Stella-Jones
Annual Report 2018

Plain-text annual report

TABLE OF CONTENTS 01 5-year Financial Highlights 02 Stella-Jones at a Glance 03 2018 Highlights 04 Chair’s Report 06 President’s Message 08 Building on a Strong Third Pillar 09 Stella-Jones’ Continental Network 10 Building on Our Reputation for Quality and Service 12 Building on Solid Performance 14 Share Information 16 Management’s Discussion and Analysis 44 Independent Auditor’s Report 47 Consolidated Financial Statements ST ELL A-JONES .COM 5-YEAR FINANCIAL HIGHLIGHTS For the years ended December 31 (millions of dollars, except per share data and financial ratios) 2018 $ 2017 $ 2016 $ 2015 $ 2014 $ OPERATING RESULTS Sales EBITDA (1) 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 FINANCIAL RATIOS Operating margin (1) EBITDA margin (1) Return on average equity (1) Total debt (2) to total capitalization (1) Total debt (2) to trailing 12-month EBITDA (1) Working capital 2,123.9 1,886.1 1,838.4 1,559.3 1,249.5 244.4 206.3 137.6 243.1 207.4 167.9 264.8 233.2 153.9 243.4 220.1 141.4 176.3 155.7 103.8 909.0 779.4 928.0 854.4 615.1 2,062.2 1,786.0 1,960.9 1,778.9 1,289.0 513.5 455.6 694.0 1,281.4 1,115.5 1,026.4 669.9 913.5 444.6 692.3 1.98 1.98 18.50 2.42 2.42 16.09 2.22 2.22 14.81 2.05 2.04 13.21 1.51 1.50 10.04 9.7% 11.5% 11.5% 11.0% 12.9% 15.7% 12.7% 14.4% 15.9% 14.1% 15.6% 17.6% 0.29:1 0.29:1 0.40:1 0.42:1 2.10x 6.70 1.87x 7.04 2.62x 8.58 2.75x 6.36 12.5% 14.1% 16.4% 0.39:1 2.52x 8.33 (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 — Accounting 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. 2018 Annual report 1 1 2018 Annual report STELLA-JONES AT A GLANCE Railway Ties 31.2% Logs and Lumber 7.2% Utility Poles 34.1% $2.1B 2018 SALES Residential Lumber 22.4% Industrial Products 5.1% 39 WOOD TREATING FACILITIES 2,110 EMPLOYEES 68% SALES FROM U.S. Stella-Jones Inc. 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 manufactures and distributes residential lumber and accessories to retailers for outdoor applications, and industrial products for construction and marine applications. The Company’s common shares are listed on the Toronto Stock Exchange. 2 Stella-Jones Inc.2018 HIGHLIGHTS Stella-Jones posted solid financial results in 2018 despite challenging market conditions. The Company used its strong cash flow to grow the business, both organically and through acquisitions and provided a solid return to share holders. It remains in a healthy financial position to pursue its growth. MARKET CONDITIONS • Railway tie inventory levels tightened • Lumber prices hit an all-time high in May 2018 followed by a sharp drop • Sustained demand for the Company’s products SOLID RESULTS • Sales increased 12.6% and across all product categories • EBITDA(1) marginally increased to $244.4 million, as it was negatively impacted by a $7.9 million loss on derivative commodity contracts • Net income decreased 18.0% to $137.6 million, primarily due to a loss on derivative commodity contracts and the December 2017 U.S. tax reform BALANCED CAPITAL ALLOCATION • $54.5 million to make acquisitions • $51.6 million for capital expenditures • $33.3 million for dividends • $4.0 million for share buybacks STRONG BALANCE SHEET • Total debt of $513.5 million • Total debt to EBITDA(1) ratio of 2.10x • Strong financial position to pursue acquisitions NETWORK EXPANSION • Acquired Prairie Forest Products in February • Acquired Wood Preservers Incorporated in April • Invested in its network to improve efficiencies and expand capacity (1) This is a non-IFRS financial measure. Please refer to the Non-IFRS financial measures section in the management’s discussion and analysis. 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 SALES (in millions of $) 1,249.5 1,559.3 1,838.4 1,886.1 2,123.9 EBITDA(1) (in millions of $) 176.3 243.4 264.8 243.1 244.4 NET INCOME (in millions of $) 103.8 141.4 153.9 167.9 137.6 2018 Annual report 3 3 2018 Annual report CHAIR’S REPORT BUILDING ON GOOD GOVERNANCE A MILESTONE YEAR 2018 was a milestone year for Stella-Jones. Stella Jones International SA sold its remaining holdings in the Company and the two founding partners, Tom A. Bruce Jones and Gianni Chiarva, stepped down from the Board of Directors. On behalf of Stella-Jones, I would like to thank them for their dedication and vision. They built Stella-Jones from a four-plant wood-treating operation in 1992 to a leading North American railway tie, utility pole and treated lumber supplier with close to 40 facilities today. BOARD CHANGES I was appointed Chair of the Board last September. I am honored and delighted to accept this role and look forward to working with the Board and Management to build upon the Company’s solid core values and exceptional track record. Furthermore, longstanding Board members Daniel Picotte and Nycol Pageau-Goyette announced that they would be stepping down in May of 2019. I would like to thank both Daniel and Nycol for their many years of dedicated service. Finally, in December, we welcomed Ms. Karen Laflamme, Executive Vice-President and Chief Financial Officer, Retail, of Ivanhoé Cambridge, to the Board. She is an accomplished executive who brings a wealth of financial, accounting and business experience to Stella-Jones. I am confident that Karen will make a positive contribution to the Board and the Audit Committee. Stella-Jones has nine Board members, composed of 44% women and 78% independent Directors. This compares with 30% and 60% respectively, last year. 4 Stella-Jones Inc.BOLSTERING OUR GOVERNANCE In 2018, the Board continued to build on its good governance by enhancing some of its practices. Thus far, we established a Governance and Nomination Committee comprised solely of independent directors and instituted a process of renewal of the Board which will continue to foster diversity. In this same spirit, Stella-Jones recently published its inaugural Environmental, Social and Governance (ESG) Report. While this is our first report, we have been committed to ESG for many years, including having implemented numerous safety and environmental initiatives. In fact, we have long had in place a dedicated Environmental, Health and Safety Committee of the Board. We are committed to being a model corporate citizen and to continuously improving our sustainability and other ESG practices. SOLID PERFORMANCE IN 2018 Despite challenging market conditions in 2018, Stella-Jones finished the year with a solid performance. Revenues increased 12.6% and EBITDA(1) increased 0.5%. We also completed two acquisitions, continued to invest in our network to better serve our customers, increased our dividend for the fourteenth consecutive year and instituted a Normal Course Issuer Bid. On behalf of the Board, I would like to welcome our new institutional shareholders and thank our long-term shareholders for their continued support. I would also like to thank all of our employees for their strong contribution in 2018. Katherine A. Lehman Chair of the Board Establishment of Governance and Nomination Committee Renewal of the Board of Directors on which 78% are now independent and 44% are women Launch of inaugural Environmental, Social and Governance Report (1) This is a non-IFRS financial measure. Please refer to the Non-IFRS financial measures section in the management’s discussion and analysis. 5 2018 Annual reportPRESIDENT’S MESSAGE BUILDING ON OUR CORE ASSETS NAVIGATING THROUGH CHALLENGING MARKET CONDITIONS In a year filled with a multitude of challenges, our operational and sales teams deserve praise for navigating through headwinds and delivering an 18th consecutive year of increased revenues. Our bottom line was impacted when compared to last year, due to the one-time benefits received from the 2017 tax reform enacted in the United States. We witnessed a rise in lumber prices and a railway tie market characterized by a tightened supply. Although these factors contracted our margins and net income, we achieved a healthy increase in revenues stemming from higher pricing and sustained strong demand in key product categories. GENERATING SOLID RESULTS In a generally robust North American economy, demand remained solid for Stella-Jones’ pressure- treated wood railway ties, utility poles and residential lumber. Total sales in 2018 surpassed the two billion-dollar mark for the first time in our history, reaching $2.1 billion. Excluding the contribution from acquisitions and the impact from foreign exchange, sales rose by a robust 10.1%, primarily driven by pricing. As expected, net income decreased to $137.6 million, primarily impacted by the effect of the U.S. tax reform last year, coupled with a loss related to derivative commodity contracts. GROWING OUR CORE PRODUCT CATEGORIES In 2018, all of Stella-Jones’ product categories increased their year-over-year sales and generated organic growth. Railway tie sales grew modestly to $662.4 million, as we progressively passed on price increases to customers. Utility pole sales increased over 10% to $725.0 million, driven by both strong demand and price increases and residential lumber sales increased by close to 30% to $474.7 million, driven primarily by pricing. However, despite higher sales prices, our increasing exposure to lumber costs has put downward pressure on our margins as a percentage of sales, as price increases are a pass through to customers. 6 Stella-Jones Inc.ALLOCATING CAPITAL TO MAXIMIZE SHAREHOLDER VALUE In 2018, we generated $128.1 million of cash flow from operations. We deployed capital primarily for acquisitions, capital expenditures and providing a return to shareholders in the form of dividends and share buybacks. In terms of network expansion, we completed two acquisitions totalling $54.5 million. We acquired Prairie Forest Products in Manitoba, which manufactures treated wood utility poles and treated residential lumber, and Wood Preservers Incorporated in Sales increased by 12.6% and EBITDA(1) was up 0.5% Virginia, a producer of marine and foundation pilings and treated margins in 2019. In addition, our solid financial position will allow utility poles. With these two additions, we closed 2018 operating us to continue to seek opportunities to expand our presence in thirty-nine wood treating plants and twelve pole peeling facilities. our core markets. During the year, we also invested $51.6 million to increase the I want to take this opportunity to express my gratitude to all capacity and efficiency of our network. In fact, the capital we members of the Stella-Jones team. Your talents and devotion deployed in our facilities in the Southeastern United States has are what make our Company a strong and growing force in our started to bear fruit in the form of improved efficiencies and we industry. I also wish to thank our Board of Directors and the many are well positioned to grow. shareholders of Stella-Jones for your continuing confidence and In 2018, we increased our dividend for a fourteenth consecutive year to $0.48 per share, returning $33.3 million to shareholders. At the end of the year, we put in place a Normal Course Issuer Bid, representing an attractive and responsible investment and a support. complementary way to return value to shareholders. As at year Brian McManus end, we had repurchased common shares for approximately President and Chief Executive Officer $4.0 million. OUTLOOK As a manufacturer of basic components of North American industrial infrastructure, Stella-Jones succeeds in tandem with the dynamism and growth of the continental economy. As we enter 2019, the market continues to indicate ongoing robust demand for our core products . Based on current market expectations and assuming stable currencies and lumber prices, we expect the Company to generate higher year-over-year sales and improved (1) This is a non-IFRS financial measure. Please refer to the Non-IFRS financial measures section in the management’s discussion and analysis. 7 2018 Annual reportBUILDING ON A STRONG THIRD PILLAR SALES BY PRODUCT CATEGORY (in millions of $) 2,500 2,000 1,500 1,000 500 0 2014 2015 2015 2017 2018 Railway Ties Utility Poles Residential Lumber Industrial Products Logs & Lumber DIVERSIFYING THE PRODUCT MIX Over the course of the past 5 years, Stella- Jones has success fully developed the residential lumber product cate gory through acquisitions and organic growth. Residentiel lumber has climbed from 10% of its overall product mix in 2014 to 22% of total sales in 2018, gaining momentum through dedicated market focus and higher lumber prices passed through to customers. While remaining continually focused on its railway tie and utility pole businesses, Stella-Jones regards residential lumber as an essential component of its core product mix. Residential lumber is an essential component of Stella-Jones’ core product mix 8 8 Stella-Jones Inc. Stella-Jones Inc.STELLA-JONES’ CONTINENTAL NETWORK 1 New Westminster, BC 15 Arlington, WA 19 Silver Springs, NV 33 Montevallo, AL 2 Prince George, BC 3 Galloway, BC 4 Carseland, AB 5 Neepawa, MB 6 South River, ON 7 Guelph, ON 8 Stouffville, ON 16 Tacoma, WA 17 Sheridan, OR 18 Eugene, OR 20 Eloy, AZ 21 Lufkin, TX 22 Russellville, AR 9 Peterborough, ON 23 Rison, AR 10 Gatineau, QC 11 Rivière-Rouge, QC 12 Delson, QC 13 Sorel-Tracy, QC 14 Truro, NS 24 Converse, LA 25 Pineville, LA 26 Alexandria, LA 27 Bangor, WI 28 Cameron, WI Treating Facilities Coal Tar Distillery 29 Memphis, TN 30 Scooba, MS 31 Fulton, KY 32 Winslow, IN 34 Clanton, AL 35 Cordele, GA 36 Whitmire, SC 37 Goshen, VA 38 Warsaw, VA 39 Dubois, PA 40 McAllisterville, PA 9 2018 Annual report23411012131415161718192023263029273132333537739403489222421366511282538BUILDING ON OUR REPUTATION FOR QUALITY AND SERVICE RAILWAY TIES UTILITY POLES $662 M 2018 REVENUES 2.7% ORGANIC GROWTH 31.2% OF REVENUES $725 M 2018 REVENUES 11.2% ORGANIC GROWTH 34.1% OF REVENUES Stella-Jones is an industry leader in the production of quality Stella-Jones provides over one million pressure-treated poles pressure treated railroad ties and timbers. We have the treating per year to replace, upgrade and develop new electrical utility capacity, sources of raw material supply and purchasing and telecommunications lines across Canada and the United power to meet the needs of Class 1, Short Line railroads States. Wood poles are the backbone of North America’s and commercial operators from coast to coast. Our extensive electric grid and are a renewable resource, providing equal or supplier network of over 1,200 hardwood sawmills allows us superior strength, resiliency and service life when compared to offer crossties and switch ties in a variety of sizes to meet to any “wood pole equivalent” structure constructed from our customers’ needs. Our agile continental network of wood alternative materials, such as steel, concrete and fiberglass. treating plants and distribution yards carry a large inventory to Stella-Jones’ quality poles are made from a variety of premium ensure that materials are delivered quickly and efficiently, even wood species to suit a range of climates. Our custom under urgent conditions. manufacturing services meet the demands of our customers’ unique specifications across the continent. In 2018, sales increased modestly, primarily as a result of price increases in the second half of the year, partially offset In 2018, sales increases were driven by greater market reach by the Company supporting the transition of a Class 1 railroad in the U.S. Southeast, increased project activity requiring customer from a “treating services only” program to a full transmission poles, healthy demand for replacement programs service “black-tie” program in the first half of the year. Sales and higher sales prices. Sales and margins for 2019 are and margins for 2019 are expected to increase year-over-year, expected to increase year-over-year, driven by both pricing primarily driven by pricing. and strong demand for replacement programs and increased project-based sales. 10 Stella-Jones Inc.RESIDENTIAL LUMBER INDUSTRIAL PRODUCTS $109 M 1.1% 5.1% 2018 REVENUES ORGANIC GROWTH OF REVENUES Stella-Jones is a leading supplier of pressure treated wood products to the marine, industrial and civic sectors for outdoor applications, producing wharf timbers, bridge timbers, crane mats, railway crossings and laminated poles, and offering a variety of select wood species and preservatives. In 2018, sales increased modestly, explained in part by demand for rail-related products and projects requiring laminated products. For 2019, sales should increase due to the full-year contribution from acquisitions. LOGS & LUMBER $153 M 26.8% 7.2% 2018 REVENUES ORGANIC GROWTH OF REVENUES $475 M 2018 REVENUES 18.1% ORGANIC GROWTH 22.4% OF REVENUES Stella-Jones provides seamless, end-to-end service to key North American retailers, supplying hundreds of millions of board feet of treated residential lumber across Canada and the United States each year. A preferred supplier of treated wood products for the dimensional lumber market, Stella- Jones treats wood boards, plywood and dimensional lumber for use in patios, decks, fences and other outdoor applications in addition to providing customized services for the residential and construction markets. In 2018, sales increased significantly due to higher selling prices, stemming from increased lumber costs passed through to customers, and to increased volume due to the Company’s This product category is used to optimize procurement, does expanding market presence. For 2019, sales are expected not generate margin and is fairly tied to the price of lumber. to be stable, year-over-year, as stronger market demand is In 2018, sales increased significantly as a result of higher expected to be offset by lower selling prices to customers, as a lumber prices which are passed through to customers as well result of lower lumber costs. as increased harvesting for poles which has generated more log sales. For 2019, with the price of lumber coming down, we expect sales to decrease and our consolidated margin to benefit. 11 2018 Annual reportBUILDING ON SOLID PERFORMANCE 2,500 2,000 1,500 1,000 500 0 300 250 200 150 100 50 0 350 300 250 200 150 100 50 0 SALES & ORGANIC GROWTH (in millions of $, except percentage) 10.1% 1,250 1,559 6.4% 1,838 1,886 2,124 12% 10.1% 10% 4.4% 1.1% 8% 6% 4% 2% 0% 2014 2015 2016 2017 2018 Sales Organic growth EBITDA(1), OPERATING INCOME(1) & EBITDA %(1) (in millions of $, except margin) Sales have steadily increased over the past five years, reaching past the two billion-dollar mark in 2018, an important milestone in the Company’s history. Stella-Jones has generated positive organic growth in each of the last five years, spiking to 10.1% in 2018, driven primarily by higher lumber prices passed through to customers, coupled with a rise in railway tie selling prices and increased volume in the utility pole product category. 