to its core competence, lumber sales. Stella-Jones progressively strengthens its expertise and the reliability of its products. On behalf of the Board, I thank our shareholders for their continued support, The Company thereby enhances the and all our employees for their excellent and productive contribution in a year conﬁdence of its customers while that tested our proven strengths. widening its client base. Tom A. Bruce Jones, CBE Chairman of the Board 5 2017 Annual Report Stella-Jones Inc. Building on Success In 2017, for the seventeenth consecutive year, Stella-Jones generated increased revenues and higher net income. This record of sustained growth and increasing profitability has been achieved by virtue of a tightly focused strategy that combines strategic acquisitions, core product offerings and steadily improved network efficiency. Year after year, these principal characteristics of the Stella- Jones business model have enhanced the Company’s market scope, steadily enlarged its potential, and made it a consistent, deeply entrenched and highly trusted force in the North American wood treating industry. The result has been, and continues to be, progressively heightened shareholder value. 6 Stella-Jones Inc.2017 Annual Report Q How did Stella-Jones perform in New milestones in revenue and net income were reached by Stella-Jones in 2017. These 2017, and what were the main achievements were driven by the continental reach of our network, the productivity of our people factors contributing to its results? and the conﬁdence of our clients. Annual sales amounted to $1.89 billion. Excluding the conversion effect caused by ﬂuctuations in the value of the Canadian dollar vis-à-vis the U.S. dollar and full-year contribution from 2016 acquisitions, sales rose by approximately 1.1%. Net income totaled $167.9 million, or $2.42 per diluted share, compared with $153.9 million, or $2.22 per diluted share, the previous year. The increase, which includes the gains from a one-time non-cash deferred tax remeasurement for our U.S. subsidiaries from recent changes in the U.S. Federal corporate income tax laws, represents the seventeenth straight year in which net income has improved. Q How would you describe market Throughout the year, demand remained generally healthy for our treated wood railway ties, utility demand for the Company’s poles and residential lumber. Our margins were negatively affected by pricing pressures in the products in 2017, and its impact railway tie category and by overall product mix. Still, the Company’s year-over-year larger presence upon Stella-Jones’ performance? in the utility pole and residential lumber markets helped partially offset the effect of lower year- over-year pricing in the tie category. 7 2017 Annual Report Stella-Jones Inc. ASSURED CONTINUITY OF SUPPLY, MADE POSSIBLE BY A NETWORK OF THIRTY- EIGHT PRODUCTION FACILITIES, TWELVE POLE PEELING FACILITIES AND A COAL TAR DISTILLERY WHICH SPAN SIX PROVINCES AND NINETEEN STATES, IS A DISTINGUISHING FEATURE OF STELLA-JONES’ SERVICE TO ITS CUSTOMERS. 8 Stella-Jones Inc.2017 Annual ReportQ As we look back on 2017 and While Stella-Jones paused its acquisition program in 2017, the Company used its strong cash forward to 2018 and beyond, ﬂow to reduce debt. The excellent ﬁnancial condition of the Company also allowed for an increase how would you characterize the in dividend payments to shareholders. Dividend payments have now increased for thirteen Company’s ﬁnancial position? consecutive years. With our ratio of long-term debt to equity substantially improved, and with a strong working capital position, the key aspects that signal a solid, well-grounded, forward-looking and growing company are precisely the same aspects that characterize the ﬁnancial position of Stella-Jones. Q How did the railway tie category A critical and enduring part of North America’s freight and passenger transportation system perform in 2017? consists of hundreds of thousands of miles of railway track. These tracks are held together by millions of crossties which must be replaced as they age. Stella-Jones is one of the continent’s foremost suppliers of this vital product. In 2017, given generally positive economic conditions, railway operators continued to invest in new track and track upgrades. Although year-over-year pricing pressures affected revenues, as the market needed to orderly dispose of high tie inventories and pass through lower untreated tie costs, our sales volume for the year remained relatively healthy. Railway ties accounted for 34.5% of total revenues. Q What results were achieved in the Stella-Jones has always played a role in supplying this basic element of North America’s industrial utility pole category? infrastructure. The pressure-treated utility pole has long remained a key component for the transmission and distribution of electricity and telecommunications. Over the last few decades, Stella-Jones has grown substantially, such that today our Company is one of the continent’s largest suppliers of poles, providing them in any required size, from a range of diverse wood species and with a variety of preservative options. In the utility pole category in 2017, we saw a gradual return to historical levels of maintenance demand across the continent. In addition, our higher proﬁle in the southeastern United States improved our sales in that region. If we exclude the sales from acquisitions and the currency conversion effect, the Company’s revenue from utility poles increased organically by 6.9%. The category accounted for 34.7% of total sales. Q During the past year, did the Yes. Our growing participation in the residential lumber market over the last few years reﬂects Company see continued growth in both our core expertise and strict business model. On the one hand, we are widely acknowledged its sales of residential lumber? experts in the pressure treatment of wood, and on the other hand, our model prescribes that our diversiﬁcation initiatives should align with our established competence. Accordingly, the manufacture of pressure treated lumber for outdoor renovation projects has proven a perfect ﬁt for expanding our business. 9 2017 Annual Report Stella-Jones Inc. One Step Further with Stella-Jones Stella-Jones is powerfully demonstrating that adherence to core competence does not preclude expansive diversiﬁcation. In recent years, the Company’s expertise in the pressure treatment of utility poles and railway ties has enabled the Company to become a major supplier of pressure-treated residential lumber used for outdoor applications such as decks and fences. Thanks to the Company’s reputation for quality, competitive pricing and reliable supply, Stella-Jones has continued to grow this product category. In 2017, we saw continued growth in residential lumber sales. With production capacity in both Canada and the United States, and as the reputation of our brand strengthened, sales reached $366.2 million, up approximately 6.0% over 2016. This increase also resulted from passing on higher untreated lumber costs. Residential lumber accounted for 19.4% of total sales during the year. Q Apart from the three main Yes, and signiﬁcantly so. As we have done for many years, we supplied wood-treated products product categories for which for niche markets, and specialized services for our railway clients. In the category which we call Stella-Jones is well known, did Industrial Products, demand remained stable with revenue amounting to $94.5 million. the Company generate revenue from ancillary activities? Finally, in our ﬁfth category which we call Logs and Lumber and which involves the marketing of untreated lumber as well as logs unsuitable for use as poles, sales were also important, totalling $119.9 million. Q What additions or improvements In regards to our network, we focused on applying the extensive experience we have gained were made to Stella-Jones’ over many years in integrating acquisitions and unlocking synergies. Contributing to the goal of network in 2017? optimizing our efﬁciencies, the plants and other assets which the Company purchased in 2016 in Texas, Louisiana and Canada have now been successfully integrated into our network. Subsequent to year end, our acquisition of Prairie Forest Products, a treated lumber and wood pole manufacturing facility in Manitoba, further reinforced the reliability of our production network and distribution capabilities. Moreover, our new state-of-the-art pole peeling and treating facility in Wisconsin, which became fully operational in 2017, has made Stella-Jones a stronger supplier to our existing customers in the utility pole market – and an increasingly attractive option for new customers. 10 2017 Annual Report Stella-Jones Inc. Q What are the Company’s prospects The Company is well positioned for growth. The reasons for our favourable outlook are clear: going forward? Following a consistent focus for decades, the Stella-Jones production network continues to be ﬁne-tuned with best practices derived from a score of acquisitions. Our extended network, strategically located across the continent to optimize sourcing, production and delivery, brings to all of our product categories a host of economies of scale. Railway tie demand is effectively continuous by virtue of the need for replacements as ties age. Stella-Jones’ position in this market is wide-ranging, and bolstered by longstanding customer relationships. In the utility pole market, where orders for renewed infrastructure are also relatively stable and expected to grow in the years ahead, Stella-Jones offers a matchless range of products, and its brand has become synonymous with assured supply. As a participant in the residential lumber business, Stella-Jones has gained signiﬁcant scope in a short period of time. As we continue to apply our wood treating expertise, sourcing experience and marketing resources to this category, we have every conﬁdence that our market penetration will grow. The foregoing factors are only magniﬁed by the positive outlook that typiﬁes most forecasts for the North American economy. Given the essential infrastructure roles within that economy that are played by the industries we serve, we anticipate sustained demand for our core products – and a corresponding growth in shareholder value. I wish to take this opportunity to thank all the members of the Stella-Jones family of companies. Our staff throughout the continent, at every posting and location, deserves our gratitude for their skill and dedication. My thanks go out equally to the members of our Board for their counsel, and our shareholders for their conﬁdence and support. Brian McManus President and Chief Executive Ofﬁcer 11 2017 Annual Report Stella-Jones Inc. 2 3 4 5 1 15 17 16 18 19 20 22 23 24 25 26 21 14 11 10 9 13 12 6 8 7 38 39 37 36 35 28 27 32 33 34 31 29 30 Treating Facilities Coal Tar Distillery 1 New Westminster, BC 14 Truro, NS 2 Prince George, BC 15 Arlington, WA 3 Galloway, BC 4 Carseland, AB 5 Neepawa, MB 16 Tacoma, WA 17 Sheridan, OR 18 Eugene, OR 27 Bangor, WI 28 Cameron, WI 29 Memphis, TN 30 Scooba, MS 31 Fulton, KY 6 South River, ON 19 Silver Springs, NV 32 Winslow, IN 7 Guelph, ON 8 Stouffville, ON 20 Eloy, AZ 21 Lufkin, TX 9 Peterborough, ON 22 Russellville, AR 10 Gatineau, QC 23 Rison, AR 11 Rivière-Rouge, QC 24 Converse, LA 12 Delson, QC 13 Sorel-Tracy, QC 25 Pineville, LA 26 Alexandria, LA 33 Montevallo, AL 34 Clanton, AL 35 Cordele, GA 36 Whitmire, SC 37 Goshen, VA 38 Dubois, PA 39 McAllisterville, PA 12 2017 Annual Report Stella-Jones Inc. 13 MANAGEMENT’S DISCUSSION AND ANALYSIS CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016 2017 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS14 MANAGEMENT’S DISCUSSION AND ANALYSIS MANAGEMENT’S DISCUSSION & ANALYSIS The following is Stella-Jones Inc.’s management discussion and analysis (“MD&A”). Throughout this MD&A, the terms “Company” and “Stella-Jones” shall mean Stella-Jones Inc., and shall include its independent operating subsidiaries. American states and are complemented by an extensive distribution network across North America. As at December 31, 2017, Stella- Jones’ workforce numbered approximately 1,880 employees. This MD&A and the Company’s audited consolidated ﬁnancial statements were approved by the Board of Directors on March 13, 2018. The MD&A provides a review of the signiﬁcant developments and results of operations of the Company during the ﬁscal year ended December 31, 2017 compared with the ﬁscal year ended December 31, 2016. The MD&A should be read in conjunction with the Company’s audited consolidated ﬁnancial statements for the years ended December 31, 2017 and 2016 and the notes thereto. The MD&A contains statements that are forward-looking in nature. Such statements involve known and unknown risks and uncertainties that may cause the actual results of the Company to be materially different from those expressed or implied by such forward-looking statements. Such items include, among others: general economic and business conditions, product selling prices, raw material and operating costs, changes in foreign currency rates and other factors referenced herein and in the Company’s continuous disclosure ﬁlings. Unless required to do so under applicable securities legislation, the Company’s management does not assume any obligation to update or revise forward-looking statements to reﬂect new information, future events or other changes. The Company’s audited consolidated ﬁnancial statements are reported in Canadian dollars and are prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and Chartered Professional Accountant (“CPA”) Canada Handbook Part I. All amounts in this MD&A are in Canadian dollars unless otherwise indicated. Additional information, including the Company’s annual information form, quarterly and annual reports, and supplementary information is available on the SEDAR web site at www.sedar.com. Press releases and other information are also available in the Investor/Media Centre section of the Company’s web site at www.stella-jones.com. OUR BUSINESS Stella-Jones Inc. is a leading producer and marketer of pressure treated wood products. The Company supplies North America’s railroad operators with railway ties and timbers, and the continent’s electrical utilities and telecommunication companies with utility poles. Stella-Jones also manufactures and distributes residential lumber and accessories to retailers for outdoor applications, as well as industrial products which include marine and foundation pilings, construction timbers, wood for bridges and coal tar based products. The Company’s common shares are listed on the Toronto Stock Exchange (TSX: SJ). As at March 13, 2018, the Company operated thirty-eight wood treating plants, twelve pole peeling facilities and a coal tar distillery. These facilities are located in six Canadian provinces and nineteen Stella-Jones Inc. Stella-Jones enjoys a number of key attributes which should further enhance the Company’s strategic positioning and competitive advantage in the wood treating industry. Among these are the ability to service clients from multiple plants, a solid ﬁnancial position that allows the Company to stockpile and air-season green wood for major long- term contracts, a long-standing stable source of wood supply, and a registration to produce and sell the wood preservative, creosote. OUR MISSION Stella-Jones’ objective is to be the performance leader in the wood preserving industry and a model corporate citizen, exercising environmental responsibility and integrity. Stella-Jones will achieve these goals by focusing on customer satisfaction, core products, key markets, innovative work practices and the optimal use of its resources. Stella-Jones is committed to providing a safe, respectful and productive environment for its employees, where problem solving, initiative and high standards of performance are rewarded. NON-IFRS FINANCIAL MEASURES This MD&A contains ﬁnancial measures not prescribed by IFRS and not likely to be comparable to similar measures presented by other issuers. These measures are as follows: • Operating income before depreciation of property, plant and equipment and amortization of intangible assets (also referred to as earnings before interest, taxes, depreciation and amortization [“EBITDA”]). • Operating income. • Cash ﬂow from operating activities before changes in non-cash working capital components and interest and income taxes paid. • Operating margin: Operating income divided by sales. • Return on average equity: Net income divided by the mathematical average of current year’s shareholders’ equity and the previous year’s shareholders’ equity. • Working capital ratio: Total current assets divided by total current liabilities. • Total debt to total capitalization: Long-term debt (including the current portion) divided by the sum of shareholders’ equity and long- term debt (including the current portion). • Total debt to EBITDA: Long-term debt (including the current portion) divided by EBITDA. Management considers these non-IFRS measures to be useful information the Company’s ﬁnancial condition and operating results as they provide additional measures of its performance. to assist knowledgeable regarding investors MANAGEMENT’S DISCUSSION AND ANALYSIS 15 Reconciliation of EBITDA and operating income to net income* (in millions of dollars) Net income for the period Plus: Provision for (recovery of) income taxes Financial expenses Operating income Depreciation and amortization EBITDA * Numbers may not add exactly due to rounding. Three-month periods ended Fiscal years ended Dec. 31, 2017 Dec. 31, 2016 Dec. 31, 2017 Dec. 31, 2016 $ 51.1 (26.0) 3.9 29.0 8.1 37.1 $ 18.5 5.4 4.2 28.2 8.8 36.9 $ 167.9 20.5 19.0 207.4 33.2 240.6 $ 153.9 61.5 17.9 233.2 31.6 264.8 SELECTED ANNUAL FINANCIAL INFORMATION (years ended December 31) Income (in millions of dollars, except per share data) Sales Operating income Net income Basic earnings per common share Diluted earnings per common share Financial Position (in millions of dollars) Current assets Total assets Long-term debt 1 Total liabilities Shareholders’ equity 1 Including the current portion. KEY PERFORMANCE INDICATORS (years ended December 31) Operating margin Return on average equity Working capital ratio Total debt to total capitalization Total debt to EBITDA Dividend per share 2017 $ 2016 $ 2015 $ 1,886.1 1,838.4 1,559.3 207.4 167.9 2.42 2.42 2017 $ 908.4 1,786.0 455.6 670.4 1,115.5 233.2 153.9 2.22 2.22 2016 $ 1,050.4 1,960.9 694.0 934.5 1,026.4 220.1 141.4 2.05 2.04 2015 $ 1,013.8 1,778.9 669.9 865.4 913.5 2017 11.0% 15.7% 7.04 0.29:1 1.89 $0.44 2016 12.7% 15.9% 8.58 0.40:1 2.62 $0.40 2015 14.1% 17.6% 6.36 0.42:1 2.75 $0.32 2017 Annual Report 16 MANAGEMENT’S DISCUSSION AND ANALYSIS FOREIGN EXCHANGE The table below shows exchange rates applicable to the years ended December 31, 2017 and 2016. Average rates are used to translate sales and expenses for the periods mentioned, while closing rates translate assets and liabilities of foreign operations and monetary assets and liabilities of the Canadian operations. Cdn$/US$ First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Year 2017 2016 Average Closing Average Closing 1.3240 1.3491 1.2664 1.2754 1.3038 1.3310 1.2977 1.2480 1.2545 1.2545 1.3792 1.2886 1.3030 1.3319 1.3257 1.2987 1.2917 1.3117 1.3427 1.3427 INDUSTRY OVERVIEW ANNUALIZED RAILWAY TIE PURCHASES AND INVENTORY (in millions of ties) Railway ties As reported by the Railway Tie Association (“RTA”), railway tie purchases for 2017 stood at 23.4 million ties, representing a slight decrease from 24.2 million ties in 2016. The RTA calculates purchases based on the difference between monthly production and the change in inventory, as reported by its members. Lower demand led to adjustments in production levels, resulting in a sharp reduction in industry inventory, which stood at 18.0 million ties as at December 31, 2017. As a result, the inventory-to-sales ratio reached 0.77:1 as at December 31, 2017, down from 0.91:1 twelve months earlier, and in-line with the previous ten-year average ratio of 0.79:1. In the last decade, volatile fuel prices and persistent highway congestion have increasingly caused shippers to favour rail, a more fuel efﬁcient transportation mode, over trucks. The resulting increase in rail transportation volume, combined with an aging infrastructure, yielded greater demand for products and services related to the modernization and extension of the North American rail network, including railway ties. Reﬂecting a stronger economy compared to the previous year, total trafﬁc on North American railroads increased by 4.8% in 2017, according to data released by the Association of American Railroads. Carload volume increased by 4.2%, mainly due to higher shipments of coal, as well as of metals and minerals, while intermodal trailer and container volume rose 5.3% from 2016 levels. 30 20 10 0 25 20 15 10 5 0 1992 1997 2002 2007 2012 2017 Source: Railway Tie Association Purchases Inventory FREIGHT HAULED ON NORTH AMERICAN RAILROADS (in millions of units) 2012 2013 2014 2015 2016 2017 Source: Association of American Railroads Intermodal Carloads Stella-Jones Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 17 OPERATING RESULTS Sales Sales for the year ended December 31, 2017 reached $1,886.1 million, up 2.6% from last year’s sales of $1,838.4 million. Acquisitions completed in 2016 contributed additional sales of $44.0 million throughout 2017, while the conversion effect from ﬂuctuations in the value of the Canadian dollar, Stella-Jones’ reporting currency, versus the U.S. dollar, decreased the value of U.S. dollar denominated sales by about $17.0 million when compared with the previous year. Excluding these factors, sales increased approximately $20.8 million, or 1.1%. SALES BY PRODUCT CATEGORY (% of sales) RAILWAY TIES 34.5% UTILITY POLES 34.7% RAILWAY TIES 39.0% UTILITY POLES 31.5% 2017 $1,886.1 M 2016 $1,838.4 M LOGS AND LUMBER 6.4% INDUSTRIAL PRODUCTS 5.0% RESIDENTIAL LUMBER 19.4% LOGS AND LUMBER 5.5% INDUSTRIAL PRODUCTS 5.2% RESIDENTIAL LUMBER 18.8% Railway ties Railway tie sales for 2017 amounted to $651.5 million, versus sales of $716.3 million in 2016. Excluding the conversion effect from fluctuations in the value of the Canadian dollar against the U.S. currency, railway tie sales decreased approximately $58.0 million, or 8.1%, mainly due to lower year-over-year pricing. Railway tie sales accounted for 34.5% of the Company’s total sales in 2017. RAILWAY TIE SALES (in millions of $) 716.3 651.5 Utility poles Utility pole sales reached $654.0 million in 2017, representing an increase of $74.7 million, or 12.9%, from sales of $579.2 million in 2016. Excluding the additional contribution from acquisitions completed in 2016 and the currency conversion effect, sales increased approximately $40.0 million, or 6.9%. This improvement essentially reﬂects organic sales growth in the southeastern United States and a return to historical maintenance demand in 2017. Utility pole sales accounted for 34.7% of the Company’s total sales in 2017. 2017 2016 UTILITY POLE SALES (in millions of $) 654.0 579.2 2017 2016 RESIDENTIAL LUMBER SALES (in millions of $) 366.2 345.7 2017 Annual Report 2017 2016 INDUSTRIAL PRODUCT SALES (in millions of $) 94.5 96.3 2017 2016 LOGS AND LUMBER SALES (in millions of $) 119.9 100.8 2017 2016 RAILWAY TIE SALES (in millions of $) 716.3 651.5 2017 2016 UTILITY POLE SALES (in millions of $) 654.0 579.2 2017 2016 RESIDENTIAL LUMBER SALES (in millions of $) 366.2 345.7 2017 2016 INDUSTRIAL PRODUCT SALES (in millions of $) 94.5 96.3 2017 2016 LOGS AND LUMBER SALES (in millions of $) 119.9 100.8 2017 2016 18 MANAGEMENT’S DISCUSSION AND ANALYSIS Residential lumber Sales in the residential lumber category totalled $366.2 million in 2017, up from $345.7 million in 2016. Excluding the currency conversion effect, sales increased $21.5 million, or 6.2%, mainly reﬂecting higher year-over-year selling prices explained by untreated lumber cost increases. Residential lumber accounted for 19.4% of Stella-Jones’ sales in 2017. Industrial products Industrial product sales were $94.5 million in 2017, compared with $96.3 million in 2016. Excluding the additional contribution from acquisitions completed in 2016 and the currency conversion effect, sales decreased 2.3%, mainly due to lower sales of marine pilings in Canada. Industrial products represented 5.0% of sales in 2017. Logs and lumber Logs and lumber sales amounted to $119.9 million in 2017, up from $100.8 million in 2016. This increase reﬂects the timing of lumber purchase and resale activities, the timing of timber harvesting, as well as higher selling prices due to increased lumber costs. Logs and lumber represented 6.4% of sales in 2017. Stella-Jones Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 19 SALES BY GEOGRAPHIC REGION (% of sales) 2017 2016 70.2% UNITED STATES 29.8% CANADA 70.9% UNITED STATES 29.1% CANADA $ 1,324.2 M $ 561.9 M $ 1,302.6 M $ 535.8 M Sales in the United States amounted to $1,324.2 million, or 70.2% of sales in 2017, representing an increase of $21.6 million, or 1.7%, over 2016. The year-over-year rise mainly stems from higher sales in the utility pole and residential lumber product categories, as well as from the additional contribution from acquisitions completed in 2016. These factors were partially offset by lower railway tie sales and a lower conversion rate on U.S. dollar denominated sales. Sales in Canada increased by $26.1 million, or 4.9% in 2017 to reach $561.9 million, representing 29.8% of Stella-Jones’ total sales. The variation is attributable to higher sales in the residential lumber and logs and lumber product categories mainly arising from higher year- over-year selling prices due to increased lumber costs. Cost of sales Cost of sales, including depreciation of property, plant and equipment, as well as amortization of intangible assets, was $1,586.3 million, or 84.1% of sales, in 2017. This compares with $1,504.6 million, or 81.8% of sales, in 2016. The increase in absolute dollars essentially reﬂects a higher business volume for the year and increased untreated lumber costs in the residential lumber category, partially offset by a lower average rate applied to convert U.S. dollar denominated costs. As a percentage of sales, the increase is mainly attributable to lower selling prices for railway ties and a less favourable geographical mix in the utility pole category. Depreciation and amortization charges totalled $33.2 million for the year ended December 31, 2017, versus $31.6 million a year earlier. The year-over-year increase is mainly due to the depreciation and amortization charges related to the tangible and intangible assets of the 2016 acquisitions for the full year, as well as to higher depreciation charges related to the completion of construction of a new wood treating facility in Cameron, Wisconsin. As a result, gross proﬁt reached $299.9 million or 15.9% of sales in 2017, versus $333.7 million or 18.2% of sales in 2016. Selling and administrative Selling and administrative expenses for 2017 were $93.8 million, or 5.0% of sales, compared with expenses of $95.0 million, or 5.2% of sales, in 2016. The variation in monetary terms mainly results from a decrease of $2.1 million in proﬁt sharing expenses, a $1.1 million reduction in stock-based compensation, as well as the effect of currency translation on U.S.