Neo Performance Materials

Ladies and gentlemen, thank you for standing by, and welcome to Neo Performance Materials' first quarter 2020 earnings announcement. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your first speaker today, Ali Madhavi, Capital Markets and Investment Relations, Thank you. Please go ahead.

Thank you, Operator. Good morning, everyone. Apologies for starting a few minutes late. As a reminder, today's call is being recorded, and a replay will be available starting tomorrow in the Investor Center on our website at neomaterials.com. Speaking first today will be NEO's President and CEO, Jeff Bedford. Following Jeff's commentary, NEO's CFO, Rayne Sullivan, will review the company's financial performance during the first quarter. Then we will open the call to questions from analysts. Please note that some of the information you will hear during today's presentation and discussion will consist of forward-looking statements including, without limitation, those regarding revenue, EBITDA, and adjusted EBITDA, product volumes, gross margin, other income and expense measures, ROCE, cash returns, and future business outlook. Actual results or trends could differ materially from those discussed today. For more information, please refer to the risk factors discussed in NEO's most recent financial filings, which were filed on CDAR earlier today and are also available on our website. NEO assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. Financial amounts presented today will be in U.S. dollars. Non-IFRS financial measures will be used during this conference call. Further information regarding NEO's use of non-IFRS measures is available in NEO's Q1 2020 earnings press release, which is available on CDAR and on our website at neomaterials.com. Let me now turn the call over to Jeff Bedford for opening remarks. Jeff?

Thanks, Ali. Good morning, everyone. While the first quarter of this year was impacted by slower economic activity, primarily in China and primarily due to the COVID-19 pandemic, NIO was able to generate consolidated revenue of $90.7 million, with adjusted EBITDA of $9.6 million. Importantly, in this current economic environment, our balance sheet remains strong, closing the quarter with $76 million in cash and cash equivalents and minimal debt. Nearly all markets in the advanced materials space and the vast majority of our customers' industries have been impacted by the pandemic. Fortunately, NIO's strong and flexible economic model positions us well for the uncertainty ahead. Let me first express on today's call how extraordinarily proud I am of the job that NEO team members around the world have done in managing through this pandemic thus far. Protecting the health and safety of our team members and their families has always been a priority at NEO, and our teams embrace this culture. In response to the coronavirus, we very quickly adopted and shared best practice globally, and we've deployed precautionary health and safety protocols. At all our manufacturing facilities across our global footprint, we instituted strict measures, including mandated infrared temperature screening for all employees and visitors, full-time use of masks, strong restrictions on visitors entering the facility, anti-epidemic and personal hygiene training, quarantine precautions for people who are not feeling well who have just traveled, innovative social distancing precautions, and planned disinfection protocols. In addition to suspending all non-essential travel, we also shifted operations at our office locations to 100% remote work. Neo employees around the world stepped up and went the extra mile. And as a result of the measures taken, we're able to keep our employees safe and keep our manufacturing facilities operational to meet the needs of our customers. We expect we'll be facing extraordinary pressures through the remainder of the year. Many of these market demand forces are out of our control. What is in our control is our ability to maintain a disciplined approach to all daily operations and to deliberately utilize our balance sheet and manage our capital to emerge at the top of the industry when markets and the global economy rebound as they undoubtedly will. Our cash position remains strong and we continue to focus on returning significant capital back to our shareholders. 74.8 million of net cash we reported at the close of the quarter included returning 2.8 million in dividends to shareholders, $2.3 million to non-controlling interest partners, and repurchasing $1 million of stock under our NCID program. Let me be clear. We fully anticipate significant volatility in our markets for the balance of this year. We also feel confident in our ability to maintain our approach to capital allocation. NEO has a strong balance sheet and no material debt. Our economic model and operational discipline helps to deliver robust free cash flow conversions particularly as we developed global manufacturing operations in low-cost jurisdictions. That allows us to remain focused on strategic, long-term execution of our business plan, even during this pandemic. It also positions us to keep a close eye on potential growth opportunities that may avail themselves. The global pandemic has impacted daily life in nearly every corner of the world. What we knew two months ago and discussed in our year-end call was that our visibility into this year would be limited to say the least. True to form, our customer's outlook continue to evolve on an almost weekly basis. We're all reading the same headlines, particularly those related to automotive OEM sales slowdowns, auto production rates shuttering to near zero in recent months in certain geographies, and a decline in air travel. The disruption to markets for these products and services is impacting all segments of the supply chain. Raw material suppliers, to value-added material processors like NEO, to OEM manufacturers, to retail consumers. This is an unprecedented set of market conditions. However, long-term drivers within our customers' industries for lower emissions and novel uses of materials to improve productivity are not being shelved. We fully expect market demand for advanced materials that enable sustainable technologies will continue to grow, as it has for the past several decades. End market demand for applications that reduced air and water pollution is strong and will continue to accelerate in our view. Government regulations and performance mandates aimed at increasing sustainability and reducing pollution are almost certain to continue to expand. NEO is prepared to meet that growing demand. Our innovative advanced materials help control vehicle emissions, increase fuel economy and surface and air transportation systems, capture pollutants in wastewater treatment plants, and reduce energy consumption in home appliances and factory assembly lines. Because of their ability to increase and enhance sustainability throughout the economy and help protect the quality of our environment, we see these as very good long-term growth markets. If anything, a crisis like this highlights why advanced industrial materials and the powerful benefits they can deliver to society are needed. Across each of our business units, we are looking for new applications and opportunities for our materials as a result of the immediate and longer-term impact of COVID. We have a long history of being able to employ our expertise and innovation in performance materials and help apply them in novel applications, almost always in close coordination with our customers. Of course, in times like this, a disciplined approach to operations is needed to ensure we maintain a position of strength in the face of headwinds. Over the past eight weeks, we have been actively taking steps to right-size production plans as needed, reduce our overhead spending, manage working capital, and re-examine our growth capital plan. We continue to maintain regular communications with our consumers and have been able to commit to serve their needs in an uncertain environment. We have seen some minor interruptions in obtaining raw materials, and we continue to monitor our key suppliers closely. But to date, these have been isolated and temporary occurrences. Investors have heard me say this before, and it bears repeating. NEO's strategic approach has been to focus on doing three things better than anyone else in the advanced materials space. First, build world-class technical know-how. Second, maintain strong and long-lasting customer relationships and development partnerships. And third, invest in the global cost-competitive manufacturing footprint. NEO's business model is one that has successfully weathered many downturns over the past 25-plus years. While the impacts of the coronavirus pandemic may have been larger than many forecasts, the NEO team has been through such trying times before. Each time, we have emerged a stronger and more resilient company. I fully expect that will be the case following this pandemic. With that, let me turn it over to Rahim to go over the details of our first quarter results, and then we'll open the call to questions. Rahim.