243 220 15.6% 265 233 14.4% 14.1% 176 156 20% EBITDA(1) for 2018 was $244.4 million, in line with last 243 244 207 206 15% 12.9% 11.5% 10% year, as it was negatively impacted by a $7.9 million loss on derivative commodity contracts in the fourth quarter. Excluding this non-operational item, EBITDA(1) would have been up approximately 4%. 5% 0% EBITDA margin(1) for 2018 was 11.5%, down from 12.9% last year, primarily due to higher lumber prices, which are a pass through to customers, as well as the negative impact from the derivative instruments mentioned above. 2014 2015 2016 2017 2018 EBITDA Operating income EBITDA % CASH FLOW FROM OPERATING ACTIVITIES (in millions of $) 254 269 301 248 262 182 In 2018, Stella-Jones generated $262.3 million of cash flow from operating activities before non-cash working capital components and interest and income taxes 128 paid (1) as compared to $248.2 million last year. However, 181 77 it generated $128.1 million of cash flow from operating activities, versus $301.1 million last year. This variance was primarily explained by increased inventories. 7 2014 2015 2016 2017 2018 Cash flow from operating activities before certain items (1) (2) Cash flow from operating activities (1) This is a non-IFRS financial measure. Please refer to the Non-IFRS financial measures section in the management’s discussion and analysis. (2) Non-cash working capital components and interest and income taxes paid 12 Stella-Jones Inc.CAPITAL DEPLOYMENT (in millions of $) 198 122 105 87 Stella-Jones has a disciplined approach to capital allocation. In 2018, the Company invested $54.5 million for business acquisitions and $51.6 million for capital 143 expenditures. It also provided a return to shareholders 250 200 150 100 50 0 $0.60 $0.50 $0.40 $0.30 $0.20 $0.10 $0.00 300 250 200 150 100 50 0 2014 2015 2016 2017 2018 Acquisition CAPEX Dividends Share buybacks DIVIDENDS PER SHARE (in dollars) $0.44 $0.40 $0.48 $0.32 $0.28 2014 2015 2016 2017 2018 EBITDA(1) & TOTAL DEBT TO EBITDA(1) (in millions of $ except ratio) 2.52x 176 2.75x 243 265 2.62x 243 244 2.10x 1.87x 2014 2015 2016 2017 2018 EBITDA Total debt to EBITDA 3.00x 2.50x 2.00x 1.50x 1.00x 0.50x 0.00x by paying dividends of $33.3 million and buying back shares for $4.0 million under a Normal Course Issuer Bid, instituted at the end of 2018, which it believes represents an attractive and responsible investment and is a complementary way to return value to shareholders. Stella-Jones has increased its dividend for the past fourteen years. In 2018, the dividend increased 9.1% to $0.48 per share. At year end, the dividend yield was 1.2%. On March 14, 2019, the Company continued this trend and announced an increase of its quarterly dividend by 16.7% to $0.14 per share. 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. Stella-Jones concluded 2018 with a total debt of $513.5 million and an EBITDA(1) of $244.4 million. This translated into a total debt to EBITDA(1) ratio of 2.1:1. The Company is therefore in a healthy financial position to pursue its development and acquisition strategy. (1) This is a non-IFRS financial measure. Please refer to the Non-IFRS financial measures section in the management’s discussion and analysis. 13 2018 Annual reportSHARE INFORMATION For the years ended December 31 (unaudited) 2018 $ 2017 $ 2016 $ 2015 $ 2014 $ TRADING DATA ON COMMON SHARES 52-week high ($) 52-week low ($) Closing ($) Total volume Average daily volume OTHER STATISTICS 52.22 37.40 39.61 51.41 38.30 50.50 51.95 40.37 43.58 53.46 32.16 52.51 36.00 25.43 32.74 53,908,544 49,339,093 46,609,923 34,802,385 17,441,546 214,775 196,570 185,697 138,655 69,488 Dividends on common shares (in millions $) Dividend per share ($) Dividend yield (%) Average number of shares outstanding (000’s) Average number of diluted shares outstanding (000’s) Shares outstanding at year end (000’s) Public float (000’s) Market capitalization (in millions $) Enterprise value (1) (in millions $) 33.3 0.48 30.5 0.44 27.7 0.40 22.1 0.32 19.3 0.28 1.2% 0.9% 0.9% 0.6% 0.9% 69,352 69,360 69,268 61,718 2,744 3,257 69,324 69,333 69,342 47,769 3,502 3,957 69,215 69,231 69,303 42,730 3,020 3,715 69,018 69,153 69,137 42,564 3,630 4,300 68,802 69,027 68,949 42,376 2,257 2,702 (1) Enterprise value is defined as market capitalization plus total debt, including the current portion of long-term debt. CLOSING SHARE PRICE AND VOLUME 6,000 5,000 4,000 3,000 2,000 1,000 0 $60 $50 $40 $30 $20 $10 $0 Jan 14 Mar 14 May 14 Jul 14 Sep 14 Nov 14 Jan 15 Mar 15 May 15 Jul 15 Sep 15 Nov 15 Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 Mar 17 May 17 Jul 17 Sep 17 Nov 17 Jan 18 Mar 18 May 18 Jul 18 Sep 18 Nov 18 Volume Price 14 Stella-Jones Inc. 15 MANAGEMENT’S DISCUSSION AND ANALYSIS CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS16 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. This MD&A and the Company’s audited consolidated financial statements were approved by the Board of Directors on March 14, 2019. The MD&A provides a review of the significant developments and results of operations of the Company during the fiscal year ended December 31, 2018 compared with the fiscal year ended December 31, 2017. The MD&A should be read in conjunction with the Company’s audited consolidated financial statements for the years ended December 31, 2018 and 2017 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 Accountants (“CPA Canada”) Handbook Part I — Accounting. 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 Relations 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 14, 2019, the Company operated thirty-nine wood treating plants, twelve pole peeling facilities and a coal tar distillery. These facilities are located in six Canadian provinces and nineteen American states and are complemented by an extensive distribution network across North America. As at December 31, 2018, the Company’s workforce numbered approximately 2,110 employees. 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. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS2018 HIGHLIGHTS Selected Key Indicators (in millions of dollars, except earnings per share (“EPS”) and key performance indicators) Operating Results Sales Gross profit (1) EBITDA (1) Operating income (1) Net income EPS – basic & diluted Cash Flows Cash flows from operating activities Cash flows from financing activities Cash flows from investing activities Financial Position Current assets Inventories Total assets Long-term debt (2) Total liabilities Shareholders’ equity Key Performance Indicators EBITDA margin (1) Operating margin (1) Return on average equity (1) Working capital ratio (1) Long-term debt (2) to total capitalization (1) Long-term debt (2) to EBITDA (1) Dividend per share 17 2018 2017 2016 2,123.9 1,886.1 1,838.4 314.2 244.4 206.3 137.6 1.98 128.1 (26.0) (108.5) 1,068.4 838.6 2,062.2 513.5 780.8 1,281.4 11.5% 9.7% 11.5% 6.70 0.29:1 2.10 0.48 299.9 243.1 207.4 167.9 2.42 301.1 (239.9) (58.5) 908.4 718.5 1,786.0 455.6 670.4 1,115.5 12.9% 11.0% 15.7% 7.04 0.29:1 1.87 0.44 333.7 264.8 233.2 153.9 2.22 181.8 (9.5) (175.6) 1,050.4 854.6 1,960.9 694.0 934.5 1,026.4 14.4% 12.7% 15.9% 8.58 0.40:1 2.62 0.40 (1) This is a non-IFRS financial measure which does not have a standardized meaning prescribed by IFRS and may therefore not be comparable to similar measures presented by other issuers. Refer to the Non-IFRS financial measures section of this MD&A. (2) Including current portion of long-term debt. Note: Numbers are rounded. • On December 18, 2018, Stella-Jones announced that the Toronto Stock Exchange had accepted its Notice of Intention to Make a Normal Course Issuer Bid. Shareholders may obtain a copy of the Notice of Intention upon request to the Company. Pursuant to the Notice, Stella-Jones may, during the twelve-month period commencing December 20, 2018 and ending December 19, 2019, purchase for cancellation, up to 3,000,000 common shares, representing approximately 4.3% of its outstanding common shares. • On November 19, 2018, Stella-Jones announced the appointment of Ms. Karen Laflamme to its Board of Directors. Ms. Laflamme is Executive Vice-President and Chief Financial Officer, Retail, of Ivanhoé Cambridge, an investor and developer of superior quality real estate properties, projects and companies around the world. Ms. Laflamme’s appointment was effective December 1, 2018. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 18 • On September 25, 2018, Stella-Jones announced the appointment of Ms. Katherine A. Lehman as Chair of the Board, the establishment of a Governance and Nomination Committee and the implementation of additional governance initiatives. • On August 14, 2018, Stella Jones International S.A. sold its remaining share ownership in Stella-Jones Inc. through a bought deal public offering of 8,445,911 common shares and a concurrent private placement of an aggregate of 13,126,925 common shares. • On April 9, 2018, the Company completed the acquisition of substantially all of the operating assets employed in the business of Wood Preservers Incorporated (“WP”), located at its wood treating facility in Warsaw, Virginia. WP manufactures, sells and distributes marine and foundation pilings and treated wood utility poles. • On February 9, 2018, the Company completed the acquisition of substantially all of 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 treated wood utility poles as well as treated residential lumber. NON-IFRS FINANCIAL MEASURES This MD&A contains financial measures which are not prescribed by IFRS and are not likely to be comparable to similar measures presented by other issuers. These measures are as follows: • Gross profit: Sales less cost of sales • EBITDA: 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 margin: EBITDA divided by sales for the corresponding period • Operating income • Operating margins: Operating income divided by sales for the corresponding period • Cash flows from operating activities before changes in non-cash working capital components and interest and income taxes paid • Long-term debt to EBITDA: Long-term debt (including the current portion) divided by EBITDA • Return on average equity: Net income divided by the mathematical average of the current and prior year’s shareholders’ equity • Working capital ratio: Total current assets divided by total current liabilities • Long-term 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) Management considers these non-IFRS measures to be useful information to assist knowledgeable investors regarding the Company’s financial condition and operating results as they provide additional measures about its performance. 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 Note: Numbers may not add exactly due to rounding. Three-month periods ended Fiscal years ended December 31, 2018 December 31, 2017 December 31, 2018 December 31, 2017 $ 20.6 6.4 4.8 31.8 10.0 41.8 $ 51.1 (26.0) 3.9 29.0 9.0 38.0 $ 137.6 49.6 19.1 206.3 38.1 244.4 $ 167.9 20.5 19.0 207.4 35.7 243.1 Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 19 FOREIGN EXCHANGE The table below shows average and closing exchange rates applicable to Stella-Jones’ quarters for the years 2018 and 2017. 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 denominated in U.S. dollars. Cdn$/US$ rate First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Year 2018 2017 Average Closing Average Closing 1.2549 1.2893 1.3080 1.3129 1.2913 1.2894 1.3168 1.2945 1.3642 1.3642 1.3240 1.3491 1.2664 1.2754 1.3038 1.3310 1.2977 1.2480 1.2545 1.2545 • Average rate: The depreciation of the U.S. dollar relative to the Canadian dollar during 2018 compared to 2017 resulted in a negative impact on sales while benefitting cost of sales. • Closing rate: The appreciation of the U.S. dollar relative to the Canadian dollar as at December 31, 2018, compared to December 31, 2017 resulted in a higher value of assets and liabilities denominated in U.S. dollars, when expressed in Canadian dollars. RAILWAY TIE INDUSTRY OVERVIEW ANNUALIZED RAILWAY TIE PURCHASES AND INVENTORY (in millions of ties) As reported by the Railway Tie Association (“RTA”), purchases for 2018 were 21.2 million ties, versus 23.4 million ties for 2017. The RTA calculates purchases based on the difference between monthly production and the change in inventory, as reported by its members. Inventory levels are lower at 14.4 million as at December 31, 2018, as purchases are outpacing production. As a result, the inventory-to-sales ratio was 0.68:1 as at December 31, 2018, beneath the previous ten- year average ratio of 0.78:1. 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. Total traffic on North American railroads increased 3.4% in 2018, according to data released by the Association of American Railroads. Carload volume grew by 2.0%, mainly due to increased shipments of petroleum and petroleum products, chemicals and metallic ores and metals, whereas the volume of intermodal trailers and containers rose 4.8% from 2017 levels. 30 20 10 0 25 20 15 10 5 0 1993 1998 2003 2008 2013 2018 Source: Railway Tie Association Purchases Inventory FREIGHT HAULED ON NORTH AMERICAN RAILROADS (in millions of units) 2013 2014 2015 2016 2017 2018 Source: Association of American Railroads Intermodal Carloads 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 20 OPERATING RESULTS Sales Sales for the year ended December 31, 2018 reached $2,123.9 million, up 12.6% versus last year’s sales of $1,886.1 million. Acquisitions contributed sales of approximately $60.5 million, while the conversion effect from fluctuations in the value of the Canadian dollar, Stella-Jones’ reporting currency, versus the U.S. dollar, had a negative impact of $12.9 million on the value of U.S. dollar denominated sales when compared with the previous year. Excluding these factors, sales increased approximately $190.2 million, or 10.1%, as detailed below. Railway Ties Utility Poles Residential Lumber Industrial Products Logs & Consolidated Sales Lumber 651.5 654.0 366.2 — (6.9) 17.8 662.4 2.7% 1.4 (3.4) 73.0 725.0 11.2% 43.9 (1.7) 66.3 474.7 18.1% 94.5 14.4 (0.9) 1.0 109.0 1.1% 119.9 1,886.1 0.8 — 32.1 152.8 26.8% 60.5 (12.9) 190.2 2,123.9 10.1% Sales (in millions of dollars, except percentages) 2017 Acquisitions FX impact Organic growth 2018 Organic growth % Note: Numbers may not add exactly due to rounding. SALES BY PRODUCT CATEGORY (% of sales) RAILWAY TIES 31.2% UTILITY POLES 34.1% RAILWAY TIES 34.5% UTILITY POLES 34.7% 2018 $2,123.9 M LOGS AND LUMBER 7.2% INDUSTRIAL PRODUCTS 5.1% RESIDENTIAL LUMBER 22.4% 2017 $1,886.1 M LOGS AND LUMBER 6.4% INDUSTRIAL PRODUCTS 5.0% RESIDENTIAL LUMBER 19.4% Railway Ties Railway tie sales for 2018 amounted to $662.4 million, representing an increase of 1.7%, from sales of $651.5 in 2017. The currency conversion effect decreased the value of U.S. dollar denominated sales by about $6.9 million. Excluding the currency conversion effect, railway tie sales increased approximately $17.8 million, or 2.7%, primarily as a result of price increases in the second half of the year, partially offset by the Company supporting the transition of a Class 1 railroad customer from a “treating services only” program to a full service “black-tie” program in the first half of the year. Railway tie sales accounted for 31.2% of the Company’s total sales in 2018. RAILWAY TIE SALES (in millions of $) 662.4 651.5 2018 2017 UTILITY POLE SALES (in millions of $) 725.0 654.0 RESIDENTIAL LUMBER SALES 2018 2017 (in millions of $) 474.7 366.2 2018 2017 INDUSTRIAL PRODUCT SALES (in millions of $) 109.0 94.5 2018 2017 LOGS AND LUMBER SALES (in millions of $) 152.8 119.9 2018 2017 Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 21 RAILWAY TIE SALES (in millions of $) 662.4 651.5 2018 2017 UTILITY POLE SALES (in millions of $) 725.0 654.0 2018 2017 RESIDENTIAL LUMBER SALES (in millions of $) 474.7 366.2 2018 2017 INDUSTRIAL PRODUCT SALES (in millions of $) 109.0 94.5 2018 2017 LOGS AND LUMBER SALES (in millions of $) 152.8 119.9 2018 2017 Utility Poles Utility pole sales reached $725.0 million in 2018, up 10.9% from sales of $654.0 million in 2017. Acquisitions contributed sales of $1.4 million, while the currency conversion effect decreased the value of U.S. dollar denominated sales by about $3.4 million. Excluding the contribution from acquisitions and the currency conversion effect, utility pole sales increased approximately $73.0 million, or 11.2%, primarily driven by increased sales in the U.S. Southeast, increased projects related to transmission poles, healthy demand for replacement programs and increased sales prices. Utility pole sales accounted for 34.1% of the Company’s total sales in 2018. Residential Lumber Sales in the residential lumber category totalled $474.7 million in 2018, up 29.6% from sales of $366.2 million in 2017. Acquisitions contributed sales of approximately $43.9 million, while the currency conversion effect decreased the value of U.S. dollar denominated sales by about $1.7 million when compared with 2017. Excluding these factors, residential lumber sales increased approximately $66.3 million, or 18.1%. This favourable variance is primarily explained by higher selling prices as a result of higher lumber costs passed through to customers and to increased volume due to the Company’s expanding market presence. Residential lumber accounted for 22.4% of the Company’s total sales in 2018. Industrial Products Industrial product sales reached $109.0 million in 2018, compared with $94.5 million last year. Acquisitions contributed sales of approximately $14.4 million, while the currency conversion effect decreased the value of U.S. dollar denominated sales by about $0.9 million when compared with 2017. Excluding the contribution from acquisitions and the currency conversion effect, sales increased 1.1%, explained in most part by demand for rail-related products and projects requiring laminated products, partially offset by lower demand for bridges and timbers. Industrial products represented 5.1% of the Company’s total sales in 2018. Logs and Lumber Sales in the logs and lumber product category totalled $152.8 million in 2018, compared with $119.9 million in 2017. Excluding the contribution from acquisitions, sales for this product category increased 26.8%. This significant variance reflects higher selling prices due to higher lumber costs coupled with increased harvesting activities to procure raw material to support strong pole sales. Logs and lumber sales represented 7.2% of the Company’s total sales in 2018. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS22 SALES BY GEOGRAPHIC REGION (% of sales) 2018 2017 68.0% UNITED STATES 32.0% CANADA 70.2% UNITED STATES 29.8% CANADA $ 1,444.3 M $ 679.6 M $ 1,324.2 M $ 561.9 M Sales in the United States amounted to $1,444.3 million, or 68.0% of sales in 2018, representing an increase of $120.0 million, or 9.1%, over sales of $1,324.2 million in 2017. This year-over-year increase is mainly attributable to higher sales across all product categories, coupled with the contribution of the WP acquisition, partially offset by the negative effect of local currency translation on U.S.-dollar denominated sales. Sales in Canada amounted to $679.6 million, or 32.0% of sales in 2018, representing an increase of $117.7 million, or 20.9%, over sales of $561.9 million in 2017. This year-over-year increase primarily reflects higher sales in the residential lumber product category driven by volume as well as increased selling prices due to higher lumber costs and the contribution of the PFP acquisition. Moreover, the increase was also impacted by higher sales in the utility pole and logs and lumber product categories. Cost of Sales Cost of sales, including depreciation of property, plant and equipment, as well as amortization of intangible assets, was $1,809.7 million, or 85.2% of sales, in 2018. This compares with $1,586.3 million, or 84.1% of sales, in 2017. The cost of sales increase is explained by the Company supporting the transition of a Class 1 railroad customer from a “treating services only” program to a full service “black-tie” program in the first half of the year. To accelerate this transition, the Company acquired untreated railway ties from the Class 1 railroad customer which increased cost of sales once these ties were treated and sold. Moreover, cost of sales was also impacted by the increasing cost of untreated railway ties and certain untreated species of poles. In addition, the higher lumber costs for the year, which were passed through to the customers via higher selling prices, have contributed to increased cost of sales in the residential product category but have also put downward pressure on margins as a percentage of sales. These cost increases were partially offset by the effect of currency translation. Depreciation and amortization charges reached $38.1 million in 2018, up from $35.7 million in 2017. As a result, gross profit reached $314.2 million, or 14.8% of sales, in 2018, compared with $299.9 million, or 15.9% of sales, in 2017. Selling and Administrative Selling and administrative expenses for 2018 were $99.0 million, compared with expenses of $93.8 million in 2017. This variation is primarily explained by higher taxable tax credits of $2.6 million recognized in 2017, coupled with higher salaries and benefits as well as greater stock-based compensation expenses in 2018, partially offset by the effect of currency translation. As a percentage of sales, selling and administrative expenses represented 4.7% of sales in 2018, slightly down from 5.0% in 2017. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS23 Other Losses (Gains), Net Stella-Jones’ other net losses of $8.9 million for 2018, included a $7.9 million non-cash loss related to the mark-to-market effect of diesel and petroleum derivative commodity contracts. In 2017, other net gains of $1.3 million 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. 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. Financial Expenses Financial expenses reached $19.1 million in 2018, in line with $19.0 million in 2017, as higher year-over-year borrowings, resulting mainly from financing for the acquisitions, were 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 Expense Stella-Jones generated income before income taxes of $187.2 million, or 8.8% of sales, in 2018, in line with income before income taxes of $188.4 million, or 10.0% of sales, in 2017. Stella-Jones’ income tax expense totalled $49.6 million in 2018, representing an effective tax rate of 26.5%. In 2017, the income tax expense stood at $20.5 million, equivalent to an effective tax rate of 10.9%. The lower effective tax rate in 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 favourably affected the Company’s U.S. subsidiaries, specifically by reducing the top federal corporate income tax rate from 35.0% to 21.0%, starting January 1, 2018. Although the Act only came 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. Net Income Net income for 2018 reached $137.6 million, or $1.98 per diluted share, versus net income of $167.9 million, or $2.42 per diluted share, in 2017. This decrease is primarily explained by the lower income tax expense in 2017. BUSINESS ACQUISITIONS Wood Preservers Incorporated On April 9, 2018, the Company completed the acquisition of substantially all of the operating assets employed in the business of WP, located at its wood treating facility in Warsaw, Virginia. WP manufactures, sells and distributes marine and foundation pilings and treated wood utility poles. Total cash outlay associated with the acquisition was approximately $27.5 million (US$21.6 million), excluding acquisition costs of approximately $423,000 recognized in the consolidated statement of income under selling and administrative expenses. The Company financed the acquisition through its existing syndicated credit facilities. The consideration transferred is also comprised of an unsecured promissory note bearing no interest and payable annually on the anniversary of the transaction in six instalments of US$500,000. This unsecured promissory note was recorded at a fair value of $3.3 million (US$2.6 million), using an effective interest rate of 4.17%. The following table 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. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS24 (Tabular information presented in millions of dollars) Assets acquired Accounts receivable Inventories Property, plant and equipment Customer relationships Goodwill Total assets acquired Liabilities assumed Deferred income tax liabilities Total net assets acquired and liabilities assumed Consideration transferred Cash Consideration payable Unsecured promissory note Consideration transferred $ 3.9 8.5 18.2 0.2 1.1 31.9 0.4 31.5 27.5 0.7 3.3 31.5 Prairie Forest Products On February 9, 2018, the Company completed the acquisition of substantially all of the operating assets employed in the business of 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 treated wood utility poles as well as treated residential lumber. Total cash outlay associated with the acquisition was approximately $27.0 million excluding acquisition costs of approximately $425,000 of which $159,000 and $266,000 were recognized respectively in the 2017 and 2018 consolidated statements of income under selling and administrative expenses. The Company financed the acquisition through its existing syndicated credit facilities. The following table 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. (Tabular information presented in millions of dollars) Assets acquired Inventories Property, plant and equipment Customer relationships Goodwill Deferred income tax assets Total assets acquired Liabilities assumed Site remediation provision Total net assets acquired and liabilities assumed Consideration transferred Cash Consideration transferred $ 10.5 7.8 5.9 4.0 0.2 28.4 1.4 27.0 27.0 27.0 Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 25 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. The table below sets forth selected financial information for the Company’s last eight quarters, ending with the most recently completed financial year: 2018 For the quarters ended (in millions of dollars, except EPS) Sales EBITDA Operating income Net income for the period EPS — basic and diluted 2017 For the quarters ended (in millions of dollars, except EPS) Sales EBITDA Operating income Net income for the period EPS — basic and diluted March 31 June 30 Sept. 30 Dec. 31 Total $ $ $ $ $ 398.8 662.3 630.0 432.8 2,123.9 44.0 35.5 23.1 0.33 80.1 71.0 48.1 0.69 78.5 67.9 45.8 0.66 41.8 31.8 20.6 0.30 244.4 206.3 137.6 1.98 March 31 June 30 Sept. 30 Dec. 31 Total $ $ $ $ $ 396.9 594.2 517.6 377.4 1,886.1 49.7 40.8 25.9 0.37 83.6 74.5 48.9 0.71 71.8 63.1 42.0 0.61 38.0 29.0 51.1 0.74 243.1 207.4 167.9 2.42 Note: Due to rounding, the sum of results for the quarters may differ slightly from the total shown for the full year. FOURTH QUARTER RESULTS Highlights Selected Key Indicators (in millions of dollars, except margins and EPS) $ % Q4–2018 Q4–2017 Variation Variation Operating results Sales Gross profit EBITDA EBITDA margin Operating income Net income EPS – basic & diluted Note: Numbers are rounded. 432.8 67.0 41.8 9.7% 31.8 20.6 0.30 377.4 53.5 38.0 10.1% 29.0 51.1 0.74 55.4 13.5 3.8 n/a 2.8 (30.5) (0.44) 14.7% 25.2% 10.0% n/a 9.7% (59.7%) (59.5%) 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 26 Operating Results Sales for the fourth quarter of 2018 amounted to $432.8 million, up 14.7% from sales of $377.4 million for the same period in 2017. Acquisitions contributed sales of approximately $11.4 million, while the conversion effect from fluctuations in the value of the Canadian dollar, Stella-Jones’ reporting currency, versus the U.S. dollar, had a positive impact of $9.0 million on the value of U.S. dollar denominated sales when compared with the corresponding period last year. Excluding these factors, sales increased approximately $35.0 million, or 9.3%, as detailed below. Sales (in millions of dollars, except percentages) Q4-2017 Acquisitions FX impact Organic growth Q4-2018 Organic growth % Note: Numbers may not add exactly due to rounding. Railway Ties Utility Poles Residential Lumber Industrial Products Logs & Consolidated Sales Lumber 118.0 162.9 — 3.3 5.7 127.0 4.8% 0.3 4.4 24.4 192.0 15.0% 48.6 7.2 0.6 3.9 60.3 8.0% 20.0 3.9 0.4 (1.2) 23.1 (6.0%) 27.9 — 0.3 2.2 30.4 7.9% 377.4 11.4 9.0 35.0 432.8 9.3% Sales of railway ties reached $127.0 million, versus $118.0 million last year. Excluding the currency conversion effect, railway tie sales rose 4.8%, driven by price increases. Utility pole sales amounted to $192.0 million, up 17.9% from $162.9 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 15.0% as a result of greater market reach in the U.S. Southeast, increased project activity requiring transmission poles, healthy demand for replacement programs and requirements following the California wildfires in late 2018. Residential lumber sales reached $60.3 million, up from $48.6 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 8.0%, reflecting stronger volume in Canada, partially offset by lower selling prices in the U.S. Industrial product sales amounted to $23.1 million, up from $20.0 million a year ago. Excluding acquisitions and the currency conversion effect, sales decreased 6.0% as a result of lower bridge and timber demand. Finally, logs and lumber sales stood at $30.4 million, versus $27.9 million last year. Excluding the currency conversion effect, sales grew 7.9%, driven, in most part, by heightened pole procurement efforts which resulted in more log sales, partially offset by lower selling prices on lumber. Gross profit amounted to $67.0 million, or 15.5% of sales, in the fourth quarter of 2018, versus $53.5 million, or 14.2% of sales, in the fourth quarter of 2017. The increase as a percentage of sales mainly reflects better year-over-year overhead absorption driven by greater production activity while product margins were comparable to the previous year. Operating income totalled $31.8 million, or 7.4% of sales, in the fourth quarter of 2018, versus $29.0 million, or 7.7% of sales, last year. Net income for the period reached $20.6 million, or $0.30 per diluted share, compared with $51.1 million, or $0.74 per diluted share, in the prior year. The year-over-year decrease is attributable to a one-off non-cash tax benefit of $30.0 million recognized in the fourth quarter of 2017, stemming from the remeasurement of deferred tax liabilities following a reduction in the U.S. top federal corporate income tax rate. Fourth quarter results were also impacted by a non-cash loss of $7.9 million related to the mark-to-market fair value of diesel and petroleum derivative commodity contracts. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 27 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 appreciation of the U.S. dollar relative to the Canadian dollar as at December 31, 2018, compared to December 31, 2017 (see “Foreign Exchange” on page 19), results in a higher value of assets and liabilities denominated in U.S. dollars, when expressed in Canadian dollars. Assets As at December 31, 2018, total assets reached $2.06 billion, versus $1.79 billion as at December 31, 2017. The higher balance of total assets mostly reflects an increase in current assets, as detailed below. As at December 31, 2018 As at December 31, 2017 Variance Assets (in millions of dollars) Accounts receivable Inventories Other current assets Total current assets Property, plant and equipment Intangible assets Goodwill Other non-current assets Total non-current assets $ 192.4 838.6 37.4 1,068.4 551.8 131.7 298.3 12.1 993.9 $ 163.5 718.5 26.4 908.4 466.1 130.3 270.3 10.9 877.6 $ 28.9 120.1 11.0 160.0 85.7 1.4 28.0 1.2 116.3 276.2 Total assets 2,062.2 1,786.0 Note: Numbers may not add exactly due to rounding. The value of accounts receivable, which is net of a credit loss provision of $2.2 million, was $192.4 million as at December 31, 2018, compared with $163.5 million as at December 31, 2017. The increase is attributable to higher sales in the fourth quarter of 2018, when compared to the fourth quarter of 2017, coupled with the effect of local currency translation on U.S.-based accounts receivable. Management considers that all recorded receivables in the statement of financial position are 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 stood at $838.6 million as at December 31, 2018, up from $718.5 million as at December 31, 2017. This increase reflects the effect of local currency translation on U.S. dollar denominated inventories and the inventories pertaining to the PFP and WP acquisitions as well as higher inventory levels in preparation for deliveries in the first half of 2019. 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. As such, inventory turnover has historically been relatively low. 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 customers enable the Company to better ascertain inventory requirements. Management continuously monitors the levels of inventory and market demand for its products. Production is adjusted accordingly to optimize efficiency and capacity utilization. The Company believes that its cash flows from operations and available syndicated credit facilities are adequate to meet its working capital requirements for the foreseeable future. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 28 The value of property, plant and equipment stood at $551.8 million as at December 31, 2018, compared with $466.1 million as at December 31, 2017. This increase is mainly related to the purchase of property, plant and equipment of $51.6 million during 2018, the additional property, plant and equipment from the PFP and WP acquisitions totalling $26.0 million and the effect of local currency translation on U.S-based property, plant and equipment, partially offset by depreciation of $21.1 million for the period. The value of intangible assets and goodwill reached $131.7 million and $298.3 million, respectively, as at December 31, 2018. Intangible assets include customer relationships, the discounted value of non-compete agreements, a creosote registration, cutting rights, standing timber, software and a favourable lease agreement. As at December 31, 2017, intangible assets and goodwill were $130.3 million and $270.3 million, respectively. The slight increase in the value of intangible assets stems primarily from customer relationships from acquisitions and the effect of local currency translation on U.S.-based intangible assets, partially offset by an amortization charge of $17.0 million in 2018. The increase in goodwill is primarily explained by acquisitions and the effect of local currency translation on U.S. dollar denominated goodwill. Liabilities As at December 31, 2018, Stella-Jones’ total liabilities stood at $780.8 million, up from $670.4 million as at December 31, 2017. This variation reflects an increase in non-current liabilities as well as current liabilities, as detailed below. Liabilities (in millions of dollars) Accounts payable and accrued liabilities Current portion of long-term debt Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total non-current liabilities Total liabilities Note: Numbers may not add exactly due to rounding. As at December 31, 2018 As at December 31, 2017 Variance $ 133.3 9.7 16.4 159.4 503.8 117.6 621.4 780.8 $ 111.2 5.7 12.1 129.0 449.9 91.5 541.4 670.4 $ 22.1 4.0 4.3 30.4 53.9 26.1 80.0 110.4 The value of current liabilities was $159.4 million as at December 31, 2018, versus $129.0 million as at December 31, 2017. This variation is primarily attributable to a $22.1 million increase in accounts payable and accrued liabilities related to higher business activity in the fourth quarter of 2018, compared to the same period last year. It is also explained by the effect of local currency translation on U.S. dollar denominated accounts payable and accrued liabilities. The Company’s long-term debt, including the current portion, was $513.5 million as at December 31, 2018, versus $455.6 million as at December 31, 2017. The increase mainly reflects higher working capital requirements, financing required for the acquisitions of PFP and WP, as well as the effect of local currency translation on U.S. dollar denominated long-term debt. As at December 31, 2018, an amount of $291.6 million was available against the Company’s syndicated credit facilities of $579.8 million (US$425.0 million). The Company’s syndicated credit facilities are made available for a five-year term until February 2024 and thus considered long-term debt. As at December 31, 2018, the Company was in full compliance with its debt covenants and contractual obligations. On January 14, 2019, the Company obtained a one-year extension of its unsecured revolving facility to February 27, 2024. This extension was granted through an amendment to the fifth amended and restated credit agreement dated as of February 26, 2016, as amended on May 18, 2016 and March 15, 2018. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 29 Shareholders’ Equity Shareholders’ equity reached $1.28 billion as at December 31, 2018 compared with $1.12 billion as at December 31, 2017. This variation reflects an increase in retained earnings and accumulated other comprehensive income, as detailed below. Shareholders’ equity (in millions of dollars) Capital Stock Contributed surplus Retained earnings Accumulated other comprehensive income As at December 31, 2018 As at December 31, 2017 $ 221.3 0.3 909.1 150.7 $ 220.4 0.3 809.0 85.8 Total shareholders’ equity 1,281.4 1,115.5 Note: Numbers may not add exactly due to rounding. Variance $ 0.9 — 100.1 64.9 165.9 The increase is attributable to net income of $137.6 million during 2018 and a $64.9 million favourable variation in the value of accumulated other comprehensive gain resulting from the effect of currency fluctuations, partially offset by dividends of $33.3 million. As part of its Normal Course Issuer Bid, the Company repurchase, as at December 31, 2018, 105,000 common shares for cancellation in consideration of $4.0 million. As at December 31, 2018, the Company had unsettled transactions to repurchase 42,000 common shares for a cash consideration of $1.6 million. The settlement of these transactions occurred in early January 2019 and the cancellation of the corresponding common shares was done at the same time. LIQUIDITY AND CAPITAL RESOURCES The following table sets forth summarized cash flow components for the periods indicated: Summary of cash flows December 31, 2018 December 31, 2017 (in millions of dollars) Operating activities Financing activities Investing activities Net change in cash and cash equivalents during the year Cash and cash equivalents - beginning Cash and cash equivalents - end Note: Numbers may not add exactly due to rounding. $ 128.1 (26.0) (108.5) (6.4) 6.4 — $ 301.1 (239.9) (58.5) 2.7 3.7 6.4 The Company’s activities, acquisitions and purchases of property, plant and equipment are primarily financed by cash flows from operating activities, available cash and long-term debt. The Company plans a similar level of capital expenditures in 2019 as compared to 2018 ($51.6 million in 2018), which will include a plant expansion in Cameron, Wisconsin. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 30 Cash Flows From Operating Activities Cash flows provided by operating activities in 2018 were $128.1 million, versus $301.1 million for the corresponding period last year. This variation mainly reflects changes in non-cash working capital components, as detailed below. Cash flows from operating activities December 31, 2018 December 31, 2017 (in millions of dollars) Net income Loss on derivative financial instruments Deferred income taxes Others Cash flows from operating activities before changes in non-cash working capital components and interest and income taxes paid Inventories Other current assets Other Changes in non-cash working capital components Interest paid Income taxes paid Cash flows from operating activities Note: Numbers may not add exactly due to rounding. $ 137.6 8.6 10.6 105.5 262.3 (56.7) (15.3) (4.1) (76.1) (18.7) (39.4) 128.1 $ 167.9 0.8 (21.1) 100.6 248.2 100.7 4.4 (2.0) 103.1 (15.8) (34.5) 301.1 Cash flows from operating activities before changes in non-cash working capital components and interest and income taxes paid was $262.3 million in 2018, compared with $248.2 million in 2017. This increase mostly reflects higher deferred income taxes and a loss on derivative financial instruments, partially offset by lower net income. Changes in non-cash working capital components decreased liquidity by $76.1 million in 2018. This was mainly due to an increase in inventory levels and cost. In 2017, changes in non-cash working capital components had increased liquidity by $103.1 million, driven by lower inventory cost and volume of railway ties. Interest and income taxes paid reduced liquidity by $18.7 million and $39.4 million, respectively, in 2018. This compares with interest paid of $15.8 million and income taxes paid of $34.5 million in 2017. As a result, cash flows from operating activities generated $128.1 million in 2018, versus $301.1 million in 2017. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 31 Cash Flows From Financing Activities Financing activities for 2018 reduced liquidity by $26.0 million, primarily related to dividend payments of $33.3 million and the repurchase of common shares totalling $4.0 million. In 2017, financing activities reduced liquidity by $239.9 million explained by a $207.4 million net decrease in debt financing. Cash flows from financing activities December 31, 2018 December 31, 2017 (in millions of dollars) Net change in syndicated credit facilities Increase in long-term debt Repayment of long-term debt Dividends on common shares Repurchase of common shares Other Cash flows from financing activities Note: Numbers may not add exactly due to rounding. $ 18.7 — (6.7) (33.3) (4.0) (0.7) (26.0) $ (391.8) 195.9 (11.5) (30.5) — (2.0) (239.9) Cash Flows From Investing Activities Investing activities used $108.5 million in liquidity in 2018, as compared to $58.5 million in 2017. The PFP and WP acquisitions required an investment of $54.5 million, while the purchase of property, plant and equipment required $51.6 million of liquidity, as detailed below. Cash flows from investing activities December 31, 2018 December 31, 2017 (in millions of dollars) Business acquisitions Purchase of property, plant and equipment Other Cash flows from investing activities Note: Numbers may not add exactly due to rounding. $ (54.5) (51.6) (2.4) (108.5) $ (5.8) (50.6) (2.1) (58.5) Financial Obligations The following table details the maturities of the financial obligations as at December 31, 2018: Financial obligations (in million of dollars) Accounts payable and accrued liabilities Long-term debt obligations Minimum payments under operating lease obligations Derivative commodity agreements Non-compete agreements Financial obligations Carrying Contractual Amount Cash flows Less than 1 year 1 – 3 years 4 – 5 years After 5 years $ 133.3 513.5 — 8.1 4.3 $ 133.3 601.8 132.8 8.3 4.6 $ 133.3 25.5 30.2 4.1 1.6 $ — 51.7 46.9 4.2 3.0 $ — 303.1 26.2 — — $ — 221.5 29.5 — — 659.2 880.8 194.7 105.8 329.3 251.0 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS 32 SHARE AND STOCK OPTION INFORMATION As at December 31, 2018, the capital stock issued and outstanding of the Company consisted of 69,267,732 common shares (69,342,095 as at December 31, 2017). The following table presents the outstanding capital stock activity for the year ended December 31, 2018: Number of shares (in thousands) Balance – Beginning of year Repurchase of common shares Employee share purchase plans Balance – End of year Year Ended December 31, 2018 69,342 (105) 31 69,268 As at March 14, 2019, the capital stock issued and outstanding consisted of 69,125,146 common shares. As at December 31, 2018, the number of outstanding options to acquire common shares issued under the Company’s Stock Option Plan was 45,000 (December 31, 2017 – 45,000) of which 39,000 (December 31, 2017 – 33,000) were exercisable. As at March 14, 2019, the number of outstanding options was 45,000, of which 39,000 were exercisable. DIVIDENDS In 2018, the Board of Directors of Stella-Jones declared the following quarterly dividends: Declared Record Date Payable Date Dividend March 13, 2018 May 2, 2018 August 7, 2018 November 1, 2018 April 6, 2018 June 6, 2018 April 27, 2018 June 27, 2018 September 3, 2018 September 21, 2018 December 3, 2018 December 20, 2018 $ 0.12 0.12 0.12 0.12 Subsequent to year end, on March 14, 2019, the Board of Directors declared a quarterly dividend of $0.14 per common share payable on April 26, 2019 to shareholders of record at the close of business on April 5, 2019. This dividend is designated to be an eligible dividend. 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 33 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 $29.7 million in 2018 (2017 – $19.0 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. RISKS AND UNCERTAINTIES Economic Conditions A negative change in economic conditions may affect most or all of the markets the Company serves, 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, 2018, the Company’s top ten customers accounted for approximately 44.2% of its sales. During this same period, the Company’s largest customer accounted for approximately 16.6%, of its total sales and is associated to the residential lumber product category while the second largest customer accounted for approximately 9.3% of total sales and is associated to the railway tie product category. 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. The Company may also enter into certain commodity hedges, where available, for a percentage of forecasted needs in order to help ensure stable production costs. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS34 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 which has 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 irresponsible practices by regulatory authorities, communities or customers could harm the reputation of the Company. Adverse publicity resulting from actual or perceived violations of environmental laws, regulations or industry practices 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 materialize even if the allegations are not valid and the Company is not found liable. Risk 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35 Insurance Coverage Risk 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 coverage 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. Currency Risk The Company is exposed to currency risks due to its export of certain goods manufactured in Canada. The Company strives to mitigate such risks by purchases of raw materials denominated in U.S. dollars for use in its Canadian manufacturing process. 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 Fluctuation Risk As at December 31, 2018, 96.0% 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 subject to floating interest rates. 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 railroad operators, large retailers and large-scale utility providers, there can be no assurance that outstanding accounts receivable will be paid on a timely basis or at all. Cyber and Information Technology 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. In addition, the Company relies on information technology systems to operate, and any disruption to such systems could cause a disruption to daily operations while the systems are being repaired or updated. 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 flows. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS36 FINANCIAL INSTRUMENTS AND RISK MANAGEMENT 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, 2018, the Company had two interest rate swap agreements hedging $252.4 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, 2018, of fixed and floating debt was 96.0% and 4.0%, respectively, including the effects of interest rate swap positions (100.0% and 0.0%, respectively, as at December 31, 2017). 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, 2018, the Company had no foreign exchange forward contract agreements in place. 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, 2018, the Company had commodity hedges for 12.0 million gallons (1.2 million in 2017) of diesel and petroleum covering requirements for 2019 and 2020. These instruments are presented at fair value and were not designated for hedge accounting purposes. SIGNIFICANT ACCOUNTING POLICIES The Company’s significant accounting policies are described in Note 2 to the December 31, 2018 and 2017 audited consolidated financial statements as well as in the impact of new accounting pronouncements MD&A section that follows with regards to accounting policy changes for revenue recognition and financial instruments. The Company prepares its consolidated financial statements in accordance with IFRS as issued by the IASB and CPA Canada Handbook Part I — Accounting. 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. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS37 Impact of New Accounting Pronouncements 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. The retrospective adoption of this new standard had no significant impact on the Company’s consolidated financial statements and the new accounting policy was defined as follows: The Company sells treated and untreated wood products (the “Products”), as well as treating services. Revenue from the sale of Products is recognized when the Company satisfies a performance obligation by transferring a promised Product to a customer. Products are considered to be transferred once the customer takes control of them, being either at the Company’s manufacturing site or at the customer’s location. Control of the Products refers to the ability to direct its use and obtain substantially all of the remaining benefits from the Product. The Company offers to treat wood products owned by third parties. Revenue from these treating services is recognized using the point in time criteria since there is a short manufacturing timeframe to treat wood products. Product sales can be subject to retrospective volume discounts based on aggregate sales over a twelve-month period per certain contractual conditions. Revenue from these sales is recognized based on the price specified in the contract, net of the estimated volume discounts. Accumulated experience is used to estimate and provide for the discounts, using the expected value method, and revenue is only recognized to the extent that it is highly probable that a significant reversal will not occur. A liability is recognized for expected volume discounts payable to customers in relation to sales made until the end of the reporting period. Products sales may also be subject to retrospective price discounts based on aggregate sales over a twelve-month period, according to certain contractual conditions. Revenue from these sales is recognized based on the expected average sales price over the specified period. Accumulated experience is used to estimate and provide for the price discounts, using the expected value method, and revenue is only recognized to the extent that it is highly probable that specified contractual conditions will be met. The customer is invoiced at the contract price and a liability is recognized to adjust to the average price. A receivable is recognized when control of the Product is transferred to the customer because it is at this point in time that the consideration becomes unconditional since only the passage of time remains before payment is due. IFRS 9 — Financial Instruments The final version of IFRS 9, Financial instruments, was issued by the IASB in July 2014 and replaces 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. The retrospective adoption of this new standard had no significant impact on the Company’s consolidated financial statements and the new accounting policy was defined as follows: The Company recognizes a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. At initial recognition, the Company measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or the financial liability. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS38 Financial Assets The Company will classify financial assets as subsequently measured at amortized cost, fair value through other comprehensive income or fair value through profit or loss, based on its business model for managing the financial asset and the financial asset’s contractual cash flow characteristics. The three categories are defined as follows: a) Amortized cost — a financial asset is measured at amortized cost if both of the following conditions are met: — the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows; and — the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. b) Fair value through other comprehensive income — financial assets are classified and measured at fair value through other comprehensive income if they are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. c) Fair value through profit or loss — any financial assets that are not held in one of the two business models mentioned in a) and b) are measured at fair value through profit or loss. When, and only when, the Company changes its business model for managing financial assets it must reclassify all affected financial assets. The Company’s financial assets are comprised of cash, cash equivalents, accounts receivable and derivative financial instruments. Cash, cash equivalents and accounts receivable are measured at amortized cost. Derivative financial instruments that are not designated as hedging instruments are measured at fair value through profit or loss. Derivative financial instruments that are designated as hedging instruments are measured at fair value through other comprehensive income. Financial Liabilities The Company’s liabilities include accounts payable and accrued liabilities, bank indebtedness, long-term debt and derivative financial instruments. Accounts payable and accrued liabilities, bank indebtedness and long-term debt are measured at amortized cost. Derivative financial instruments that are not designated as hedging instruments are measured at fair value through profit or loss. Derivative financial instruments that are designated as hedging instruments are measured at fair value through other comprehensive income. After initial recognition, an entity cannot reclassify any financial liability. Impairment The Company assesses, on a forward-looking basis, the expected credit losses associated with its investment in debt securities carried at amortized cost and fair value through other comprehensive income. The impairment methodology applied depends on whether there has been a significant increase in credit risk. For trade receivables, the Company applies the simplified approach permitted by IFRS 9, which requires expected lifetime losses to be recognized from initial recognition of the receivables. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS 39 Hedging Transactions As part of its hedging strategy, the Company considers derivative financial instruments such as 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 derivative financial instruments are treated as cash flow hedges for accounting purposes and are fair-valued through other comprehensive income. The effective portion of changes in the fair value of derivative instruments that are designated and qualify as cash flow hedges is recognized in the cash flow hedge reserve within equity. The gain or loss relating to the ineffective portion is recognized immediately in profit or loss, within other income (expenses). When forward contracts are used to hedge forecast transactions, the Company generally designates only the change in fair value of the forward contract related to the spot component as the hedging instrument. Gains or losses relating to the effective portion of the change in the spot component of the forward contracts are recognized in the cash flow hedge reserve within equity. The change in the forward element of the contract that relates to the hedged item is recognized within other comprehensive income in the costs of hedging reserve within equity. In some cases, the Company may designate the full change in fair value of the forward contract (including forward points) as the hedging instrument. In such cases, the gains or losses relating to the effective portion of the change in fair value of the entire forward contract are recognized in the cash flow hedge reserve within equity. Amounts accumulated in equity are reclassified in the periods when the hedged item affects profit or loss. When a hedging instrument expires, or is sold or terminated, or when a hedge no longer meets the criteria for hedge accounting, any cumulative deferred gain or loss and deferred costs of hedging in equity at that time remains in equity until the forecast transaction occurs. When the forecast transaction is no longer expected to occur, the cumulative gain or loss and deferred costs of hedging that were reported in equity are immediately reclassified to profit or loss. Impact of New Accounting Pronouncements Not Yet Implemented IFRS 16 — Leases In January 2016, the IASB released IFRS 16, Leases, to set out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a lease agreement. The standard 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. Under the new standard, the Company will recognize, in the statement of financial position, assets (right to use the leased assets) totalling approximately $119.0 million, equivalent to the discounted cash flows of the future minimum payments, and corresponding financial liabilities. The assets will be depreciated over the duration of the lease agreements which has a weighted average of 78 months. The liabilities will be depleted upon contractual payment to the lessors and a corresponding financing expense will be recorded to the consolidated statements of income. The Company is currently assessing the impact of the new standard on its net income. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS40 The following table outlines the key areas that will be impacted by the adoption of IFRS 16: Impacted areas of the business Analysis Conclusion Financial reporting The analysis includes determining which contracts will be in scope as well as the options available under the new standard and whether to apply the new standard on a full retrospective application in accordance with IAS 8 or retrospectively without restatement of comparative amounts. The Company will adopt IFRS 16 for its fiscal year beginning January 1, 2019, retrospectively, without restatement of comparative amounts and shall use the exemptions for short-term leases and leases for which the underlying asset is of low value. Information systems The Company has analyzed the need to make changes within its information systems environment to optimize the management of close to 700 lease agreements that will fall within the scope of the new standard. The Company has implemented an information technology solution to support recognition and measurement of leases in scope. The implementation was completed before the end of fiscal 2018. Internal controls The Company has performed a review and analysis of the changes to the control environment as a result of the adoption of IFRS 16. New controls were implemented to enable monthly reconciliations of the assets and liabilities to detailed subledgers as well as reconciliations of the related financial and depreciation expenses. A roll forward analysis of these assets and liabilities will also be performed monthly. All lease agreements are approved by Head Office Management to ensure they are all captured for accounting purposes. Stakeholders The Company has performed an analysis of the impact on the disclosure to its stakeholders as a result of the adoption of IFRS 16. The Company concluded that there will be no negative impact or breaches of agreement covenant as a result of the adoption of IFRS 16. IFRIC 23 — Uncertainty over Income Tax Treatments In June 2017, the IASB issued IFRIC 23, Uncertainty over Income Tax Treatments. This interpretation specifies that if an entity concludes it is probable that the taxation authority will accept an uncertain tax treatment, it shall determine the tax result consistently with the tax treatment used or planned to be used in its income tax filing. If it is not probable, the entity shall reflect the effect of uncertainty for each uncertain tax treatment by using either of the following methods, depending on which one the entity expects to better predict the resolution of the uncertainty: • most likely amount: single most likely amount in a range of possible outcomes; • expected value: sum of the probability-weighted amounts in a range of possible outcomes. An entity shall apply IFRIC 23 for annual reporting periods beginning on or after January 1, 2019, with earlier application permitted. The Company will not early adopt IFRIC 23 and does not expect a significant impact. IFRS 3 — Business Combinations In October 2018, the IASB issued amendments to the definition of a business in IFRS 3, Business Combinations. The objective of the amendments is to assist entities in determining whether a transaction should be accounted for as a business combination or as an asset. The amendments apply prospectively to acquisitions that occur in annual periods beginning on or after January 1, 2020, with earlier application permitted. Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSIS41 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. 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, 2018 and have concluded that such DC&P were designed and operating effectively. INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible 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, 2018. 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, 2018 to December 31, 2018 that have materially affected or are reasonably likely to materially affect the Company’s ICFR. 2018 Annual ReportMANAGEMENT’S DISCUSSION AND ANALYSIS42 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. For 2019, based on current market conditions and assuming stable currencies and the current level of lumber prices, Management expects higher year-over-year sales for Stella-Jones, driven by stronger pricing for railway ties and utility poles as well as increased market reach for the residential lumber and the utility pole product categories. Management also expects improved year-over-year margins across all product categories. Higher margins will be primarily driven by increased pricing and volume for railway ties coupled with improved product mix for utility poles. Furthermore, it is important to note that the 2019 EBITDA will be positively impacted by the implementation of IFRS 16 while net income will be negatively impacted by higher financing expenses. The Company plans on spending a similar level of capital expenditures in 2019 as compared to 2018 ($51.6 million in 2018), which will include a plant expansion in Cameron, Wisconsin. In the railway tie product category, North American railroads will continue to maintain their continental rail network, as operators constantly seek optimal line efficiency. Sales and margins for 2019 are expected to improve year-over-year, primarily driven by pricing. In fact, Management believes that the increasing costs of untreated railway ties, combined with a tighter supply market, will lead to continued upward selling price adjustments for the quarters ahead. In the utility pole product category, demand for regular maintenance projects has historically been relatively steady. Sales and margins for 2019 are expected to increase year-over-year driven by both pricing and strong demand for replacement programs and increased project-based sales. In the residential lumber product category, 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 2019 are expected to be stable, year-over-year, as higher market demand is expected to be offset by lower selling prices to customers, as a result of the lower lumber costs. Management closely monitors variations in these commodity prices, and adjusts its procurement practices accordingly, in order to maintain dollar margins on similar volume. It is important to highlight that sales for the logs and lumber product category, an activity used to optimize procurement and which does not generate margin, is fairly tied to the price of lumber. Therefore, a decrease in the price of lumber will lead to lower sales but higher overall margins when taken as a whole with other product categories and vice versa. As one of the leading 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 optimizing operating capacity and minimizing costs throughout the organization. Cash generation and maintaining a prudent use of leverage remain priorities for Management. The cash flows provided from operating activities will be used to reduce debt, invest in working capital and in property, plant and equipment, buy back its own shares as well as maintain an optimal dividend policy to the benefit of shareholders. 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 synergies, and add value for shareholders. March 14, 2019 Stella-Jones Inc.MANAGEMENT’S DISCUSSION AND ANALYSISCONSOLIDATED FINANCIAL STATEMENTS 43 December 31, 2018 and 2017 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 14, 2019 2018 Annual Report 44 INDEPENDENT AUDITOR’S REPORT To the Shareholders of Stella-Jones Inc. OUR OPINION In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Stella-Jones Inc. and its subsidiaries (together, the Company) as at December 31, 2018 and 2017, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS). WHAT WE HAVE AUDITED The Company’s consolidated financial statements comprise: • the consolidated statements of financial position as at December 31, 2018 and 2017; • the consolidated statements of changes in shareholders’ equity for the years then ended; • the consolidated statements of income for the years then ended; • the consolidated statements of comprehensive income for the years then ended; • the consolidated statements of cash flows for the years then ended; and • the notes to the consolidated financial statements, which include a summary of significant accounting policies. BASIS FOR OPINION We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. INDEPENDENCE We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements. OTHER INFORMATION Management is responsible for the other information. The other information comprises the Management’s Discussion and Analysis, which we obtained prior to the date of this auditor’s report and the information, other than the consolidated financial statements and our auditor’s report thereon, included in the annual report. Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. Stella-Jones Inc.INDEPENDENT AUDITOR’S REPORT 45 In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. RESPONSIBILITIES OF MANAGEMENT AND THOSE CHARGED WITH GOVERNANCE FOR THE CONSOLIDATED FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, 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. In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Company’s financial reporting process. AUDITOR’S RESPONSIBILITIES FOR THE AUDIT OF THE CONSOLIDATED FINANCIAL STATEMENTS Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: • Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. • Obtain an understanding of internal control relevant to the audit 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 Company’s internal control. • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. 2018 Annual Report 46 INDEPENDENT AUDITOR’S REPORT • Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern. • Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Sonia Boisvert. Montréal, Québec March 14, 2019 1 FCPA auditor, FCA, public accountancy permit No. A116853 Stella-Jones Inc. CONSOLIDATED STATEMENTS OF FINANCIAL POSITION 47 As at December 31, 2018 and 2017 (expressed in thousands of Canadian dollars) Note 2018 $ — 192,380 — 838,558 1,882 35,567 1,068,387 551,785 131,658 298,270 7,545 4,559 2017 $ 6,430 163,458 473 718,462 1,122 18,435 908,380 466,056 130,349 270,261 6,173 4,761 2,062,204 1,785,980 133,259 4,381 9,714 12,016 159,370 111,206 — 5,695 12,114 129,015 503,767 449,945 92,557 13,959 7,393 3,748 72,408 11,392 7,675 — 780,794 670,435 221,328 348 909,060 150,674 1,281,410 2,062,204 220,467 298 809,022 85,758 1,115,545 1,785,980 ASSETS Current assets Cash Accounts receivable Derivative financial instruments Inventories Income taxes receivable Other current assets Non-current assets Property, plant and equipment Intangible assets Goodwill Derivative financial instruments Other non-current assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Accounts payable and accrued liabilities Derivative financial instruments 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 The accompanying notes are an integral part of these consolidated financial statements. Approved by the Board of Directors, Katherine A. Lehman Director George J. Bunze, CPA, CMA Director 5 18 6 7 8 8 18 9 18 10 11 10 15 11 16 18 13 17 22 2018 Annual Report 48 CONSOLIDATED STATEMENTS OF CHANGE IN SHAREHOLDERS’ EQUITY For the years ended December 31, 2018 and 2017 (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, 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 Share-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 Balance – January 1, 2018 220,467 298 809,022 150,620 (69,421) 4,559 85,758 1,115,545 Comprehensive income (loss) Net income for the year Other comprehensive income (loss) Comprehensive income (loss) for the year Dividends on common shares — — — — Employee share purchase plans 1,330 Repurchase of common shares (note 13) (469) Share-based compensation (note 13) — 861 — 137,597 — — — — 137,597 — 927 101,529 (37,602) 989 64,916 65,843 — 138,524 101,529 (37,602) 989 64,916 203,440 — (33,290) — — 50 — (5,196) — 50 (38,486) — — — — — — — — — — — — — — — — — — — — (33,290) 1,330 (5,665) 50 (37,575) Balance – December 31, 2018 221,328 348 909,060 252,149 (107,023) 5,548 150,674 1,281,410 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 49 For the years ended December 31, 2018 and 2017 (expressed in thousands of Canadian dollars, except earnings per common share) Note 2018 $ 2017 $ 2,123,893 1,886,142 1,809,733 1,586,263 98,995 8,864 93,828 (1,337) 14 1,917,592 1,678,754 14 15 15 13 13 206,301 19,102 187,199 207,388 19,009 188,379 39,018 10,584 49,602 137,597 1.98 1.98 41,566 (21,076) 20,490 167,889 2.42 2.42 The accompanying notes are an integral part of these consolidated financial statements. 2018 Annual Report 50 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the years ended December 31, 2018 and 2017 (expressed in thousands of Canadian dollars) Net income for the year Other comprehensive income Items that may subsequently be reclassified to net income 2018 $ 2017 $ 137,597 167,889 Net change in gains (losses) on translation of financial statements of foreign operations 101,529 (81,920) Income taxes on change in gains (losses) on translation of financial statements of foreign operations Change in gains (losses) on translation of long-term debts designated as hedges of net investment in foreign operations Income taxes on change in gains (losses) 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 (34,332) 29,332 (3,270) 1,372 (6,221) 1,026 (383) (296) 1,209 (282) 65,843 203,440 (737) (246) (49,646) 118,243 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 Loss on derivative financial instruments 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 Income taxes receivable Accounts payable and accrued liabilities Asset retirement obligations Provisions and other long-term liabilities Other current assets 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 Repayment of non-competes payable Dividends on common shares Repurchase of common shares Proceeds from issuance of common shares Investing activities Increase in other assets Business acquisitions Addition of 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 FLOWS 51 For the years ended December 31, 2018 and 2017 (expressed in thousands of Canadian dollars) Note 2018 $ 2017 $ 7 8 15 15 12 12 12 12 4 137,597 167,889 21,086 17,016 8,601 19,102 39,018 10,584 7,189 2,060 19,078 16,656 770 19,009 41,566 (21,076) 4,549 (199) 262,253 248,242 (13,230) (56,716) — 13,428 (2,304) (1,968) (15,335) (76,125) (18,693) (39,371) 128,064 (255) 18,742 — (6,705) (1,745) (33,290) (4,038) 1,330 (11,026) 100,683 (2,746) 16,694 (3,369) (1,494) 4,380 103,122 (15,797) (34,454) 301,113 (1,132) (391,796) 195,870 (11,507) (2,156) (30,504) — 1,301 (25,961) (239,924) (836) (54,491) (4,028) (51,568) 2,390 (108,533) (6,430) 6,430 — (710) (5,792) (2,080) (50,572) 676 (58,478) 2,711 3,719 6,430 2018 Annual Report 52 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. The Company 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 – Accounting. These consolidated financial statements were approved by the Board of Directors on March 14, 2019. 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 LLC Kisatchie Midnight Express, L.L.C. 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 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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 53 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 assumed 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 functional and 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. Revenues 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, within other losses (gains), net, except for 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 are translated at historical exchange rates. 