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Executives

Gary Kubera – President and CEO

Rich McLellan – SVP-Finance and CFO

Analysts

Jacob Bout – CIBC

Patrick Kenny – National Bank Financial

Alex Syrnyk – BMO

Rob Hope – TD Securities

Benoit Laprade – Scotia Bank

Canexus Corporation (OTCPK:CXUSF) Q3 2013 Earnings Call November 8, 2013 10:00 AM ET

Operator

Thank you for standing by. This is the chores call conference operator. Welcome to the Canexus Corporation Third Quarter Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there we will be an opportunity to ask questions. (Operator Instructions).

At this time, I would like to turn the conference over to Gary Kubera, Chief Financial Officer (sic). Please go ahead.

Gary Kubera

Thank you, operator. As normal, Rich and I are here on the line. But today, we happen to be in separate locations. So if we need to do some hand-offs here, we’ll do our best to make that smooth.

As we have typically done, we’ve posted a presentation to our website that I hope you have access to. I’ll be directing my comments to that presentation. And I would just like to remind you please review our forward-looking statements that support our comments today.

On page 2, we just like to primarily give you an update on our Unit Train Project, actually our whole NATO project and how that is progressing. And then give you an update of the conditions we’re seeing in our chemicals business.

Page 3, has a recent overhead from NATO, we’re progressing very well, you can see from this picture which is a couple of weeks old, there is still a lot of construction activity going on. But we are in the very later stages.

On page number 4, we do expect mechanical completion late to super late November, early December. We are already in the process of commissioning the various systems and components of it that we would expect to ship our first unit train by mid-December and actually several unit trains within the month of December. And then we would be going through full ramp up during the first quarter.

We’re trying to be fairly cautious with start-up giving winter conditions. We want to make sure crews are trained and we’re considering all the factors on site. But we do expect by the end of the first quarter to have our capabilities at the full rate of the first phase of the project.

The second phase then of course is still on track towards mid-2014 at which time we’ll have our second pipeline connection in, which will open the door to our ramp up to our initial operating rate 10 to 11 unit trains per week.

Cost of the project remains unchanged and our exit rate from 2014 is still expected to be the same. And everybody is interested on updates on the commercial status. We had expected to have at least one formal announcement to make within the third quarter that didn’t quite get completed. But I will tell you we continue to advance conversations and our prior thoughts and comments about being 80% to 100% contracted by the end of the year still remain true. Of course as we have a formal progress, we’ll make a point of letting you know.

I think also note is that while we still are very much working on these initial contracts that we’ll fill capacity from NATO point of view, we also are engaging in conversations for the longer term. The different services that we expect to be providing at the terminal in 2015 and beyond, there is a lot of interest that will give us diversification of cash flows at the site and provide other growth opportunities there.

So, we’re being careful not to get too much of that going before the initial phases are complete but our view of the value of the site long-term, the major trends that are happening and how we want to position ourselves from a NATO point of view, we continue to feel very good about.

Our Manifest business has continued to be below where we expected from a volume point of view. There are several factors going into that. We have some outages we’re taking in the fourth quarter to deal with some side-dish who is unrelated to the transloading which will affect our throughput. But we expect to enter 2014 fully contracted on the Manifest side. We’ve developed a very strong set of customers that have strategic reasons there. And we would expect that business to meet expectations starting in December and through the 2014 time-frame.

I’m going to switch now to our chemical business on page 6. I would say that the status of sodium chlorate performance is on track. Volume in the second quarter was a little bit below expectations. We’ve seen a nice improvement in the third quarter, where volume was up over 10% on a quarter-to-quarter basis. We expect demand to be relatively stable going forward. We will see some increases in the fourth quarter like we did in the third quarter. And we’re in the late stages of completing our contracts for 2014. And that looks to be about on-track with our expectations.

We are seeing a bit of price pressure as contracts get renewed into 2014. I would call that quite modest price pressure which will be partly based on mix. But I would also say that there were some recent announcement at the industry that looked like they will result in some consolidation, which long-term I think is very beneficial for the industry. I’m not sure what impact or how soon that would be felt but in this kind of relatively slow growth volume industry, consolidation is often very helpful. And I think it will be in this case also.

In Brazil, we’re seeing stable demand from Fibria, and again we expect stability in Brazil to continue into the future.