Thanks, Jeff. Good morning, everyone. I hope everyone's doing well, you and your families, and thanks for joining us today. Our Q4 revenue totaled $90.7 million, which compares to $109 million in the prior year period. Net income for the quarter was $518,000, or $0.01 per share, and adjusted net income was $869,000, or $0.02 per share. On an adjusted EBITDA basis, the company earned $9.6 million in the quarter, which compares to $16.5 million in the prior year period. We will discuss these results segment by segment, starting with Magnet Clutch. Our magnet quench settlement led the decline in revenues as volumes were adversely affected by slower economic activity in various regions globally, including in the automotive industry and by the industry-wide impacts of the COVID-19 pandemic. The economic impact of COVID-19 started in China and some other parts of Asia much earlier than the impact in the rest of the world. Magnet quenches products are ultimately destined for use in applications across the global market, but the first level supply partners often located in China and in other parts of Asia. Accordingly, the impact of COVID-19 was felt by MagnetQuench over the majority of the quarter. MagnetQuench adjusted EBITDA with 7.7 million, which compared to 10.9 million in the same period of 2019. Adjusted EBITDA was 7.7 million compared to 10.9 million in the same period of 2019, and it was affected by lower volumes, both in margin and overhead absorption, and by changes in foreign exchange rates, and by the timing of the impacts of NEO's input pass-through mechanics. This pass-through mechanic, which updates selling prices on a lagged basis, is a key feature of NEO's strategic focus on value-added margins. In our C&O segment, we are pleased to see growth in our automotive environmental catalyst programs. this continued growth has been consistent for a three-way gasoline catalyst for an extended period of time now. However, this is the first quarter in recent history where our diesel catalysts have shown growth year over year, following the decline in the diesel market generally and our historical overweight exposure to that segment. As previously discussed, our diesel exposure is now more reflective of the overall market and our growth has been driven by newer formulations of products, from our product development efforts. Of course, with COVID-19, this trend might be short-lived, but we think that this will be an overall market-driven, and we are well-positioned for future growth as end markets return. Similar to MagnaClench's impact from COVID-19, CEO's rare separation business, while supporting technology and various global end markets, has its first-level supply chain partners often in China and Asia. And accordingly, volumes were lower, and prices declined in the quarter. The largest single impact in C&O, and in fact for NIO overall in the quarter, was the reduced spot sales in the quarter. As we discussed last year, in Q1 2019, C&O had a number of unusually large spot sales concentrated in one quarter, and there were few spot sales in Q1 2020. In our rare metals segment, We booked an operating loss of $0.2 million in the quarter, driven largely by the previously discussed decline in pricing for tantalum-based products and by a general slowdown in the gallium trichloride-related markets. The rare metals segment had considerable material in the production system, so when material prices change, there is a lead-lag impact into the current period results as the operation is processing and selling material on hand purchased in the prior period. End market pricing has been reasonably stable for the last several quarters, and most of the historical higher cost inventory has now largely been consumed, with a smaller amount remaining at the end of the quarter. Notwithstanding the impact of COVID-19, we would expect this unusually long lead-leg impact to resolve in the second half of 2020. A few more comments on some other cash-related items. NEO invested $1.5 million towards capital expenditures and paid $2.6 million in cash taxes in the quarter. NEO returned $2.9 million to dividends to our shareholders and repurchased $1 million in shares within the NCIB program. And NEO also paid $2.2 million in dividends to a non-controlling minority interest partner in our boost and boost joint venture, with an equivalent amount being returned to the consolidated NEO. With the impact of COVID-19 and the generally lower market outlook, it is also important for the company to think about liquidity and the impact of cash flow from lower sales. Although predicting the quantum of the change in sales at this point is a highly uncertain process, we can provide some commentary with respect to the company's overall cash position. As previously noted, the company has a very conservative balance sheet with $74.8 million in net cash available and no material debt outstanding. Further, the company has no meaningful debt covenants. With the vast majority of our manufacturing in cost-competitive jurisdictions and a highly variable cost component to cost of sales, the company is in a strong position to deal with the prospects of declining sales, profitability, and cash flow in the upcoming quarters. The company will closely monitor discretionary cash flows, working capital, and capital expenditures over this period of time. However, with our strong cash position, We will also continue to invest in strategic capital projects promising R&D endeavors and continue to return capital to our shareholders in dividends and share repurchases. We believe that we can be responsible cash stewards while continuing our strategies around growth and improving shareholder returns. With that, let's open up for questions.