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. Goodwill and fair value adjustments arising on the acquisition of a foreign operation are treated as assets and liabilities of the foreign operation and translated at the financial position rate. d) Hedges of net investments in foreign operations Foreign currency differences arising on the translation of financial liabilities 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 54 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Revenue recognition The Company has adopted IFRS 15 Revenue from Contracts with Customers from January 1, 2018 which resulted in changes in accounting policies. In accordance with the transition provisions in IFRS 15, the Company has adopted the new rules retrospectively. The Company sells treated and untreated wood products (the “Products”), as well as wood treating services. Revenue from the sale of Products is recognized when the Company satisfies a performance obligation by transferring a promised Product to a customer. Products are considered to be transferred once the customer takes control of them, being either at the Company’s manufacturing site or at the customer’s location. Control of the Products refers to the ability to direct its use and obtain substantially all the remaining benefits from the Product. The Company offers to treat wood products owned by third parties. Revenue from these treating services is recognized using the point in time criteria since there is a short manufacturing timeframe to treat wood products. Product sales can be subject to retrospective volume discounts based on aggregate sales over a twelve-month period, per certain contractual conditions. Revenue from these sales is recognized based on the price specified in the contract, net of the estimated volume discounts. Accumulated experience is used to estimate and provide for the discounts, using the expected value method, and revenue is only recognized to the extent that it is highly probable that a significant reversal will not occur. A liability is recognized for expected volume discounts payable to customers in relation to sales transacted to the end of the reporting period. Product sales may also be subject to retrospective price discounts based on aggregate sales over a twelve-month period, according to certain contractual conditions. Revenue from these sales is recognized based on the expected average sales price over the specified period. Accumulated experience is used to estimate and provide for the price discounts, using the expected value method, and revenue is only recognized to the extent that it is highly probable that specified contractual conditions will be met. The customer is invoiced at the contract price and a liability is recognized to adjust to the average price. A receivable is recognized when control of the Products is transferred to the customer because it is at this point in time that the consideration becomes unconditional since only the passage of time remains before the payment is due. 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. 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 credit loss provision. 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 costs necessary to make the sale. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 55 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 and impairment. 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. Software Customer relationships Customer relationships Non-compete agreements Creosote registration Method Straight-line Straight-line Declining balance Straight-line – Useful life 10 years 3 to 12 years 4% to 20% 3 to 5 years Indefinite Standing timber costs are recorded at cost less accumulated amortization and impairment. Amortization 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 and impairment. Amortization 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 56 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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 57 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 income tax expense or credit for the period is the tax payable on the current period’s taxable income based on the applicable income tax rate for each jurisdiction adjusted by changes in deferred tax assets and liabilities attributable to temporary differences and to unused tax losses. The current income tax charge is calculated on the basis of the tax laws enacted or substantively enacted at the end of the reporting period in the countries where the Company operates and generates taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. It establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities. Deferred income tax is provided in full, 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. However, deferred tax liabilities are not recognized if they arise from the initial recognition of goodwill. Deferred income tax is also not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantially enacted by the end of the reporting period and are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled. Deferred tax assets are recognized only if it is probable that future taxable amounts will be available to utilize those temporary differences and losses. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 58 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. Share-based compensation and other share-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 share-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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 59 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Financial Instruments IFRS 9, Financial instruments replaces the provisions of IAS 39 that relate to the recognition, classification and measurement of financial assets and financial liabilities, derecognition of financial instruments, impairment of financial assets and hedge accounting. The adoption of IFRS 9 from January 1, 2018 resulted in changes in accounting policies applied retrospectively. The Company recognizes a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. At initial recognition, the Company measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or the financial liability. Financial assets The Company will classify financial assets as subsequently measured at amortized cost, fair value through other comprehensive income or fair value through profit or loss, based on its business model for managing the financial asset and the financial asset’s contractual cash flow characteristics. The three categories are defined as follows: a) Amortized cost — a financial asset is measured at amortized cost if both of the following conditions are met: • the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows; and • the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. b) Fair value through other comprehensive income — financial assets are classified and measured at fair value through other comprehensive income if they are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. c) Fair value through profit or loss — any financial assets that are not held in one of the two business models mentioned in a) and b) are measured at fair value through profit or loss. When, and only when, the Company changes its business model for managing financial assets it must reclassify all affected financial assets. The Company’s financial assets are comprised of cash, cash equivalents, accounts receivable and derivative financial instruments. Cash, cash equivalents and accounts receivable are measured at amortized cost. Derivative financial instruments that are not designated as hedging instruments are measured at fair value through profit or loss. Derivative financial instruments that are designated as hedging instruments are measured at fair value through other comprehensive income. Financial liabilities The Company’s liabilities include accounts payable and accrued liabilities, bank indebtedness, long-term debt and derivative financial instruments. Accounts payable and accrued liabilities, bank indebtedness and long-term debt are measured at amortized cost. Derivative financial instruments that are not designated as hedging instruments are measured at fair value through profit or loss. Derivative financial instruments that are designated as hedging instruments are measured at fair value through other comprehensive income. After initial recognition, an entity cannot reclassify any financial liability. Impairment The Company assesses, on a forward-looking basis, the expected credit losses associated with its investment in debt securities carried at amortized cost and fair value through other comprehensive income. The impairment methodology applied depends on whether there has been a significant increase in credit risk. For trade receivables, the Company applies the simplified approach permitted by IFRS 9, which requires expected lifetime losses to be recognized from initial recognition of the receivables. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 60 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Financial instruments (continued) Hedging transactions As part of its hedging strategy, the Company considers derivative financial instruments such as 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 derivative financial instruments are treated as cash flow hedges for accounting purposes and are fair-valued through other comprehensive income. The effective portion of changes in the fair value of derivative instruments that are designated and qualify as cash flow hedges is recognized in the cash flow hedge reserve within equity. The gain or loss relating to the ineffective portion is recognized immediately in profit or loss, within other income (expenses). When forward contracts are used to hedge forecast transactions, the Company generally designates only the change in fair value of the forward contract related to the spot component as the hedging instrument. Gains or losses relating to the effective portion of the change in the spot component of the forward contracts are recognized in the cash flow hedge reserve within equity. The change in the forward element of the contract that relates to the hedged item is recognized within other comprehensive income in the costs of hedging reserve within equity. In some cases, the Company may designate the full change in fair value of the forward contract (including forward points) as the hedging instrument. In such cases, the gains or losses relating to the effective portion of the change in fair value of the entire forward contract are recognized in the cash flow hedge reserve within equity. Amounts accumulated in equity are reclassified in the periods when the hedged item affects profit or loss. When a hedging instrument expires, or is sold or terminated, or when a hedge no longer meets the criteria for hedge accounting, any cumulative deferred gain or loss and deferred costs of hedging in equity at that time remains in equity until the forecast transaction occurs. When the forecast transaction is no longer expected to occur, the cumulative gain or loss and deferred costs of hedging that were reported in equity are immediately reclassified to profit or loss. 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 new standards, along with any consequential amendments, effective January 1, 2018. These changes were made in accordance with the applicable transitional provisions. 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. Note 2 provides a summary of the new revenue recognition accounting policy that was implemented retrospectively on January 1, 2018. The adoption of this new standard had no significant impact on the Company’s consolidated financial statements. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 61 2 SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) IFRS 9 – Financial Instruments The final version of IFRS 9, Financial instruments, was issued by the IASB in July 2014 and replaces 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. Note 2 provides a summary of the new financial instruments accounting policy that was implemented retrospectively on January 1, 2018. The adoption of this new standard had no significant impact on the Company’s consolidated financial statements. Impact of accounting pronouncements not yet implemented IFRS 16 – Leases In January 2016, the IASB released IFRS 16, Leases, to set out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a lease agreement. The standard 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. Under the new standard, the Company will recognize, in the statement of financial position, assets (right to use the leased assets) totalling approximately $119,000, equivalent to the discounted cash flows of the future minimum payments, and corresponding financial liabilities. The assets will be depreciated over the duration of the lease agreements, which has a weighted average of 78 months. The liabilities will be depleted upon contractual payment to the lessors and a corresponding financing expense will be recorded to the consolidated statement of income. The Company is currently assessing the impact of the new standard on its net income. The Company will adopt IFRS 16 for its fiscal year beginning January 1, 2019 retrospectively without restatement of comparative amounts and will use the exemptions for short-term leases and leases for which the underlying asset is of low value. IFRIC 23 – Uncertainty over Income Tax Treatments In June 2017, the IASB issued IFRIC 23, Uncertainty over Income Tax Treatments. This interpretation specifies that if an entity concludes it is probable that the taxation authority will accept an uncertain tax treatment, it shall determine the tax result consistently with the tax treatment used or planned to be used in its income tax filing. If it is not probable, the entity shall reflect the effect of uncertainty for each uncertain tax treatment by using either of the following methods, depending on which one the entity expects to better predict the resolution of the uncertainty: • • An entity shall apply IFRIC 23 for annual reporting periods beginning on or after January 1, 2019, with earlier application permitted. The Company will not early adopt IFRIC 23 and does not expect a significant impact. most likely amount: single most likely amount in a range of possible outcomes; expected value: sum of the probability-weighted amounts in a range of possible outcomes. IFRS 3 – Business Combinations In October 2018, the IASB issued amendments to the definition of a business in IFRS 3, Business Combinations. The objective of the amendments is to assist entities in determining whether a transaction should be accounted for as a business combination or as an asset. The amendments apply prospectively to acquisitions that occur in annual periods beginning on or after January 1, 2020, with earlier application permitted. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 62 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 April 9, 2018, the Company completed the acquisition of substantially all of the operating assets employed in the business of Wood Preservers Incorporated (“WP”), located at its wood treating facility in Warsaw, Virginia. WP manufactures, sells and distributes marine and foundation pilings and treated wood utility poles. Total cash outlay associated with the acquisition was approximately $27,506 (US$21,609), excluding acquisition costs of approximately $423 recognized in the consolidated statement of income under selling and administrative expenses. The Company financed the acquisition through its existing syndicated credit facilities. The consideration transferred is also comprised of an unsecured promissory note bearing no interest and payable annually on the anniversary of the transaction in six instalments of US$500. This unsecured promissory note was recorded at a fair value of $3,339 (US$2,623), using an effective interest rate of 4.17%. The following table 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 Accounts receivable Inventories Property, plant and equipment Customer relationships Goodwill Liabilities assumed Deferred income tax liabilities Total net assets acquired and liabilities assumed Consideration transferred Cash Consideration payable Unsecured promissory note Consideration transferred $ 3,923 8,485 18,212 242 1,061 31,923 424 31,499 27,506 654 3,339 31,499 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 63 4 BUSINESS ACQUISITIONS (CONTINUED) The Company’s valuation of intangible assets has identified customer relationships which are amortized at a declining rate of 4.00%. 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 is 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. In the period from April 9, 2018 to December 31, 2018, sales and net income for the Warsaw plant amounted to $28,760 and $1,859, respectively. Pro forma information for the twelve-month period ended December 31, 2018, had the WP acquisition occurred as of January 1, 2018, cannot be estimated as Management does not have all the required discrete financial information for the first three months of the year. b) On February 9, 2018, the Company completed the acquisition of substantially all of 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 treated wood utility poles as well as treated residential lumber. Total cash outlay associated with the acquisition was approximately $26,985 excluding acquisition costs of approximately $425 of which $159 and $266 were recognized respectively in the 2017 and 2018 consolidated statements of income under selling and administrative expenses. The Company financed the acquisition through its existing syndicated credit facilities. The following table 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 Site remediation provision Total net assets acquired and liabilities assumed Consideration transferred Cash Consideration transferred $ 10,536 7,763 5,880 3,995 229 28,403 1,418 26,985 26,985 26,985 The Company’s valuation of intangible assets has identified customer relationships which are amortized at a declining rate of 10.00%. 