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Edited Transcript of SJ.TO earnings conference call or presentation 7-Nov-19 3:00pm GMT

Q3 2019 Stella-Jones Inc Earnings Call

SAINT-LAURENT Nov 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Stella-Jones Inc earnings conference call or presentation Thursday, November 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Éric Vachon

Stella-Jones Inc. - CEO, President, Interim CFO & Director

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Conference Call Participants

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* Benoit Poirier

Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst

* Hamir Patel

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst

* Maxim Sytchev

National Bank Financial, Inc., Research Division - MD & AEC-Sector Analyst

* Michael Tupholme

TD Securities Equity Research - Research Analyst

* Walter Noel Spracklin

RBC Capital Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella Jones Q3 2019 Earnings Conference Call. (Operator Instructions)

Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, November 7, 2019.

I will now turn the conference over to Éric Vachon, President and CEO. Please go ahead, sir.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [2]

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Good morning, ladies and gentlemen. Thank you for joining us for this discussion on the financial and operating results for Stella Jones third quarter ended September 30, 2019. Our press release reporting Q3 results was published earlier this morning. It, along with our MD&A, can also be found on our website at www.stellajones.com. And it will be posted on SEDAR today as well.

Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. Before we begin, I would like to also remind you that on January 1, 2019, the company retrospectively adopted IFRS 16 leases, but has not restated comparatives for 2018 reporting period. Please refer to our MD&A for further details.

Let me now begin with a brief overview of the quarter. We are pleased with our third quarter results, which saw EBITDA up 22% to $96.1 million and increase in net income and diluted EPS to $53.7 million and $0.78 per share, respectively. We saw solid performances in our utility pole, railway tie and industrial product categories, all of which generated increased sales, stemming from a combination of higher pricing and volume. While sales in the third quarter reached $626.6 million, decreasing slightly by $3.4 million from 2018, profitability increased. We generated solid margins even when adjusting for the impact of IFRS '16 and maintained strong cash flow, which we used primarily to reduce debt and repurchase shares.

The decrease in overall sales for the quarter was due to lower sales in the logs and lumber category, which was unfavorably impacted by lower lumber market costs, resulting in a sales decline of over $20 million for the category. Excluding this impact, overall sales for the quarter would have increased 2.5%. Sales in the residential lumber product category also declined because of lower lumber costs, but the impact was less pronounced as it was largely offset by higher sales volume.

Looking at the third quarter results by product category. Utility pole sales reached $211.5 million, up 5.4% from sales of $200.6 million last year. Excluding the currency conversion effect, utility pole sales increased $9.6 million or 4.8%, primarily driven by increased sales prices, coupled with healthy replacement demand. Railway tie sales amounted to $190.7 million, up 1.6% from sales of $187.7 million last year. Excluding the currency conversion effect, railway tie sales increased $2.3 million or 1.2%. While we expected this delta to be more significant in the quarter due to ongoing strong demand and high selling prices, growth was partially offset as a result of the tight supply market for untreated railway ties, which has required us to treat railway ties that are not air-seasoned, resulting in longer treating cycle times.

In addition, during the quarter, we manufactured finished product for a customer who later informed us they would only be taking delivery in the next few months. As a result, some third quarter sales have been pushed out to the next quarters. Consequently, railway tie sales for 2019 will be flat year-over-year and, in turn, profitability will be impacted.

Sales in the residential lumber category totaled $158.2 million, down 1.4% from sales of $160.5 million last year. Excluding the currency conversion effect, residential lumber sales decreased $2.8 million or 0.5%. This variance is primarily explained by lower lumber prices, partially offset by higher sales volumes.

Industrial product sales reached $37.6 million compared with $32.4 million last year. Excluding the currency conversion effect, sales increased $4.9 million or 15.1%, largely as a result of stronger rail-related and piling product sales. Sales in the logs and lumber category totaled $28.6 million compared with $48.8 million last year. Excluding the currency conversion effect, sales decreased just over $20 million. As discussed earlier, this variance is a result of reduced selling prices, which is passed through to customers, driven by lower lumber market costs, a decrease in lumber transaction volumes as well as lower log sales due to the timing of harvesting activities.