Thank you. As a reminder, to ask a question, please press star followed by the number one on your telephone keypad. We'll pause for just a moment to complete the Q&A roster. Your first question comes from Mark Neville from Scotiabank. Your line is open.

Hey, good morning, guys. I'm just sort of, I guess, thinking high-level first. Again, a lot of your, I guess, manufacturing is in Asia-Pacific areas, Again, a lot of your sales exposure, at least initially, is in Asia Pacific. But again, as you mentioned, a lot of these supply chains are global. So just trying to think about, I guess, the cadence through the year of what things look like. I guess we can date the shape of the recovery, but I'm just trying to think about the Q2 versus the Q1, how significant of a step down there might be, or if would Q1, just given your footprint, sort of be the trial? It doesn't sound like that, but I know it's a tough question, but just sort of trying to sort of square all those things to get sort of an idea of what the next public order might look like.

Yeah, sure. So, look, I think that as we talked in our remarks, Mark, that with Q1, because we were in Asia, we were impacted. We were impacted sooner than companies that aren't as exposed in China. But having said that, I don't think that the full impact occurred in Q1. And given what we're seeing in the outlook currently, which continues to evolve, we would expect that there would be a further step down in Q2. But we're also, again, from the outlook sitting here today, seeing that then from there, there's a slight build in Q3 and onward from there. I think the question about how long and et cetera, and the knock-on impacts are the question in everybody's mind, but we would expect a step down in Q2, and then sort of a leveling and growth from there is kind of the current shape of the outlook.

