Neo Performance Materials

Ladies and gentlemen, thank you for standing by and welcome to the NEO Performance Materials Q2 2020 Earnings Announcement Conference Call. 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 this time, you will need to press star 1 on your telephone keypad. If you require any further assistance, please press star 0. Thank you. I would now like to hand the conference over to your speaker today. Ali Madabi, you may begin.

Thank you and good morning, everyone. As a reminder, today's call is being recorded and a replay will be available starting tomorrow in the Investor Center on our website located at neomaterials.com. Joining me this morning on the call are Konstantin Karianopoulos, NEO's President and CEO, as well as Rahim Shaliman, NEO's Chief Financial Officer. who will then provide additional details regarding the company's second quarter performance. Then we will open the call to questions to analysts only. 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 Q2 2020 earnings press release, which is available on CDAR and on our website at neomaterials.com. Let me now turn the call over to Konstantin.

Thank you, Ali, and good morning, everyone. It's good to be speaking with all of you, our shareholders, analysts, and stakeholders around the world. These are certainly challenging times, no question about that. However, as I examine strategic opportunities on NIO's near-term horizon, I do see some very interesting and potentially exciting options for the company. It is a truism, and it has been said before, that in crisis, there is opportunity. That has always been a guiding business principle at NIO since the beginning. As many of you know, my involvement with NIO spans more than a quarter century. starting in 1994. Eight of those years, I was president, CEO, and director. And for the most recent seven years, I have served as director of NEO and its predecessor company. Since NEO's successful reemergence as a private company and then publicly traded company in 2017, I have served as board chairman. There's a powerful connection for me to this organization and to our entire team around the world. I'm proud of the fact that we have assembled some of the world's best talent here at NEO that will be critical to help grow our business. Despite the current economic environment and its challenges and uncertainty, we are extraordinarily well positioned in markets that are set to experience significant long-term growth, particularly those related to increased sustainability. In particular, the advanced industrial materials we make are key to addressing some of the world's most difficult problems, such as climate change and other environmental challenges. While the CEO job at a public company is challenging in even the best of circumstances, I will say that I've never been more excited over the past 25 years as I am today because of the strategic possibilities I see for NEO. Let me first say that NIO would not be the company we are today without Jeff Bedford's many contributions to building the organization and our robust business model. Jeff is a valued colleague and a good friend to me and to all of us at NIO. His steady hand, industry knowledge, and grounded vision over the past 20 years have prepared us to embark on our next stage of growth. I'm also pleased to report that we have appointed Claire Kennedy to replace me as a chair of the NIO board. Claire has served as a NEO director for the past three years, as well as on the previous NEO board for a couple of years before the sale to Mollicorp. A lead director for the Bank of Canada, where she chairs the Audit and Finance Committee, Claire is a seasoned corporate governance professional, an expert in international tax and transfer pricing, and holds a Bachelor of Laws degree from Queen's University. She also happens to be a professional engineer with a background in chemical engineering, and a degree in chemical engineering from the University of Toronto, something I must admit is dear and near to my heart as a fellow chemical engineer. In short, we're very fortunate to have such a formidable and experienced talent in Claire advising and leading our board. Also with regard to leadership, we recently welcomed Greg Sher as an independent director of the board. Greg is a capital markets and private equity professional with extensive experience working with companies at different stages of growth, as well as M&A. With the addition of Greg, we now have a majority independent board. Let me first address the primary topic in virtually every discussion today, COVID-19. This virus has driven one of the most disruptive global pandemics of the past 100 years. Neo felt the pressures of the pandemic at the start of the year across our Asian facilities and supply chains. Fortunately, our teams did an outstanding job at limiting impacts to the health and safety of our employees and their families. All of us have had to accept a new normal in our