-based selling and administrative expenses. Last year’s expenses also included approximately $2.9 million in acquisition costs directly related to business acquisitions completed in 2016. Other losses (gains), net Stella-Jones’ other net gains of $1.3 million for the year ended December 31, 2017 mainly consisted of a $4.1 million foreign exchange gain and a $2.1 million reversal of a provision for site remediation, partially offset by a $3.2 million expense on freight and distribution accruals and a $1.3 million loss on asset disposal. In 2016, other net losses of $5.5 million were mostly related to ﬁnal site remediation provisions of $5.2 million related to a non-operating site. The Company’s exposure to foreign exchange gains or losses from currency ﬂuctuations is related to its sales and purchases in U.S. dollars by its Canadian-based operations and to U.S. dollar denominated long- term debt held by its Canadian company. Stella-Jones U.S. Holding Corporation, the Company’s wholly-owned U.S. subsidiary, is a foreign operation that has a different functional currency from that of the Company and foreign exchange gains and losses on translating its ﬁnancial statements are deferred in shareholders’ equity. The Company monitors its transactions in U.S. dollars generated by Canadian-based operations. Its basic hedging activity for economic purposes consists of entering into foreign exchange forward contracts for the sale of U.S. dollars and purchasing certain goods and services in U.S. dollars. The Company will also consider foreign exchange forward contracts for the purchase of U.S. dollars for signiﬁcant purchases of goods and services that are not covered by natural hedges. 2017 Annual Report 20 MANAGEMENT’S DISCUSSION AND ANALYSIS Financial expenses Financial expenses reached $19.0 million in 2017, up from $17.9 million in 2016. This increase is attributable to a higher fixed interest rate applicable to the senior notes issued through a private placement on January 17, 2017, partially offset by the effect of local currency conversion on financial expenses related to the Company’s U.S. dollar denominated borrowings. Income before income taxes and income tax expenses Stella-Jones generated income before income taxes of $188.4 million, or 10.0% of sales, in 2017, versus $215.4 million, or 11.7% of sales, in 2016. The year-over-year decrease in income before income taxes is attributable to lower gross proﬁt, as detailed above. Stella-Jones’ provision for income taxes totaled $20.5 million in 2017, representing an effective tax rate of 10.9%. In 2016, income tax expenses stood at $61.5 million, equivalent to an effective rate of 28.5%. The lower effective tax rate for 2017 reﬂects changes to the U.S. Federal Corporate income tax rate following the enactment of the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017. The Act will favourably affect the Company’s U.S. subsidiaries, speciﬁcally by reducing the top federal corporate income tax rate from 35.0% to 21.0%, effective January 1, 2018. Although the Act only comes into effect on January 1, 2018, changes to the tax rates required the remeasurement of the deferred income tax liability as at December 31, 2017. As a result of the reduction in tax rates, a one-off non-cash deferred tax beneﬁt of $30.0 million was recognized in the statement of income for the fourth quarter ended December 31, 2017 which explains the lower effective tax rate for 2017. Management expects the Company’s overall effective tax rate for 2018 to be approximately 26.0%. Net income Net income for the year ended December 31, 2017 reached $167.9 million, or $2.42 per diluted share, compared with $153.9 million, or $2.22 per diluted share, in 2016. This represents a year-over-year increase in net income of 9.1%. BUSINESS ACQUISITION On December 19, 2017, the Company completed the acquisition of substantially all the operating assets employed in the business of Wood Products Industries Inc. (“WPI”) located in South River, Ontario. The Company plans on using these assets to treat residential lumber. Total cash outlay associated with the acquisition was approximately $4.2 million, excluding acquisition costs of approximately $234,000, recognized in the consolidated statement of income under selling and administrative expenses. The Company ﬁnanced the acquisition through its existing syndicated credit facilities. SUBSEQUENT EVENT On February 9, 2018, the Company completed the acquisition of substantially all the operating assets employed in the business of Prairie Forest Products (“PFP”), a division of Prendiville Industries Ltd. located at its wood treating facility in Neepawa, Manitoba, as well as at its peeling facility in Birch River, Manitoba. PFP manufactures, sells and distributes utility poles and residential lumber and sales for the twelve-month period ending October 31, 2017 were approximately $35.1 million. Total cash outlay associated with the acquisition was $26.5 million, excluding acquisition costs of approximately $326,000 of which $159,000 was recognized in the 2017 consolidated statement of income under selling and administrative expenses. The Company ﬁnanced the transaction through its existing syndicated credit facilities. At the time of preparing the MD&A, Management did not have on hand all the required information to determine the fair value of assets acquired and liabilities assumed. Preliminary information indicates that property plant and equipment and inventory represent approximately $7.8 million and $9.5 million respectively from the total purchase price of $26.5 million. Stella-Jones Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 21 QUARTERLY RESULTS The Company’s sales follow a seasonal pattern, with railway tie, utility pole and industrial product shipments strongest in the second and third quarters to provide industrial end users with product for their summer maintenance projects. Residential lumber sales also follow a similar seasonal pattern. In the fall and winter seasons, there tends to be less activity; thus the ﬁrst and fourth quarters are typically characterized by relatively lower sales levels. The table below sets forth selected ﬁnancial information for the Company’s last eight quarters, ending with the most recently completed ﬁnancial year: 2017 For the quarters ended March 31 June 30 Sept. 30 Dec. 31 Total (in millions of dollars, except per share data) $ $ $ $ $ Sales 396.9 594.2 517.6 377.4 1,886.1 Operating income before depreciation of property, plant and equipment and amortization of intangible assets 1 Operating income 1 Net income for the period Earnings per common share Basic and diluted 2016 49.1 40.8 25.9 83.1 74.5 48.9 71.3 63.1 42.0 37.1 29.0 51.1 240.6 207.4 167.9 0.37 0.71 0.61 0.74 2.42 For the quarters ended March 31 June 30 Sept. 30 Dec. 31 Total (in millions of dollars, except per share data) $ $ $ $ $ Sales 421.0 563.1 512.6 341.7 1,838.4 Operating income before depreciation of property, plant and equipment and amortization of intangible assets 1 Operating income 1 Net income for the period Earnings per common share Basic and diluted 61.7 54.6 35.0 89.9 83.2 54.7 76.3 67.3 45.7 36.9 28.2 18.5 264.8 233.2 153.9 0.51 0.79 0.66 0.27 2.22 1 Operating income before depreciation of property, plant and equipment and amortization of intangible assets and operating income are ﬁnancial measures not prescribed by IFRS and are not likely to be comparable to similar measures presented by other issuers. Management considers they represent useful information for comparison with other similar operations in the industry, as they present ﬁnancial results related to industry practice, not affected by non-cash charges or capital structure. Operating income before depreciation of property, plant and equipment and amortization of intangible assets and operating income are readily reconcilable to net income presented in the consolidated ﬁnancial statements, as there are no adjustments for unusual or non-recurring items. Note: due to rounding, the sum of results for the quarters may differ slightly from the total shown for the full year. 2017 Annual Report The value of accounts receivable stood at $163.5 million as at December 31, 2017, up from $160.8 million as at December 31, 2016. The variation results from higher business activity in the fourth quarter of 2017 compared to last year, partially offset by the effect of local currency translation on U.S. dollar denominated accounts receivable. The value of inventories reached $718.5 million as at December 31, 2017, versus $854.6 million as at December 31, 2016. This decrease essentially stems from lower untreated railway tie prices and volumes as well as the effect of local currency translation on U.S. inventories. Because of the long periods required to air season wood, which can occasionally exceed nine months before a sale is concluded, inventories are a signiﬁcant component of working capital. In addition, important raw material and ﬁnished goods inventory are required at certain times of the year to support the residential lumber product category. However, solid relationships and long-term contracts with certain customers enable the Company to better ascertain inventory requirements. The Company believes that its cash ﬂows from operations and available credit facilities are adequate to meet its working capital requirements for the foreseeable future. Property, plant and equipment amounted to $472.0 million as at December 31, 2017, compared with $463.7 million as at December 31, 2016. This increase is essentially related to purchases of property, plant and equipment for the year ($52.2 million), partially offset by a depreciation charge of $17.9 million and the effect of local currency translation on U.S.-based property, plant and equipment. The value of intangible assets reached $124.4 million as at December 31, 2017. Intangible assets include customer relationships, the discounted value of the non-compete agreements, a creosote registration, cutting rights, standing timber and a favourable land lease agreement. As at December 31, 2016, intangible assets were $147.3 million. The year-over-year decrease is mainly explained by an amortization charge of $15.3 million for 2017 and the effect of local currency translation on U.S. dollar denominated intangible assets. As at December 31, 2017, the value of goodwill stood at $270.3 million, down from $287.4 million a year earlier. This decrease in goodwill mostly reﬂects the effect of local currency translation on U.S. dollar denominated goodwill. 22 MANAGEMENT’S DISCUSSION AND ANALYSIS Fourth Quarter Results Sales for the fourth quarter of 2017 amounted to $377.4 million, up 10.4% from sales of $341.7 million for the same period in 2016. Excluding the conversion effect from ﬂuctuations in the value of the Canadian dollar, versus the U.S. dollar, sales increased approximately $48.3 million, or 14.1%. Sales of railway ties reached $118.0 million, versus $113.1 million last year. Excluding the currency conversion effect, railway tie sales rose 8.7% driven by higher year-over-year volume. Utility pole sales amounted to $162.9 million, up 12.7% from $144.6 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 14.5% as a result of organic sales growth in the southeastern United States and healthy maintenance demand. Residential lumber sales reached $48.6 million, up from $44.5 million last year, reﬂecting solid market demand. Industrial product sales amounted to $20.0 million, up from $15.0 million a year ago, as a result of higher sales of rail related products. Finally, logs and lumber sales stood at $27.9 million, versus $24.5 million last year, driven in most part by the passthrough of higher lumber cost to customers. Gross proﬁt amounted to $53.5 million, or 14.2% of sales, in the fourth quarter of 2017, versus $52.0 million, or 15.2% of sales, in the fourth quarter of 2016. The decrease as a percentage of sales mainly reﬂects the sales mix within each product category and softer pricing in certain regions. Operating income totalled $29.0 million, or 7.7% of sales, in the fourth quarter of 2017, versus $28.2 million, or 8.2% of sales, last year. Net income for the period reached $51.1 million, or $0.74 per diluted share, compared with $18.5 million, or $0.27 per diluted share, in the prior year. The year-over-year increase is attributable to a one-off non- cash tax beneﬁt stemming from the remeasurement of deferred tax liabilities following a reduction in the U.S. top federal corporate income tax rate. STATEMENT OF FINANCIAL POSITION As a majority of the Company’s assets and liabilities are denominated in U.S. dollars, exchange rate variations may signiﬁcantly affect their value. As such, the depreciation of the U.S. dollar relative to the Canadian dollar as at December 31, 2017, compared to December 31, 2016 (see Foreign Exchange on page 16), results in a lower value of assets and liabilities denominated in U.S. dollars, when expressed in Canadian dollars. Assets As at December 31, 2017, total assets and current assets reached $1.79 billion and $908.4 million, respectively, down from $1.96 billion and $1.05 billion, respectively, as at December 31, 2016. These decreases are mainly attributable to a reduction in inventories and to the effect of local currency translation on U.S.-based assets. Stella-Jones Inc. Liabilities As at December 31, 2017, Stella-Jones’ total liabilities stood at $670.4 million, down from $934.5 million as at December 31, 2016. This variation mainly reﬂects the decrease in total long-term debt, as explained below, and the effect of local currency translation on U.S. dollar denominated liabilities. The value of current liabilities was $129.0 million as at December 31, 2017, up from $122.4 million a year earlier. This variation is essentially due to a $10.1 million increase in accounts payable and accrued liabilities related to higher business activity in the fourth quarter of 2017 compared to last year. The Company’s long-term debt, including the current portion, amounted to $455.6 million as at December 31, 2017, versus $694.0 million as at December 31, 2016. The decrease essentially reﬂects a solid operating cash ﬂow generation during the year, as well as the effect of local currency translation on U.S. dollar denominated long-term debt. As at December 31, 2017, an amount of $354.5 million was available against the Company’s syndicated credit facilities of $595.9 million (US$475.0 million). Shareholders’ equity Shareholders’ equity was $1.12 billion as at December 31, 2017 compared with $1.03 billion as at December 31, 2016. This increase is attributable to net income of $167.9 million for the year, partially offset by dividends on common shares totalling $30.5 million and a $48.7 million unfavourable variation in the value of accumulated other comprehensive income resulting from the effect of currency ﬂuctuations. LIQUIDITY AND CAPITAL RESOURCES The following table sets forth summarized cash ﬂow components for the periods indicated: Summary of cash ﬂows (years ended December 31) (in millions of dollars) Operating activities Financing activities Investing activities Net change in cash and cash equivalents Cash and cash equivalents – beginning Cash and cash equivalents – end 2017 $ 301.1 (239.9) (58.5) 2.7 3.7 6.4 2016 $ 181.8 (9.5) (175.6) (3.3) 7.0 3.7 MANAGEMENT’S DISCUSSION AND ANALYSIS 23 The Company’s activities, acquisitions and purchases of property, plant and equipment are primarily ﬁnanced by cash ﬂows from operating activities, available cash, long-term debt, and the issuance of common shares. The Company plans on spending between $30.0 million to $40.0 million on property, plant and equipment in the upcoming year, half of which is related to efﬁciency improvements with the balance dedicated to sustaining operations. The Company’s syndicated credit facilities are made available for a ﬁve-year term and are thus considered long-term debt. Cash ﬂow from operating activities before changes in non-cash working capital components and interest and income taxes paid was $245.7 million for the year ended December 31, 2017, versus $268.9 million in 2016. This variation mostly reﬂects a lower operating income for the year. Changes in non-cash working capital components increased liquidity by $105.7 million in 2017. The main element of this variation was a decrease of $103.2 million in inventories related to lower untreated railway tie prices and volumes. In 2016, changes in non-cash working capital components had reduced liquidity by $30.1 million, mainly due to a $39.9 million increase in inventories. Interest and income taxes paid further reduced liquidity by $15.8 million and $34.5 million, respectively, in 2017, versus $18.6 million and $38.3 million, respectively, a year earlier. The decrease in interest paid mainly stems from lower year-over-year borrowings, while the decrease in income taxes paid reﬂects a lower balance of taxes receivable as at December 31, 2017. As a result, cash ﬂows provided by operating activities were $301.1 million in comparison with $181.8 million in 2016. in 2017, up signiﬁcantly Financing activities for the year ended December 31, 2017 reduced liquidity by $239.9 million. The main factor explaining this cash usage was a net decrease of $391.8 million in the syndicated credit facilities resulting from a solid operating cash ﬂow generation and the payment of dividends on common shares totalling $30.5 million. These factors were partially offset by a $184.4 million net increase in long-term debt mainly resulting from the January 17, 2017 private placement for which proceeds were used to pay down a portion of the Company’s syndicated credit facilities. For the year ended December 31, 2016, ﬁnancing activities had required liquidity of $9.5 million. Investing activities required $58.5 million in cash during 2017. Purchases of property, plant and equipment required an investment of $52.2 million, including $4.1 million to ﬁnalize the construction of a new pole peeling and pole treating facility in Cameron, Wisconsin, while business acquisitions resulted in a cash outlay of $5.8 million. In 2016, cash ﬂows from investing activities had decreased liquidity by $175.6 million due to business acquisitions ($107.3 million) and purchases of property, plant and equipment ($63.2 million). 2017 Annual Report 24 MANAGEMENT’S DISCUSSION AND ANALYSIS FINANCIAL OBLIGATIONS The following table details the maturities of the ﬁnancial obligations as at December 31, 2017: (in millions of dollars) Accounts payable and accrued liabilities Long-term debt obligations Minimum payments under operating lease obligations Non-compete agreements Total Carrying Contractual Amount Cash ﬂow Less than 1 year 1 – 3 years 4 – 5 More than 5 years years $ 111.2 455.6 — 5.5 $ 111.2 538.4 80.1 5.8 $ 111.2 20.1 22.7 1.7 572.3 735.5 155.7 $ — 42.3 30.7 2.9 75.9 $ — 265.2 14.1 1.2 $ — 210.8 12.6 — 280.5 223.4 Note: due to rounding, the sum of results may differ slightly from totals. SHARE AND STOCK OPTION INFORMATION DIVIDENDS As at December 31, 2017, the capital stock issued and outstanding consisted of 69,342,095 common shares (69,303,307 as at December 31, 2016). The following table presents the outstanding capital stock activity for the year ended December 31, 2017: Year Ended Dec. 31, 2017 Number of shares (in ‘000s) Balance – Beginning of year Stock option plan Employee share purchase plans Balance – End of year 69,303 10 29 69,342 As at March 13, 2018, the capital stock issued and outstanding consisted of 69,342,095 common shares. As at December 31, 2017, the number of outstanding options to acquire common shares issued under the Company’s Stock Option Plan was 45,000 (December 31, 2016 – 55,000) of which 33,000 (December 31, 2016 – 31,000) were exercisable. As at March 13, 2018, the number of outstanding options was 45,000 of which 33,000 were exercisable. In 2017, the Board of Directors of Stella-Jones declared the following quarterly dividends: • $0.11 per common share payable on April 28, 2017 to shareholders of record at the close of business on April 3, 2017. • $0.11 per common share payable on June 27, 2017 to shareholders of record at the close of business on June 5, 2017. • $0.11 per common share payable on September 22, 2017 to shareholders of record at the close of business on September 1, 2017. • $0.11 per common share payable on December 21, 2017 to shareholders of record at the close of business on December 4, 2017. Subsequent to the end of the year, on March 13, 2018, the Board declared a quarterly dividend of $0.12 per common share payable on April 27, 2018 to shareholders of record at the close of business on April 6, 2018. The declaration, amount and date of any future dividends will continue to be considered by the Board of Directors of the Company based upon and subject to the Company’s covenants in its loan documentation as well as its ﬁnancial performance and cash requirements. There can be no assurance as to the amount or timing of such dividends in the future. Stella-Jones Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 25 COMMITMENTS AND CONTINGENCIES The Company is from time to time involved in various claims and legal proceedings arising in the ordinary course of business. It is the opinion of Management that a ﬁnal determination of these proceedings cannot be made at this time but should not materially affect the Company’s ﬁnancial position or results of operations. The Company has issued guarantees amounting to $19.0 million (2016 – $28.9 million) under letters of credit and various bid and performance bonds. The Company’s management does not believe these guarantees are likely to be called on and, as such, no provisions have been recorded in the consolidated ﬁnancial statements. The Company’s operations are subject to Canadian federal and provincial as well as U.S. federal and state environmental laws and regulations governing, among other matters, air emissions, waste management and wastewater efﬂuent discharges. The Company takes measures to comply with such laws and regulations. However, the measures taken are subject to the uncertainties of changing legal requirements, enforcement practices and developing technological processes. CURRENT ECONOMIC CONDITIONS Operations The Company’s core railway tie and utility pole product categories are integral to the North American basic transportation and utility infrastructure. Such infrastructure needs to be regularly maintained which provides Stella-Jones with relatively steady demand for its core products. In periods of economic growth, the Company may also beneﬁt from additional demand stemming from expansions to the railway and telecommunication networks. Based on current market conditions, and assuming stable currencies, Stella-Jones’ total sales and operating margins are expected to improve progressively in 2018 when compared to 2017. Operating margins will remain softer in the ﬁrst half of 2018. In the railway tie product category, North American railroads will continue to maintain their continental rail network, as operators constantly seek optimal line efﬁciency. The Company is anticipating that 2018 annual railway tie sales should be relatively stable when compared to 2017. Meanwhile, softer pricing is expected to continue to negatively impact operating margins in the ﬁrst half of the year, which should gradually return to historical levels by the end of 2018. In the utility pole product category, demand for regular maintenance projects has historically been relatively steady. Following a return to normal demand patterns in 2017, the Company expects a better sales mix within the product category in 2018. However, these factors should be offset by slight cost increases for certain wood species and the timing of price adjustments. In the residential lumber product category, the Company expects to further beneﬁt from continued demand for new construction and outdoor renovation projects in the North American residential and commercial markets. Sales for 2018 are also expected to increase as a result of higher wood cost. Liquidity As at December 31, 2017, the Company was in full compliance with its debt covenants and contractual obligations. In addition, as at December 31, 2017 an amount of $354.5 million was available against the Company’s syndicated credit facilities of $595.9 million (US$475.0 million). Accounts receivable increased slightly in 2017, as the impact of higher business activity in the fourth quarter of 2017 compared to last year more than offset the effect of local currency translation on U.S. dollar denominated accounts receivable. Management considers that all recorded accounts receivable are fully collectible as major customers, mainly Class 1 railroad operators, large retailers and large-scale utility service providers, have good credit standing and limited history of default. Inventories decreased in 2017 due to lower untreated railway tie prices and volume as well as the effect of local currency translation on U.S. inventories. To ensure efﬁcient treating operations, given that air-dried wood reduces treatment cycles, inventory turnover has historically been relatively low. Nevertheless, Management continuously monitors the levels of inventory and market demand for its products. Production is adjusted accordingly to optimize efﬁciency and capacity utilization. RISKS AND UNCERTAINTIES Economic Conditions The difﬁculties in certain global credit markets, softening economies and an apprehension among customers may negatively impact the markets the Company serves in all of its operating categories. Additionally, certain negative economic conditions may affect most or all of the markets it serves at the same time, reducing demand for its products and adversely affecting its operating results. These economic conditions may also impact the ﬁnancial condition of one or more of the Company’s key suppliers, which could affect its ability to secure raw materials and components to meet its customers’ demand for its products. Dependence on Major Customers The Company is dependent on major customers for a signiﬁcant portion of its sales, and the loss of one or more of its major customers could result in a signiﬁcant reduction in its proﬁtability. For the year ended December 31, 2017, the Company’s top ten customers accounted for approximately 46.4% of its sales. During this same period, the Company’s two largest customers accounted for approximately 15.6% and 10.0%, respectively, of its total sales. 