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 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 64 4 BUSINESS ACQUISITIONS (CONTINUED) In the period from February 9, 2018 to December 31, 2018, sales and net income for the Neepawa plant amounted to $31,657 and $890, respectively. Pro forma information for the twelve-month period ended December 31, 2018, had the PFP acquisition occurred as of January 1, 2018, cannot be estimated as Management does not have all the required discrete financial information for the first month of the year. 5 ACCOUNTS RECEIVABLE Trade receivables Less: Credit loss provision Trade receivables – net Note Amounts receivable from related parties 20 Other receivables 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 2018 $ 184,376 (2,209) 182,167 454 9,759 192,380 2018 $ 113,783 51,214 11,251 8,128 184,376 2018 $ 516,742 321,816 838,558 2017 $ 159,964 (991) 158,973 — 4,485 163,458 2017 $ 98,355 43,416 9,230 8,963 159,964 2017 $ 423,312 295,150 718,462 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 65 7 PROPERTY, PLANT AND EQUIPMENT As at January 1, 2017 Cost Accumulated depreciation Net book amount Year ended December 31, 2017 Opening net book amount Business acquisitions Additions Disposals Depreciation Land Buildings Production equipment $ $ $ Rolling stock $ Others $ Total $ 45,981 113,768 356,892 29,815 12,584 559,040 — (16,542) (64,602) (12,901) (6,404) (100,449) 45,981 97,226 292,290 16,914 6,180 458,591 45,981 97,226 292,290 16,914 6,180 458,591 204 941 3,353 301 9 4,384 4,250 35,337 1,130 2,663 4,808 47,764 (143) (235) (998) (629) (4) (2,009) — (3,066) (10,231) (4,276) (1,505) (19,078) Exchange differences (1,974) (5,516) (15,343) (884) (303) (24,020) Closing net book amount 48,452 93,600 304,408 12,556 7,040 466,056 As at December 31, 2017 Cost Accumulated depreciation Net book amount Year ended December 31, 2018 Opening net book amount Business acquisitions Additions Disposals Depreciation 48,452 112,272 376,203 27,944 14,762 579,633 — (18,672) (71,795) (15,388) (7,722) (113,577) 48,452 93,600 304,408 12,556 7,040 466,056 48,452 93,600 304,408 12,556 7,040 466,056 1,121 1,630 7,823 12,797 4,117 117 25,975 3,165 43,919 (1,622) — (478) 669 (853) 1,031 50,414 (3) (2,956) — (3,406) (12,260) (4,272) (1,148) (21,086) Exchange differences 2,618 7,416 21,386 1,189 773 33,382 Closing net book amount 52,199 108,598 369,772 13,406 7,810 551,785 As at December 31, 2018 Cost Accumulated depreciation Net book amount 52,199 131,933 457,904 32,998 16,959 691,993 — (23,335) (88,132) (19,592) (9,149) (140,208) 52,199 108,598 369,772 13,406 7,810 551,785 December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 66 8 INTANGIBLE ASSETS AND GOODWILL The intangible assets include customer relationships, non-compete agreements, cutting rights, standing timber, a favourable land lease agreement, software 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 of 2.95%. 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 2018 $ 144,546 153,724 298,270 2017 $ 128,898 141,363 270,261 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 10.10%. 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). December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 67 8 INTANGIBLE ASSETS AND GOODWILL (CONTINUED) The net book amount of these intangible assets and goodwill was as follows: Intangible assets Cutting rights relationships Customer Non-compete agreements Software Others Creosote registration Total Goodwill $ $ $ $ $ $ $ $ As at January 1, 2017 Cost 6,821 157,626 17,413 7,140 7,903 41,933 238,836 287,367 Accumulated amortization (1,455) (66,208) (10,764) (2,081) (5,955) — (86,463) — Net book amount 5,366 91,418 6,649 5,059 1,948 41,933 152,373 287,367 Year ended December 31, 2017 Opening net book balance 5,366 91,418 6,649 5,059 1,948 41,933 152,373 287,367 Business acquisitions Additions Amortization — — — — — — — 1,603 — 477 (176) (13,445) (1,839) (677) (519) — — — — 844 2,080 (16,656) — — Exchange differences — (4,255) (368) — (70) (2,755) (7,448) (17,950) Closing net book amount 5,190 73,718 4,442 5,985 1,836 39,178 130,349 270,261 As at December 31, 2017 Cost 6,821 148,740 16,270 8,743 8,310 39,178 228,062 270,261 Accumulated amortization (1,631) (75,022) (11,828) (2,758) (6,474) — (97,713) — Net book amount 5,190 73,718 4,442 5,985 1,836 39,178 130,349 270,261 Year ended December 31, 2018 Opening net book balance 5,190 73,718 4,442 5,985 1,836 39,178 130,349 270,261 Business acquisitions Additions Amortization — — 6,122 — — — — — 869 3,159 (256) (12,193) (1,612) (831) (2,124) — — — 6,122 4,028 (17,016) 5,599 — — Exchange differences — 4,363 298 — 88 3,426 8,175 22,410 Closing net book amount 4,934 72,010 3,128 6,023 2,959 42,604 131,658 298,270 As at December 31, 2018 Cost 6,821 165,931 17,692 9,612 11,557 42,604 254,217 298,270 Accumulated amortization (1,887) (93,921) (14,564) (3,589) (8,598) — (122,559) — Net book amount 4,934 72,010 3,128 6,023 2,959 42,604 131,658 298,270 December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 68 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 notes Secured promissory note Unsecured promissory note Unsecured promissory note Secured promissory note Unsecured promissory note 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) 2018 $ 53,021 54 60,815 19,369 133,259 2018 $ 273,055 204,630 17,930 7,321 3,936 3,596 1,540 1,506 572 — 514,086 (605) 513,481 9,810 (96) 9,714 503,767 2017 $ 41,373 380 51,761 17,692 111,206 2017 $ 232,083 188,176 15,944 7,422 7,000 — 2,278 2,008 844 586 456,341 (701) 455,640 5,791 (96) 5,695 449,945 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 69 10 LONG-TERM DEBT (CONTINUED) a) The Company’s syndicated credit facilities consist of (i) an unsecured revolving facility in the amount of US$325,000 made available to the Company and SJ Holding (the “Borrowers”), a wholly-owned subsidiary of the Company until February 27, 2023 and (ii) an unsecured term facility in the amount of US$100,000 made available to the Company until February 26, 2019. The syndicated credit facilities are made available to the Borrowers by a syndicate of lenders under a fifth amended and restated credit agreement (the “Credit Agreement”) dated as of February 26, 2016, as amended on May 18, 2016 and March 15, 2018. As at December 31, 2018 the syndicated credit facilities provided financing up to US$425,000 of which US$213,729 was available. Additionally, the Credit Agreement makes available an accordion option whereas upon request, the Company could increase the revolving facility by US$350,000. 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, 2018 are provided in Note 18, Financial instruments. As at December 31, 2018, borrowings by Canadian entities denominated in U.S. dollars represented $170,525 (US$125,000) 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, 2018 no amounts were drawn under the demand loan facilities. 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 net funded 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, 2018, 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 net funded debt to EBITDA ratio is greater than 3.25:1. In the case where the net funded 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 the 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 net funded 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 15.00%. As at December 31, 2018, the Company was in full compliance with these covenants, requirements and ratios. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 70 10 LONG-TERM DEBT (CONTINUED) c) Pursuant to two business acquisitions dated June 3, 2016, the Company issued two unsecured promissory notes totalling $18,256 (US$14,104) bearing interest at 1.41%. The notes are payable in three instalments, including interest, totalling US$3,000 in June 2019 and 2020 and US$9,000 in June 2021. The notes were initially recorded at a fair value totalling $15,676 (US$12,112) using an effective interest rate of 5.00%. The difference between the face value and the fair value of the notes is being accreted on an effective yield basis over its term. d) As part of a business acquisition dated June 3, 2016, the Company assumed a promissory note bearing interest at 5.76%, secured by the land of the Pineville facility and having a balance of US$5,685. 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. e) Pursuant to a business acquisition dated 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. f) As part of WP acquisition completed on April 9, 2018, the Company recorded an unsecured promissory note of $3,596 (US$3,000) bearing no interest. The unsecured promissory note is payable annually on the anniversary of the transaction in six instalments of US$500, until April 2024 and was recorded at a fair value of $3,339 (US$2,623) using an effective interest rate of 4.17%. 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 completed on October 1, 2015, the Company recorded a secured promissory note of $5,800 bearing no interest. The secured promissory note 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 secured promissory note 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 note is being accreted on an effective yield basis over its term. The secured promissory note is guaranteed by irrevocable letters of credit in the same amount and with the same maturity date as the future payments. h) Pursuant to a business acquisition dated 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) As part of the WPI acquisition completed on December 19, 2017, the Company recorded an unsecured promissory note of $900 bearing no interest. The unsecured promissory note is payable in quarterly installments of $75 in March, June, September and December of each year, up to December 2020. The unsecured promissory note 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 note is being accreted on an effective yield basis over its term. j) 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 was 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 was being accreted on an effective yield basis over its term. This debt was reimbursed in 2018 in accordance with the agreement. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 10 LONG-TERM DEBT (CONTINUED) k) The repayment requirements on the long-term debt during the next five years and thereafter are as follows: 2019 2020 2021 2022 2023 Thereafter Fair value adjustment 71 Principal $ 10,433 7,002 13,355 1,298 274,390 208,975 515,453 (1,367) 514,086 l) The aggregate fair value of the Company’s long-term debt was estimated at $501,950 as at December 31, 2018 (2017 – $453,478) 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, 2017 16,487 3,664 20,151 2,956 7,963 10,919 31,070 Additions Business acquisitions Provision reversal Payments Interest accretion 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 Additions Business acquisitions Provision reversal Payments Interest accretion Exchange differences 1,519 1,418 506 — 2,025 1,418 (830) (523) (1,353) 5,597 — — — — — 5,597 — — 7,622 1,418 (1,353) (2,867) (537) (3,404) (1,539) (1,745) (3,284) (6,688) — 812 — 142 — 954 — — 124 392 124 392 124 1,346 Balance as at December 31, 2018 12,096 3,294 15,390 6,306 4,279 10,585 25,975 December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 72 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 2018 $ 9,294 2,722 12,016 6,095 7,864 13,959 25,975 2017 $ 9,141 2,973 12,114 6,609 4,783 11,392 23,506 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 flows have been estimated using pre-tax rates between 3.24% and 3.45% that reflect current market assessment of the time value of money and the risk specific to the obligation. As of December 31, 2018, a total site remediation provision of $12,096 (2017 — $12,044) 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 16, 2015 reached their third year anniversary on March 16, 2018 and were fully paid. On March 21, 2016 and March 19, 2018, the Company granted a total of 47,667 RSUs to certain executives and key employees as part of the long-term incentive plan. No RSUs were granted in 2017. On March 13, 2018, the Remuneration Committee and Board of Directors departed from the RSU award calculation and granted a special long-term incentive to senior management totalling 200,000 RSUs. Subsequently, on May 7, 2018, a special long-term incentive award of 7,632 RSUs was given to a newly added member of the senior management team. On May 2, 2018, as an incentive to continue on as President and Chief Executive Officer (“President and CEO”) of the Company, the Company granted 200,000 RSUs to the President and CEO, with an effective grant date of May 7, 2018. Vesting dates are May 7, 2019 (for the first 60,000 RSUs); May 7, 2020 (for the second 60,000 RSUs) and May 7, 2021 (for the final 80,000 RSUs), subject to additional terms and conditions relating to resignation, disability, death and others. No further RSUs will be granted to the President and CEO prior and up to May 7, 2021, the final vesting date. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 73 11 PROVISIONS AND OTHER LONG-TERM LIABILITIES (CONTINUED) Other long-term liabilities (continued) Restricted stock units (continued) On May 6, 2013, as part of a five-year incentive agreement and pursuant to its long-term incentive plan, the Company granted 400,000 RSUs to the President and CEO, with a vesting date of May 6, 2016. The compensation expense related to the five-year agreement was 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 amortized over the remaining two-year period. As of December 31, 2018, the prepaid balance was nil (2017 — $1,592). 12 CASH FLOW INFORMATION The following table presents the movements in the liabilities from financing activities for the years ended December 31, 2017 and 2018: Liabilities from financing activities Long-term debt Syndicated credit facilities Non-competes payable Balance as at January 1, 2017 (47,898) (646,487) Cash flows Foreign exchange adjustments Other non-cash movements (184,363) 8,704 — 391,796 22,608 — $ $ $ (7,963) 2,156 454 (155) Total $ (702,348) 209,589 31,766 (155) Balance as at December 31, 2017 (223,557) (232,083) (5,508) (461,148) Cash flows Foreign exchange adjustments Other non-cash movements 6,705 (22,740) (833) (18,742) (22,230) — 1,745 (392) (124) (10,292) (45,362) (957) Balance as at December 31, 2018 (240,425) (273,055) (4,279) (517,759) December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 74 13 CAPITAL STOCK Number of common shares outstanding – Beginning of year* Stock option plan* Employee share purchase plans* Repurchase of common shares* 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 2018 69,342 — 31 (105) 69,268 2017 69,303 10 29 — 69,342 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. 2018 $ 137,597 69,352 8 69,360 $ 1.98 $ 1.98 2017 $ 167,889 69,324 9 69,333 $ 2.42 $ 2.42 c) Normal Course Issuer Bid On December 18, 2018 the TSX accepted the Company’s Notice of Intention to Make a Normal Course Issuer Bid. The Normal Course Issuer Bid was initiated for a twelve-month period starting on December 20, 2018. During this period, the Company may purchase for cancellation up to 3,000,000 common shares. As at December 31, 2018, the Company repurchased 105,000 common shares for cancellation in consideration of $4,038 representing an average price of $38.15 per common share. As at December 31, 2018, the Company had unsettled transactions to repurchase 42,000 common shares for a cash consideration of $1,627 representing an average price of $39.05 per common share. As of December 31, 2018, the Company recorded a financial liability with an offset amount in equity in the amount of $1,627. The settlement of these transactions occurred in early January 2019 and the cancellation of the corresponding common share was done at the same time. d) 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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 75 13 CAPITAL STOCK (CONTINUED) Changes in the number of options outstanding under the Plan were as follows: 2018 Weighted average exercise price** $ 40.05 — — 40.05 38.67 Number of options* 45 — — 45 39 2017 Weighted average exercise price** $ 34.57 9.90 — 40.05 36.79 Number of options* 55 (10) — 45 33 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, 2018: Date granted May 2013 November 2015 Options outstanding Number of options* Exercise price** Options exercisable Number of options* Exercise price** Expiration date $ 22.13 49.01 15 30 45 $ 22.13 49.01 15 24 39 May 2023 November 2025 * Number of options is presented in thousands. ** Exercise price is presented in dollars per option. e) Share-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 2018. The 2018 expense recorded for share-based compensation amortized to earnings was $50 (2017 – $87). f) 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 2018, 17,591 common shares (2017 – 15,621) were issued to Canadian resident employees at an average price of $37.02 per share (2017 – $39.52). 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 2018, 13,889 common shares (2017 – 13,167) were issued to U.S. resident employees at an average price of $40.11 per share (2017 – $41.65). December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 76 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 2018 $ 1,537,542 143,473 38,102 43,746 105,513 49,216 1,917,592 2018 $ 127,587 50 7,189 2,259 6,388 143,473 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 2018 $ 10,168 1,797 7,137 19,102 2017 $ 1,324,289 135,302 35,734 54,148 91,430 37,851 1,678,754 2017 $ 123,355 87 4,549 1,990 5,321 135,302 2017 $ 9,596 2,613 6,800 19,009 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 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 77 2017 $ 40,450 1,116 41,566 12,379 (30,094) (3,361) (21,076) 20,490 2018 $ 38,710 308 39,018 10,965 (191) (190) 10,584 49,602 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 26.46% (2017 – 26.24%) 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 2018 $ 187,199 49,533 454 (5,368) 5,062 (191) 118 (6) — 49,602 2017 $ 188,379 49,431 12,930 (7,759) 409 (30,094) (2,245) (462) (1,720) 20,490 December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 78 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 2018 $ 2,894 11,454 (106,905) — (92,557) 2018 $ (72,408) (10,584) (3,935) (2) (5,628) (92,557) 2017 $ 5,554 8,243 (86,081) (124) (72,408) 2017 $ (101,171) 21,076 2,697 140 4,850 (72,408) December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 79 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 $ $ 2,232 (2,232) — — — — — — — — — — 2,231 1,150 — — 3,381 (17) (3,270) — (94) — Deferred pension benefits $ 2,165 112 (246) — (80) 1,951 165 (282) — 68 1,902 Reserves $ 12,480 (3,606) — 180 (589) 8,465 120 — 1,094 615 10,294 Unrealized foreign exchange on debts and translation of foreign operations $ (2,049) — 2,049 — — — — — — — — Property, plant and equipment $ (79,785) 15,684 — (40) 4,272 (59,869) (13,158) — (1,096) (4,610) (78,733) Intangible assets $ (34,330) 8,371 — — 1,524 (24,435) 35 — — (1,607) (26,007) Others $ 96 (96) — — — — 2,152 — — — 2,152 Total $ 16,973 (3,591) 904 180 (669) 13,797 2,420 (3,552) 1,094 589 14,348 Others $ (1,982) 612 (256) — (275) (1,901) 119 (383) — — (2,165) Total $ (118,146) 24,667 1,793 (40) 5,521 (86,205) (13,004) (383) (1,096) (6,217) (106,905) Deferred tax assets As at January 1, 2017 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2017 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2018 Deferred tax liabilities As at January 1, 2017 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2017 Recognized in the statement of income Recognized in other comprehensive income Business acquisitions Exchange differences As at December 31, 2018 As of December 31, 2018, the Company did not recognize deferred income tax assets of $1,925 (2017 – nil) in respect of capital losses amounting to $14,579 (2017 – nil) that can be carried forward indefinitely against future taxable capital gains. 