Right. I guess just thinking what you've seen over the last sort of six, eight weeks, has the rate of declines sort of moderated, or I guess what I'm asking is have you sort of knock on wood, sort of seen the worst of it and sort of at this point coming out or still sort of early to sort of make that call?

I think that we're, you know, as we talked about a step down in Q2, I think as we've worked through Q2, it's been consistent with what we were expecting as we were going into Q2. So, you know, I think that and then as I said from there, the current expectation is things start to improve from there. So I would say, you know, as we're sort of two months into Q2, it's just sort of as expected, which would be lower than Q1.

Right. Okay. Just on the corporate expense, Q1, I noticed it was higher. Is that just the R&D?

Corporate expenses in Q1, depending on whether you're talking about SG&A or R&D, SG&A is higher in 2020 versus 2019 because 2019 had the recovery of a number of costs related to the termination of luxury transactions. But I think overall S&A's run rate is kind of consistent. And R&D would kind of be bounced around with, I would say, normal level, whether it's, you know, a little bit up or a little bit down, quarter to quarter is more project specific. It's largely consistent with some reduction, I think, just in kind of discretionary spend, but largely consistent.

Okay. Maybe just one last one then. So the NCIB, you know, obviously the balance sheet's in great shape. There's a lot of cash. Generally, Business is pretty self-sustaining when it comes to the cash generation. But again, the NCIB, you're sort of limited to what you can do. So I'm just sort of curious if there's any thoughts to maybe doing something a little bigger. I appreciate, you know, you kind of conserve cash at the moment. Everybody's trying to do that. But just maybe thoughts around that and how the balance sheet evolves and return of capital.

Yeah, absolutely. So, you know, the NCIB we wanted to put in place because it's prudent to have one generally, in my view. You know, and the NCIB, to your point, I think is the volumes that we're allowed because of the low daily average trading, you know, is not – it's fairly limited. But I think that also kind of plays into your question of do we want to do something bigger and the tradeoff would be less liquidity again. So I think that, you know, at this point, you know, given where we are, you know, we think it's a good idea to have the NCIB, but that's all we're sort of considering at this point.

Okay. Thank you. Yeah.

If your next question comes from Yuri Link from Canaccord Genuity, your line is open.

Hey, good morning, guys. Morning. Just morning. On the MagnaCoin side, just what are you doing with prices right now, and are you feeling any additional pressure to reduce prices beyond what the input costs might dictate?

So at this point, you know, there's no change in the way that we're thinking about pricing as far as the pass-through mechanic, et cetera. You know, we fully expect that, you know, the automotive – there's stress in the automotive industry that they typically come back through the supply chain looking for ways that we can save money. You know, we're always doing that, and we will continue to do that. But, you know, at this point, we're not contemplating changing – the way we're thinking about pricing and our formulas, but we certainly will be talking to customers about is there ways we can get costs out of the system and share that benefit.

Okay. And just as volumes have declined and sounds like they've continued to decline in the Q2, I mean, are you looking at shuttering any capacity at this point or have you done that yet?

We have. So we have our plants in China, two of them not the MagnaQuench plants, but our Zibo and Jianying have gone into sort of temporary shutdowns for a period of time. They'll likely restart back up in June. And, you know, other facilities, we've looked at slowing the plant down and reducing our costs there, trying to match up with the demand outlook that we have currently.

Okay, makes sense. Okay, I'll turn it over. Thanks.

As a reminder, if you'd like to ask a question, please press star 1. Your next question comes from Mack Whale from Cormark Securities. Your line is open.

When you look at the average pricing in the quarter, is that reflecting sort of the pricing that you had going into the quarter, or is it really still on the down slope?

Mack, I think it – Depends, I think, on which average pricing you're referring to. I think, you know, MagnaQuench would have been reflective of what we would have planned for the quarter generally because the prices are set in advance. Same with the auto catalyst business. The separation business would be responding to much more of what the price, the market price is within the quarter. And in the rare metals business, prices are actually holding and doing okay throughout the quarter. They're not declining. So I don't know if that answers your question, but it's a different story for each of the areas.