daily lives, but at NEO we intend to maintain vigilance against complacency in managing safe operating environments. The best way for us to ensure reliable supply of high quality products and services to our customers is to ensure that our workforce and facilities are safe. In this regard, I'd particularly like to highlight the efforts of Don Miles, NEO's Vice President of Health, Environment, Safety, and Sustainability. Don and his team have worked relentlessly and tirelessly to help lead and coordinate our efforts around the world. And those efforts have helped steer us through a challenging environment while we were able to maintain supply to all of our customers in 2020. Across our more than 1,800 employee team, We've had one COVID-19 case reported. Fortunately, our employee who contracted the virus was quickly isolated, sought appropriate treatment, and was able to recover and return back to work within a few weeks. The virus was contained to the single incident largely because of the conservative approach we take with health and safety matters across all of our facilities. Of course, the future trajectory of the pandemic is uncertain. At this point, we anticipate that demand will recover across our market sectors over the next several quarters and into 2021. One thing, however, is clear. Deterioration in our business performance over the past two quarters is purely a reflection of the macro environment. That is especially true for our magna quenching chemicals and oxides business, which has significant exposure to the automotive sector. As well, our rare metals business has significant exposure to aerospace, and that has been hit hard as well. Fortunately, as a company, we have enacted strategic plans tailored to each of our manufacturing facilities to enable us to provide reliable supply to our customers during this pandemic, while also positioning us to win new business and commercialize new products. Over the years, NIO has made substantial investments in our people, process, and technology to ensure a low-cost, nimble operating model. We have invested time and resources in collaboration with our customers, often working through development cycles that last multiple years to bring about innovation. We have no debt, and we have managed to remain cash flow positive from operations by leveraging an efficient and improving unit economic model. Those efficiencies gained over the years have resulted in a great deal of flexibility for NEO. financial flexibility, operational flexibility, strategic flexibility. All of these have been crucial to NIO's ability to currently manage through this business disruption. They provide a defense of resiliency should the pandemic endure longer than any of us hopes. They also position us to take advantage of new opportunities that are presenting themselves as we speak. Let me give you one example, albeit one that is still in an early stage effort. Our R&D teams have recently identified several inorganic materials that are expected to exhibit antiviral and antibacterial functions. Formulations of these materials have been synthesized and we're currently working with two European institutions to demonstrate feasibility. Discussions are also underway with a third institution in North America to expand testing of these materials. There is no guarantee, of course, that this will work or that it will result in a commercial product. but it demonstrates the kind of innovative thinking and molecular engineering that has helped us to produce many new and innovative products over the years that have helped our customers make the world a better place. While the near-term interruptions related to COVID are likely to continue, there have been some short-term signs of improved economic activity in recent months. Factory activity in China expanded at its fastest rate in nearly 10 years in July. The purchasing managers index in China hit its highest level in July than at any point over the last nine years. Separate surveys of South Korean and Japanese manufacturing sectors in July also shows that those nations had the best performances since February and continue to progress toward growth. Passenger vehicle sales growth has been positive in both China and South Korea in May and June. The supply chains for both North American and European automakers have been making steady progress as they return from idle shutdowns, with the majority of plants operating either at or near capacity. Factory activity overall in the U.S. also picked up speed in June and then again in July, according to manufacturing indices. These are encouraging short-term signals, but they're also concerning signs as pockets of new COVID outbreaks continue to wreak havoc in parts of the Americas. India and Europe. Many manufacturing facilities still trying to adapt to operating in a new normal are finding it difficult to maintain an efficient operating pace until the pandemic is resolved. The end result is continued lower