Turning to page 7 in our chlor-alkali business, again I would say we’re seeing stability. We’ve not seen any deterioration in cost to crisis, they have not recovered as we have expected. But the Asian prices appear to be stable. We see some indications of prices trying to go up but we haven’t seen any manifestation of that yet in our actual prices.

We are seeing improvements in acid volumes. But the chlorine molecule in general continues to be under pressure. So while, as we ramp up volumes on acid, we’ll see a nice up-lift relative to chlorine values. The overall acid prices particularly because of mix with us continuing to sell more in the U.S. will be under a bit of pressure.

We are also in the time where we expect increased volumes from drilling in Western Canada, we’re starting to see some signs of that but exactly how much improvement will be felt, it’s a bit too early to tell of that is true.

In the third quarter we’ve commissioned our latest acid plant. We now have the capability to convert up to 60% of our chlorine into hydrochloric acid. We are running the – the fact we started up in May at full rates. And we would expect this latest expansion to ramp up to capacity over the next several years. And again, as we have opportunities to overtake shares the market growth, we have the flexibility now to sell either chlorine or acid. And that should allow us to operate the plant at high rates and to develop the mix that would give us the best value on the chlorine side of the molecule.

In our chemicals business in general, we are managing them as if there is no improvement expected over the next several quarters. We do believe that there is reasons in both sides of the business to expect eventual improvement. But since we haven’t seen it, we’re being very cautious we’re being scrutinizing our cost, our capital to make sure that we continue to run as efficiently as possible through those.

So I’ll just make some final comments before we open it up on questions. We will expect the ramp up from our NATO both Manifest and Unit Train to happen throughout the course of 2014. The first half of the year as I mentioned earlier, we will be limited to just one pipeline connection and the underlying contracts that support that.

There could be some upside if market conditions and differentials stay as strong as they are where these initial customers want to shift more than that. And we will look to accommodate that. But then we’ll really see the ramp up as our second pipeline connection comes in mid-year. And realize full operating rates in the fourth quarter and then of course continuing into 2015.

So that concludes my comments. We’d be happy to take any questions for either Rich or I.

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from Jacob Bout of CIBC. Please go ahead.

Jacob Bout – CIBC

Good morning.

Gary Kubera

Hi Jacob.

Jacob Bout – CIBC

Just point of color of clarification here. In your prepared remarks you said, or I thought I heard you say that you expect to be fully contracted for the pipeline to rail by the end of this year or is it by early 2014 as page 4 of your presentation?

Gary Kubera

I guess, I’d call them the same Jacob whether – we are fired up along that. I think there is a high probability that despite the end of the year could have slipped into 2014. We’ve seen enough these cases where our expectations don’t quite get met. So, let’s stay with early 2014 for consistency.

Jacob Bout – CIBC

And why, especially considering where the differentials are right now why is it taking this amount of time to sign these contracts?

Gary Kubera

Each one is different. Some of the cases have been, we want long-term commitments. And people take those carefully. We want to make sure we’re working with the right parties. There are a number of contracts we could have signed that were shorter in duration or with people that we would view as less strategic.

We’re focusing on the customers we think are good fits with us and have longer term strategic potential. But some of these have changed a little bit, and every time they change as new information comes out, we’re trying to accommodate either our needs or customer’s need. So they just dragged on. I will tell you that none of the strategic customers we’ve been working with have dropped off. So, it’s a matter of just getting some of these final pieces completed and finalized.

Jacob Bout – CIBC

Maybe just flipping over to chlorate. The Chlor-alkali I guess is marketing some of the products from Tronex.

Gary Kubera

Yes.

Jacob Bout – CIBC

Could something like this happen with their chlorate profit?

Gary Kubera

Anything can happen. I wouldn’t – I think when you have a fairly a low-growth concentrated market. Anybody with higher cost plants is going to feel some of the pressure. And that often leads to market structural changes.

Jacob Bout – CIBC

Maybe just last question. The $50 million upside or the $50 million that you talk about for the pipeline to rail, to see if there is a plus on there, what is the upside from there and what have you baked into that $50 million number for that?