When you look at downstream at the inventory of your customers or deeper into the supply chain, what visibility do you have? Do you expect a lag, a big lag on a return of production before you'll see some orders? Or can you just speak a little bit to your visibility on that?

Yeah, sure. I think that... That's one of the reasons why. There was a pretty abrupt shutdown for a lot of our customers because of government regulations, et cetera. And I think that we're definitely sort of seeing that impacting us in the second quarter. And then as far as visibility looking out, again, I think it's still evolving and we're talking to our customers, but I can tell you that Some of our larger customers, they're beginning to open their plants again and start running, obviously not at full capacity. But that gives us signals that they are going to be needing demand again as we go through. I don't think there was significant inventory. It really depends on which supply chain, which customer. I think traditionally the automotive guys don't run with a lot of inventory. You know, clearly if demand slows, there's a time period where they will rebalance inventories. But, you know, I think that as their plants start opening up and running again, then, you know, they'll start looking to us to start supplying them again.

Okay. And then just lastly, you know, when you think about what's happened, I mean, your quarter was actually pretty good. It could have been a lot worse. And certainly Q2, as you talked about, we're going to see some impact. But in the grand scheme of things, you're in a pretty good situation with cash, not trading at a great multiple, but can you speak to whether you start to get aggressive on changing your exposure? And what I mean by that is the themes you talk about, there are other areas you can go into or just shift into different elements or different types of products and maybe even a different vertical approach. Is there an opportunity here in this sort of crisis to swoop in and say, you know, this is something we've talked about doing in the past. We're going to go after this now because you're really in a situation where your competitors or other segments could be really hit hard. I'm wondering if it's too early, you haven't had those discussions yet, or whether it's something you could speak to us about today. Okay.

Yeah, I think it's still pretty early. But look, I think in some ways we're a bit of a victim of our own success in the sense that we pushed hard, you know, with automotive and magnet quench and thinking about where else we could be applying the magnet quench sort of products. And we clearly are looking for alternatives that are maybe not as focused in automotive or other parts of the world where we don't have the penetration today. And that continues. You know, I have to say with all of us working from our home office, it does make it difficult to go out and do due diligence and those types of things. So it's a bit early, but I completely agree. I mean, I think we are in, you know, in a tough environment and a somewhat eminable position with a very good balance sheet. It's very, you know, we have a high variable cost type business model. So we can flex it up and down and continue to think about the long-term strategy here. And quite frankly, as I said in my remarks, no question, we're all seeing what's happening short-term, but long-term, these materials, they continue to be really important. We think that there's opportunities that may open up because of people thinking differently because of what we've gone through the last six months that will be a benefit to us. So we are absolutely looking for those types of opportunities.

Okay. Okay, that's helpful. And just lastly, how does it impact You know, you spoke about sort of M&A and due diligence and that type of thing. What about internally on the R&D? You know, you work closely with customers. Can you speak to whether you're expecting a sort of a gap, say, I don't know, six or eight months from now, where this has impacted your R&D people and their ability to speak with customers? Or is that sort of lab work that you need to do That's beyond the desk engineering, so to speak. Can you speak to your ability to keep the pipeline of new products strong?

Yeah, so I think that we continue to have dialogue with our customers and talking to them about R&D and some of the projects. I also think that, you know, a lot of our customers, the focus has turned a little more immediate given everything that's going on. But, you know, the R&D, there's ebbs and flows, and as things start to normalize, we can catch up, right? I mean, these things are – we have the ability to sort of move things back and forth. So, you know, at this point, I don't see it being a significant impact on our ability to keep the pipeline filled, as you said. You know, if this extends for an extended period of time, it might, but at this point, I don't think that's where we are.

Okay, great. Thanks, Derek. Yep. Yep.

If you have no further questions, I turn the call back over to the presenters for closing remarks.

Thank you. On behalf of the NEO team, thank you again for joining us today. We look forward to speaking with you again on the back of reporting Q2 results. In the meantime, we hope that you all stay healthy and safe. This concludes today's call. I will now turn the call back over to the operator to close the lines.

Thank you. Ladies and gentlemen, you may now disconnect.