economic output. Some of these more optimistic industry forecasts indicate that 15 to 20 million fewer automobiles will be sold to customers this calendar year. At these levels, the impact of the pandemic on consumer behavior is more severe than what was experienced in the 2009 global financial crisis. And by all indications, we're not out of the woods yet. This leaves us with two competing ideas around demand. There is heightened uncertainty and risk in the short term, whether that's viewed as the next few quarters or the next few years. But at the same time, we are confident in the so-called megatrends, The need for globally clean air, better fuel economy, and efficient regional supply chain has only accelerated. These megatrends have been developing over decades and will continue to accelerate over the coming decade. NEO manufactures advanced materials that are vital to multiple technologies used in each of these trends. As a prime example, we have seen sales of alternative fuel vehicles continue to accelerate. We believe this shift and increasing preference for electric, hybrid electric, and plug-in hybrid vehicles is an enormous opportunity for NIO over the next decade. In fact, in my view, we're rapidly reaching a tipping point in the ongoing penetration of electric vehicles versus internal combustion engine vehicles in Europe and China. For example, at this stage, there's a very strong case to be made in favor of electric vehicles in terms of the total cost of ownership compared to internal combustion. While this analysis incorporated various government incentives for electric vehicles, the fact that the EU and other regions are planning to expand those incentives presents NIO with a number of interesting strategic opportunities that our teams are now closely examining. One small aspect of that opportunity is to expand their magnetic materials production capacity, with commercial applications targeting more efficient electric motors across multiple industries, including automotive, electronics, and home appliances. For example, since we added our production capacity of MQ-1 compression molded magnets with the acquisition of a facility in Suzhou in China last year, we have been flooded with requests from all over the world for these magnets, which are predominantly used in electronics and small motor applications. That facility is now running flat out, and we expect to expand Our production capacity of magnets both in Chuzhou and in our Tianjin China plant. Strong demand for MagnetQuench products is the result of years of intense collaboration with customers to build more powerful and lighter weight precision motors using NEO's permanent magnets. It is no surprise that we have many long-lasting relationships, including customers who have been with us for the past 15 to 20 plus years. What it takes to succeed in supplying these highly demanding industries is dedication to quality, consistency, service, and ongoing product innovation. My commitment to our customers is this. We will continue to do what it takes to help you unlock innovation for your products and help build your business. As I've been thinking about NIO's core competencies and competitive advantages, it is clear that the unique assets we have assembled are not easily replicated. We have the right leadership in place to lead our businesses. We are committed to developing our people internally. We continue to attract and recruit energetic minds. And we have expanded our geographic footprint to reinforce our ability to serve our customers. Our focus on producing advanced materials that enable advances in sustainable outcomes is core to NEO's mission. Not only do the products we make advance sustainability, but we strive to manufacture them with sustainable practices in mind. Our Karat, Thailand plant has successfully completed an EcoVadis sustainability assessment on the neomagnetic material products they make. They were awarded a silver medal in that assessment, which involves a very detailed and rigorous examination. This is the second EcoVadis achievement for NEO in less than three years. Our magnet quench plant in Tianjin was also recently named the Green Factory by the Tianjin Municipal Bureau of Industry and Information Technology Association. They won this recognition by implementing advances in energy efficiency, water and waste recycling, pollution mitigation, land use, and reductions in both energy consumption and carbon emissions per unit of product manufactured. As we design the NEO of the next decade, the key focus of mine and ours collectively will be to recalibrate our strategy and to work with a number of stakeholders to ensure that we are accelerating paths for sustained growth. We will do what it takes to exceed the needs and desires of our customers. Over the coming quarters, I look forward to sharing more of our vision with our stakeholders. With that, let me turn the call over to Rahim for the quarterly business review.