Gary Kubera

Well, that action rate for 2014 is based on the 10 to 11 railcars if actually in the Unit Trains per week. If our efficiencies are proven out and the offside factors work as well as they need to – taking that to 12 or 13 railcars per week would be the upside. We want to be very cautious with service levels and so pushing to those higher levels is of strong interest to us but we don’t want to get ahead of ourselves and contract will point where we then can meet service expectations. So really the upside is getting a bit more volume through there than we’re currently planning.

Jacob Bout – CIBC

And would you have to spend more money to take advantage of that Diluent pipeline that you’ve got?

Gary Kubera

On Diluent, as I think we’ve talked in past, a lot of our infrastructure in this project supports Diluent. We do have the pipeline, dual pipeline in place. We’ve got some headers in place at our current configuration. So that the bend base spending. We would and will need to spend more money to fully finalize the capabilities on site to handle Diluent. And so that is currently not in our spending scope and we will be evaluating that on an ongoing basis of how we develop that capability.

Jacob Bout – CIBC

All right. I’ll leave it there. Thank you.

Gary Kubera

Okay. Thanks Jacob.

Operator

The next question is from Patrick Kenny of National Bank Financial. Please go ahead.

Patrick Kenny – National Bank Financial

Yes, good morning guys.

Gary Kubera

Hi Patrick.

Patrick Kenny – National Bank Financial

Just on NATO, you guys continue to expect to generate $50 million plus of cash flow from the unit train operations once they fully ramp up. I’m just wondering if you could also confirm your expectations for the truck to rail transloading side of the business. I believe that’s previously you talked about $10 million to $15 million from that side of the business. Just wondering if that’s changed at all?

Gary Kubera

No, I would say Patrick, that’s still a good number for a Manifest side.

Jacob Bout – CIBC

Okay, great. And then, just wondering too if we can get a bit more color on the in-service timing of the second unit train phase and NATO you maintained guidance of mid-2014. But there has been a few weeks delay in the start-up of the first phase. So, I’m just wondering, has that pushed back the expected timing of the second phase from say, early July to late August sort of thing or is there something else going on there that doesn’t impact the second phase?

Gary Kubera

No, good question. And I think our expectations that this should not affect that phase. There is really three components that mostly are required to enable the full second phase by the middle of 2014. It is the completion of the inter-pipe fund tie-ins that they’re doing. It’s the completion of the inter-pipe tie-ins to their Lamont Station that we are doing, both of those pipeline projects.

And then, it’s the installation of the second set of 12-loading arms on our site. So those are the three components that enable the higher capacity at the site. As of right now our project plans and from our understanding the inter-pipe fund project plans, all still support a mid-2014 startup.

Patrick Kenny – National Bank Financial

Okay, great. I appreciate that color. And then maybe lastly for Rich, I was just wondering how much buffer you have from both the balance sheet metric perspective and on the payout ratio as you look to bridge the gap between now and full ramp up of cash flows in NATO. At what point do you see the need to perhaps short the balance sheet with another truant of equity or contemplate temporary reduction in the distribution?

Rich McLellan

Yes, thanks Patrick. Right now we don’t contemplate any temporary reduction in dividends. As we indicated, we expect that will be over 100% payout ratio for the next few quarters. But then when we get into Q4 ‘14, we expect to be well below 100% and back on track. So we think we’re able to manage to get to that point and be comfortable with a sustainable dividend at current levels going forward from there.

In terms of our balance sheet, I’ll just remind you that in past projects like TCP we’ve used our balance sheet by relaxing covenants. And I would say that given the late stage of NATO Unit Train construction and contracting that it would make sense to do that now if we required any incremental liquidity over what we have now and what we foresee going forward.

And so, and we know as well that we have the support of our major lenders to do this. So again, we feel comfortable that with the spending profile ahead of us and with the ramp up profile ahead of us for the unit train operations that the dividend is manageable over the next while until we get to Q4.

The other comment I’ll make Patrick is that and Gary alluded to this is that on the Manifest side, we expect to exit 2014 so December’s run rates there should be something close to 24,000 barrels a day, just the diluted betterment and crude oil side of the Manifest business. And that run-rate or better is expected for all of 2014.

So we should see some improvement from NATO commencing in December. The well disposal work-over work that’s been going on has gone very well and we expect the work-over rate to be off the area where that’s affecting the two loading tracks by the end of next week.

Patrick Kenny – National Bank Financial

Great. I appreciate the color. That’s all I had guys.

Gary Kubera

Thank you, Patrick.