Turning now to profitability. Gross profit amounted to $110.2 million or 17.6% of sales in the third quarter of 2019 compared with $97.4 million or 15.5% of sales last year. The increase is explained by higher selling prices, lower lumber costs when compared to last year and improved operational efficiencies. These factors were partially offset by higher volume for utility poles, higher production costs for railway ties, given the longer treating cycles and the effect of currency translation.

EBITDA stood at 96.1% -- pardon me. EDITBA stood at $96.1 million or a margin of 15.3% versus $78.5 million or a margin of 12.5% last year. The increase in EBITDA is explained by increased gross margins and the adoption of IFRS 16, which effectively subtracted $8.4 million in right-of-use asset depreciation and $1.1 million in financing expenses from cost of sales. With the adoption of IFRS 16, it becomes difficult to compare our EBITDA to last year. As a general rule of thumb, you can subtract the reclass from cost of sales or in this case, $9.5 million from our Q3 2019 EBITDA to make it more comparable. While you're doing this, you can see that our EBITDA increased over 10% year-over-year, a very healthy growth rate on a true comparable basis.

Operating income stood at $78.6 million or 12.5% of sales in the third quarter compared to $67.9 million or 10.8% of sales last year. Net income for the third quarter of 2019 was $53.7 million or $0.78 per diluted share, up from $45.8 million or $0.66 per diluted shares last year.

Turning now to liquidity and capital resources. Cash flow from operating activities before changes in noncash working capital components and interest and income taxes paid reached $97.4 million in the third quarter, up from $81.3 million when compared with the same period last year. The increase primarily reflects higher net income and the impact of IFRS 16.

Combined with favorable changes in working capital items, we generated strong cash flow from operating activities of $123.7 million versus $91.3 million last year. As always, we continue to be mindful of our capital allocation. Maintaining a prudent use of leverage, ensuring sufficient maintenance CapEx, making acquisitions at reasonable multiples, buying back shares and paying dividends are all key priorities. We intend to maintain an optimal balance amongst all of these facets.

In the third quarter, we used our cash flow to reduce debt by $64 million, and in the absence of M&A, we use our normal course issuer bid program opportunistically to repurchase shares for $30 million. We also supported purchase of property, plant and equipment for $14 million and paid dividends of $10 million. We concluded the third quarter in a very healthy financial position. As at September 30, 2019, our long-term debt, including the current portion, was $562.8 million versus $513.5 million as at December 31, 2018. The increase mainly reflects higher working capital requirements, higher capital expenditures and financing required for the acquisition of a residential lumber facility in Shelburne, Ontario, partially offset by the effect of local currency translation on U.S. dollar-denominated long-term debt.

On the dividend front, the Board of Directors of Stella Jones yesterday declared a quarterly dividend of $0.14 per common share payable on December 19, 2019, to shareholders of record at the close of business on December 2, 2019.

Turning now to our outlook. For 2019, excluding sales from the logs and lumber product category, we expect higher year-over-year overall sales based on current market conditions, the current level of lumber prices and stable currencies. This increase is driven by stronger pricing for railway ties and utility poles as well as an increase in market reach for the utility pole product category. More specifically, in the utility pole product category, sales and margins for 2019 are expected to increase year-over-year, driven by both pricing and healthy demand for replacement programs.

In the railway tie product category, sales for 2019 are expected to be comparable year-over-year, explained by improved pricing, but offset by lower volumes as mentioned earlier. Managers believe that the increasing cost of untreated railway ties, combined with a tighter supply market will lead to continued upward selling pricing adjustments for the quarters ahead.

In the industrial lumber product category, sales for 2019 are expected to be slightly below last year, given the slow start to the year and lower selling prices to customers as a result of the increased lumber cost. Management closely monitors variations of these commodity prices and adjust its procurement practices accordingly in order to maintain dollar margin on a similar volume.

In the industrial product category for 2019, we expect higher sales, driven by healthy demand for rail-related projects and piling products. It is important to highlight that sales for the logs and lumber product category and activity used to optimize procurement and which does not generate margin is closely tied to the market price of lumber. For 2019, we expect lower year-over-year sales for this product category, explained by lower lumber prices when compared to 2018 and reduced volumes. The decrease in sales for logs and lumber product category will favorably impact overall margins as a percentage of sales, when taken as a whole with other product categories and vice versa.