Rahim. Thanks, Constantine, and good day, everyone. Our second quarter financial and operating results were a direct result of COVID's impact on every industry that we sell into. We knew that the quarter would be difficult to forecast with substantial uncertainty coming from customer orders, which softened throughout the year. That said, our teams maintained as best communication with customers as possible to ensure reliable, stable supply. Despite rolling disruptions across various supply chains and regions, we were able to maintain deliveries for our customers throughout the quarter. We also quickly implemented cost savings measures, including tightening our working capital to reduce risk exposures as the magnitude of the pandemic became clear. Across our three business units, we reported 67.7 million in revenue compared to 101.7 million in the prior year period. A net loss of 63.4 million or a loss of $1.62 per share. Adjusted net loss was 5.6 million which compares to adjusted net income of 5.2 million in the prior year period. It was an impairment to goodwill and intangible assets driving that loss that I'll overview in a few minutes. We reported adjusted EBITDA of 1.2 million compared to 12 million in the prior year period. The various end markets we sell into provide some helpful context for evaluating our second quarter results and expectations for the second half of 2020. Across the global automotive sector, Passenger vehicle sales for the first half of 2020 have been down by 28% compared to 2019. Within the auto catalyst product set, D&O's product volumes performed well above that automotive benchmark, while MagnetQuench's volumes in automotive slightly outperformed that benchmark. In addition, MagnetQuench benefited from sales and strength around personal electronics, Sales of PCs, tablets, and phones have all been favorable as global consumers have shifted their daily behavior patterns by working from home, educating students from home, and increasing their reliance on video conferencing, such as telehealth services. Within the aerospace sector, the near-term impact has been more severe than automotive. Airlines have pushed out or canceled many near-term orders, and as a result, deliveries of our high temperature materials products has been similarly soft. As a result of these slower end markets, we selectively idled some of our manufacturing facilities to control costs and to avoid an extensive buildup of inventory. Our commercial and technical teams were asked to work from home in most geographies, and we implemented rationed work crews to perform essential activities and retooling at our plants and laboratories during these downtimes. Some comments more specific to each segment. Within MagnaQuench, we observed a couple of distinct trends. As a first-tier supplier within the Asian region, we felt the impact of COVID during the first quarter, which continued into Q2 as well. Once this first wave of impact began to ease and Asian consumer demand began to return, the pandemic then started to affect other parts of the world. While those supply chains have restarted, There continues to be inconsistent stoppages in places like Germany, Mexico, and the U.S., among others, as individual customers react to mitigate local COVID outbreaks. We anticipate this type of inconsistent demand for the next several quarters. The final dynamic has been a general increase in the demand for magnetics surrounding consumer electronics. This now supports a relatively small portion of MagnetClench's powder business, but it is a positive trend for our growth plans in magnet manufacturing. During the second quarter, we continued to expand our magnet manufacturing capacity, and we are pleased to continue to make strategic investments to support this future growth. We're approaching one year since the acquisition of AsiaMag, and the integration of magnet making capabilities is ahead of schedule. While new product qualifications have been slowed due to COVID, we are pleased with the customer response and see tremendous pull for a Magniquench branded magnet. Although the impact of this acquisition to our financials remains small today, the acquisition has so far been successful in growing its existing volumes, as well as providing an avenue of stronger growth opportunities into the future and across numerous industries, including further penetration into motors for EV and hybrid vehicles, as Konstantin described earlier. Shifting to our chemicals and oxide segment, The impact of COVID certainly impacted our sales performance into all of the end markets we serve. The most critical aspect during the quarter was to ensure a stable supply to customers in each of our local geographies. We mentioned earlier that our sales performance in the auto catalyst segment was above the general performance of automotive. We continue to see growth opportunities in some of our newer formulations of product, including newer diesel products. However, in this quarter, we also recognized write-down as some of our older diesel products, as we believe customers will switch to newer formulations more rapidly throughout the recovery stage of automotive. Within our rarest separation business, there was a slower demand pull for many of the products as economic activity ground to a halt in many jurisdictions. There was also a tempered downtick in market pricing for a number of our materials. We saw fewer spot sales in the quarter partially related to reduced economic activity in general. Our water treatment business growth momentum tapered during the first half of the year as the pandemic interrupted or delayed the start of new customer trials at local wastewater treatment plants. Those activities have restarted to slowly resume and our technical teams focused on improving quality controls of upstream raw materials over this timeframe. Finally, in rare metals, we saw demand get pushed out to future quarters for high temperature metals for aerospace superalloys. Despite the headwinds in aerospace, rare metals has continued to gain traction in both the healthcare and mobile communication spaces. Operationally, we believe we have turned a corner in working through some of our higher cost inventory for tantalum products, although we did record some extra charges relating to idling or slowing some of our facilities. Consolidated, SG&A was higher in the quarter compared to recent trends due to management changes and an increase in the provision for legal contingencies, whereas R&D expenses were in line with the first quarter and down approximately 9% from the prior year period. This quarter, we recognized a charge related to impairment. We recognized a total of $59.1 million of impairment charges against Goodwill, intangibles, and certain property, plant, and equipment assets. The impairment charges were related to our C&O and rare metal segments with no impairments related to magnet wedge. This is a non-cash charge and the write-downs primarily related to the non-productive assets that were revalued in the application of the initial purchase price equation from when the company emerged from bankruptcy in 2016. The significant impact of COVID on cash flows, particularly near term, affected the comparison of the discounted cash flows versus the carrying values that were on our balance sheet. Despite the lower economic outlook, we remained confident in the earnings potential of each of our business segments. Maintaining flexibility was a key short-term focus heading into the pandemic, and we both tightened up our working capital and generated excess cash during the quarter. Our cash balance remains very strong at 78.7 million, and we generated 7.8 million of free cash flow during the first half of 2020. We continue to maintain our dividends in the quarter and returned an additional 5.5 million to NEO shareholders through the first half of the year. We repurchased a total of 1.3 million of shares outstanding through the first six months of the year. We filed a new NCIB program during the quarter. To summarize, our business model remains strong despite operating in a volatile market environment. Should the adverse impact of the pandemic continue longer than the recent trends expect, we remain confident in our financial and operational flexibility to continue to weather the storm. That said, our primary focus is to continue to invest and to improve our global operating footprint and to focus on delivering new products for our customers and delivering an improved return on capital for our shareholders. I'll now turn the call back to the operator to open up for questions.