2017 Annual Report 26 MANAGEMENT’S DISCUSSION AND ANALYSIS Availability and Cost of Raw Materials Management considers that the Company may be affected by potential ﬂuctuations in wood prices. While the Company has entered into long- term cutting licenses and beneﬁts from long-standing relationships with private woodland owners and other suppliers, there can be no assurance that such licenses will be respected or renewed on expiry, or that its suppliers will continue to provide adequate timber to the Company. In addition, there are a limited number of suppliers for certain preservatives that the Company employs in its production process, which lessens the availability of alternate sources of supply in the event of unforeseen shortages or disruptions of production. While the Company is mitigating this risk by researching and identifying alternate suppliers outside of its traditional sources of supply, there can be no assurance that it will be able to secure the supply of all materials required to manufacture its products. Environmental Risk The Company is subject to a variety of environmental laws and regulations, including those relating to emissions to the air, discharges into water, releases of hazardous and toxic substances, and remediation of contaminated sites. These environmental laws and regulations require the Company to obtain various environmental registrations, licenses, permits and other approvals, as well as carry out inspections, compliance testing and meet timely reporting requirements in order to operate its manufacturing and operating facilities. Compliance with these environmental laws and regulations will continue to affect the Company’s operations by imposing operating and maintenance costs and capital expenditures. Failure to comply could result in civil or criminal enforcement actions, which could result, among others, in the payment of substantial ﬁnes, often calculated on a daily basis, or in extreme cases, the disruption or suspension of operations at the affected facility. Under various federal, provincial, state and local laws and regulations, the Company could, as the owner, lessor or operator, be liable for the costs of removal or remediation of contamination at its sites. The remediation costs and other costs required to clean up or treat contaminated sites could be substantial. However, in certain cases, the Company beneﬁts from indemnities from the former owners of its sites. Contamination on and from the Company’s sites may subject it to liability to third parties or governmental authorities for injuries to persons, property or the environment and could adversely affect the Company’s ability to sell or rent its properties or to borrow money using such properties as collateral. The possibility of major changes in environmental laws and regulations is another risk faced by the Company. While it is not possible to predict the outcome and nature of these changes, they could substantially increase the Company’s capital expenditures and compliance costs at the facilities affected. While the Company has been party to environmental litigation in the past, which have included, among others, claims for adverse physical effects and diminution of property value, the outcomes and associated costs have not been material. There is, however, no guarantee that this will continue to be the case in the future, as the result of disputes regarding environmental matters and conclusions of environmental litigation cannot be predicted. The Company’s business has grown and its image strengthened, in large part by its consistent production and delivery of high quality products, while maintaining as well, a high level of environmental responsibility. Claims of environmentally irresponsible practices by regulatory authorities or local communities could harm the reputation of the Company. Adverse publicity resulting from actual or perceived violations of environmental laws and regulations could negatively impact customer loyalty, reduce demand, lead to a weakening of conﬁdence in the marketplace and ultimately, a reduction in the Company’s share price. These effects could result even if the allegations are not valid and the Company is not found liable. Risks Related to Acquisitions As part of its growth strategy, the Company intends to acquire additional complementary businesses where such transactions are economically and strategically justiﬁed. There can be no assurance that the Company will succeed in effectively managing the integration of other businesses which it might acquire. If the expected synergies do not materialize, or if the Company fails to successfully integrate such new businesses into its existing operations, this could have a material adverse effect on the Company’s business, operating results, proﬁtability and ﬁnancial position. The Company may also incur costs and direct Management’s attention to potential acquisitions which may never be consummated. In addition, although the Company performs due diligence investigations in connection with its acquisitions, an acquired business could have liabilities that the Company fails or is unable to uncover prior to acquisition and for which the Company may be responsible. Such liabilities could have a material adverse effect on the Company’s business operating results, proﬁtability and ﬁnancial position. Litigation Risk The Company is subject to the risk of litigation in the ordinary course of business by employees, customers, suppliers, competitors, shareholders, government agencies, or others, through private actions, class actions, administrative proceedings, regulatory actions or other litigation. The outcome of litigation is difﬁcult to assess or quantify. Claimants in these types of lawsuits or claims may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to these lawsuits or claims may remain unknown for substantial periods of time. Regardless of outcome, litigation could result in substantial costs to the Company. In addition, litigation could divert Management’s attention and resources away from the day-to- day operations of the Company’s business. Stella-Jones Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 27 Insurance Coverage The Company maintains property, casualty, general liability and workers’ compensation insurance, but such insurance may not cover all risks associated with the hazards of its business and is subject to limitations, including deductibles and maximum liabilities covered. The Company may incur losses beyond the limits, or outside the coverage, of its insurance policies, including liabilities for environmental compliance and remediation. In addition, from time to time, various types of insurance for companies in the Company’s industry have not been available on commercially acceptable terms or, in some cases, have not been available at all. In the future, the Company may not be able to obtain coverage at current levels, and its premiums may increase signiﬁcantly on coverage that it maintains. Inﬂuence by Stella Jones International S.A. As at December 31, 2017, Stella Jones International S.A. (“SJ International”) owned or controlled 26,572,836 common shares of the Company, which represented approximately 38.3% of the outstanding common shares. On February 21, 2018, SJ International sold 5,000,000 shares as part of a secondary offering and reduced its ownership to 31.1%. Under this current share ownership, SJ International maintains the ability to inﬂuence all matters submitted to the shareholders for approval, including without limitation, the election and removal of directors, amendments to the articles of incorporation and by-laws and the approval of any business combination. The interests of SJ International may not in all cases be aligned with interests of the other shareholders. Currency Risk The Company is exposed to currency risks due to its export of goods manufactured in Canada. The Company strives to mitigate such risks by purchases of goods and services denominated in U.S. dollars. The Company may also use foreign exchange forward contracts to hedge contracted net cash inﬂows and outﬂows of U.S. dollars. The use of such currency hedges involves speciﬁc risks including the possible default by the other party to the transaction or illiquidity. Given these risks, there is a possibility that the use of hedges may result in losses greater than if hedging had not been used. Interest Rate Fluctuations As at December 31, 2017, all of the Company’s long-term debt was at ﬁxed interest rates, therefore reducing the Company’s exposure to interest rate risk. The Company enters into interest rate swap agreements in order to reduce the impact of ﬂuctuating interest rates on its long-term debt. These swap agreements require the periodic exchange of payments without the exchange of the notional principal amount on which the payments are based. The Company designates its interest rate hedge agreements as cash ﬂow hedges of the underlying debt. Interest expense on the debt is adjusted to include the payments made or received under the interest rate swap agreements. However, if interest rates increase, the debt service obligations on the variable rate indebtedness of the Company would increase even though the amount borrowed remained the same, and this could have adverse effect on the Company’s business operating results, proﬁtability and ﬁnancial position. Customers’ Credit Risk The Company carries a substantial level of trade accounts receivable on its statement of ﬁnancial position. This value is spread amongst numerous contracts and clients. Trade accounts receivable include an element of credit risk should the counterparty be unable to meet its obligations. Although the Company reduces this risk by dealing primarily with Class 1 railways, as well as with utility and telecommunication companies and other major corporations, there can be no assurance that outstanding accounts receivable will be paid on a timely basis or at all. Cyber Risk The Company relies on information technology to process, transmit and store electronic data in its daily business activities. Despite its security design and controls, and those of third-party providers, the Company’s information technology and infrastructure may be vulnerable to cyber-attacks by hackers or breach due to employee error, malfeasance or other disruptions. Any such breach could result in operational disruption and increased costs or the misappropriation of sensitive data that could disrupt operations, subject the Company to litigation and have a negative impact on its reputation. To limit exposure to incidents that may affect conﬁdentiality, integrity and availability of information, the Company has invested in data privacy controls, threat protections as well as detection and mitigation policies, procedures and controls. Corporate Tax Risk In estimating the Company’s income tax payable, Management uses accounting principles to determine income tax positions that are likely to be sustained by applicable tax authorities. However, there is no assurance that tax beneﬁts or tax liability will not materially differ from estimates or expectations. The tax legislation, regulation and interpretation that apply to the Company’s operations are continually changing. In addition, future tax beneﬁts and liabilities are dependent on factors that are inherently uncertain and subject to change, including future earnings, future tax rates, and anticipated business in the various jurisdictions in which Stella-Jones operates. Moreover, the Company’s tax returns are continually subject to review by applicable tax authorities. These tax authorities determine the actual amounts of taxes payable or receivable, any future tax beneﬁts or liabilities and the income tax expense that Stella-Jones may ultimately recognize. Such determinations may become ﬁnal and binding on the Company. Any of the above factors could have a material adverse effect on net income or cash ﬂow. 2017 Annual Report 28 MANAGEMENT’S DISCUSSION AND ANALYSIS FINANCIAL INSTRUMENTS AND RISK MANAGEMENT SIGNIFICANT ACCOUNTING POLICIES The Company uses derivative instruments to provide economic hedges to mitigate various risks. The fair values of these instruments represent the amount of the consideration that could be exchanged in an arm’s length transaction between willing parties who are under no compulsion to act. The fair value of these derivatives is determined using prices in active markets, where available. When no such market is available, valuation techniques are applied such as discounted cash ﬂow analysis. The valuation technique incorporates all factors that would be considered in setting a price, including the Company’s own credit risk, as well as the credit risk of the counterparty. Interest Rate Risk Management Interest rate risk is the risk that the fair value or future cash ﬂows of a ﬁnancial instrument will ﬂuctuate because of changes in market interest rates. The Company enters into both ﬁxed and ﬂoating rate debt. The risk management objective is to minimize the potential for changes in interest rates to cause adverse changes in cash ﬂows to the Company. The Company enters into interest rate swap agreements in order to reduce the impact of ﬂuctuating interest rates on its short- and long-term debt. As at December 31, 2017, the Company had several interest rate swap agreements hedging $232.1 million in debts and having maturity dates ranging from April 2021 to December 2021. These instruments are presented at fair value and designated as cash ﬂow hedges. The ratio as at December 31, 2017, of ﬁxed and ﬂoating debt was 100.0% and 0.0%, respectively, including the effects of interest rate swap positions (66.25% and 33.75%, respectively, as at December 31, 2016). Foreign Exchange Risk Management The Company’s ﬁnancial results are reported in Canadian dollars, while a portion of its Canadian-based operations are in U.S. dollars. Foreign exchange risk is the risk that ﬂuctuations in foreign exchange rates may have on operating results and cash ﬂows. The Company’s risk management objective is to reduce cash ﬂow risk related to foreign denominated cash ﬂows. When the natural hedge of sales and purchases does not match, the Company considers foreign exchange forward contracts to hedge contracted net cash inﬂows and outﬂows of U.S. dollars. As at December 31, 2017, the Company had no foreign exchange forward contract agreements in place. The Company’s signiﬁcant accounting policies are described in Note 2 to the December 31, 2017 and 2016 audited consolidated ﬁnancial statements. The Company prepares its consolidated ﬁnancial statements in accordance with IFRS as issued by the IASB and CPA Canada Handbook Part I. The preparation of ﬁnancial statements in conformity with IFRS requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the ﬁnancial statements and the reported amounts of revenue and expenses during the reporting period. Signiﬁcant items subject to estimates and assumptions include the estimated useful life of assets, impairment of goodwill, determination of the fair value of the assets acquired and liabilities assumed in the context of an acquisition and impairment of long-lived assets. It is possible that actual results could differ from those estimates, and such differences could be material. Estimates are reviewed periodically and, as adjustments become necessary, they are reported in the consolidated statement of income in the period in which they become known. CHANGES IN ACCOUNTING POLICIES The Company has adopted the following revised standard along with any consequential amendments, effective January 1, 2017. This change was made in accordance with the applicable transitional provisions. IAS 7 - Statement of Cash Flows On January 29, 2016, the IASB published amendments to IAS 7, Statement of Cash Flows. The amendments are intended to clarify IAS 7 to improve information provided to users of ﬁnancial statements about an entity’s ﬁnancing activities. The adoption of this revised standard requires the Company to provide incremental disclosure in its annual consolidated ﬁnancial statements. Impact of accounting pronouncements not yet implemented Diesel and Petroleum Price Risk Management Diesel and petroleum price risk is the risk that future cash ﬂows will ﬂuctuate because of changes in price of diesel and petroleum. In order to manage its exposure to diesel and petroleum prices and to help mitigate volatility in operating cash ﬂow, the Company uses derivative commodity contracts based on the New York Harbor Ultra Low Sulfur Diesel Heating Oil to reduce the risk of ﬂuctuating prices on these commodities. As at December 31, 2017, the Company had commodity hedges for 1.2 million gallons of diesel and petroleum. These instruments are presented at fair value and were not designated for hedge accounting purposes. IFRS 9 - Financial Instruments The ﬁnal version of IFRS 9, Financial Instruments (“IFRS 9”), was issued by the IASB in July 2014 and will replace IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 introduces a model for classiﬁcation and measurement, a single, forward-looking expected loss impairment model and a substantially reformed approach to hedge accounting. The new single, principle-based approach for determining the classiﬁcation of ﬁnancial assets is driven by cash ﬂow characteristics and the business model in which an asset is held. The new model also results in a single impairment model being applied to all ﬁnancial instruments, which will require more timely recognition Stella-Jones Inc. of expected credit losses. It also includes changes in respect of an entity’s own credit risk in measuring liabilities elected to be measured at fair value, so that gains caused by the deterioration of an entity’s own credit risk on such liabilities are no longer recognized in proﬁt or loss. IFRS 9, which is to be applied retrospectively, is effective for annual periods beginning on or after January 1, 2018. In addition, an entity’s own credit risk changes can be applied early in isolation without otherwise changing the accounting for ﬁnancial instruments. Management has not identiﬁed any material impacts resulting from the transition to IFRS 9. IFRS 15 - Revenue from Contracts with Customers In May 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers, to specify how and when to recognize revenue as well as requiring the provision of more informative and relevant disclosures. IFRS 15 supersedes IAS 18, Revenue, IAS 11, Construction Contracts, and other revenue related interpretations. In September 2015, the IASB issued an amendment to IFRS 15 to defer the effective date by one year to 2018. Management has not identiﬁed any material impacts resulting from the transition to IFRS 15. IFRS 16 - Leases In January 2016, the IASB released IFRS 16, Leases, which supersedes IAS 17, Leases, and the related interpretations on leases: IFRIC 4, Determining whether an arrangement contains a lease, SIC 15, Operating Leases – Incentives and SIC 27, Evaluating the substance of transactions in the legal form of a lease. The standard is effective for annual periods beginning on or after January 1, 2019, with earlier application permitted for companies that also apply IFRS 15, Revenue from Contracts with Customers. The Company is currently evaluating the impact of the standard on its consolidated ﬁnancial statements. The Company’s future minimum payments under operating leases amount to $80.1 million. Under the new standard the Company will recognize, in the statement of ﬁnancial position, an asset (the right to use the leased items), equivalent to the actualized cash ﬂows of the future minimum payments, and a corresponding ﬁnancial liability. DISCLOSURE CONTROLS AND PROCEDURES The Company maintains appropriate information systems, procedures and controls to ensure that information used internally and disclosed externally is complete, accurate, reliable and timely. The disclosure controls and procedures (“DC&P”) are designed to provide reasonable assurance that information required to be disclosed in the annual ﬁlings, interim ﬁlings or other reports ﬁled under securities legislation is recorded, processed, summarized and reported within the time periods speciﬁed in the securities legislation and include controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to Management, including its certifying ofﬁcers, as appropriate to allow timely decisions regarding required disclosure. MANAGEMENT’S DISCUSSION AND ANALYSIS 29 The President and Chief Executive Ofﬁcer and the Senior Vice- President and Chief Financial Ofﬁcer of the Company have evaluated, or caused the evaluation of, under their direct supervision, the design and operating effectiveness of the Company’s DC&P (as deﬁned in Regulation 52-109 - Certiﬁcation of Disclosure in Issuer’s Annual and Interim Filings) as at December 31, 2017, and have concluded that such DC&P were designed and operating effectively. INTERNAL CONTROL OVER FINANCIAL REPORTING is responsible Management for establishing and maintaining adequate internal controls over ﬁnancial reporting (“ICFR”) to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with IFRS. Management has evaluated the design and operating effectiveness of its ICFR as deﬁned in Regulation 52-109 – Certiﬁcation of Disclosure in Issuer’s Annual and Interim Filings. The evaluation was based on the criteria established in the “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). This evaluation was performed by the President and Chief Executive Ofﬁcer and the Senior Vice-President and Chief Financial Ofﬁcer of the Company with the assistance of other Company Management and staff to the extent deemed necessary. Based on this evaluation, the President and Chief Executive Ofﬁcer and the Senior Vice-President and Chief Financial Ofﬁcer concluded that the ICFR were appropriately designed and operating effectively, as at December 31, 2017. In spite of its evaluation, Management does recognize that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance and not absolute assurance of achieving the desired control objectives. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING No changes were made to the design of ICFR during the period from October 1, 2017 to December 31, 2017 that have materially affected or are reasonably likely to materially affect the Company’s ICFR. 2017 Annual Report 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OUTLOOK The Company’s railway tie and utility pole product categories are essential components of the North American basic transportation and utility infrastructure. Such infrastructure needs to be regularly maintained which provides Stella-Jones with relatively steady demand for these products. In periods of economic growth, the Company may also beneﬁt from additional demand stemming from expansions to the railway and telecommunication networks. Based on current market conditions, and assuming stable currencies, Stella-Jones’ total sales and operating margins are expected to improve progressively in 2018 when compared to 2017. Operating margins will remain softer in the ﬁrst half of 2018. The Company’s overall effective tax rate for 2018 is expected to be approximately 26.0%. As one of the largest North American providers of industrial treated wood products, Stella-Jones will leverage the strength of its continental network to capture more of its existing clients’ business in its core railway tie and utility pole markets, while diligently seeking market opportunities in all product categories. The Company will also remain focused on improving operating efﬁciencies throughout the organization. In the short-term, the Company will focus on integrating the PFP acquisition as well as optimizing operating capacity and minimizing costs throughout the organization. Cash generation and maintaining a prudent use of leverage remain priorities for Management. The solid cash ﬂows provided by operating activities will be used to reduce debt, invest in working capital as well as in property, plant and equipment and in maintaining an optimal dividend policy to the beneﬁt of shareholders. In the railway tie product category, North American railroads will continue to maintain their continental rail network, as operators constantly seek optimal line efﬁciency. The Company is anticipating that 2018 annual railway tie sales should be relatively stable when compared to 2017. Meanwhile, softer pricing may continue to negatively impact operating margins in the ﬁrst half of the year, which should gradually return to historical levels by the end of 2018. Over the long-term, the Company’s strategic vision, focused on continental expansion, remains intact, as Management believes that the fundamentals of each product category will remain strong. A solid ﬁnancial position will allow Stella-Jones to continue to seek opportunities to further expand its presence in its core markets. These opportunities must meet its stringent investment requirements, provide synergistic opportunities, and add value for shareholders. March 13, 2018 In the utility pole product category, demand for regular maintenance projects has historically been relatively steady. Following a return to normal demand patterns in 2017, the Company expects a better sales mix within the product category in 2018. However, these factors should be offset by slight cost increases for certain wood species and the timing of price adjustments. In the residential lumber product category, the Company expects to further beneﬁt from continued demand for new construction and outdoor renovation projects in the North American residential and commercial markets. Sales for 2018 are also expected to increase as pricing will reﬂect the higher wood cost. Stella-Jones Inc. CONSOLIDATED FINANCIAL STATEMENTS 31 December 31, 2017 and 2016 Management’s Statement of Responsibility for Financial Information The consolidated ﬁnancial statements contained in this Annual Report are the responsibility of Management, and have been prepared in accordance with International Financial Reporting Standards. Where necessary, Management has made judgments and estimates of the outcome of events and transactions, with due consideration given to materiality. Management is also responsible for all other information in the Annual Report and for ensuring that this information is consistent, where appropriate, with the information and data included in the consolidated ﬁnancial statements. The Company maintains a system of internal controls to provide reasonable assurance as to the reliability of the ﬁnancial records and safeguarding of its assets. The consolidated ﬁnancial statements have been examined by the Company’s independent auditors, PricewaterhouseCoopers LLP, and they have issued their report thereon. The Board of Directors is responsible for overseeing Management in the performance of its responsibilities for ﬁnancial reporting. The Board of Directors exercises its responsibilities through the Audit Committee, which is comprised of ﬁve independent directors. The Audit Committee meets from time to time with Management and the Company’s independent auditors to review the ﬁnancial statements and matters relating to the audit. The Company’s independent auditors have full and free access to the Audit Committee. The consolidated ﬁnancial statements have been reviewed by the Audit Committee, who recommended their approval by the Board of Directors. Brian McManus President and Chief Executive Ofﬁcer Éric Vachon, CPA, CA Senior Vice-President and Chief Financial Ofﬁcer Saint-Laurent, Québec March 13, 2018 2017 Annual Report 32 INDEPENDENT AUDITOR’S REPORT To the Shareholders of Stella-Jones Inc. We have audited the accompanying consolidated ﬁnancial statements of Stella-Jones Inc. and its subsidiaries, which comprise the consolidated statement of ﬁnancial position as at December 31, 2017 and 2016 and the consolidated statements of change in shareholders’ equity, income, comprehensive income and cash ﬂow for the years then ended, and the related notes, which comprise a summary of signiﬁcant accounting policies and other explanatory information. Management’s responsibility for the consolidated ﬁnancial statements Management is responsible for the preparation and fair presentation of these consolidated ﬁnancial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated ﬁnancial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated ﬁnancial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated ﬁnancial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated ﬁnancial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated ﬁnancial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated ﬁnancial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated ﬁnancial statements. We believe that the audit evidence we have obtained in our audits is sufﬁcient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated ﬁnancial statements present fairly, in all material respects, the ﬁnancial position of Stella-Jones Inc. and its subsidiaries as at December 31, 2017 and 2016 and their ﬁnancial performance and their cash ﬂows for the years then ended in accordance with International Financial Reporting Standards. Montréal, Québec March 13, 2018 1 FCPA auditor, FCA, public accountancy permit No. A116853 Stella-Jones Inc. ASSETS Current assets Cash Restricted cash Accounts receivable Derivative ﬁnancial instruments Inventories Prepaid expenses Income taxes receivable Non-current assets Property, plant and equipment Intangible assets Goodwill Derivative ﬁnancial instruments Other assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Accounts payable and accrued liabilities Current portion of long-term debt Current portion of provisions and other long-term liabilities Non-current liabilities Long-term debt Deferred income taxes Provisions and other long-term liabilities Employee future beneﬁts Derivative ﬁnancial instruments Shareholders’ equity Capital stock Contributed surplus Retained earnings Accumulated other comprehensive income Commitments and contingencies Subsequent events CONSOLIDATED STATEMENTS OF FINANCIAL POSITION 33 As at December 31, 2017 and 2016 (expressed in thousands of Canadian dollars) Note 2017 $ 2016 $ 6,430 — 163,458 473 718,462 18,435 1,122 2,267 1,452 160,755 1,739 854,556 23,934 5,720 908,380 1,050,423 472,041 124,364 270,261 6,173 4,761 463,650 147,314 287,367 5,056 7,134 1,785,980 1,960,944 111,206 5,695 12,114 101,142 6,707 14,590 129,015 122,439 449,945 72,408 11,392 7,675 — 687,320 101,171 16,480 6,753 363 670,435 934,526 220,467 298 809,022 85,758 1,115,545 1,785,980 219,119 258 672,620 134,421 1,026,418 1,960,944 5 18 6 7 8 8 18 9 10 11 10 15 11 16 18 13 17 22 The accompanying notes are an integral part of these consolidated ﬁnancial statements. Approved by the Board of Directors, Tom A. Bruce Jones, CBE Director George J. Bunze, CPA, CMA Director 2017 Annual Report 34 CONSOLIDATED STATEMENTS OF CHANGE IN SHAREHOLDERS’ EQUITY For the years ended December 31, 2017 and 2016 (expressed in thousands of Canadian dollars) Accumulated other comprehensive income Translation of long-term debts designated as net investment hedges Foreign currency translation adjustment Unrealized gains on cash ﬂow hedges Total shareholders’ equity Total Capital stock Contributed surplus Retained earnings Balance – January 1, 2016 216,474 503 546,402 247,092 (97,184) 215 150,123 913,502 $ $ $ $ $ $ $ $ Comprehensive income (loss) Net income for the year Other comprehensive income (loss) Comprehensive income (loss) for the year Dividends on common shares — — — — — 153,898 — — — — 153,898 — 9 (23,968) 4,652 3,614 (15,702) (15,693) — 153,907 (23,968) 4,652 3,614 (15,702) 138,205 — (27,689) Exercise of stock options 1,479 (401) Employee share purchase plans 1,166 — Stock-based compensation (note 13) — 156 — — — 2,645 (245) (27,689) — — — — — — — — — — — — — — — — — — — — (27,689) 1,078 1,166 156 (25,289) Balance – December 31, 2016 219,119 258 672,620 223,124 (92,532) 3,829 134,421 1,026,418 Balance – January 1, 2017 219,119 258 672,620 223,124 (92,532) 3,829 134,421 1,026,418 Comprehensive income (loss) Net income for the year Other comprehensive income (loss) Comprehensive income (loss) for the year Dividends on common shares Exercise of stock options Employee share purchase plans Stock-based compensation (note 13) — — — — 146 1,202 — — 167,889 — — — — 167,889 — (983) (72,504) 23,111 730 (48,663) (49,646) — 166,906 (72,504) 23,111 730 (48,663) 118,243 — (30,504) (47) — 87 — — — — — — — — — — — — — — — — — — — — — — — (30,504) 99 1,202 87 (29,116) 1,348 40 (30,504) Balance – December 31, 2017 220,467 298 809,022 150,620 (69,421) 4,559 85,758 1,115,545 The accompanying notes are an integral part of these consolidated ﬁnancial statements. Stella-Jones Inc. Sales Expenses Cost of sales Selling and administrative Other losses (gains), net Operating income Financial expenses Income before income taxes Provision for (recovery of) income taxes Current Deferred Net income for the year Basic earnings per common share Diluted earnings per common share CONSOLIDATED STATEMENTS OF INCOME 35 For the years ended December 31, 2017 and 2016 (expressed in thousands of Canadian dollars, except earnings per common share) Note 2017 $ 2016 $ 1,886,142 1,838,353 1,586,263 1,504,639 93,828 (1,337) 94,962 5,509 14 1,678,754 1,605,110 14 15 15 13 13 207,388 19,009 188,379 233,243 17,859 215,384 41,566 (21,076) 20,490 47,526 13,960 61,486 167,889 153,898 2.42 2.42 2.22 2.22 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 2017 Annual Report 36 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the years ended December 31, 2017 and 2016 (expressed in thousands of Canadian dollars) Net income for the year Other comprehensive income Items that may subsequently be reclassiﬁed to net income 2017 $ 2016 $ 167,889 153,898 Net change in losses on translation of ﬁnancial statements of foreign operations (81,920) (26,863) Income taxes on change in losses on translation of ﬁnancial statements of foreign operations Change in gains on translation of long-term debts designated as hedges of net investment in foreign operations Income taxes on change in gains on translation of long-term debts designated as hedges of net investment in foreign operations Change in gains on fair value of derivatives designated as cash ﬂow hedges Income taxes on change in gains on fair value of derivatives designated as cash ﬂow hedges Items that will not subsequently be reclassiﬁed to net income Remeasurements of post-retirement beneﬁt obligations Income taxes on remeasurements of post-retirement beneﬁt obligations Comprehensive income for the year The accompanying notes are an integral part of these consolidated ﬁnancial statements. 9,416 2,895 29,332 7,291 (6,221) 1,026 (2,639) 4,897 (296) (1,283) (737) (246) 40 (31) (49,646) (15,693) 118,243 138,205 Stella-Jones Inc. Cash ﬂows provided by (used in) Operating activities Net income for the year Adjustments for Depreciation of property, plant and equipment Amortization of intangible assets Financial expenses Current income taxes expense Deferred income taxes Restricted stock units expense Other Changes in non-cash working capital components and others Accounts receivable Inventories Prepaid expenses Income taxes receivable Accounts payable and accrued liabilities Asset retirement obligations Provisions and other long-term liabilities Interest paid Income taxes paid Financing activities Increase in deferred ﬁnancing costs Net change in syndicated credit facilities Increase in long-term debt Repayment of long-term debt Net change in non-competes payable Dividend on common shares Proceeds from issuance of common shares Investing activities Decrease (increase) in other assets Business acquisitions Increase in intangible assets Purchase of property, plant and equipment Proceeds on disposal of assets Net change in cash and cash equivalents during the year Cash and cash equivalents – Beginning of year Cash and cash equivalents – End of year The accompanying notes are an integral part of these consolidated ﬁnancial statements. CONSOLIDATED STATEMENTS OF CASH FLOW 37 For the years ended December 31, 2017 and 2016 (expressed in thousands of Canadian dollars) Note 2017 $ 2016 $ 167,889 153,898 7 8 15 15 12 12 12 12 4 12 17,919 15,285 19,009 41,566 (21,076) 4,549 571 245,712 (11,026) 103,213 4,380 (2,746) 16,694 (3,369) (1,494) 105,652 (15,797) (34,454) 301,113 (1,132) (391,796) 195,870 (11,507) (2,156) (30,504) 1,301 (239,924) (710) (5,792) (477) (52,175) 676 15,784 15,803 17,859 47,526 13,960 5,538 (1,499) 268,869 21,017 (39,858) 3,117 (499) 5,785 2,038 (21,676) (30,076) (18,648) (38,317) 181,828 (1,051) 70,738 — (59,176) 5,452 (27,689) 2,244 (9,482) 952 (107,305) (6,381) (63,212) 346 (58,478) (175,600) 2,711 3,719 6,430 (3,254) 6,973 3,719 2017 Annual Report 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 1 DESCRIPTION OF THE BUSINESS Stella-Jones Inc. (the “Company”) is a leading producer and marketer of pressure treated wood products. The Company supplies North America’s railroad operators with railway ties and timbers, and the continent’s electrical utilities and telecommunication companies with utility poles. Stella-Jones Inc. also manufactures and distributes residential lumber and accessories to retailers for outdoor applications, as well as industrial products which include marine and foundation pilings, construction timbers, wood for bridges and coal tar based products. The Company has treating and pole peeling facilities across Canada and the United States and sells its products primarily in these two countries. The Company’s headquarters are located at 3100 de la Côte-Vertu Blvd., in Saint-Laurent, Quebec, Canada. The Company is incorporated under the Canada Business Corporations Act, and its common shares are listed on the Toronto Stock Exchange (“TSX”) under the stock symbol SJ. 2 SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The Company prepares its consolidated ﬁnancial statements in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and Chartered Professional Accountants Canada Handbook Part I. These consolidated ﬁnancial statements were approved by the Board of Directors on March 13, 2018. Basis of measurement The consolidated ﬁnancial statements have been prepared under the historical cost convention, except for derivative ﬁnancial instruments and certain long-term liabilities which are measured at fair value. The Company has consistently applied the same accounting policies for all periods presented, except for the newly adopted standards. Principles of consolidation Subsidiaries The consolidated ﬁnancial statements include the accounts of the Company and its wholly owned subsidiaries. The Company owns 100% of the equity interests of its subsidiaries. The signiﬁcant subsidiaries are as follows: Subsidiary Parent Stella-Jones U.S. Holding Corporation (“SJ Holding”) Stella-Jones Inc. Stella-Jones Corporation Stella-Jones U.S. Holding Corporation McFarland Cascade Holdings, Inc. (“McFarland”) Stella-Jones Corporation Cascade Pole and Lumber Company McFarland Cascade Holdings, Inc. McFarland Cascade Pole & Lumber Company McFarland Cascade Holdings, Inc. Stella-Jones CDN Finance Inc. Stella-Jones Inc. Stella-Jones U.S. Finance II Corporation Stella-Jones U.S. Holding Corporation Stella-Jones U.S. II LLC Stella-Jones U.S. Holding Corporation Stella-Jones U.S. Finance III Corporation Stella-Jones U.S. Holding Corporation Stella-Jones U.S. III L.L.C. Kisatchie Midnight Express, LLC Lufkin Creosoting Co., Inc. Stella-Jones U.S. Holding Corporation McFarland Cascade Holdings, Inc. McFarland Cascade Holdings, Inc. Country of incorporation United States United States United States United States United States Canada United States United States United States United States United States United States Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 39 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Principles of consolidation (continued) Subsidiaries (continued) On October 24, 2017, SJ Holding incorporated Stella-Jones U.S. III L.L.C., a wholly-owned Limited Liability Company, and Stella-Jones U.S. Finance III Corporation, a wholly owned corporation, both under the laws of Delaware. On November 29, 2017, Stella-Jones Inc. disposed of its participation in SJ Holding in favor of Canadalux S.à.r.l. Shortly after on the same day, Canadalux S.à.r.l. was liquidated into Stella-Jones Inc. The Company controls an entity when it is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Company controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are de-consolidated from the date that control ceases. Business combinations The acquisition method of accounting is used to account for the acquisition of subsidiaries by the Company. The consideration transferred for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the group. The consideration transferred also includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition-related costs are expensed as incurred. Identiﬁable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. The excess of the aggregate of the consideration transferred, the fair value of any non-controlling interest in the acquiree and the acquisition- date fair value of any previous equity interest in the acquiree over the fair value of the group’s share of the net identiﬁable assets acquired and liabilities assumed is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the consolidated statement of income. Accounting policies of the subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Company. Foreign currency translation a) Functional and presentation currency Items included in the ﬁnancial statements of each of the Company’s entities are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The consolidated ﬁnancial statements are presented in Canadian dollars, which is the Company’s presentation currency. b) Foreign currency transactions Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Revenue and expenses denominated in a foreign currency are translated by applying the monthly average exchange rates. Monetary assets and liabilities denominated in foreign currencies are translated at the rate in effect at the statement of ﬁnancial position date. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities not denominated in the functional currency are recognized in the consolidated statement of income within other losses (gains), net, except for qualifying cash ﬂow hedges which are recognized in other comprehensive income and deferred in accumulated other comprehensive income in shareholders’ equity. Non-monetary assets and liabilities denominated in foreign currencies that are measured at fair value are translated to the functional currency at the exchange rate at the date that the fair value was determined. Foreign currency differences arising on translation are recognized in the consolidated statement of income, except for differences arising on the translation of available-for-sale (equity) investments and foreign currency differences arising on the translation of a ﬁnancial liability designated as a hedge of a net investment, which are recognized in other comprehensive income. Non-monetary assets and liabilities denominated in foreign currencies that are measured at cost remain translated in the functional currency at historical exchange rates. 2017 Annual Report 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Foreign currency translation (continued) c) Foreign operations The ﬁnancial statements of entities that have a functional currency different from that of the Company are translated using the rate in effect at the statement of ﬁnancial position date for assets and liabilities, and the monthly average exchange rates during the year for revenues and expenses. Adjustments arising from this translation are recorded in accumulated other comprehensive income in shareholders’ equity. d) Hedges of net investments in foreign operations Foreign currency differences arising on the translation of a ﬁnancial liability designated as a hedge of net investment in foreign operations are recognized in other comprehensive income to the extent that the hedge is effective, and are presented within equity. To the extent that the hedge is ineffective, such differences are recognized in the consolidated statement of income. When the hedged portion of a net investment (the subsidiary) is disposed of, the relevant amount in equity is transferred to the consolidated statement of income as part of the gain or loss on disposal. Revenue recognition Revenue from the sale of products is recognized when the entity has transferred to the buyer the signiﬁcant risks and rewards of ownership of the goods, the entity does not retain either continuing managerial involvement to the degree usually associated with ownership or effective control over the goods sold, the amount of revenue can be measured reliably, it is probable that the economic beneﬁts associated with the transaction will ﬂow to the entity, and the costs incurred or to be incurred in respect of the sale, can be measured reliably. Revenue is net of trade or volume discounts, returns and allowances and claims for damaged goods. The Company also offers to treat wood products owned by third parties. Revenue from these treating services are recognized when the service is rendered. Cash and cash equivalents Cash and cash equivalents include cash on hand, bank balances and short-term liquid investments with initial maturities of three months or less. Restricted cash Restricted cash consists of an amount deposited in an escrow account and intended for capital improvements to be realized in the short-term. Accounts receivable Accounts receivable are amounts due from customers from the sale of products or services rendered in the ordinary course of business. Accounts receivable are classiﬁed as current assets if payment is due within one year or less. Accounts receivable are recognized initially at fair value and subsequently measured at amortized cost, less provision for doubtful accounts. Inventories Inventories of raw materials are valued at the lower of weighted average cost and net realizable value. Finished goods are valued at the lower of weighted average cost and net realizable value and include the cost of raw materials, direct labour and manufacturing overhead expenses. Net realizable value is the estimated selling price less cost necessary to make the sale. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 41 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Property, plant and equipment Property, plant and equipment are recorded at cost, including borrowing costs incurred during the construction period, less accumulated depreciation. The Company allocates the amount initially recognized in respect of an item of property, plant and equipment to its signiﬁcant parts, and depreciates separately each such part. Depreciation is calculated on a straight-line basis using rates based on the estimated useful lives of the assets. Buildings Production equipment Rolling stock Ofﬁce equipment Useful life 7 to 60 years 5 to 60 years 3 to 20 years 2 to 10 years The assets’ residual values and useful lives are reviewed and adjusted, if appropriate, at the end of each reporting period. Financial expenses Borrowing costs are recognized as ﬁnancial expenses in the consolidated statement of income in the period in which they are incurred. Borrowing costs attributable to the acquisition, construction or production of qualifying assets are added to the cost of those assets, until such time as the assets are substantially ready for their intended use. Intangible assets Intangible assets with ﬁnite useful lives are recorded at cost and are amortized over their useful lives. Intangible assets with indeﬁnite useful lives are recorded at cost and are not amortized. The amortization method and estimate of the useful life of an intangible asset are reviewed on an annual basis. Customer relationships Customer relationships Non-compete agreements Creosote registration Method Straight-line Declining balance Straight-line – Useful life 3 to 12 years 6% to 20% 3 to 5 years Indeﬁnite Standing timber costs are recorded at cost less accumulated amortization, which is provided on the basis of timber volumes harvested. In Canada, the Company has perpetual cutting rights where planning and site preparation costs for speciﬁc geographical areas are capitalized until the harvest process can begin. Amortization amounts are charged to operations based on a pro rata calculation of timber volumes harvested over the estimated volumes to be harvested in the speciﬁc area. Cutting rights are recorded at cost less accumulated amortization, which is provided on the basis of timber volumes harvested. Amortization amounts are charged to operations based on a pro rata calculation of timber volumes harvested over the estimated volumes to be harvested during a forty-year period, and are applied against the historical cost. The amortization expense is included in cost of sales in the consolidated statements of income. The creosote registration is subject to an annual impairment test or more frequently if events or changes in circumstances indicate that it might be impaired. 2017 Annual Report 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Goodwill In the context of an acquisition, goodwill represents the excess of the consideration transferred over the fair value of the Company’s share of the net identiﬁable assets, liabilities and contingent liabilities of the acquiree and the fair value of the non controlling interest in the acquiree at the date of acquisition. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Impairment losses on goodwill are not reversed. For the purpose of impairment testing, goodwill is allocated to cash-generating units (“CGUs”) or groups of CGUs that are expected to beneﬁt from the business combination in which the goodwill arose. The Company deﬁnes CGUs as either plants specialized in the treatment of utility poles and residential lumber or plants specialized in the treatment of railway ties. Impairment Impairments are recorded when the recoverable amounts of assets are less than their carrying amounts. The recoverable amount is the higher of an asset’s fair value less cost of disposal and its value in use. Impairment losses are evaluated for potential reversals when events or changes in circumstances warrant such consideration, except goodwill. Non-ﬁnancial assets The carrying values of non-ﬁnancial assets with ﬁnite lives, such as property, plant and equipment and intangible assets with ﬁnite useful lives, are assessed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Long-lived assets that are not amortized are subject to an annual impairment test. The recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use (being the present value of the expected future cash ﬂows of the relevant asset or CGU). An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount. For the purpose of assessing impairment, assets are grouped at the lowest levels for which there are separately identiﬁable cash ﬂows (CGUs). Non-ﬁnancial assets other than goodwill that have suffered impairment are reviewed for possible reversal of the impairment at each reporting date. Leases The Company leases certain property, plant and equipment. Leases in which a signiﬁcant portion of the risks and rewards of ownership are retained by the lessor are classiﬁed as operating leases. Payments made under operating leases, net of any incentives received from the lessor, are charged to the consolidated statement of income on a straight-line basis over the term of the lease. Leases of property, plant and equipment where the Company assumes substantially all the risks and rewards of ownership are classiﬁed as ﬁnance leases. Finance leases are capitalized at the lease’s commencement at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each ﬁnance lease payment is allocated between the liability and ﬁnance charges so as to achieve a constant rate on the ﬁnance balance outstanding. The corresponding rental obligations, net of ﬁnance charges, are included in long-term debt. The interest element of the ﬁnance cost is charged to the consolidated statement of income over the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The depreciable amount of a leased asset is allocated to each accounting period during the period of expected use on a systematic basis consistent with the depreciation policy the Company adopts for depreciable assets that are owned. If there is reasonable certainty that the Company will obtain ownership by the end of the lease term, the period of expected use is the useful life of the asset; otherwise, the asset is depreciated over the shorter of the lease term and its useful life. Non-current assets held for sale Non-current assets are classiﬁed as assets held for sale when their carrying amount is to be recovered principally through a sales transaction and a sale is considered highly probable. They are stated at the lower of carrying amount and fair value less cost of disposal if their carrying amount is to be recovered principally through a sales transaction rather than through continuing use. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 43 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Provisions Provisions for site remediation and other provisions are recognized when the Company has a legal or constructive obligation as a result of past events, when it is probable that an outﬂow of resources will be required to settle the obligation and when a reliable estimate can be made of the amount of the obligation. If some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement is recorded in the consolidated statement of ﬁnancial position as a separate asset, but only if it is virtually certain that reimbursement will be received. Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax rate that reﬂects current market assessments of the time value of money and the risks speciﬁc to the obligation. The increase in the provision due to passage of time is recognized as a ﬁnancial expense. The Company considers the current portion of the provision to be an obligation whose settlement is expected to occur within the next twelve months. Site remediation obligations Site remediation obligations relate to the discounted present value of estimated future expenditures associated with the obligations of restoring the environmental integrity of certain properties. The Company reviews estimates of future site remediation expenditures on an ongoing basis and records any revisions, along with the accretion expense on existing obligations, in other losses (gains), net in the consolidated statement of income. At each reporting date, the liability is remeasured for changes in discount rates and in the estimate of the amount, timing and cost of the work to be carried out. Income taxes The tax expense comprises current and deferred tax. Tax expense is recognized in the consolidated statement of income, except to the extent that it relates to items recognized in other comprehensive income or directly to shareholders’ equity. Current tax The current income tax charge is based on the results for the period as adjusted for items that are not taxable or not deductible. Tax adjustments from prior years are also recorded in current tax. Current tax is calculated using tax rates and laws that were enacted or substantively enacted at the end of the reporting period. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. Provisions are established where appropriate on the basis of amounts expected to be paid to the tax authorities. During the year, the tax provision calculation is based on an estimate of the annual tax rate. Deferred tax Deferred tax is recognized, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated ﬁnancial statements. Deferred income tax is determined on a non-discounted basis using tax rates and laws that have been enacted or substantively enacted at the consolidated statement of ﬁnancial position date and are expected to apply when the deferred tax asset or liability is settled. Deferred tax assets are recognized to the extent that it is probable that the assets can be recovered. Deferred income tax assets and liabilities are presented as non-current. Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income tax assets and liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity or different taxable entities where there is an intention to settle the balances on a net basis. Deferred tax assets and liabilities are not recognized in respect of temporary differences that arise on initial recognition of assets and liabilities acquired other than in a business combination. 2017 Annual Report 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Employee future beneﬁts Other post-retirement beneﬁt programs The Company provides other post-retirement healthcare beneﬁts to certain retirees. The entitlement to these beneﬁts is usually conditional on the employee remaining in service up to retirement age and the completion of a minimum service period. The expected costs of these beneﬁts are attributed from the date when service by the employee ﬁrst leads to beneﬁts under the plan, until the date when further service by the employee will lead to no material amount of further beneﬁts. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to other comprehensive income in the period in which they arise. The cost of future beneﬁts earned by employees is established by actuarial calculations using the projected beneﬁt method pro-rated on years of service based on Management’s best estimate of economic and demographic assumptions. Deﬁned beneﬁt pension plan The Company accrues obligations and related costs under deﬁned beneﬁt pension plans, net of plan assets. The cost of pensions earned by employees is actuarially determined using the projected unit credit method and Management’s best estimate of expected plan investment performance, salary escalation, retirement ages of employees and discount rates on obligations. Past service costs from plan amendments are recognized in net income when incurred. Remeasurements consisting of actuarial gains and losses, the actual return on plan assets (excluding the net interest component) and any change in the asset ceiling are recognized in other comprehensive income. The amounts recognized in other comprehensive income are recognized immediately in retained earnings without recycling to the consolidated statements of income in subsequent periods. Stock-based compensation and other stock-based payments The Company operates a number of equity-settled and cash-settled share-based compensation plans under which it receives services from employees as consideration for equity instruments of the Company or cash payments. Equity-settled plan The Company accounts for stock options granted to employees using the fair value method. Under this method, compensation expense for stock options granted is measured at fair value at the grant date using the Black-Scholes valuation model and is charged to operations over the vesting period of the options granted, with a corresponding credit to contributed surplus. For grants of share-based awards with graded vesting, each tranche is considered a separate grant with a different vesting date and fair value. Any consideration paid on the exercise of stock options is credited to capital stock together with any related stock-based compensation expense included in contributed surplus. Cash-settled plan The Company has restricted stock units (“RSUs”) and measures the liability incurred and the compensation expenses at fair value by applying the Black-Scholes valuation model. The compensation expenses are recognized in the consolidated statements of income over the vesting periods. Until the liability is settled, the fair value of that liability is remeasured at each reporting date, with changes in fair value recognized in the consolidated statements of income. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 45 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Financial instruments Financial assets and ﬁnancial liabilities are recognized when the Company becomes a party to the contractual provisions of the instrument. Financial assets are derecognized when the rights to receive cash ﬂows from the assets have expired or have been transferred and the Company has transferred substantially all risks and rewards of ownership. Financial liabilities are derecognized when the obligation speciﬁed in the contract is discharged, cancelled or expires. Financial assets and ﬁnancial liabilities are offset and the net amount is reported in the consolidated statement of ﬁnancial position when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or realize the asset and settle the liability simultaneously. At initial recognition, the Company classiﬁes its ﬁnancial instruments in the following categories depending on the purpose for which the instruments were acquired: a) Financial assets and ﬁnancial liabilities at fair value through proﬁt or loss: A ﬁnancial asset or ﬁnancial liability is classiﬁed in this category if acquired principally for the purpose of selling or repurchasing in the short term. Derivatives are also included in this category unless they are designated as hedges. Interest rate swap agreements, foreign exchange forward contracts and derivative commodity contracts are considered by the Company as derivative ﬁnancial instruments and, if required, are designated as cash ﬂow hedges (see (e) below). Financial instruments in this category are recognized initially and subsequently at fair value. Transaction costs are expensed in the consolidated statement of income. Gains and losses arising from changes in fair value are presented in the consolidated statement of income as part of other gains and losses in the period in which they arise. Financial assets and ﬁnancial liabilities at fair value through proﬁt or loss are classiﬁed as current except for the portion expected to be realized or paid beyond twelve months of the consolidated statement of ﬁnancial position date, which is classiﬁed as non-current. b) Available-for-sale investments: Available-for-sale investments are non-derivatives that are either designated in this category or not classiﬁed in any of the other categories. Available-for-sale investments are recognized initially at fair value plus transaction costs and are subsequently carried at fair value. Gains or losses arising from changes in fair value are recognized in other comprehensive income. Available-for-sale investments are classiﬁed as non-current unless they mature within twelve months, or Management expects to dispose of them within twelve months. Interest on available-for-sale investments, calculated using the effective interest method, is recognized in the consolidated statement of income as part of interest income. Dividends on available-for-sale equity instruments are recognized in the consolidated statement of income as part of other gains and losses when the Company’s right to receive payment is established. When an available-for-sale investment is sold or impaired, the accumulated gains or losses are moved from accumulated other comprehensive income to the consolidated statement of income and are included in other gains and losses. c) Loans and receivables: Loans and receivables are non-derivative ﬁnancial assets with ﬁxed or determinable payments that are not quoted in an active market. The Company’s loans and receivables comprise accounts receivable and cash and cash equivalents, and are included in current assets due to their short-term nature. Loans and receivables are initially recognized at the amount expected to be received, less, when material, a discount to reduce the loans and receivables to fair value. Subsequently, loans and receivables are measured at amortized cost using the effective interest method less a provision for impairment, if any. 2017 Annual Report 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Financial instruments (continued) d) Financial liabilities at amortized cost: Financial liabilities at amortized cost include accounts payable and accrued liabilities, bank indebtedness and long-term debt. Accounts payable and accrued liabilities are initially recognized at the amount required to be paid, less, when material, a discount to reduce the payables to fair value. Subsequently, accounts payable and accrued liabilities are measured at amortized cost using the effective interest method. Bank indebtedness and long-term debt are recognized initially at fair value, net of any transaction costs incurred, and subsequently at amortized cost using the effective interest method. Financial liabilities are classiﬁed as current liabilities if payment is due within twelve months. Otherwise, they are presented as non- current liabilities. e) Derivative ﬁnancial instruments: The Company uses derivatives in the form of interest rate swap agreements to manage risks related to its variable rate debt, foreign exchange forward contracts to limit its exposure to the ﬂuctuations of the U.S. dollar and derivative commodity contracts to limit its exposure to the ﬂuctuation of diesel and petroleum prices. All derivatives classiﬁed as held-for-trading are included in the consolidated statement of ﬁnancial position and are classiﬁed as current or non-current based on the contractual terms speciﬁc to the instrument, with gains and losses on remeasurement recorded in income. All derivatives qualifying for hedge accounting are included in the consolidated statement of ﬁnancial position and are classiﬁed as current or non-current based on the contractual terms speciﬁc to the instruments, with gains and losses on remeasurement included in other comprehensive income. Hedging transactions As part of its hedging strategy, the Company considers foreign exchange forward contracts to limit its exposure under contracted cash inﬂows of sales denominated in U.S. dollars from its Canadian-based operations. The Company also considers interest rate swap agreements in order to reduce the impact of ﬂuctuating interest rates on its short-term and long-term debt. These contracts are treated as cash ﬂow hedges for accounting purposes and are not fair-valued through proﬁt and loss. Effective derivative ﬁnancial instruments held for cash ﬂow hedging purposes are recognized at fair value, and the changes in fair value related to the effective portion of the hedge are recognized in other comprehensive income. The changes in fair value related to the ineffective portion of the hedge are immediately recorded in the consolidated statement of income. The changes in fair value of foreign exchange forward contracts and interest rate swap agreements recognized in other comprehensive income are reclassiﬁed in the consolidated statement of income under sales and ﬁnancial expenses respectively in the periods during which the cash ﬂows constituting the hedged item affect income. When the derivative ﬁnancial instrument no longer qualiﬁes as an effective hedge, or when the hedging instrument is sold or terminated prior to maturity, hedge accounting, if applicable, is discontinued prospectively. Accumulated other comprehensive income related to a foreign exchange forward contract or interest swap hedges that cease to be effective is reclassiﬁed in the consolidated statement of income under other losses (gains), net and ﬁnancial expenses respectively in the periods during which the cash ﬂows constituting the hedged item affect income. Furthermore, if the hedged item is sold or terminated prior to maturity, hedge accounting is discontinued, and the related accumulated other comprehensive income is then reclassiﬁed in the consolidated statement of income. The Company designated a portion of its U.S. dollar-denominated long-term debt as a hedge of its net investment in foreign operations. For such debt designated as a hedge of the net investment in foreign operations, exchange gains and losses are recognized in accumulated other comprehensive income. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 47 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Earnings per share Basic earnings per share is calculated by dividing the net income for the period attributable to equity owners of the Company by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated using the treasury stock method. Under this method, earnings per share data are computed as if the options were exercised at the beginning of the year (or at the time of issuance, if later) and as if the funds obtained from exercise were used to purchase common shares of the Company at the average market price during the period. Segment reporting Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision maker. The chief operating decision maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identiﬁed as the senior management team, which makes strategic and operational decisions. Change in accounting policies The Company has adopted the following revised standard, along with any consequential amendments, effective January 1, 2017. This change was made in accordance with the applicable transitional provisions. IAS 7 - Statement of Cash Flows On January 29, 2016, the IASB published amendments to IAS 7, Statement of Cash Flows. The amendments are intended to clarify IAS 7 to improve information provided to users of ﬁnancial statements about an entity’s ﬁnancing activities. The incremental disclosures can be found in Note 12. Impact of accounting pronouncements not yet implemented IFRS 15 – Revenue from Contracts with Customers In May 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers, to specify how and when to recognize revenue as well as requiring the provision of more informative and relevant disclosures. IFRS 15 supersedes IAS 18, Revenue, IAS 11, Construction Contracts, and other revenue related interpretations. In September 2015, the IASB issued an amendment to IFRS 15 to defer the effective date by one year to 2018. Management has not identiﬁed any material impacts resulting from the transition to IFRS 15. IFRS 16 - Leases In January 2016, the IASB released IFRS 16, Leases, which supersedes IAS 17, Leases, and the related interpretations on leases: IFRIC 4, Determining whether an arrangement contains a lease, SIC 15, Operating Leases – Incentives and SIC 27, Evaluating the substance of transactions in the legal form of a lease. The standard is effective for annual periods beginning on or after January 1, 2019, with earlier application permitted for companies that also apply IFRS 15, Revenue from Contracts with Customers. The Company is currently evaluating the impact of the standard on its consolidated ﬁnancial statements. The Company’s future minimum payments under operating leases amount to $80,134. Under the new standard the Company will recognize, in the statement of ﬁnancial position, an asset (the right to use the leased items), equivalent to the actualized cash ﬂows of the future minimum payments, and a corresponding ﬁnancial liability. IFRS 9 – Financial Instruments The ﬁnal version of IFRS 9, Financial instruments (“IFRS 9”), was issued by the IASB in July 2014 and will replace IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 introduces a model for classiﬁcation and measurement, a single, forward-looking expected loss impairment model and a substantially reformed approach to hedge accounting. The new single, principle-based approach for determining the classiﬁcation of ﬁnancial assets is driven by cash ﬂow characteristics and the business model in which an asset is held. The new model also results in a single impairment model being applied to all ﬁnancial instruments, which will require more timely recognition of expected credit losses. It also includes changes in respect of an entity’s own credit risk in measuring liabilities elected to be measured at fair value, so that gains caused by the deterioration of an entity’s own credit risk on such liabilities are no longer recognized in proﬁt or loss. IFRS 9, which is to be applied retrospectively, is effective for annual periods beginning on or after January 1, 2018. In addition, an entity’s own credit risk changes can be applied early in isolation without otherwise changing the accounting for ﬁnancial instruments. Management has not identiﬁed any material impacts resulting from the transition to IFRS 9. 2017 Annual Report 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 3 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS The preparation of ﬁnancial statements in conformity with IFRS requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the ﬁnancial statements and the reported amounts of revenue and expenses during the reporting period. Signiﬁcant items subject to estimates and assumptions include the estimated useful life of assets, impairment of goodwill, determination of the fair value of the assets acquired and liabilities assumed in the context of an acquisition and impairment of long-lived assets. Management also makes estimates and assumptions in the context of business combination mainly with sale forecast, margin forecast, income tax rate and discount rate. It is possible that actual results could differ from those estimates, and such differences could be material. Estimates are reviewed periodically and, as adjustments become necessary, they are reported in the consolidated statement of income in the period in which they become known. 4 BUSINESS ACQUISITIONS a) On December 19, 2017, the Company completed the acquisition of substantially all the operating assets employed in the businesses of Wood Products Industries Inc. (“WPI”) located in South River, Ontario. The Company plans on using these assets to treat residential lumber. Total cash outlay associated with the acquisition was approximately $4,245, excluding acquisition costs of approximately $234, recognized in the consolidated statement of income under selling and administrative expenses. The Company ﬁnanced the acquisition through its existing syndicated credit facilities. b) On December 21, 2016, the Company completed the acquisition of substantially all the operating assets employed in the businesses of Bois KMS (GMI) Ltée (“KMS”) and Northern Pressure Treated Wood (N.P.T.W.) Ltd (“NPTW”). KMS and NPTW manufacture treated wood utility poles in their facilities located in Rivière-Rouge, Québec and Kirkland Lake, Ontario, respectively, and were acquired for synergistic reasons. Total cash outlay associated with the acquisition was $19,249, excluding acquisition costs of approximately $1,048, recognized in the 2016 consolidated statement of income under selling and administrative expenses. The Company ﬁnanced the acquisition through its existing syndicated credit facilities. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 49 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 4 BUSINESS ACQUISITIONS (CONTINUED) The following is a ﬁnal summary of the assets acquired, the liabilities assumed and the consideration transferred at fair value as at the acquisition date. No signiﬁcant adjustments were made to the preliminary fair value determination. Assets acquired Inventories Property, plant and equipment Customer relationships Goodwill Deferred income tax assets Liabilities assumed Accounts payable and accrued liabilities Site remediation provision Total net assets acquired and liabilities assumed Consideration transferred Cash Consideration payable Consideration transferred $ 4,488 6,923 1,050 6,934 930 20,325 78 937 19,310 19,249 61 19,310 The Company’s valuation of intangible assets has identiﬁed customer relationships having a thirty-ﬁve month useful life. Signiﬁcant assumptions used in the determination of intangible assets, as deﬁned by Management, include year-over-year sales growth, discount rate and operating income before depreciation and amortization margin. Goodwill is amortized and is deductible for Canadian tax purposes, and represents the future economic value associated with the enhanced procurement network, acquired workforce and synergies with the Company’s operations. Goodwill is allocated to a CGU deﬁned as plants specialized in the treatment of utility poles and residential lumber. 2017 Annual Report 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 4 BUSINESS ACQUISITIONS (CONTINUED) c) On June 3, 2016, the Company completed, through a wholly-owned U.S. subsidiary, the acquisition of the equity interests of 440 Investments, LLC, the parent company of Kisatchie Treating, L.L.C., Kisatchie Pole & Piling, L.L.C., Kisatchie Trucking, LLC and Kisatchie Midnight Express, LLC (collectively, “Kisatchie”). Kisatchie produces treated poles, pilings and timbers, with two wood treating facilities in Converse and Pineville, Louisiana and was acquired for synergistic reasons. Total cash outlay associated with the acquisition was $46,153 (US$35,659), excluding acquisition costs of approximately $873, recognized in the 2016 consolidated statement of income under selling and administrative expenses. The following is a ﬁnal summary of the assets acquired, the liabilities assumed and the consideration transferred at fair value as at the acquisition date. No signiﬁcant adjustments were made to the preliminary fair value determination. The original transaction was made in U.S. dollars and converted into Canadian dollars as at the acquisition date. Assets acquired Cash acquired Accounts receivable Inventories Prepaids Property, plant and equipment Customer relationships Goodwill Liabilities assumed Accounts payable and accrued liabilities Long-term debt Deferred income tax liabilities Site remediation provision Total net assets acquired and liabilities assumed Consideration transferred Cash Unsecured promissory note Consideration payable Consideration transferred $ 2,628 5,312 12,930 150 21,217 6,860 17,523 66,620 1,680 8,775 63 1,195 54,907 46,153 7,838 916 54,907 The Company’s valuation of intangible assets has identiﬁed customer relationships amortized at a declining rate of 20.00%. Signiﬁcant assumptions used in the determination of intangible assets, as deﬁned by Management, include year-over-year sales growth, discount rate and operating income before depreciation and amortization margin. Goodwill is amortized and deductible for U.S. tax purposes, and represents the future economic value associated with the enhanced procurement network, acquired workforce and synergies with the Company’s operations. Goodwill is allocated to a CGU deﬁned as plants specialized in the treatment of utility poles and residential lumber. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 51 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 4 BUSINESS ACQUISITIONS (CONTINUED) The Company ﬁnanced the acquisition through a combination of its existing syndicated credit facilities, an unsecured promissory note of $9,128 (US$7,052) and assumed a promissory note secured by the land of the Pineville facility having a balance of US$5,685. The unsecured promissory note bears interest at 1.41%, is payable in three installments, including interest, of US$1,500 in June 2019 and 2020 and US$4,500 in June 2021. This unsecured promissory note was recorded at a fair value of $7,838 (US$6,056), using an effective interest rate of 5.00%. The secured promissory note bears interest of 5.76%, is payable in quarterly installments of US$162 up to July 2028 and was recorded at a fair value of $8,775 (US$6,780) using an effective interest rate of 4.00%. d) On June 3, 2016, the Company completed, through a wholly-owned U.S. subsidiary, the acquisition of the shares of Lufkin Creosoting Co., Inc. (“Lufkin Creosoting”). Lufkin Creosoting produces treated poles and timbers at its wood treating facility in Lufkin, Texas and was acquired for synergistic reasons. Total cash outlay associated with the acquisition was $46,503 (US$35,929), excluding acquisition costs of approximately $978, recognized in the 2016 consolidated statement of income under selling and administrative expenses. The following is a ﬁnal summary of the assets acquired, the liabilities assumed and the consideration transferred at fair value as at the acquisition date. No signiﬁcant adjustments were made to the preliminary fair value determination. The original transaction was made in U.S. dollars and converted into Canadian dollars as at the acquisition date. Assets acquired Cash acquired Accounts receivable Inventories Property, plant and equipment Customer relationships Goodwill Liabilities assumed Accounts payable and accrued liabilities Deferred income tax liabilities Site remediation provision Total net assets acquired and liabilities assumed Consideration transferred Cash Unsecured promissory note Consideration receivable Consideration transferred $ 1,074 19,734 5,261 16,244 10,290 23,701 76,304 13,777 9,421 842 52,264 46,503 7,838 (2,077) 52,264 2017 Annual Report 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 4 BUSINESS ACQUISITIONS (CONTINUED) The Company’s valuation of intangible assets has identiﬁed customer relationships amortized at a declining rate of 20.00%. Signiﬁcant assumptions used in the determination of intangible assets, as deﬁned by Management, include year-over-year sales growth, discount rate and operating income before depreciation and amortization margin. Goodwill is not amortized and not deductible for U.S. tax purposes, and represents the future economic value associated with the enhanced procurement network, acquired workforce and synergies with the Company’s operations. Goodwill is allocated to a CGU deﬁned as plants specialized in the treatment of utility poles and residential lumber. The Company ﬁnanced the acquisition through a combination of its existing syndicated credit facilities and an unsecured promissory note of $9,128 (US$7,052), bearing interest at 1.41%. The note is payable in three installments, including interest, of US$1,500 in June 2019 and 2020 and US$4,500 in June 2021.The promissory note was fair valued at $7,838 (US$6,056) using an effective interest rate of 5.00%. 5 ACCOUNTS RECEIVABLE Trade receivables Less: Provision for doubtful accounts Trade receivables – net Other receivables 2017 $ 159,964 (991) 158,973 4,485 163,458 As at December 31, 2017, trade receivables of $60,618 (2016 – $58,557) were past due but not impaired. The aging of gross trade receivables at each reporting date was as follows: Current Past due 1-30 days Past due 31-60 days Past due more than 60 days 6 INVENTORIES Raw materials Finished goods Stella-Jones Inc. 2017 $ 98,355 43,416 9,230 8,963 159,964 2017 $ 423,312 295,150 718,462 2016 $ 142,801 (268) 142,533 18,222 160,755 2016 $ 83,976 40,129 6,311 12,385 142,801 2016 $ 554,142 300,414 854,556 7 PROPERTY, PLANT AND EQUIPMENT As at January 1, 2016 Cost Accumulated depreciation Net book amount Year ended December 31, 2016 Opening net book amount Business acquisitions Additions Disposals Depreciation Depreciation included in inventory As at December 31, 2016 Cost Accumulated depreciation Net book amount Year ended December 31, 2017 Opening net book amount Business acquisitions Additions Disposals Depreciation Depreciation included in inventory NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 53 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) Land Buildings Production equipment $ $ $ Rolling stock $ Others $ Total $ 42,607 88,980 298,481 18,167 14,461 462,696 — (14,036) (56,289) (9,982) (6,855) (87,162) 42,607 74,944 242,192 8,185 7,606 375,534 42,607 74,944 242,192 8,185 7,606 375,534 3,788 7,623 21,986 10,677 283 44,357 270 18,740 42,001 2,456 5,031 68,498 — (83) (576) — (659) (2,541) (8,584) (3,511) (1,148) (15,784) (193) (544) (455) 138 (523) (1,715) (10) (6,581) 45,981 113,768 356,892 29,815 19,724 566,180 — (16,542) (64,602) (12,901) (8,485) (102,530) 45,981 97,226 292,290 16,914 11,239 463,650 45,981 97,226 292,290 16,914 11,239 463,650 204 941 3,353 301 9 4,808 4,384 4,250 35,337 1,130 4,266 49,367 (143) (235) (998) (629) (4) (2,009) (2,879) (9,705) (3,798) (1,537) (17,919) (187) (526) (478) (884) (644) (1,835) (304) (24,021) — — — — — Exchange differences (684) (1,347) (4,678) Closing net book amount 45,981 97,226 292,290 16,914 11,239 463,650 Exchange differences (1,974) (5,516) (15,343) Closing net book amount 48,452 93,600 304,408 12,556 13,025 472,041 As at December 31, 2017 Cost Accumulated depreciation Net book amount 48,452 112,272 376,203 27,944 23,505 588,376 — (18,672) (71,795) (15,388) (10,480) (116,335) 48,452 93,600 304,408 12,556 13,025 472,041 2017 Annual Report 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 8 INTANGIBLE ASSETS AND GOODWILL The intangible assets include customer relationships, non-compete agreements, cutting rights, standing timber, a favourable land lease agreement and a creosote registration. Customer relationships comprise long-term agreements with certain customers and ongoing business relationships. The acquisition cost was established based on future beneﬁts associated with these relationships. The acquisition cost of the non-compete agreements was established based on the discounted value of future payments using a discount rate ranging from 2.90% to 3.00%. Impairment tests for goodwill Goodwill is allocated for impairment testing purposes to CGUs which reﬂect how it is monitored for internal management purposes. The recoverable amount of a CGU is determined based on fair value less cost to dispose (“FVLCTD”) calculations. FVLCTD calculations use cash ﬂow projections based on ﬁnancial budgets covering a ﬁve-year period that are based on the latest budgets for revenue and cost as approved by senior management. Cash ﬂow projections beyond ﬁve years are based on Management’s forecasts and assume a growth rate not exceeding gross domestic product for the respective countries. Post-tax cash ﬂow projections are discounted using a real post-tax discount rate of 8.00%. One percent real growth rates are assumed in perpetuity for most of the businesses given the commodity nature of the majority of the products (i.e. volume growth is assumed to be offset by real price declines). The assumptions used in calculating FVLCTD have considered the current economic environment. The carrying value of goodwill is allocated to the following CGUs: CGUs Plants specialized in the treatment of utility poles and residential lumber Plants specialized in the treatment of railway ties 2017 $ 128,898 141,363 270,261 2016 $ 136,066 151,301 287,367 Impairment tests for intangible assets with indeﬁnite useful life The only intangible asset with indeﬁnite useful life is the creosote registration. This registration provides the Company with the right to produce and import creosote out of its Memphis, Tennessee facility. The Company’s approach to creosote supply is to produce a portion of its requirements and to buy the remainder on the open market. As a result, the creosote registration procures the advantage of being able to produce, which is less expensive than buying on the market. Moreover, when procuring creosote on the market, the import feature of the registration enables the Company to negotiate better pricing. The recoverable amount of the creosote registration is determined based on value-in-use calculations. Value-in-use calculations use cash ﬂow projections based on ﬁnancial budgets covering a ﬁve-year period that are based on the latest forecasts for cost savings as approved by senior management. Cash ﬂow projections beyond ﬁve years are based on internal management forecasts and assume a growth rate not exceeding domestic product for the respective countries. Pre-tax cash ﬂow projections are discounted using a real pre-tax discount rate of 8.00%. One percent real growth rates are assumed in perpetuity for most of the business given the commodity nature of the majority of the products (i.e. volume growth is assumed to be offset by real price declines). Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 55 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 8 INTANGIBLE ASSETS AND GOODWILL (CONTINUED) The net book amount of these intangible assets was as follows: Intangible assets Cutting rights Customer Non-compete agreements relationships $ $ $ Creosote registration $ Others $ Total $ Goodwill $ As at January 1, 2016 Cost 6,821 141,262 11,601 7,606 43,222 210,512 245,696 Accumulated amortization (1,242) (53,276) (9,576) (5,482) — (69,576) — Net book amount 5,579 87,986 2,025 2,124 43,222 140,936 245,696 Year ended December 31, 2016 Opening net book balance 5,579 87,986 2,025 2,124 43,222 140,936 245,696 Business acquistions Additions Amortization — — — 19,294 — — 6,051 (14,349) (1,454) Amortization included in inventory (213) — Exchange differences — (1,513) — 27 — 330 — (473) — — — — 19,294 47,251 6,381 (15,803) (686) — — — (33) (1,289) (2,808) (5,580) Closing net book amount 5,366 91,418 6,649 1,948 41,933 147,314 287,367 As at December 31, 2016 Cost 6,821 157,626 17,413 7,903 41,933 231,696 287,367 Accumulated amortization (1,455) (66,208) (10,764) (5,955) — (84,382) — Net book amount 5,366 91,418 6,649 1,948 41,933 147,314 287,367 Year ended December 31, 2017 Opening net book balance 5,366 91,418 6,649 1,948 41,933 147,314 287,367 Business acquisitions Additions Amortization — — — — — — — (13,445) (1,840) — 477 — Amortization included in inventory (176) — — (519) — — — — — 477 (15,285) (695) 844 — — — Exchange differences — (4,255) (367) (70) (2,755) (7,447) (17,950) Closing net book amount 5,190 73,718 4,442 1,836 39,178 124,364 270,261 As at December 31, 2017 Cost 6,821 148,740 16,270 8,310 39,178 219,319 270,261 Accumulated amortization (1,631) (75,022) (11,828) (6,474) — (94,955) — Net book amount 5,190 73,718 4,442 1,836 39,178 124,364 270,261 2017 Annual Report 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 9 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Trade payables Amounts due to related parties Accrued expenses Other payables 10 LONG-TERM DEBT Syndicated credit facilities Unsecured senior notes Unsecured promissory note Unsecured promissory note Secured promissory note Unsecured promissory note Balance of purchase price Unsecured promissory note Unsecured promissory note Balance of purchase price Unsecured promissory note Unsecured promissory note Deferred ﬁnancing costs Less: Current portion of long-term debt Less: Current portion of deferred ﬁnancing costs Total current portion of long-term debt Note 20 Note 10(a) 10(b) 10(c) 10(d) 10(e) 10(f) 10(g) 10(h) 10(i) 10(j) 10(k) 10(k) Stella-Jones Inc. 2017 $ 41,373 380 51,761 17,692 111,206 2017 $ 232,083 188,176 7,972 7,972 7,422 7,000 2,278 2,008 586 844 — — 456,341 (701) 455,640 5,791 (96) 5,695 449,945 2016 $ 31,770 632 39,507 29,233 101,142 2016 $ 646,487 — 8,265 8,265 8,682 10,872 2,701 2,776 1,214 — 4,143 980 694,385 (358) 694,027 6,919 (212) 6,707 687,320 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 57 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 10 LONG-TERM DEBT (CONTINUED) a) The Company’s syndicated credit facilities consist of an unsecured revolving facility in the amount of US$325,000 available until February 26, 2022, an unsecured term facility in the amount of US$50,000 available until February 26, 2018 and an unsecured term facility in the amount of US$100,000 available until February 26, 2019 made available to the Company and SJ Holding (the “Borrowers”), a wholly-owned subsidiary of the Company, by a syndicate of lenders under a ﬁfth amended and restated credit agreement (the “Credit Agreement”) dated as of February 26, 2016, and amended on May 18, 2016. As at December 31, 2017 the syndicated credit facilities provided ﬁnancing up to US$475,000 of which US$282,574 was available. Additionally, the Credit Agreement makes available an accordion option whereas upon request, the Company could increase the revolving facility by US$125,000. During 2017, the Company made certain amendments to the Credit Agreement and changes to the revolving facility. On February 3, 2017, the Borrowers obtained a one-year extension to February 26, 2022 of the revolving facility. On July 5, 2017, the Borrowers requested a reduction of the revolving facility from US$425,000 to $US325,000. Borrowings under the syndicated credit facilities may be obtained in the form of Canadian prime rate loans, bankers’ acceptances (“BAs”), U.S. base rate loans, LIBOR loans in U.S. dollars and letters of credit. The interest rate margin with respect to Canadian prime rate loans and U.S. base rate loans will range from 0.00% to 1.25% based on the Credit Agreement’s pricing grid. The interest rate margin with respect to BAs, LIBOR loans and fees for letters of credit will range from 1.00% to 2.25% based on the Credit Agreement’s pricing grid. The Company enters into interest rate swap agreements in order to reduce the impact of ﬂuctuating interest rates on its debt. Details of the outstanding interest rate swap agreements as at December 31, 2017 are provided in Note 18, Financial instruments. As at December 31, 2017, borrowings by Canadian entities denominated in U.S. dollars represented $232,083 (US$185,000) and the total amount was designated as a hedge of net investment in foreign operations. The Company has demand loan agreements, with two banks participating in the syndicated credit facilities, providing ﬁnancing up to US$50,000 under terms and conditions similar to those under the Credit Agreement. This indebtedness, if required by the Company, will be presented under short term liabilities as the banks have the option to request reimbursement of their loans at any time. As at December 31, 2017 no amounts were drawn under the demand loan agreements. In order to maintain the syndicated credit facilities and the demand loans in place, the Company needs to comply with afﬁrmative covenants, negative covenants, reporting requirements and ﬁnancial ratios consisting of a total debt to EBITDA ratio of no more than 3.50:1 and an interest coverage ratio equal to or greater than 3.00:1. As at December 31, 2017, the Company was in full compliance with these covenants, requirements and ratios. Additionally, the Credit Agreement prohibits the Company from paying dividends aggregating in any one year in excess of 50.00% of the Company’s consolidated net income for the preceding year if the total debt to EBITDA ratio is greater than 3.25:1. In the case where the total debt to EBITDA ratio is equal or lower than 3.25:1, there are no restrictions to the payment of dividends, so long as the Company is otherwise in compliance with the terms of its Credit Agreement. b) On January 17, 2017, the Company concluded a US$150,000 private placement with certain U.S. investors. Pursuant to the private placement, the Company entered into a note purchase agreement providing for the issuance by Stella-Jones Inc. of senior notes - series A in the aggregate amount of US$75,000 bearing interest at 3.54% payable in a single instalment at maturity on January 17, 2024 and senior notes - series B in the aggregate amount of US$75,000 bearing interest at 3.81%, payable in a single instalment at maturity on January 17, 2027. Such notes are unsecured and proceeds were used to reimburse a portion of the revolving credit facility. The notes were designated as hedges of net investment in foreign operations. In order to maintain the senior notes in place, the Company needs to comply with afﬁrmative covenants, negative covenants, reporting requirements and ﬁnancial ratios comprised of the total debt to EBITDA ratio of not more than 3.50:1, the interest coverage ratio equal to or greater than 2.50:1 and a priority debt to equity ratio not more than 15%. As at December 31, 2017, the Company was in full compliance with these covenants, requirements and ratios. 2017 Annual Report 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 10 LONG-TERM DEBT (CONTINUED) c) As part of the Kisatchie acquisition, the Company issued an unsecured promissory note of $9,128 (US$7,052) bearing interest at 1.41%. The note is payable in three instalments, including interest, of US$1,500 in June 2019 and 2020 and US$4,500 in June 2021. The note was initially recorded at a fair value of $7,838 (US$6,056) using an effective interest rate of 5.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. d) As part of the Lufkin Creosoting acquisition, the Company issued an unsecured promissory note of $9,128 (US$7,052) bearing interest at 1.41%. The note is payable in three instalments, including interest, of US$1,500 in June 2019 and 2020 and US$4,500 in June 2021. The note was initially recorded at a fair value of $7,838 (US$6,056) using an effective interest rate of 5.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. e) As part of the Kisatchie acquisition, the Company assumed a promissory note, secured by the land of the Pineville facility, of US$5,685 bearing interest at 5.76%. The note is payable in quarterly instalments, including interest, of US$163, up to July 2028. The note was initially recorded at a fair value of $8,775 (US$6,780) using an effective interest rate of 4.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. f) Pursuant to a business acquisition on May 22, 2014, the Company issued an unsecured promissory note of $15,466 (US$14,169) bearing interest at 1.93%. The note is payable in ﬁve equal annual instalments, including interest, of US$3,000, up to May 2019. The note was initially recorded at a fair value of $13,426 (US$12,301) using an effective interest rate of 7.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. g) Pursuant to a business acquisition on October 1, 2015, the Company recorded a balance of purchase price of $5,800 bearing no interest. The balance of purchase price is payable in ﬁve annual instalments of $2,900 in October 2016, $500 in October 2017 and $800 in October 2018, 2019 and 2020, respectively. The balance of purchase price was initially recorded at a fair value of $5,430 using an interest rate of 2.91%. The difference between the face value and the fair value of the balance of purchase price is being accreted on an effective yield basis over its term. The balance of purchase price is guaranteed by ﬁve irrevocable letters of credit in the same amount and with the same maturity date as the future payments. h) Pursuant to a business acquisition on September 1, 2015, the Company issued an unsecured promissory note of $3,993 (US$3,000) bearing no interest. The note is payable in ﬁve equal annual instalments of US$600, up to September 2020. The note was initially recorded at a fair value of $3,275 (US$2,460) using an effective interest rate of 7.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. i) Pursuant to a business acquisition completed on December 4, 2015, the Company issued an unsecured promissory note of $1,939 (US$1,451) bearing interest at 1.68%. The note is payable in three equal annual instalments, including interest, of US$500, up to December 2018. The note was initially recorded at a fair value of $1,754 (US$1,312) using an effective interest rate of 7.00%. The difference between the face value and the fair value of the note is being accreted on an effective yield basis over its term. j) As part of the WPI acquisition completed on December 19, 2017, the Company recorded a balance of purchase price of $900 bearing no interest. The balance of purchase price is payable in quarterly installments of $75 in March, June, September and December of each year, up to December 2020. The balance of purchase price was initially recorded at a fair value of $844 using an effective interest rate of 3.29%. The difference between the face value and the fair value of the balance of purchase price is being accreted on an effective yield basis over its term. k) These debts were reimbursed in 2017 in accordance with the agreement. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 59 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 10 LONG-TERM DEBT (CONTINUED) l) The repayment requirements on the long-term debt during the next ﬁve years and thereafter are as follows: 2018 2019 2020 2021 2022 Thereafter Fair value adjustment Principal $ 6,543 9,631 5,916 11,062 232,649 192,142 457,943 (1,602) 456,341 m) The aggregate fair value of the Company’s long-term debt was estimated at $453,478 as at December 31, 2017 (2016 – $694,385) based on discounted future cash ﬂows, using interest rates available to the Company for issues with similar terms and average maturities. 11 PROVISIONS AND OTHER LONG-TERM LIABILITIES Provisions Other long-term liabilities Site remediation $ Others $ Total $ RSUs $ Non- competes payable $ Total $ Grand total $ Balance as at January 1, 2016 11,641 4,280 15,921 13,219 2,355 15,574 31,495 5,121 2,974 785 5,906 10,951 5,936 16,887 22,793 — 2,974 (62) (858) (920) — — — — — — 2,974 (920) (2,954) (455) (3,409) (21,214) (598) (21,812) (25,221) Additions Business acquisitions Provision reversal Payments Interest accretion Additions Business acquisitions Provision reversal Payments Interest accretion Exchange differences (233) (88) (321) — — — — — 127 143 127 143 127 (178) Balance as at December 31, 2016 16,487 3,664 20,151 2,956 7,963 10,919 31,070 911 58 1,786 2,697 727 — 58 (2,331) (106) (2,437) — — — — — 727 3,424 — — 58 (2,437) (2,183) (1,504) (3,687) (1,435) (2,156) (3,591) (7,278) Exchange differences (898) (134) (1,032) — — — — — 155 155 155 (454) (454) (1,486) Balance as at December 31, 2017 12,044 3,706 15,750 2,248 5,508 7,756 23,506 2017 Annual Report 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 11 PROVISIONS AND OTHER LONG-TERM LIABILITIES (CONTINUED) Analysis of provisions and other long-term liabilities: Current Provisions Other long-term liabilities Total current Non-current Provisions Other long-term liabilities Total non-current 2017 $ 9,141 2,973 12,114 6,609 4,783 11,392 23,506 2016 $ 10,785 3,805 14,590 9,366 7,114 16,480 31,070 Provisions Site remediation Site remediation obligations represent discounted cash ﬂow estimates relating to future environmental remediation costs of current and former treating sites for a period ranging from one to ﬁfteen years. These discounted cash ﬂow have been estimated using a pre-tax rate of 3.63% that reﬂect current market assessment of the time value of money and the risk speciﬁc to the obligation. As of December 31, 2017, a total site remediation provision of $12,044 ($16,487 as of December 31, 2016) was recorded to support the ongoing compliance efforts. Other long-term liabilities Restricted stock units The Company has a long-term incentive plan, for certain executives and key employees, under which grants of RSUs are permitted upon the Company attaining a minimum 12.50% return on capital employed. When this condition is met, the number of RSUs granted is based on a percentage of the individual’s salary, divided by the average trading price of the Company’s common shares on the TSX for the ﬁve days immediately preceding the grant date. The RSUs are full-value phantom shares payable in cash on the third anniversary of their date of grant, provided the individual is still employed by the Company. The amount to be paid is determined by multiplying the number of RSUs by the six-month average trading price of the Company’s common shares on the TSX immediately preceding the anniversary. The RSUs granted on March 17, 2014 reached their third year anniversary on March 17, 2017 and were fully paid. On March 16, 2015 and March 21, 2016 the Company granted a total of 63,336 RSUs to certain executives and key employees as part of the long-term incentive plan. On May 6, 2013, as part of a ﬁve-year incentive agreement and pursuant to the Stella-Jones Inc. long-term incentive plan, the Company granted 400,000 RSUs to the President and Chief Executive Ofﬁcer (the “President”), with a vesting date of May 6, 2016. As part of the agreement, in the event that the President voluntarily leaves the employment of the Company prior to the ﬁfth anniversary of the incentive agreement, any amounts paid to him will be reimbursed to the Company. In the event that the President is required to cease his functions prior to the ﬁfth anniversary of the incentive agreement due to long-term disability or death, he shall be entitled to a prorated payment. The compensation expense related to the ﬁve-year agreement will be recognized in the consolidated statement of income over a ﬁve-year period. On May 6, 2016, the full amount of $19,106 was paid under these RSUs. The difference between the amount paid and the expense recognized in the consolidated statement of income has been recorded as a prepaid expense and will be amortized over the remaining two- year period. As of December 31, 2017, the prepaid balance was $1,592 ($5,413 as of December 31, 2016). Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 61 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 12 CASH FLOW INFORMATION a) Liabilities from ﬁnancing activities The following table presents the movements in the liabilities from ﬁnancing activities for the twelve-month period ended December 31, 2017: Liabilities from ﬁnancing activities Long-term debt Syndicated credit facilities Non-competes payable $ $ $ Total $ Balance as at December 31, 2016 (47,898) (646,487) (7,963) (702,348) Cash ﬂows provided by (used in) Foreign exchange adjustments Other non-cash movements (184,363) 8,704 — 391,796 22,608 — Balance as at December 31, 2017 (223,557) (232,083) 2,156 454 (155) (5,508) 209,589 31,766 (155) (461,148) b) Cash and cash equivalents The following table presents the reconciliation of the amount of cash and cash equivalents: Cash Restricted cash Balance per statement of cash ﬂows 2017 $ 6,430 — 6,430 2016 $ 2,267 1,452 3,719 2017 Annual Report 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 13 CAPITAL STOCK Number of common shares outstanding – Beginning of year* Stock option plan* Employee share purchase plans* Number of common shares outstanding – End of year* * Number of common shares is presented in thousands. a) Capital stock consists of the following: Authorized An unlimited number of preferred shares issuable in series An unlimited number of common shares b) Earnings per share 2017 69,303 10 29 69,342 2016 69,137 139 27 69,303 The following table provides the reconciliation between basic earnings per common share and diluted earnings per common share: Net income applicable to common shares Weighted average number of common shares outstanding* Effect of dilutive stock options* Weighted average number of diluted common shares outstanding* Basic earnings per common share** Diluted earnings per common share** * Number of shares is presented in thousands. ** Basic and diluted earnings per common share are presented in dollars per share. 2017 $ 167,889 69,324 9 69,333 $ 2.42 $ 2.42 2016 $ 153,898 69,215 16 69,231 $ 2.22 $ 2.22 c) Stock option plan The Company has a stock option plan (the “Plan”) for directors, ofﬁcers and employees whereby the Board of Directors or a committee appointed for such purpose (“Committee”) may, from time to time, grant to directors, ofﬁcers or employees of the Company options to acquire common shares in such numbers, for such terms and at such exercise prices as are determined by the Board of Directors or such Committee. The stated purpose of the Plan is to secure for the Company and its shareholders the beneﬁts of incentives inherent in share ownership by directors, ofﬁcers and employees of the Company. The aggregate number of common shares in respect of which options may be granted is 4,800,000 and no optionee may hold options to purchase common shares exceeding 5.00% of the number of common shares issued and outstanding from time to time. The exercise price of an option shall not be lower than the closing price of the common shares on the TSX on the last trading day immediately preceding the date of the granting of the option. Each option shall be exercisable during a period established by the Board of Directors or Committee, and the term of the option may not exceed 10 years. Options will not be assignable and will terminate, in the case of an employee, either 30 or 180 days following cessation of service with the Company, depending on the circumstances of such cessation, and in the case of a director who is not an employee of the Company, either 30 or 180 days following the date on which such optionee ceases to be a director of the Company, depending on the circumstances. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 63 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 13 CAPITAL STOCK (CONTINUED) Changes in the number of options outstanding under the Plan were as follows: 2017 Weighted average exercise price** $ 34.57 9.90 — 40.05 36.79 Number of options* 55 (10) — 45 33 2016 Weighted average exercise price** $ 15.35 7.75 — 34.57 28.59 Number of options* 194 (139) — 55 31 Outstanding – Beginning of year Exercised Granted Outstanding – End of year Options exercisable – End of year The following options were outstanding under the Plan as at December 31, 2017: Date granted May 2013 November 2015 Options outstanding Options exercisable Number of options* Exercise price** Number of options* Exercise price** Expiration date $ 22.13 49.01 15 30 45 $ 22.13 49.01 15 18 33 May 2023 November 2025 * Number of options is presented in thousands. ** Exercise price is presented in dollars per option. d) Stock-based compensation The Company records expenses related to the fair value of the stock options granted under the Plan using the Black Scholes option pricing model. This model determines the fair value of stock options granted and amortizes it to income over the vesting period. No options were granted during 2017. The 2017 expense recorded for stock-based compensation amortized to earnings was $87 (2016 – $156). e) Employee share purchase plans The aggregate number of common shares reserved for issuance under the Company’s two employee share purchase plans is 1,000,000. Under the ﬁrst plan, Company employees who are Canadian residents are eligible to purchase common shares from the Company at an amount equal to 90.00% of the market price. Employees who hold common shares in the employee share purchase plan for eighteen months following the date of acquisition of such shares receive additional common shares of the Company equivalent to 10.00% of the amount of their contributions made on the date of acquisition. In 2017, 15,621 common shares (2016 – 13,271) were issued to Canadian resident employees at an average price of $39.52 per share (2016 – $39.50). 2017 Annual Report 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 13 CAPITAL STOCK (CONTINUED) e) Employee share purchase plans (continued) Under the second plan, Company employees who are U.S. residents are eligible to purchase common shares from the Company at market price. Employees who hold common shares in the employee share purchase plan for eighteen months following the date of acquisition of such shares receive additional common shares of the Company equivalent to 10.00% of the amount of their contributions made on the date of acquisition. In 2017, 13,167 common shares (2016 – 13,680) were issued to U.S. resident employees at an average price of $41.65 per share (2016 – $43.11). As at December 31, 2017, the total number of common shares issued under these plans is 885,975 (2016 – 857,187), having a market value of $44,742, using the Company’s TSX closing share price on December 29, 2017 of $50,50, which was the last day of trading in 2017. 14 EXPENSES BY NATURE Raw materials and consumables Employee beneﬁt expenses Depreciation and amortization Other expenses incurred in manufacturing process Freight Other expenses Employee beneﬁt expenses Salaries, wages and beneﬁts Share options granted to directors and employees RSUs Pension costs Group registered retirement savings plans Employee beneﬁt expenses are included in cost of sales and selling and administrative expenses. Financial expenses Interest on syndicated credit facilities Interest on promissory notes and non-compete agreements Interest on unsecured senior notes Interest on debentures Stella-Jones Inc. 2017 $ 9,596 2,613 6,800 — 19,009 2017 $ 1,324,289 135,302 33,204 56,678 91,430 37,851 2016 $ 1,252,578 141,839 31,587 44,767 91,141 43,198 1,678,754 1,605,110 2017 $ 123,355 87 4,549 1,990 5,321 135,302 2016 $ 128,841 156 5,538 1,993 5,311 141,839 2016 $ 14,760 2,278 — 821 17,859 15 INCOME TAXES Current tax Current tax on income for the year Adjustments in respect of prior years Total current tax Deferred tax Origination and reversal of temporary differences Impact of change in tax rate Adjustments in respect of prior years Total deferred tax Income tax expense NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 65 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 2017 $ 40,450 1,116 41,566 12,379 (30,094) (3,361) (21,076) 20,490 2016 $ 50,464 (2,938) 47,526 11,020 (225) 3,165 13,960 61,486 The tax on the Company’s income before income tax differs from the theoretical amount that would arise using the weighted average tax rate applicable to income of the consolidated entities as follows: Income before income tax Tax calculated at domestic tax rates of 26.24% (2016 – 26.40%) applicable to income in the respective countries Tax effects of: Difference in tax rate of foreign subsidiaries Income not subject to tax Expenses not deductible for tax purposes Remeasurement of deferred tax – change in tax rate Adjustments in respect of prior years Exchange revaluation of deferred tax Manufacturing and processing tax credit Income tax expense 2017 $ 188,379 49,431 12,930 (7,759) 409 (30,094) (2,245) (462) (1,720) 20,490 2016 $ 215,384 56,861 14,074 (6,999) 475 (225) 227 8 (2,935) 61,486 2017 Annual Report 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 15 INCOME TAXES (CONTINUED) The analysis of deferred tax assets and deferred tax liabilities is as follows: Deferred tax assets To be recovered after more than 12 months To be recovered within 12 months Deferred tax liabilities To be reversed after more than 12 months To be reversed within 12 months Deferred tax liability, net The gross movement on the deferred income tax account is as follows: As at January 1 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31 2017 $ 5,554 8,243 (86,081) (124) (72,408) 2017 $ (101,171) 21,076 2,697 140 4,850 (72,408) 2016 $ 4,474 12,499 (117,688) (456) (101,171) 2016 $ (78,564) (13,960) (1,058) (8,966) 1,377 (101,171) Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 67 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 15 INCOME TAXES (CONTINUED) The movement in deferred income tax assets and liabilities during the year, without taking into consideration the offsetting of balances within the same tax jurisdiction, is as follows: Unrealized foreign exchange on debts and translation of foreign operations Cumulative losses $ $ 1,165 1,571 (504) — — 2,232 (2,232) — — — — — — — — — — 2,231 1,150 — — 3,381 Deferred pension beneﬁts $ 2,283 (40) (31) — (47) 2,165 112 (246) — (80) 1,951 Reserves $ 13,586 (1,205) — 336 (237) 12,480 (3,606) — 180 (589) 8,465 Unrealized foreign exchange on debts and translation of foreign operations $ (1,679) (1,130) 760 — — (2,049) — 2,049 — — — Property, plant and equipment $ (64,330) (13,568) — (4,992) 1,081 (81,809) 15,492 — (40) 4,271 (62,086) Intangible assets $ (29,493) 919 — (4,310) 580 (32,304) 8,563 — — 1,523 (22,218) Others $ Total $ 10 57 29 — — 96 (96) — — — — 17,044 383 (506) 336 (284) 16,973 (3,591) 904 180 (669) 13,797 Others $ (106) (564) (1,312) — — (1,982) 612 (256) — (275) (1,901) Total $ (95,608) (14,343) (552) (9,302) 1,661 (118,144) 24,667 1,793 (40) 5,519 (86,205) Deferred tax assets As at January 1, 2016 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2016 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2017 Deferred tax liabilities As at January 1, 2016 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2016 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2017 Deferred income tax liabilities have not been recognized for the withholding tax and other taxes that would be payable on the unremitted earnings of certain subsidiaries. Such amounts are permanently reinvested. Unremitted earnings totaled $398,767 as at December 31, 2017 (2016 – $318,721). On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act, which included a number of provisions that will affect the Company’s U.S. subsidiaries, speciﬁcally the reduction in the top federal corporate income tax rate from 35% to 21%, effective January 1, 2018. The Company recognized a tax beneﬁt of $30,040 in the consolidated statement of income resulting from the revaluation of the deferred tax liability. 2017 Annual Report 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS For its Canadian operations, the Company recognizes costs for several types of employee future beneﬁts. Post-employment beneﬁts are offered to certain retired employees and consist of group health and dental care, life insurance and complementary retirement beneﬁts. The Company contributes to a multi-employer plan for certain hourly employees and to three deﬁned beneﬁt pension plans for salaried and certain non-union hourly wage employees. For its U.S. operations, the Company’s wholly-owned subsidiary, McFarland, contributes to two deﬁned beneﬁt pension plans. All other active employees are entitled to a group registered retirement savings plan to which the Company matches one and a half times the employee contribution. The Company’s contribution cannot exceed 6.00% of the employee’s annual base salary. The recognized costs for employee future beneﬁts were as follows: Post-retirement beneﬁts Deﬁned beneﬁt pension plans Contributions to multi-employer plan Contributions to group registered retirement savings plans 2017 $ 156 1,411 423 5,321 The net amount recognized on the consolidated statement of ﬁnancial position is detailed as follows: Liabilities Accrued beneﬁt liability included in employee future beneﬁts Accrued beneﬁt obligation, included in employee future beneﬁts 2017 $ (5,174) (2,501) (7,675) 2016 $ 166 1,392 435 5,311 2016 $ (4,534) (2,219) (6,753) a) The post-retirement beneﬁts program is not funded and, since June 1, 2011, this program is closed to new participants. For this program, the Company measures its accrued beneﬁt obligations for accounting purposes as at December 31 of each year. The most recent actuarial valuation of this plan was as at July 1, 2015, and the next required valuation will be as at July 1, 2018. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 69 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) The following information as established by independent actuaries pertains to the Company’s post-retirement beneﬁts program: Accrued beneﬁt obligation Balance – Beginning of year Current service cost Interest cost Beneﬁts payments Remeasurement adjustments Plan experience Changes in demographic assumptions Changes in ﬁnancial assumptions Balance – End of year Plan assets Employer’s contributions Beneﬁts paid Fair value – End of year Accrued beneﬁt obligation The signiﬁcant assumptions used are as follows: Accrued beneﬁt obligation as at December 31 Discount rate Beneﬁt costs for the year ended December 31 Discount rate 2017 $ 2,219 68 88 (62) — — 188 2,501 62 (62) — 2,501 2017 % 3.40 3.90 2016 $ 2,327 71 95 (66) (124) (114) 30 2,219 66 (66) — 2,219 2016 % 3.90 4.00 For measurement purposes, a 6.50% annual rate of increase in the per capita cost of covered health care beneﬁts was assumed starting in 2015. This rate is assumed to decrease gradually by 0.38% per year, to reach 5.00% in 2020. An increase or decrease of 1.00% in this rate would have the following impact: Impact on accrued beneﬁt obligation Impact on beneﬁt costs Increase of 1% Decrease of 1% $ 86 2 $ (73) (2) 2017 Annual Report 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) The items of the Company’s post-retirement beneﬁts program costs recognized during the year are as follows: Current service cost Interest cost Post-retirement beneﬁts program costs recognized Consolidated statement of comprehensive income Year ended December 31 Actuarial gains (losses) Total recognized in other comprehensive income before income tax Accumulated actuarial (losses) gains recognized in other comprehensive income Balance of actuarial losses as at January 1 Net actuarial gains (losses) recognized in the year, net of tax Balance of actuarial losses as at December 31 2017 $ 68 88 156 2017 $ (188) (188) 2017 $ (228) (124) (352) 2016 $ 71 95 166 2016 $ 208 208 2016 $ (351) 123 (228) b) The Company’s Canadian deﬁned beneﬁt pension plans base the beneﬁts on the length of service and ﬁnal average earnings. The McFarland deﬁned beneﬁt pension plans base the beneﬁts on the length of service and ﬂat dollar amounts payable monthly. The Company measures its accrued beneﬁt obligations and the fair value of plan assets for accounting purposes as at December 31 of each year. Actuarial valuations are updated every three years, and the latest valuations performed for the ﬁve existing pension plans are as follows: Plan 1 Canadian pension plan – Closed to new participants Plan 2 Canadian pension plan – Closed to new participants Plan 3 Canadian pension plan – Closed to new participants Plan 4 U.S. pension plan – Closed to new participants Plan 5 U.S. pension plan Date of last actuarial valuation December 31, 2016 December 31, 2014 December 31, 2015 December 31, 2015 December 31, 2015 Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 71 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) Information about the Company’s deﬁned beneﬁt pension plans other than the multi-employer deﬁned beneﬁt plan, in aggregate, is as follows: Accrued beneﬁt obligation Balance – Beginning of year Current service cost Interest cost Beneﬁts payments Remeasurement adjustments Plan experience Changes in demographic assumptions Changes in ﬁnancial assumptions Exchange difference Balance – End of year Plan assets Fair value – Beginning of year Interest income on plan assets Return on plan asset excluding interest income Employer’s contributions Employee’s contributions Effect of asset ceiling Beneﬁts paid Exchange difference Fair value – End of year Accrued beneﬁt liability 2017 $ 27,440 1,025 1,076 (821) (947) 330 1,949 (650) 29,402 22,906 665 513 1,102 35 263 (821) (435) 24,228 (5,174) 2016 $ 27,545 1,009 1,099 (2,730) 778 (172) 443 (532) 27,440 22,719 680 1,133 1,468 36 (263) (2,730) (137) 22,906 (4,534) Included in the above accrued beneﬁt obligation and fair value of plan assets at year-end are the following amounts in respect of beneﬁt plans that are not fully funded: Accrued beneﬁt obligation Fair value of plan assets Funded status – Plan deﬁcit 2017 $ (13,309) 7,652 (5,657) 2016 $ (12,716) 7,340 (5,376) 2017 Annual Report 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) The percentage of plan assets consists of the following for the year ended December 31: Listed equity securities Listed debt securities Guaranteed insurance contracts Short-term investments and cash The signiﬁcant weighted average assumptions used are as follows: Accrued beneﬁt obligation as at December 31 Discount rate Rate of compensation increase Beneﬁt costs for the year ended December 31 Discount rate 2017 % 31.00 42.00 26.00 1.00 100.00 2017 % 3.50 3.25 3.90 The items of the Company’s deﬁned beneﬁt plan costs recognized during the year are as follows: Current service cost, net of employee’s contributions Interest cost Interest income on plan assets Deﬁned beneﬁt plan expense 2017 $ 1,000 1,076 (665) 1,411 Expected contributions to the deﬁned beneﬁt pension plans for the year ending December 31, 2018 are $996. 2016 % 40.00 31.00 27.00 2.00 100.00 2016 % 3.90 3.25 4.00 2016 $ 973 1,099 (680) 1,392 Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 73 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) Consolidated statement of comprehensive income Year ended December 31 Actuarial losses Total recognized in other comprehensive income before income tax Accumulated actuarial losses recognized in other comprehensive income Balance of actuarial losses as at January 1 Net actuarial losses recognized in the year, net of tax Balance of actuarial losses as at December 31 2017 $ (549) (549) 2017 $ (3,153) (859) (4,012) 2016 $ (168) (168) 2016 $ (3,039) (114) (3,153) 17 COMMITMENTS AND CONTINGENCIES a) The Company has issued guarantees amounting to $19,036 (2016 – $28,880) under letters of credit and various bid and performance bonds. The Company’s management does not believe these guarantees are likely to be called on. As a result, no provisions have been recorded in the consolidated ﬁnancial statements. b) Future minimum payments under operating leases related to land, equipment and rolling stock are as follows: 2018 2019 2020 2021 2022 Thereafter $ 22,747 17,672 13,042 8,747 5,334 12,592 80,134 c) The Company’s operations are subject to Canadian federal and provincial as well as U.S. federal and state environmental laws and regulations governing, among other matters, air emissions, waste management and wastewater efﬂuent discharges. The Company takes measures to comply with such laws and regulations. However, the measures taken are subject to the uncertainties of changing legal requirements, enforcement practices and developing technological processes. d) The Company has contracts whereby third party licensees that harvest certain areas assume the responsibility for reforestation. Should the third party licensees fail to perform, the Company is responsible for these additional future reforestation costs, which are currently estimated to be $410 (2016 – $281). Payments, if any, required as a result of this contingency will be expensed in the period in which they are determined and are not included in the provision for reforestation. 2017 Annual Report 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS Financial instruments, carrying values and fair values The Company has determined that the fair value of its short-term ﬁnancial assets and ﬁnancial liabilities approximates their carrying amounts as at the consolidated statement of ﬁnancial position dates because of the short-term maturity of those instruments. The fair values of the long-term receivables and interest-bearing ﬁnancial liabilities also approximate their carrying amounts unless otherwise disclosed elsewhere in these consolidated ﬁnancial statements. The fair value of interest rate swap agreements, foreign exchange forward contract agreements and derivative commodity contacts have been recorded using mark-to-market information. The following table provides a summary of these fair values which are detailed further in this note: Current assets Interest rate swap agreements Derivative commodity contracts Non-current assets Interest rate swap agreements Derivative commodity contracts Non-current liabilities Interest rate swap agreements Foreign exchange forward contracts 2017 $ — 473 473 6,173 — 6,173 — — — 2016 $ 311 1,428 1,739 4,989 67 5,056 109 254 363 Credit risk Credit risk is the risk that one party to a ﬁnancial instrument will cause a ﬁnancial loss for the other party by failing to discharge an obligation. At December 31, 2017, the Company’s credit exposure consists primarily of the carrying amount of cash and cash equivalents, accounts receivable and derivative ﬁnancial instruments. Credit risk associated with cash and cash equivalent, and derivative ﬁnancial instruments is minimised by dealing with creditworthy ﬁnancial institutions. The Company’s exposure to credit risk is inﬂuenced mainly by the individual characteristics of each customer. Management believes that the credit risk of accounts receivable is limited because the Company deals primarily with railroad companies, public service companies and utility and telecommunication companies as well as other major corporations. Management has established a credit policy under which each new customer is analyzed individually for creditworthiness before the Company’s standard payment and delivery terms and conditions are offered. The Company’s review includes external ratings, where available, and credit references from other suppliers. Purchase limits are established for each customer, which represent the maximum open amount not requiring additional approval from Management. A monthly review of the accounts receivable aging is performed by Management for each selling location. Customers that fail to meet the Company’s benchmark creditworthiness may transact with the Company only on a prepayment basis. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 75 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS (CONTINUED) Credit risk (continued) Note 5 provides details on the receivable aging as well as on the provision for doubtful accounts for the years ended December 31, 2017 and 2016. The Company’s largest customer had sales representing 15.60% of the total sales for the twelve-month period ending December 31, 2017 (2016 – 15.30%) and an account receivable balance of $6,152 as at December 31, 2017 (2016 – $4,127). Price risk The Company is exposed to commodity price risk on diesel and petroleum. The Company uses derivative commodity contracts based on the New York Harbor Ultra Low Sulfur Diesel Heating Oil to help manage its cash ﬂows with regards to these commodities. The Company does not designate these derivatives as cash ﬂow hedges of anticipated purchases of diesel and petroleum. Gains or losses from these derivative ﬁnancial instruments are recorded in the consolidated statements of income under other losses (gain), net. The following table summarizes the derivative commodity contracts as at December 31, 2017 and 2016: Hedged item Diesel and petroleum Diesel and petroleum Hedged item Diesel and petroleum Diesel and petroleum Diesel and petroleum Gallons Effective date Maturity date Fixed rate 2017 600,000* January 2018 December 2018 600,000* January 2018 December 2018 US$1.72 US$1.61 2016 Gallons Effective date Maturity date Fixed rate 3,000,000* January 2017 December 2017 1,680,000* January 2017 December 2017 600,000* January 2018 December 2018 US$1.50 US$1.65 US$1.72 * Represents a volume evenly split throughout the year. The fair value of the above derivative commodity hedges based on cash settlement requirements as at December 31, 2017 is an asset of $473 recorded under current assets (2016 – a total asset of $1,495 of which $67 was recorded under non-current assets) in the consolidated statement of ﬁnancial position. The fair value of these hedge agreements have been determined by obtaining mark-to-market values as at December 31, 2017 and 2016 from a third party. This type of measurement falls under Level 2 in the fair value hierarchy as per IFRS 7, Financial Instruments: Disclosures. A description of each level of the hierarchy is as follows: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2: Inputs other than quoted prices included within Level 1 that are observable for these assets or liabilities, either directly (i.e. as prices) or indirectly (i.e. derived from prices). Level 3: Inputs for the assets or liabilities that are not based on observable market data (unobservable inputs). Liquidity risk Liquidity risk is the risk that the Company will not be able to meet its ﬁnancial obligations as they fall due. The Company’s approach to managing liquidity is to ensure, on a long-term basis, that it will always have sufﬁcient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring losses or risking damage to its reputation. The Company ensures that it has sufﬁcient credit facilities to support working capital, meet expected operational expenses and service ﬁnancial obligations. Inventories are a signiﬁcant component of working capital because of the long periods required to air-season wood, which can occasionally exceed nine months before a sale is made. 2017 Annual Report 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS (CONTINUED) Liquidity risk (continued) The Company monitors all ﬁnancial liabilities and ensures it will have sufﬁcient liquidity to meet these future payments. The operating activities of the Company are the primary source of cash ﬂows. The Company also has syndicated credit facilities (Note 10(a)) made available by a syndicate of lenders which can be used for working capital and general corporate requirements. As at December 31, 2017, an amount of $354,489 (US$282,574) (2016 - $112,513 (US$83,796) was available under the Company’s syndicated credit facilities. The following table details the maturities of the ﬁnancial liabilities as at December 31: Carrying Contractual amount cash ﬂows Less than 1 year 1 and 3 years 3 and 5 More than 5 years years Between Between 2017 Accounts payable and accrued liabilities 111,206 111,206 111,206 $ $ $ $ — $ — $ — Long-term debt obligations 455,640 538,383 20,067 42,321 265,193 210,802 Non-competes payable 5,508 5,896 1,694 2,948 1,254 — 572,354 655,485 132,967 45,269 266,447 210,802 Carrying Contractual amount cash ﬂows Less than 1 year 1 and 3 years 3 and 5 More than 5 years years Between Between 2016 Accounts payable and accrued liabilities 101,142 101,142 101,142 $ $ $ $ — $ — $ — Long-term debt obligations 694,027 773,926 25,184 53,315 689,583 5,844 Interest rate swap agreements 363 141 723 (153) (429) Non-competes payable 7,963 8,550 2,238 2,921 2,686 — 705 803,495 883,759 129,287 56,083 691,840 6,549 Market risk Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates, will affect the Company’s income or the value of its holdings of ﬁnancial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters while optimizing the return on risk. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 77 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS (CONTINUED) Currency risk The Company’s exposure to foreign exchange gains or losses from currency ﬂuctuations is related to sales and purchases in U.S. dollars by its Canadian-based operations and to U.S. dollar-denominated long-term debt held by its Canadian company. The Company monitors its transactions in U.S. dollars generated by Canadian-based operations and enters into hedging transactions to mitigate its currency risk. The Company’s basic hedging activity consists of entering into foreign exchange forward contracts for the sale of U.S. dollars and the purchase of certain goods and services in U.S. dollars. The Company also considers foreign exchange forward contracts for the purchase of U.S. dollars for signiﬁcant purchases of goods and services that were not covered by natural hedges. On November 1, 2016, the Company entered into a sixty-month foreign exchange forward contract agreement, selling US$500 per-month at a strike rate of 1.385 and a fade-in rate of 1.178. The Company will obtain the strike rate as long as the spot exchange rate on the transaction date is greater than or equal to the fade-in rate. If the spot exchange rate is lower than the fade-in rate, the transaction will not occur. On July 28, 2017, the Company terminated these contracts and received a cash settlement of $1,087. The fair value of this hedge agreement was determined by obtaining mark-to-market values as at December 31, 2016 from a third party. This type of measurement falls under Level 2 in the fair value hierarchy as per IFRS 7, Financial Instruments: Disclosures. These foreign exchange forward contract agreements did not qualify for hedge accounting and the fair value based on cash settlement requirements as at December 31, 2016 was a $254 liability recorded under non-current liabilities. The following table provides information on the impact of a 10.00% strengthening of the U.S. dollar against the Canadian dollar on net income and equity for the years ended December 31, 2017 and 2016. For a 10.00% weakening of the U.S. dollar against the Canadian dollar, there would be an equal and opposite impact on net income, comprehensive income and equity: Decrease (increase) of net income Increase of equity 2017 $ (806) 37,352 2016 $ 107 51,425 This analysis considers the impact of foreign exchange variance on ﬁnancial assets and ﬁnancial liabilities denominated in U.S. dollars which are on the consolidated statement of ﬁnancial position of the Canadian entities: Assets Cash Accounts receivable Liabilities Accounts payable and accrued liabilities Long-term debt 2017 $ 11,484 2,545 14,029 5,968 — 5,968 2016 $ — 3,506 3,506 2,624 1,952 4,576 The foreign exchange impact for the U.S. dollar-denominated long-term debt, in the Canadian entities, has been excluded for the most part from the sensitivity analysis for other comprehensive income, as the long-term debt is designated as a hedge of net investment in foreign operations (Note 10). 2017 Annual Report 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS (CONTINUED) Interest rate risk As at December 31, 2017, the Company has mitigated its exposure to interest rate risk on long-term debt after giving effect to its interest rate swap agreements; 100.00% (2016 – 66.25%) of the Company’s long-term debt is at ﬁxed rates. The Company enters into interest rate swap agreements in order to reduce the impact of ﬂuctuating interest rates on its short- and long-term debt. These swap agreements require the periodic exchange of payments without the exchange of the notional principal amount on which the payments are based. The Company designates its interest rate hedge agreements as cash ﬂow hedges of the underlying debt. Interest expense on the debt is adjusted to include the payments made or received under the interest rate swap agreements. The syndicated credit facilities deﬁned in Note 10(a) is made available by a syndicate of bank lenders. The ﬁnancing of these loans is tied to the Canadian bank’s prime rate, the BA rate, the U.S. bank’s base rate or LIBOR. The Company has minimized its exposure to interest rate ﬂuctuations by entering into interest rate swaps as detailed below. The impact of a 10.00% increase in these rates on the closing annual balance of the syndicated credit facilities, for borrowings that have not been swapped, would have increased interest expense by $146 for the year ended December 31, 2017 (2016 – $684). The following tables summarize the Company’s interest rate swap agreements as at December 31: Notional amount Related debt instrument US$85,000 US$100,000 Syndicated credit facilities Syndicated credit facilities Notional amount Related debt instrument CA$63,000 Syndicated credit facilities US$75,000 US$25,000 US$25,000 US$25,000 US$25,000 US$85,000 US$100,000 Syndicated credit facilities Syndicated credit facilities Syndicated credit facilities Syndicated credit facilities Syndicated credit facilities Syndicated credit facilities Syndicated credit facilities Fixed rate % 1.68* 1.06* Fixed rate % 0.70* 0.97* 0.71* 0.69* 0.71* 0.70* 1.68* 1.06* Effective date Maturity date 2017 Notional equivalent CA$ December 2015 April 2021 106,633 December 2017 December 2021 125,450 Effective date Maturity date 2016 Notional equivalent CA$ February 2016 February 2018 63,000 June 2014 June 2017 100,702 December 2012 December 2017 December 2012 December 2017 December 2012 December 2017 December 2012 December 2017 33,567 33,567 33,567 33,567 December 2015 April 2021 114,129 December 2017 December 2021 134,270 * Plus applicable spread of 1.00% to 2.25% based on pricing grid included in the Credit Agreement. Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 79 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 18 FINANCIAL INSTRUMENTS (CONTINUED) Interest rate risk (continued) The Company’s interest rate swap agreements are designated as cash ﬂow hedges. The cash ﬂow hedge documentation allows the Company to substitute the underlying debt as long as the hedge effectiveness is demonstrated. As at December 31, 2017, all cash ﬂow hedges were effective. The fair value of these ﬁnancial instruments has been determined by obtaining mark-to-market values as at December 31, 2017 from different third parties. This type of measurement falls under Level 2 in the fair value hierarchy as per IFRS 7, Financial Instruments: Disclosures. The fair value of the interest rate swap agreements based on cash settlement requirements as at December 31, 2017 is a non-current asset of $6,173 recorded in the consolidated statement of ﬁnancial position (2016 – a net asset of $5,191 of which an asset of $311 is recorded in current assets, an asset of 4,989 is recorded in non-current assets and a liability of $109 is recorded in non-current liabilities). A 10.00% decrease in interest rates as at December 31, 2017 would have reduced the net gain recognized in other comprehensive income by approximately $617 (2016 – $519). For a 10.00% increase in the interest rates, there would be an equal and opposite impact on the net gain. 19 CAPITAL DISCLOSURES The Company’s objective in managing capital is to ensure sufﬁcient liquidity to pursue its organic growth strategy and undertake selective acquisitions, while at the same time taking a conservative approach to ﬁnancial leverage and management of ﬁnancial risk. The Company manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of the underlying assets. In order to maintain or adjust the capital structure, the Company may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares, or acquire or sell assets to improve its ﬁnancial performance and ﬂexibility. The Company’s capital is composed of total debt, which includes bank indebtedness, and shareholders’ equity, which includes capital stock. Total debt Shareholders’ equity Total capital Total debt to total capitalization ratio 2017 $ 455,640 1,115,545 1,571,185 0.29:1 2016 $ 694,027 1,026,418 1,720,445 0.40:1 The Company’s primary uses of capital are to ﬁnance non-cash working capital and capital expenditures for capacity expansion as well as acquisitions. The Company currently funds these requirements out of its internally generated cash ﬂows and its syndicated credit facilities. However, future corporate acquisitions may require new sources of ﬁnancing. The primary measure used by the Company to monitor its ﬁnancial leverage is the total debt to total capitalization ratio, which it aims to maintain within a range of 0.20:1 to 0.50:1. The total debt to total capitalization ratio is deﬁned as total debt divided by total capital. 2017 Annual Report 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 20 RELATED PARTY TRANSACTIONS a) Transactions The Company had the following transactions with related parties: Stella Jones International S.A.* Marketing and technical service fees paid Stella International S.A. and James Jones & Sons Limited** Marketing and technical service fees paid Other 2017 $ 200 100 Legal fees charged by a ﬁrm in which a director of the Company is a partner 838 2016 $ 200 100 1,202 * As of December 31, 2017, Stella Jones International S.A. holds, directly or indirectly, approximately 38.30% of the outstanding common shares of the Company. Pursuant to the secondary offering closed on February 21, 2018, the percentage of outstanding common shares held by Stella International S.A. was reduced to 31.10%. ** Stella International S.A. and James Jones & Sons Limited hold 51.00% and 49.00% of all voting shares of Stella Jones International S.A., respectively. These transactions occurred in the normal course of operations and have been measured at fair value. As at December 31, the consolidated statement of ﬁnancial position includes the following amounts with related parties: Accounts payable to Stella International S.A. and James Jones & Sons Limited Accounts payable to Stella Jones International S.A. Accounts payable to a ﬁrm in which a director of the Company is a partner 2017 $ 25 50 305 380 2016 $ 25 50 557 632 b) Key management compensation Key management includes certain directors (executive and non-executive), and certain senior management. The compensation paid or payable to key management for employee services is as follows: 2017 $ 4,728 4,063 8,791 2016 $ 5,494 4,435 9,929 Salaries, compensation and beneﬁts Share-based expenses Stella-Jones Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 81 December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 21 SEGMENT INFORMATION The Company operates within two business segments which are the production and sale of pressure-treated wood and the procurement and sales of logs and lumber. The pressure-treated wood segment includes railway ties, utility poles, residential lumber and industrial products. The logs and lumber segment comprises of the sales of logs harvested in the course of the Company’s procurement process that are determined to be unsuitable for use as utility poles. Also included in this segment is the sale of excess lumber to local home-building markets. Assets and net income related to the logs and lumber segment are nominal. Operating plants are located in ﬁve Canadian provinces and nineteen American states. The Company also operates a large distribution network across North America. Sales attributed to countries based on location of customer are as follows: Canada U.S. Sales by product as at December 31 are as follows: Pressure-treated wood Railway ties Utility poles Residential lumber Industrial products Logs and lumber 2017 $ 561,905 1,324,237 1,886,142 2017 $ 651,549 653,946 366,225 94,516 119,906 2016 $ 535,800 1,302,553 1,838,353 2016 $ 716,292 579,208 345,749 96,310 100,794 1,886,142 1,838,353 2017 Annual Report 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated) 21 SEGMENT INFORMATION (CONTINUED) Property, plant and equipment, intangible assets and goodwill attributed to the countries based on location are as follows: Property, plant and equipment Canada U.S. Intangible assets Canada U.S. Goodwill Canada U.S. 22 SUBSEQUENT EVENTS 2017 $ 120,804 351,237 472,041 23,989 100,375 124,364 14,864 255,397 270,261 2016 $ 104,835 358,815 463,650 26,374 120,940 147,314 14,164 273,203 287,367 a) On February 9, 2018, the Company completed the acquisition of substantially all the operating assets employed in the business of Prairie Forest Products (“PFP”), a division of Prendiville Industries Ltd., located at its wood treating facility in Neepawa, Manitoba as well as at its peeling facility in Birch River, Manitoba. PFP manufactures, sells and distributes utility poles and residential lumber and was acquired for synergistic reasons. Sales for the twelve-month period ended October 31, 2017 were approximately $35,100. Total cash outlay associated with the acquisition was $26,494 excluding acquisition costs of approximately $326 of which $159 was recognized in the 2017 consolidated statement of income under selling and administrative expenses. The Company ﬁnanced the acquisition through its existing syndicated credit facilities. At the time of preparing these consolidated ﬁnancial statements, Management did not have on hand all the required information to determine the fair value of assets acquired and liabilities assumed. Preliminary information indicates that property plant and equipment and inventory represent approximately $7,763 and $9,500 respectively from the total purchase price of $26,494. b) On March 13, 2018, the Board of Directors declared a quarterly dividend of $0.12 per common share payable on April 27, 2018 to shareholders of record at the close of business on April 6, 2018. 23 COMPARATIVE FIGURES Certain comparative ﬁgures have been reclassiﬁed in order to comply with the basis of presentation adopted in the current year. Stella-Jones Inc. DIRECTORS AND OFFICERS BOARD OF DIRECTORS Tom A. Bruce Jones, CBE (1) Chairman of the Board, Stella-Jones Inc. Chairman of the Board, James Jones & Sons Limited (Forest products company) Larbert, Scotland Director since July 1993 George J. Bunze, CPA, CMA (2) (3) Vice-Chairman and Director, Kruger Inc. (Manufacturer of paper, tissue, wood products, energy (hydro/ wind) and wine and spirits products) Montréal, Québec Director since May 2001 Gianni Chiarva (3) Vice-Chairman of the Board, Stella-Jones Inc. Chairman, Stella Jones International S.A. Milan, Italy Director since July 1993 Katherine A. Lehman (2) Managing Partner, Hilltop Private Capital LLC New York, NY, USA Director since October 2016 Brian McManus President and Chief Executive Ofﬁcer, Stella-Jones Inc. Montréal, Québec Director since June 2001 83 Nycol Pageau-Goyette (1) (2) (3) President, Pageau Goyette et associés limitée (Management services ﬁrm) Montréal, Québec Director since July 1993 James A. Manzi, Jr. (2) Corporate Director Tampa, FL, USA Director since April 2015 Simon Pelletier (2) (4) Senior Vice-President, North American Sales and Operations, Metso (Manufacturer of mineral processing equipment and service provider to mining and construction industries) Senneville, Québec Director since May 2012 Daniel Picotte (1) Partner, Fasken Martineau DuMoulin LLP (Law ﬁrm) Montréal, Québec Director since July 1993 Mary Webster (1) Corporate Director Wayzata, MN, USA Director since May 2007 (1) Member of the Environmental, Health and Safety Committee (2) Member of the Audit Committee (3) Member of the Remuneration Committee (4) Lead Director A full report of Stella-Jones’ corporate governance practices is set out in the Management Proxy Circular for the May 3, 2018 Annual Meeting of Shareholders. OFFICERS Tom A. Bruce Jones, CBE Chairman of the Board Gianni Chiarva Vice-Chairman of the Board Brian McManus President and Chief Executive Ofﬁcer Éric Vachon, CPA, CA Senior Vice-President and Chief Financial Ofﬁcer Marla Eichenbaum Vice-President, General Counsel and Secretary Ian Jones Senior Vice-President Gordon Murray Vice-President, Environment and Technology and General Manager, Atlantic Region André Daigle Vice-President, Central Region SUBSIDIARIES – SENIOR MANAGEMENT Shane Campbell Vice-President, Operations McFarland Cascade Holdings, Inc. George Caric Vice-President, Marketing Stella-Jones Corporation Kevin Comerford Vice-President, Poles and Residential Sales McFarland Cascade Holdings, Inc. W.G. Downey, Jr. Vice-President, U.S. Tie Procurement Stella-Jones Corporation Marcell Driessen Vice-President, Human Resources Stella-Jones Corporation/ McFarland Cascade Holdings, Inc. Ian Jones Senior Vice-President McFarland Cascade Holdings, Inc. James Kenner Vice-President and General Counsel, U.S. Operations Stella-Jones Corporation Patrick Kirkham Vice-President, Operations Stella-Jones Corporation Jim Raines Vice-President, Sales Stella-Jones Corporation Michael Sylvester Senior Vice-President, Stella-Jones Corporation David Whitted Vice-President, Sales Operations Stella-Jones Corporation Jon Younce Vice-President, U.S. Fibre and Transportation/Logistics McFarland Cascade Holdings, Inc. Ron Zeegers Vice-President, Operations, Western Canada Stella-Jones Inc. 2017 Annual Report 84 OPERATING NETWORK – CANADA CORPORATE HEAD OFFICE ALBERTA BRITISH COLUMBIA Stella Jones Inc. 3100 de la Côte-Vertu Blvd. Suite 300 Saint-Laurent, Québec H4R 2J8 T: (514) 934-8666 F: (514) 934-5327 montreal@stella-jones.com BRITISH COLUMBIA Plant 7400 Galloway Mill Road Galloway British Columbia V0B 1T2 T: (250) 429-3493 F: (250) 429-3931 galloway@stella-jones.com Plant 39 miles SE of Calgary Hwy. 24 Carseland, Alberta T0J 0M0 T: (403) 934-4600 F: (403) 934-5880 carseland@stella-jones.com Plant and Sales Ofﬁce 25 Braid Street New Westminster British Columbia V3L 3P2 T: (604) 521-4385 F: (604) 526-8597 n.west@stella-jones.com Plant and Sales Ofﬁce 7177 Paciﬁc Street Prince George British Columbia V2N 5S4 T: (250) 561-1161 F: (250) 561-0903 p.george@stella-jones.com Fibre & Woodlands Dept. 4661 60th Street SE Salmon Arm British Columbia V1E 1X2 T: (250) 832-1180 F: (250) 832-7933 salmonarm@stella-jones.com MANITOBA Plant 205 Hwy. 16 West Neepawa, Manitoba R0J 1H0 T: (204) 476-7700 F: (204) 476-2212 neepawa@stella-jones.com NOVA SCOTIA ONTARIO Plant and Sales Ofﬁce 278 Park Street Truro, Nova Scotia B2N 5C1 T: (902) 893-9456 F: (902) 893-3874 truro@stella-jones.com Plant and Sales Ofﬁce Guelph Utility Pole 7818 Wellington Road 22 R.R. #5 Guelph, Ontario N1H 6J2 T: (519) 822-3901 F: (519) 822-5411 guelph@stella-jones.com ONTARIO QUÉBEC Plant and Sales Ofﬁce 1 Ram Forest Road Stouffville, Ontario L4A 2G7 T: (905) 727-1164 F: (905) 727-7758 gormley@stella-jones.com Plant and Sales Ofﬁce 321 Lansdowne Street East Peterborough, Ontario K9J 7X6 T: (705) 745-3223 F: (705) 745-3793 peterborough@stella-jones.com Plant and Sales Ofﬁce 41 Rodier Street Delson, Québec J5B 2H8 T: (450) 632-2011 T: 1 (800) 387-5027 F: (450) 632-3211 delson@stella-jones.com Plant and Sales Ofﬁce 426 chemin de Montréal East Gatineau, Québec J8M 1V6 T: (819) 986-8998 F: (819) 986-9875 gatineau@stella-jones.com Plant 2210 chemin St-Roch Sorel-Tracy, Québec J3R 3L2 T: (450) 742-5977 F: (450) 742-8832 sorel@stella-jones.com Plant 11045 Hwy. 124 South River, Ontario P0A 1X0 T: (705) 386-2371 F: (705) 386-2335 sriver@stella-jones.com QUÉBEC Plant 2549 Chemin Francisco Rivière-Rouge, Québec J0T 1T0 T: (819) 275-3353 F: (819) 275-1002 rouge@stella-jones.com Stella-Jones Inc. OPERATING NETWORK – UNITED STATES 85 CORPORATE OFFICE LEGAL AND COMPLIANCE ALABAMA Stella-Jones Corporation Park West One 1000 Cliff Mine Road Suite 500 Pittsburgh, PA 15275 U.S.A T: (412) 325-0202 F: (412) 774-1689 sjcorp@stella-jones.com Stella-Jones Corporation 15700 College Blvd., Suite 300 Lenexa, KS 66219 U.S.A. T: (913) 948-9478 F: (913) 538-2226 sjcorp@stella-jones.com Plant Stella-Jones Corporation 100 McKinney Drive Clanton, AL 35045 U.S.A. T: (205) 280-3950 F: (205) 665-2545 sjcorp@stella-jones.com Plant Stella-Jones Corporation 1051 Highway 25 South Montevallo, AL 35115 U.S.A. T: (205) 679-4005 F: (205) 665-2545 sjcorp@stella-jones.com ARIZONA ARKANSAS GEORGIA INDIANA Plant McFarland Cascade 850 West Chambers St. Eloy, AZ 85231 U.S.A. T: (520) 466-7801 F: (520) 466-3607 info@mcfarland cascade.com Plant Stella-Jones Corporation 4260 South Arkansas Ave. Russellville, AR 72802 U.S.A. T: (479) 968-5085 F: (479) 968-4636 sjcorp@stella-jones.com Plant McFarland Cascade 6040 Highway 79N Rison, AR 71665 U.S.A. T: (870) 325-7070 F: (870) 325-7050 info@mcfarland cascade.com Plant Stella-Jones Corporation 3500 Pateville Road Cordele, GA 31015 U.S.A. T: (229) 273-8012 F: (229) 273-8220 sjcorp@stella-jones.com Plant Stella-Jones Corporation 3818 S. County Road 50 E Winslow, IN 47598 U.S.A. T: (812) 789-5331 F: (812) 789-5335 sjcorp@stella-jones.com KENTUCKY LOUISIANA Plant Stella-Jones Corporation 3855 Highway 51 North Fulton, KY 42041 U.S.A. T: (270) 472-5557 F: (270) 472-5559 sjcorp@stella-jones.com Plant Stella-Jones Corporation 3600 Koppers Road Alexandria, LA 71302 U.S.A. T: (318) 442-5733 F: (318) 473-4378 sjcorp@stella-jones.com Plant McFarland Cascade 10020 Highway 483 Converse, LA 71419 U.S.A. T: (318) 645-7525 F: (318) 645-7530 info@mcfarlandcascade. com Plant McFarland Cascade 74 Wadley Street Pineville, LA 71360 U.S.A. T: (318) 442-4414 F: (318) 445-9144 info@mcfarlandcascade. com MISSISSIPPI Plant McFarland Cascade 13539 Highway 45 Scooba, MS 39358-7611 U.S.A. T: (662) 476-8000 F: (601) 476-8005 info@mcfarland cascade.com NEVADA OREGON Plant McFarland Cascade 1680 E Spruce Avenue Silver Springs, NV 89429 U.S.A. T: (775) 577-2000 F: (775) 577-9045 info@mcfarland cascade.com Plant and Ofﬁce McFarland Cascade 90049 Highway 99N. Eugene, OR 97402 U.S.A. T: (541) 689-1278 F: (541) 689-6027 info@mcfarland cascade.com Plant McFarland Cascade 22125 SW Rock Creek Road Sheridan, OR 97378 U.S.A. T: (503) 843-2122 F: (503) 843-7058 info@mcfarland cascade.com PENNSYLVANIA Plant Stella-Jones Corporation 5865 Route 235 McAlisterville, PA 17049 U.S.A. T: (717) 463-2131 F: (717) 463-3998 sjcorp@stella-jones.com Plant Stella-Jones Corporation 392 Larkeytown Road Dubois, PA 15801 U.S.A. T: (814) 371-7331 F: (814) 375-0946 sjcorp@stella-jones.com 2017 Annual Report 86 OPERATING NETWORK – UNITED STATES SOUTH CAROLINA TENNESSEE TEXAS VIRGINIA WASHINGTON Plant McFarland Cascade 1121 Delta Road Whitmire, SC 29178 U.S.A. T: (803) 694-3668 F: (803) 694-3976 info@mcfarland cascade.com Coal Tar Distillation Facility Stella-Jones Corporation 1471 Channel Avenue Memphis, TN 38109 U.S.A. T: (901) 942-3326 F: (901) 942-3128 sjcorp@stella-jones.com Plant McFarland Cascade 5865 US Highway 69 Lufkin, TX 75901 U.S.A. T: (936) 824-2297 F: (936) 634-2100 info@mcfarlandcascade. com Plant Stella-Jones Corporation 9223 Maury River Road Goshen, VA 24439 U.S.A. T: (540) 997-9251 F: (540) 997-0047 sjcorp@stella-jones.com Plant and Corporate Ofﬁce McFarland Cascade 1640 East Marc St. Tacoma, WA 98421 U.S.A. T: (253) 572-3033 F: (253) 382-3000 info@mcfarland cascade.com WASHINGTON WISCONSIN Plant McFarland Cascade 6520 - 188th NE Arlington, WA 98223 U.S.A. T: (360) 435-2146 F: (360) 435-3035 info@mcfarland cascade.com Plant Stella-Jones Corporation W1038 County Road U Bangor, WI 54614 U.S.A. T: (608) 486-2700 F: (608) 486-4538 sjcorp@stella-jones.com Plant McFarland Cascade 1014 S. 1st Street Cameron, WI 54822 U.S.A. T: (715) 458-2018 F: (715) 458-2024 info@mcfarlandcascade. com Stella-Jones Inc. Corporate Information Annual Meeting of Shareholders May 3, 2018 10:00 a.m. Hotel Omni Mont-Royal Salon Pierre De Coubertin 1050 Sherbrooke Street West Montréal, Québec Stock Information Shares listed: Toronto Stock Exchange Ticker symbol: SJ Initial public offering: 1994 52-week high/low (Jan. 1 – Dec. 31, 2017): $51.41 / $38.30 Share price at March 13, 2018: $47.30 Common shares outstanding as at December 31, 2017: 69.34 million Dividend Policy The Board of Directors considers a dividend on a quarterly basis, subject to the Company’s ﬁnancial covenants and conditional upon its ﬁnancial performance and cash requirements. On March 13, 2018, the Board of Directors declared a quarterly dividend of $0.12 per common share. Transfer Agent and Registrar Computershare Investor Services Inc. Auditors PricewaterhouseCoopers LLP Legal Counsel Fasken Martineau Dumoulin LLP Cohen & Grigsby, P.C. Foley & Lardner LLP S T E L L A - J O N E S 2 0 1 7 A N N U A L R E P O R T WWW.STELLA-JONES.COM Railway operators recognize Stella-Jones as one of North America’s foremost producers of railway ties. Similarly, the providers of electricity and telecommunications throughout the continent know Stella-Jones as a principal producer of utility poles. This level of accomplishment, authority and identity in the treated wood industry has consistently positioned the Company to grow its business among both existing and new customers.

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