For 2019, we also expect improved year-over-year margin on a consolidated basis. Higher margin will be primarily driven by increased pricing for railway ties, coupled with improved product mix and demand for utility poles. Having said this, given that some railway tie sales have been pushed out over to the next quarters, profitability for 2019 will be impacted. As a result, we have adjusted our EBITDA guidance range to be between $310 million to $315 million. Adjusting for this impact of IFRS 16, this will represent a year-over-year increase of over 11%.

Furthermore, we plan on spending $60 million to $70 million of capital expenditures in 2019. This includes the plant expansion at Cameron, Wisconsin, as well as the Shelburne acquisition and upgrade.

For 2020, based on current market conditions and assuming stable currencies, we expect higher year-over-year overall sales for Stella Jones, driven by stronger pricing and increased market reach in the utility pole, railway tie and residential lumber product categories. As a result, operating margins in absolute dollars and as a percentage of sales are expected to improve over 2019, primarily driven by pricing improvements and operational efficiencies. Our strategy remains intact, as we will continue to focus on optimizing our operations across the organization while seeking acquisitions to further expand our presence in our core product categories.

This concludes my prepared remarks, and I will now be pleased to answer any questions you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Walter Spracklin from RBC Capital Markets.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [2]

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Yes. I guess focusing here on the 2020 with the push forward of the sales into 2020, would we see -- and a reduction in EBITDA associated with that, would we see a kind of similar lift to what we would have otherwise expected in 2020 as a result of that push forward?

And I don't know if you can give any color around what your view is around the current consensus being around, let's call it, $335 million, $340 million for next year, if that's consistent with what you're seeing in terms of what you can see looking forward in 2020 so far?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [3]

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Great. Thank you, Walter, for the question. So to answer your -- you've got multiple aspects [associated] to your question. So the push of sales forward will, obviously, be accompanied with the EBITDA margin into next year. So you're completely correct that those sales will move -- some of them will move into Q4 and Q1 of next year, and the EBITDA margin will follow as well. With regards to quantifying EBITDA levels for 2020, I will refer to our call we'll have for Q4 in March. I'm going next week to meet our team at a -- a budget meeting where I'll have better guidance and then a better view on next year's numbers.

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Walter Noel Spracklin, RBC Capital Markets, Research Division - Analyst [4]

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Okay. Would that apply as well for CapEx program at this point? Or can you give us some indication as to whether just directionally, do you see it being up or down relative to 2019.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [5]

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I'd be happy to guide you on CapEx. We believe a $50 million mark would be in line with our historical spend.

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Operator [6]

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Your next question comes from the line of Hamir Patel from CIBC Capital Markets.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [7]

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Could you speak to the state of the M&A pipeline, and if you see any more opportunities in any particular product category?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [8]

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Perfect. So thank you, Hamir. We -- so as we've discussed in the past, there are several targets that the company has identified in the North American market that we are continually in discussions with. And we're working diligently in discussions with some of these sellers to be able to establish a deal, which obviously would be in line with historical discipline that we have with regards to multiples.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [9]

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Great. And I wanted to turn to the tie side. From your discussions with customers, do you have a sense yet as to whether volumes will be up or down next year? And any differences that you're seeing maybe between the Class 1s and the short lines.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [10]

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Certainly. So the -- so obviously, as we stated in our outlook, we're seeing improved sales next year and improved margins. So although we're going to budget next week, I do have a sense of preliminary numbers that we based our outlook on. So for Class 1s, overall, we're seeing growth in volume and in the details, there's plus and minuses in there, but net, it would be an increase for us next year. And we see demand for the non-Class 1 market to continue to be strong, and we do plan on taking an opportunistic approach to that market since we'll -- most likely, we'll be doing less boultonizing next year since our dry inventory program is much healthier than it was last year at the same time.