Thank you. We will now take questions. As a reminder, to ask a question, you will need to press star one on your touchtone phone. To withdraw your question, press the pound or hash key. Your first question comes from Mark Neville from Scotiabank. Your line is open.

Hi, good morning, guys. Thanks for taking my questions. First, Constantine, welcome back to the CEO chair. I guess first question for you. You spoke about sort of Just general uncertainty, obviously. I'm curious to get a sense of your near-term priorities. And then when you think about the longer term, you touched on some of this, but some of the areas of focus, whether parts of the business that you have already or maybe some interest outside of that and maybe how you intend to use the balance sheet maybe to fund that growth.

Thanks.

Thanks, Mark. Clearly, the first priority was to get the quarter done on time and get through this. I guess there's a bit of a rustiness. Last time I did one of these was seven, eight years ago. But more seriously, clearly, in my view, we need to do three things. One is recalibrate our strategy to turn this crisis into an opportunity. We're seeing some very interesting developments in Europe, and we have one of the most strategic assets in the industry in Estonia. So we like our position there, specifically as it relates to green tech, sustainable technologies, EVs, and the like, where the Europeans seem to be putting an awful lot of focus on growth and development of supply chains there. In addition, we internally at least we're accelerating our review of a number of M&A opportunities. So I think that combined with our strategic calibration, I think should position us to be in a good place over the next couple of quarters. Some of the M&A, some of the acquisition opportunities we're looking at, are in the advanced materials segment, materials that relate to our businesses, our customers, and our product lines. And hopefully, over the next little while, we'll be able to talk some more about it. In the meantime, we're spending a lot of time and effort, both at the board level and the senior management level, health and safety, environment and sustainability, making sure that we do all the right things at all of our plants right around the world, as well as our offices where most of our folks still continue to work from home and they will continue to do so for the foreseeable future. So, I guess in a nutshell, Marc, staying safe, doing the right things and recalibrate our strategy and M&A focus to take advantage of some of the sustainability opportunities that we see in the near term.