Operator

The next question is from Alex Syrnyk of BMO. Please go ahead.

Alex Syrnyk – BMO

Hi, good morning.

Gary Kubera

Hi, Alex.

Alex Syrnyk – BMO

I’m just wondering if you could talk a little bit about the chlor-alkali segment. So if I’m to take, I mean, if I’m to assume the fourth quarter comes in roughly in line on the EBITDA basis, but what we saw in the third quarter. It looks like you’re on track to do about let’s call it $28 million of EBITDA for 2013 in that segment.

I know that in the second quarter there is some outages at the North Vancouver plant and then as well in 2014 you’re expecting some lift from the incremental hydrochloric acid capacity. I was just wondering if you could talk about what you expect that lift to be on hydrochloric acid given your comments, your opening comments about some pricing weakness.

Gary Kubera

Yes, that’s a hard question, Alex. And I’m not trying to dodge in. I think – I think my starting point for answering that would be that the – at a minimum the acid additional volume should offset any weakness we might expect to see going through next year in chlorine pricing or acid pricing.

So I think we’re moving towards at least a stable quarter-to-quarter, year-to-year situation. And if we see where chlorine prices and where acid prices that weaken or we see improvements in the caustic side that creates some upside. I don’t think we’re moving towards a major move-up in cash flow expectations as we move towards next year. But we certainly are not looking for further down-drafting across the whole business. But it’s – I would tell you it’s very fluid right now in kind of how the markets are evolving. And views change rather quickly in these kinds of markets.

Alex Syrnyk – BMO

Okay.

Rich McLellan

The other thing that I would add Alex is that, we’re seeing some positive indications from companies that are active in the Beaver Hill Lake complex and Swan Hills region in particular. And if that comes to pass over the next three quarters or two quarters in particular then there could be some upside just because of the proximity of that market to our business and also due to the higher volumes of acid that those formations typically utilized.

Alex Syrnyk – BMO

Okay, great. That’s helpful. And then, just in terms of the Unit Train ramp up in the first half of 2014. So prior to you tying in the Cold Lake system to the facility, I mean, can we expect in terms of the capacity utilization you’ll be looking at on that first phase. Should we assume at this point that you’re just sending through the make material? Or I mean, I guess the other way to ask the question is, are some of the contracts that you’re working out on now, will those be reflective or will those really just kick-in in mid-2014 or beyond or are those contemplating some material moving in the front half of the year as well?

Gary Kubera

I think the base assumption is likely to be that the volumes moving through are predominantly MEG with a little bit of Synovis. And a couple of things could happen it’s possible that some of the contracts could start some business flowing earlier. But I would say the base assumption is more likely that they start with the Cold Lake startup. If differentials stay as they are, we could see the desire by those initial customers to move more through in the first part. But I think there is, we want to make sure we go through a logical ramp-up so we won’t push that too fast until we’ve proven what we could do.

So that impact if that happens is more likely to be in the second quarter. And that I think we would see partial ramp-up in the third quarter with the Cold Lake tie-in and then the full rates in the fourth quarter.

Alex Syrnyk – BMO

Okay.

Gary Kubera

I would put it as an upside rather than a base case, maybe say it more directly.

Alex Syrnyk – BMO

Okay, okay, great. And then, just I guess lastly in terms of the South America segment. I think we saw, it looks like revenues came down to fit there or it looks like volume stayed roughly the same as we were last year. Are you seeing some pricing, some pricing pressure in that region on the material that’s not really exposed to the Fibria contract?

Gary Kubera

Revenue is always a little bit elusive in South America because of the strong pass-through nature of the Fibria contract. So, if we see electricity rates changes you can see a meaningful drop in revenue but not in cash flow. So I’m not aware of any significant merchant market pricing degradation. So I would – without having a direct analytical answer, I’d suggest it’s probably electricity pass-through.

Rich McLellan

Alex, actually I can confirm that. In fact the press release alluded to that. We have seen transmission cost come down in Brazil, even quarter-over-quarter between Q2 and Q3. The other dynamic is that we signed a contract that had lower electricity rates that too effecting I believe it was March 1, of this year.

And so, electricity prices have come down and Gary is exactly right, when electricity prices come down because of the U.S. dollar fixed margin nature of the majority of our business. Revenues come down but cash flow stays the same. So, and on the merchant side, we did see some lower volume of merchant chlorate move but again, no significant movement in pricing, so those were really the reasons.