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Operator [11]

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Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [12]

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Just to come back on the previous question related to boultonization, could you maybe provide some color about the percentage of your railway ties that is using boultonization? And where should we see the improvement going into next year and whether we are looking for a normalized boultonization going back to 2021?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [13]

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Right. So Benoit, without quantifying it, I can tell you, this year, Q2 and Q3, heavily use the boultonizing process as we saw depletion in our inventory levels, and that is related to availability of product in the market or untreated tie in to market. What we've seen in the last few months, our key procurement areas have dried up, and we are seeing hardwood logs made available to sawmills, and our procurement team is quite happy, quite pleased actually with what we've been able to procure on a monthly basis. So we are building our drive program slowly but surely coming into -- closing the year and going into next year. So definitely, the boultonizing process will be used much less. The game there for us is the throughput or the quantity as high as we can produce at a given facility in 1 month. Obviously, as we've discussed in the past, when you boultonize, your cycle time is much longer than when you use a dry -- a tie that has properly air season, therefore, having more products being available for sales, we can probably -- we will most likely make -- taking better advantage of requirements in the non-Class 1 business.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [14]

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Okay, perfect. That's great color. And could you maybe provide some color about the railway ties, the composite aspect, whether there's been some change in the market demand, given the -- we are dealing with the wet environment. Have you seen any change on the composite tie demand with respect to that.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [15]

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Great question, Benoit. Thank you. So we have ongoing discussions with other railroads in North America being Class 1s and either short lines and so on. And we're not seeing a shift from wood or away from wood to substitute products. So there's no change in trends. Several of our clients do not spec either composite or concrete. And those that do will actually procure small quantities annually simply for their (inaudible).

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [16]

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Okay. That's pretty good. And when we look at the utility poles, given the wildfire, we've seen some strong growth so far. But could you comment about the organic growth expectation for utility pole and also given the technology that you have in terms of putting a mesh on the wood -- about the -- an update on the success so far.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [17]

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Okay. So well, obviously, the wildfires on the U.S. West Coast are very unfortunate. We have our emergency teams ready 24-hour/7, and we've been supporting our clients for quick adjustments to supply product, then we'll come to phase of rebuilding. And that will stretch over several quarters, Benoit. So it's not as if we will see a huge spike. It will be a lift over, let's say, the 3 or 4 next quarters of next year. But you should not expect us to have a big spike and comment in a conference call that we've got increased sales because of these events. This is always also a great opportunity for us to leverage our network and to demonstrate to our customers that we've got strong inventory levels and have the ability to serve to them from different locations.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [18]

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Okay. And when we look at 2020 for residential lumber, what would you expect, given the dynamics? I'm talking here, pricing versus volume for 2024 residential lumber. Any color you could provide, Eric?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [19]

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Well, it's always difficult to predict the cycle on the lumber markets, and we've seen sawmills closed in Canada in the recent months and hard to predict that impact as well. What -- so what we're seeing now is we're seeing are not between tie and how to procure lumber at a reasonable price, and we're actually getting into more longer-term commitments to ensure that we're building next year's program. So I would suspect that on the revenue side, what is going to be driving the increase is very much related more to volume.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [20]

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Okay. Okay. That's great color. And when we look at your inventory of railway ties, could you maybe provide some color about the -- what we should expect in terms of working cap for the full year in 2019, but also next year, given you might be able to worry you will be successful in building more inventory. Just wondering if there's a big impact we should expect in terms of the working capital.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [21]

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So I do expect a cash draw in our cash flow on that inventory line. Last call, I guided around $40 million. I would say it's in that range of $40 million to $45 million. Obviously, if we can procure more railway ties, we will. It's also a question of sort of the hardwood log that have become available, the sawmills are cutting down, and we're buying everything we can to build our drive program, but also keep in mind that there's a rhythm to which the sawmills can deliver. But if, for any reason, we can optimize and get more inventory in, we will definitely take that opportunity. So -- but right now, I will guide to $40 million to $45 million.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [22]

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For 2019, Eric, or even for next year?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [23]

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No, for 2019 -- honestly, probably most likely for next year because it is going to take us several months into next year to continue rebuilding that dry inventory level. Obviously, it depends on the pace. But yes, I would suspect there could be a drug again next year.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [24]

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Okay, perfect. And for the total working capital. Okay. And with respect to the CFO role, could you provide an update on the CFO search, Eric.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [25]

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Certainly. So we have engaged a third-party firm to help us recruit, and we're right now in the thick of the process. Things are moving along very well. I'm quite pleased with the process. And it's always difficult to predict when these processes conclude. But let's say, I'm hopeful that in the next few months, we'll be making an announcement to the market for a replacement for the CFO position.