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 $461,407 as at December 31, 2018 (2017 – $398,767). December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 80 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 2018 $ 167 1,467 625 6,388 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 2018 $ (5,185) (2,208) (7,393) 2017 $ 156 1,411 423 5,321 2017 $ (5,174) (2,501) (7,675) 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 December 1, 2018, and the next required valuation will be as at December 1, 2021. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) The following information as established by independent actuaries pertains to the Company’s post-retirement benefits program: 81 Accrued benefit obligation Balance – Beginning of year Current service cost Interest cost Benefits payments Remeasurement adjustments Plan experience 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 2018 $ 2,501 80 87 (71) (237) (152) 2,208 71 (71) — 2,208 2018 % 3.90 3.40 2017 $ 2,219 68 88 (62) — 188 2,501 62 (62) — 2,501 2017 % 3.40 3.90 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% $ 27 3 $ (24) (2) December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 82 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 gains (losses) 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 2018 $ 80 87 167 2018 $ 389 389 2018 $ (352) 286 (66) 2017 $ 68 88 156 2017 $ (188) (188) 2017 $ (228) (124) (352) 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 American pension plan - Closed to new participants Plan 5 American pension plan Date of last actuarial valuation December 31, 2016 December 31, 2017 December 31, 2018 December 31, 2018 December 31, 2018 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 83 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 2018 $ 29,402 1,038 1,055 (1,406) 20 (31) (1,726) 861 29,213 24,228 590 (738) 933 36 (193) (1,406) 578 24,028 (5,185) 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) 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 2018 $ (29,140) 21,384 (7,756) 2017 $ (13,309) 7,652 (5,657) December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 84 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 2018 % 27.00 42.00 30.00 1.00 100.00 2018 % 3.90 3.25 3.50 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 2018 $ 1,002 1,055 (590) 1,467 Expected contributions to the defined benefit pension plans for the year ending December 31, 2019 are $1,081. 2017 % 31.00 42.00 26.00 1.00 100.00 2017 % 3.50 3.25 3.90 2017 $ 1,000 1,076 (665) 1,411 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 16 EMPLOYEE FUTURE BENEFITS (CONTINUED) Consolidated statement of comprehensive income Year ended December 31 Actuarial gains (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 gain (losses) recognized in the year, net of tax Balance of actuarial losses as at December 31 2018 $ 820 820 2018 $ (4,012) 641 (3,371) 85 2017 $ (549) (549) 2017 $ (3,153) (859) (4,012) 17 COMMITMENTS AND CONTINGENCIES a) The Company has issued guarantees amounting to $29,716 (2017 – $19,036) 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: 2019 2020 2021 2022 2023 Thereafter $ 30,236 25,572 21,366 16,059 10,091 29,451 132,775 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 86 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 contracts 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 Derivative commodity contracts Non-current assets Interest rate swap agreements Current liabilities Derivative commodity contracts Non-current liabilities Derivative commodity contracts 2018 $ — — 7,545 7,545 4,381 4,381 3,748 3,748 2017 $ 473 473 6,173 6,173 — — — — 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, 2018, 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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 87 18 FINANCIAL INSTRUMENTS (CONTINUED) Credit risk (continued) Note 5 provides details on the receivable aging as well as on the credit loss provision for the years ended December 31, 2018 and 2017. The Company’s largest customer had sales representing 16.60% of the total sales for the twelve-month period ending December 31, 2018 (2017 – 15.60%) and an account receivable balance of $5,678 as at December 31, 2018 (2017 – $6,152). The sales for this customer are included in the residential lumber product category. 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, 2018 and 2017: Hedged item Diesel and petroleum Diesel and petroleum Hedged item Diesel and petroleum Diesel and petroleum Gallons Effective date Maturity date Fixed rate 2018 6,000,000* January 2019 December 2019 6,000,000* January 2020 December 2020 US$2.23 US$2.23 2017 Gallons Effective date Maturity date Fixed rate 600,000* January 2018 December 2018 600,000* January 2018 December 2018 US$1.72 US$1.61 * 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, 2018 is a total liability of $8,129 of which $4,381 is recorded under current liabilities and $3,748 recorded under non-current liabilities (2017 – a current asset of $473) in the consolidated statement of financial position. The fair value of these hedge agreements was determined by obtaining mark-to- market values as at December 31, 2018 and 2017 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 88 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, 2018, an amount of $291,569 (US$213,729) (2017 - $354,489 (US$282,574)) 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 2018 Accounts payable and accrued liabilities 133,259 133,259 133,259 $ $ $ $ — $ — $ — Long-term debt obligations 513,481 601,849 25,507 51,683 303,142 221,517 Derivative commodity contracts Non-competes payable 8,129 4,279 8,354 4,570 4,108 1,603 4,246 2,967 — — — — 659,148 748,032 164,477 58,896 303,142 221,517 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 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. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 89 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 when required 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. 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, comprehensive income and equity for the years ended December 31, 2018 and 2017. 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 2018 $ 385 37,895 2017 $ (806) 37,352 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 Inventories Liabilities Accounts payable and accrued liabilities 2018 $ — 900 820 1,720 5,566 5,566 2017 $ 11,484 2,545 — 14,029 5,968 5,968 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). December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 90 18 FINANCIAL INSTRUMENTS (CONTINUED) Interest rate risk As at December 31, 2018, the Company has mitigated its exposure to interest rate risk on long-term debt after giving effect to its interest rate swap agreements; 96.00% (2017 – 100.00%) 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 $370 for the year ended December 31, 2018 (2017 – $146). 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 US$85,000 US$100,000 Syndicated credit facilities Syndicated credit facilities Fixed rate % 1.68* 1.06* Fixed rate % 1.68* 1.06* Effective date Maturity date 2018 Notional equivalent CA$ December 2015 April 2021 115,957 December 2017 December 2021 136,420 Effective date Maturity date 2017 Notional equivalent CA$ December 2015 April 2021 106,633 December 2017 December 2021 125,450 * Plus applicable spread of 1.00% to 2.25% based on pricing grid included in the Credit Agreement. 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, 2018, 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, 2018 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, 2018 is a non-current asset of $7,545 recorded in the consolidated statement of financial position (2017 – a non-current asset of $6,173). A 10.00% decrease in interest rates as at December 31, 2018 would have reduced the net gain recognized in other comprehensive income by approximately $755 (2017 – $617). For a 10.00% increase in the interest rates, there would be an equal and opposite impact on the net gain. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 91 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 2018 $ 513,481 1,281,410 1,794,891 0.29:1 2017 $ 455,640 1,115,545 1,571,185 0.29:1 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. December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 92 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 2018 $ — 62 Legal fees charged by a firm in which a director of the Company is a partner 499 2017 $ 200 100 838 * As of December 31, 2017, Stella Jones International S.A. held, directly or indirectly, approximately 38.30% of the outstanding common shares of the Company. Pursuant to a secondary offering closed on February 21, 2018, the percentage of outstanding common shares held by Stella International S.A. was reduced to 31.10%. On August 14, 2018, Stella Jones International S.A. sold its remaining share ownership in the Company through a bought public offering and concurrent private placement. ** 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 receivable from Stella Jones International S.A. 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 2018 $ 454 — — (54) 400 2017 $ — (25) (50) (305) (380) 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: Salaries, compensation and benefits Share-based payments 2018 $ 5,010 5,293 10,303 2017 $ 4,728 4,063 8,791 December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. 93 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 six 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 2018 $ 679,642 1,444,251 2,123,893 2018 $ 662,414 724,950 474,680 109,035 152,814 2017 $ 561,905 1,324,237 1,886,142 2017 $ 651,549 653,946 366,225 94,516 119,906 2,123,893 1,886,142 December 31, 2018 and 2017(amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2018 Annual Report 94 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 2018 $ 124,246 427,539 551,785 33,977 97,681 131,658 19,403 278,867 298,270 2017 $ 114,819 351,237 466,056 29,974 100,375 130,349 14,864 255,397 270,261 a) On January 14, 2019, the Company obtained a one-year extension of its unsecured revolving facility to February 27, 2024. This extension was granted through an amendment to the fifth amended and restated credit agreement dated as of February 26, 2016, as amended on May 18, 2016 and March 15, 2018. b) On March 14, 2019, the Board of Directors declared a quarterly dividend of $0.14 per common share payable on April 26, 2019 to shareholders of record at the close of business on April 5, 2019. December 31, 2018 and 2017 (amounts expressed in thousands of Canadian dollars, except as otherwise indicated)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSStella-Jones Inc. DIRECTORS AND OFFICERS 95 BOARD OF DIRECTORS Katherine A. Lehman Chair of the Board, Stella-Jones Inc. Managing Partner, Hilltop Private Capital LLC (Private equity firm) New York, NY, USA Director since October 2016 George J. Bunze, CPA, CMA (2) (3) (4) 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 OFFICERS Katherine A. Lehman Chair of the Board Brian McManus President and Chief Executive Officer Brian McManus President and Chief Executive Officer, Stella-Jones Inc. Montréal, Québec Director since June 2001 Nycol Pageau-Goyette (1) (2) (3) (4) President, Pageau Goyette et associés limitée (Management services firm) Montréal, Québec Director since July 1993 Karen Laflamme FCPA, FCA, ASC (2) Executive Vice-President and Chief Financial Officer, Retail, Ivanhoé Cambridge (investor and developer of superior quality real estate properties, projects and companies) Director since December 2018 James A. Manzi, Jr. (2) (3) Corporate Director Tampa, FL, USA Director since April 2015 Simon Pelletier (1) (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) Member of the Governance and Nomination Committee A full report of Stella-Jones’ corporate governance practices is set out in the Management Proxy Circular for the May 2, 2019 Annual Meeting of Shareholders. 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 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 Wayne Kusmierczyk Vice-President, Operations (Southern Yellow Pine) McFarland Cascade Holdings, Inc. Andy Morgan Vice-President, Operations (Western Species) McFarland Cascade Holdings, Inc. Jim Raines Vice-President, Sales Stella-Jones Corporation Patrick Stark Vice-President, Environment, Health and Safety U.S. Operations 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. 2018 Annual Report 96 OPERATING LOCATIONS – 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 BRITISH COLUMBIA Plant 7400 Galloway Mill Road Galloway British Columbia V0B 1T2 T: (250) 429-3493 F: (250) 429-3931 Plant 39 miles SE of Calgary Hwy. 24 Carseland, Alberta T0J 0M0 T: (403) 934-4600 F: (403) 934-5880 Plant and Sales Office 25 Braid Street New Westminster British Columbia V3L 3P2 T: (604) 521-4385 F: (604) 526-8597 Plant and Sales Office 7177 Pacific Street Prince George British Columbia V2N 5S4 T: (250) 561-1161 F: (250) 561-0903 Fibre & Woodlands Dept. 4661 60th Street SE Salmon Arm British Columbia V1E 1X2 T: (250) 832-1180 F: (250) 832-7933 MANITOBA Plant 205 Hwy. 16 West Neepawa, Manitoba R0J 1H0 T: (204) 476-7700 F: (204) 476-2212 NOVA SCOTIA ONTARIO Plant and Sales Office 278 Park Street Truro, Nova Scotia B2N 5C1 T: (902) 893-9456 F: (902) 893-3874 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 Plant and Sales Office 1 Ram Forest Road Stouffville, Ontario L4A 2G7 T: (905) 727-1164 F: (905) 727-7758 Plant and Sales Office 321 Lansdowne Street East Peterborough, Ontario K9J 7X6 T: (705) 745-3223 F: (705) 745-3793 ONTARIO QUÉBEC Plant 11045 Hwy. 124 South River, Ontario P0A 1X0 T: (705) 386-2371 F: (705) 386-2335 Plant and Sales Office 41 rue Rodier Delson, Québec J5B 2H8 T: (450) 632-2011 T: 1 (800) 387-5027 F: (450) 632-3211 Plant and Sales Office 426 chemin de Montréal East Gatineau, Québec J8M 1V6 T: (819) 986-8998 F: (819) 986-9875 Plant 2210 chemin St-Roch Sorel-Tracy, Québec J3R 3L2 T: (450) 742-5977 F: (450) 742-8832 QUÉBEC Plant 2549 Chemin Francisco Rivière-Rouge, Québec J0T 1T0 T: (819) 275-3353 F: (819) 275-1002 Stella-Jones Inc. OPERATING LOCATIONS – UNITED STATES 97 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 Stella-Jones Corporation 15700 College Blvd., Suite 300 Lenexa, KS 66219 U.S.A. T: (913) 948-9478 F: (913) 538-2226 Plant Stella-Jones Corporation 100 McKinney Drive Clanton, AL 35045 U.S.A. T: (205) 280-3950 F: (205) 665-2545 Plant Stella-Jones Corporation 1051 Highway 25 South Montevallo, AL 35115 U.S.A. T: (205) 679-4005 F: (205) 665-2545 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 Plant Stella-Jones Corporation 4260 South Arkansas Ave. Russellville, AR 72802 U.S.A. T: (479) 968-5085 F: (479) 968-4636 Plant McFarland Cascade 6040 Highway 79N Rison, AR 71665 U.S.A. T: (870) 325-7070 F: (870) 325-7050 Plant Stella-Jones Corporation 3500 Pateville Road Cordele, GA 31015 U.S.A. T: (229) 273-8012 F: (229) 273-8220 Plant Stella-Jones Corporation 3818 S. County Road 50 E Winslow, IN 47598 U.S.A. T: (812) 789-5331 F: (812) 789-5335 KENTUCKY LOUISIANA Plant Stella-Jones Corporation 3855 Highway 51 North Fulton, KY 42041 U.S.A. T: (270) 472-5557 F: (270) 472-5559 Plant Stella-Jones Corporation 3600 Koppers Road Alexandria, LA 71302 U.S.A. T: (318) 442-5733 F: (318) 473-4378 Plant McFarland Cascade 10020 Highway 483 Converse, LA 71419 U.S.A. T: (318) 645-7525 F: (318) 645-7530 Plant McFarland Cascade 74 Wadley Street Pineville, LA 71360 U.S.A. T: (318) 442-4414 F: (318) 445-9144 MISSISSIPPI Plant McFarland Cascade 13539 Highway 45 Scooba, MS 39358-7611 U.S.A. T: (662) 476-8000 F: (601) 476-8005 NEVADA OREGON Plant McFarland Cascade 1680 E Spruce Avenue Silver Springs, NV 89429 U.S.A. T: (775) 577-2000 F: (775) 577-9045 Plant and Office McFarland Cascade 90049 Highway 99N Eugene, OR 97402 U.S.A. T: (541) 689-1278 F: (541) 689-6027 Plant McFarland Cascade 22125 SW Rock Creek Road Sheridan, OR 97378 U.S.A. T: (503) 843-2122 F: (503) 843-7058 PENNSYLVANIA Plant Stella-Jones Corporation 5865 Route 235 McAlisterville, PA 17049 U.S.A. T: (717) 463-2131 F: (717) 463-3998 Plant Stella-Jones Corporation 392 Larkeytown Road Dubois, PA 15801 U.S.A. T: (814) 371-7331 F: (814) 375-0946 2018 Annual Report 98 OPERATING LOCATIONS – UNITED STATES SOUTH CAROLINA TENNESSEE TEXAS VIRGINIA Plant McFarland Cascade 1121 Delta Road Whitmire, SC 29178 U.S.A. T: (803) 694-3668 F: (803) 694-3976 Coal Tar Distillation Facility Stella-Jones Corporation 1471 Channel Avenue Memphis, TN 38109 U.S.A. T: (901) 942-3326 F: (901) 942-3128 Plant McFarland Cascade 5865 US Highway 69 Lufkin, TX 75901 U.S.A. T: (936) 824-2297 F: (936) 634-2100 Plant Stella-Jones Corporation 9223 Maury River Road Goshen, VA 24439 U.S.A. T: (540) 997-9251 F: (540) 997-0047 Plant McFarland Cascade 15939 Historyland Highway Warsaw, VA 22572 U.S.A. T: (804) 333-8490 F: (804) 333-9269 WASHINGTON Plant and Corporate Office McFarland Cascade 1640 East Marc St. Tacoma, WA 98421 U.S.A. T: (253) 572-3033 F: (253) 382-3000 Plant McFarland Cascade 6520 - 188th NE Arlington, WA 98223 U.S.A. T: (360) 435-2146 F: (360) 435-3035 WISCONSIN Plant Stella-Jones Corporation W1038 County Road U Bangor, WI 54614 U.S.A. T: (608) 486-2700 F: (608) 486-4538 Plant McFarland Cascade 1014 S. 1st Street Cameron, WI 54822 U.S.A. T: (715) 458-2018 F: (715) 458-2024 Stella-Jones Inc. CORPORATE INFORMATION Annual Meeting of Shareholders May 2, 2019 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, 2018): $52.22 / $37.40 Share price at March 14, 2019: $41.35 Common shares outstanding as at December 31, 2018: 69.27 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 14, 2019, the Board of Directors declared a quarterly dividend of $0.14 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 I N C . 2 0 1 8 A N N U A L R E P O R T Visit our New Website at WWW.STELLA-JONES.COM 

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