Alex Syrnyk – BMO

Okay, great. I’ll turn it over. Thanks guys.

Gary Kubera

Thank you, Alex.

Operator

The next question is from Rob Hope of TD Securities. Please go ahead.

Rob Hope – TD Securities

Good morning.

Gary Kubera

Hello Rob.

Rob Hope – TD Securities

Maybe just one or two questions on NATO as well. Just on the conversations that you’re having with perspective customers there. Are these shippers on Access or Cold Lake, or are you looking to potentially add more pipeline connections to the facility?

Gary Kubera

Well, everything that we’re working on right now is either Access or Cold Lake. But over time, and I wouldn’t say over time is in the next 12 months that there is interest both on a number of customers but also from our point to consider other pipeline tie-ins.

Again, I think that really plays to the longer nature development of the site which we want to focus on those long-term sustainable cash flow streams, so that will be one of the main focus areas for us as we look to develop the site. Whether that’s on the Condi side, whether that’s on the Cavern storage side, whether that’s related to into Diluent recovery or even straight storage that people may want in that area.

Rich McLellan

And then Rob, just to be clear as well, it’s not just producers that we’re in discussions with. It can be marketing and trading companies or refineries that have contracts for those barrels in place.

Rob Hope – TD Securities

Okay, great. And that actually leaves me to my follow-up question. One of your customers has been talking about Diluent recovery in the region. What or maybe what magnitude of changes would you need to be able to load rail-bit?

Gary Kubera

Very little. The system itself is well set up to handle multiple products, rail-bit might require depending on its temperature profile, some additional pumping capability. But we anticipated doing things like rail-bit in our development thought processes so it would not be much of a stretch or cost to be able to do that.

Rob Hope – TD Securities

And then one final on that topic. Would you potentially invest in Diluent recovery unit or would you prefer a producer handle that?

Gary Kubera

We are not opposed to invest in Diluent recovery. Whether we do that ourselves or with a partner or we just link with one or more people that want to do it, I don’t think we’ve set a model yet. But I think an investment or a co-investment is definitely a possibility.

Rob Hope – TD Securities

All right, great. Thank you.

Gary Kubera

You’re very welcome.

Operator

(Operator Instructions). Next question is from Benoit Laprade of Scotia Bank. Please go ahead.

Benoit Laprade – Scotia Bank

Thank you and good morning gentlemen.

Gary Kubera

Hi Benoit.

Benoit Laprade – Scotia Bank

Just a quick question on the capital spending front for 2014, do you have an estimate of how much you intend to spend and if you could split it maintenance versus growth? And if you would have an idea in terms of how it was going to be distributed among quarters?

Rich McLellan

Sure. We’ve incurred about $142 million of the $225 million related to the NATO projects so that leaves little over $80 million left to spend. I would anticipate that about $40 million of that will carry forward into the first half of 2014 to complete the two projects or three projects that Gary alluded to earlier.

So the pipeline connection from the MEG Canexus pipelines system up to Lamont Station and the additional loading arms. And then in addition to that Benoit we have about $25 million of maintenance capital that will be spent. And really those are the only commitment that we have that it could be dealt with. And I can’t map out exactly how that maintenance capital will be spent by quarter for you right now. But if you look at kind of historical patterns, they’re probably not likely too bit similar next year. So the second quarter is typically a time when we spend a little more maintenance capital.

Benoit Laprade – Scotia Bank

And the bulk of the 40 remaining will be obviously in the first half?

Rich McLellan

Yes. And I think the pipeline work will likely be done mostly in the first quarter and the loading arms in the latter part of the first quarter and into really the second quarter. The incremental loop track that we needed to install is already in place.

Benoit Laprade – Scotia Bank

Great. Thanks.

Gary Kubera

Thank you, Benoit.

Operator

There are no more questions at this time. I will now hand the call back over to Gary Kubera, for closing comments.

Gary Kubera

Okay. Well, thank you operator and thank everybody for joining us. As I mentioned earlier, we will continue to advice you of any material changes in our business if they occur between our conference calls. Thank you.

Operator

This concludes today’s conference call. You may now disconnect your lines. Thank you for participating and have a pleasant day.

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