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Operator [26]

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(Operator Instructions) Your next question comes from the line of Michael Tupholme from TD Securities.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [27]

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Can you provide any further details around the customer decision to defer sales? And if you do have a sense, and it's possible to share that. But also, is it fair to say that this is not in any way indicative of any kind of a general trend? It's a specific situation.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [28]

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So thank you, Mike. So I don't want to talk customer specifics. So -- but I did mention the fact that it's a customer -- it is not an industry spread trend. And there is no change in trend. As much as I can say, we have good relationships with this customer, and have a long-term relationship, and we're supporting them in this change. My understanding is that they're better managing their own internal inventory, and we're just pushing themselves into next year. But we know that we'll have strong demand from them in the coming year.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [29]

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Okay. You've talked a little bit about improving conditions on the procurement side in terms of raw fiber availability. Just wondering -- you've also talked about expecting some price-driven growth in the ties segment in 2020. And I'm just trying to square those 2 comments. If availability of raw material is improving yet you're still confident in seeing some pricing growth, is that just that the comps are a little bit easier, maybe in the first half? Or is this a function partly of your commentary about trying to be more opportunistic in the non-Class 1 market?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [30]

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Yes. And that's exactly it. It's in the non-Class 1 market because the first half of 2019 saw some price increases in the railway ties. So year-over-year in the first half of next year in that non-Class 1 business, we'll have opportunity to nudge up pricing just a bit. Exactly. So you're spot on.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [31]

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Okay, perfect. And then with respect to the utility pole segment, still healthy growth this quarter, but it did come down from where it was in the second quarter. And if I recall, the last conference call, you had talked about the potential for seeing double-digit organic growth for the full year 2019. Any commentary on sort of if there's been any changes in the, I guess, in the outlook or the organic growth outlook for the utility pole segment?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [32]

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No, not at all. So when you compare year-over-year, I can say as much as in 2018, we did have, in Q3, an important transmission project, which we, obviously, ended last year, and we do not have a replacement project, if you want for that -- for that specific sales volume for this year. But demand remains healthy. And to your point, I am hopeful to see strong close to the year. Call it, like, the mid-single digits, but it's still will be very healthy.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [33]

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Okay. Perfect. And then just lastly, the 2019 EBITDA guidance range that you provided, just to be clear, in terms of sort of what's driving you towards that type of range versus what you had previously communicated, is that mainly a function of this shift in deliveries for this one particular customer into next year on the tie side? Or are there other factors that went into that change.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [34]

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That is the main factor there, Mike.

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Operator [35]

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Your next question comes from the line of Maxim Sytchev from National Bank Financial.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD & AEC-Sector Analyst [36]

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Eric, I just got one question, and I'm not sure if you can provide this data point. But in terms of -- if you're going to be doing less boultonizing next year, can you maybe walk us through in terms of how we should be thinking about this in terms of the margin impact, the potential lift from that. Can you maybe quantify that?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [37]

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Quantifying is difficult. So -- there's 2 aspects to it. So one is when we have to use the boultonizing process, it is in accord with our customers, and we do get a bit more of a compensation for it. Where the cost efficiencies are a bit higher, there's less absorption of fixed cost because we absorb our fixed cost based on volumes produced. So there's definitely a better allocation of our fixed cost, and there's definitely an uplift. Difficult for me to quantify it. It's a good question. I mean I could have one of our analysts run some models on it, and then he could follow-up with you eventually, but it's not a data point I would have at this point.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD & AEC-Sector Analyst [38]

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But still, just in terms of how we should think directionally, it should help the margin profile. Is that a fair assessment?

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [39]

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It would, but it would be like in decimals of a percentage point, right? We're not taking significant lift.

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Operator [40]

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There are no further questions at this time. Mr. Vachon, I turn the call back over to you for closing remarks.

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Éric Vachon, Stella-Jones Inc. - CEO, President, Interim CFO & Director [41]

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Thank you for joining us on this call, and we look forward to speaking with you again at our next quarterly call.

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Operator [42]

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Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.