Okay. Thanks for that. Maybe Rahim or Konstantin, I'd just like to get a sense of maybe the sales cadence through the quarter into Q3. Obviously, a tough quarter. I appreciate some of the markets were challenged, but maybe just sort of how things progress through the quarter and into July again. I know there's some unevenness, but just to get a sense of, you know, if we've bottomed the pace of the recovery or if it's linear, et cetera.

Thanks. You know, honestly, it's real tough to talk about the cadence within the quarter because if we look at it from a monthly perspective or a weekly perspective, what we would find is different behaviors in different regions of the world. So, you know, I'd say, you know, in the second half of Q1, really, or really the second half of March and the first beginning of April, we actually saw a lot of pull coming out of our plants in China going to other industries as people were, I think, concerned about extended shutdown. So we saw kind of, you know, an acceleration there, and then we saw it slow down later in the month. So it really moved, I would say, region to region and kind of product set to product set. So I could only describe the cadence as as volatile in that universe. As we kind of see going into June, July and the like, I think that the volatility remains. There still is softness. But again, I think that the softness obviously is to be expected. But again, there's a regional dynamic. Europe is down for a good portion of the summer, so we'll naturally see some slowdown there. China is constantly talked about. We've seen some positive things with a number of customers there. But I think our cadence of recovery is also going to be dependent upon how everyone in the supply chain has managed inventory. So I think calling short-term region-to-region is a really tough kind of game.

Okay, fair enough. Maybe one last one then, Rahim. I was just reading some MD&A. Was there sort of a mark-to-market inventory adjustment in C&O? And if so, how large was that and if that was adjusted for in EBITDA?

There was. There was a mark-to-market adjustment. It was about $1 million. It was not adjusted in EBITDA. Okay. All right.

Thank you very much, guys. I'll get back to you.

Your next question comes from Steve Arthur from RBC Capital Markets. Your line is open.

Great. Thank you. And, yes, welcome back, Constantine, to these calls. You've covered a lot of ground in your comments already, but just wondering if you can elaborate on a couple of things. Of course, I understand a huge amount of variability in demand right now. I guess any sense of whether your customer inventories have been depleted to levels that they're comfortable with so that your demand now will be more tied to customer need or there's still more inventory adjustments to come, what do you think?

Thanks, Steve.

Well, unfortunately, I don't have a black and white answer. I'd love to say the answer is yes. However, under normal conditions, through the year we see different type of inventory adjustments throughout the different geographies. So typically in the first quarter, which is the fourth quarter in Japan, our customers there clean up their books and reduce inventories ahead of year end. This year in particular was a little harder with all the shutdowns in China and in Japan in the first quarter. The second quarter was a little bit different with China and Asia starting back up, but Europe and the United States going into a shutdown mode. As Rahim said, the third quarter of the calendar year is typically when European plants shut down and then people hit the beaches in Europe. And that is clearly generating some uncertainty around COVID transmission. I recently had a conversation with the CEO, one of our largest customers, but he's also in as much uncertainty as everybody else is. I think it's very wait and see. It's week by week, if not day by day. We all see the bigger trends and we're all bullish. about the future uh as it relates to our industry our materials the whole ev versus um internal combustion engine uh opportunities but for the time being it's you know it's hugely unpredictable and and and things can change um day to day um a lot of the plants that we started supplying again, maybe shutting down in the next couple weeks if spikes really manifest themselves, whether they're in Europe, in the Southern Hemisphere, in Asia, or in the United States. So at this stage, I think pretty well our supply chains have gone through a significant adjustment of inventories, but what the next quarter or the quarter after that will hold is anybody's guess. We remain cautiously optimistic, but cautious, I think, is the operating word here, Steve.

Steve, maybe a couple of comments. About a year ago at this time, we had talked about specific inventory adjustments that we saw in our customers for specific programs. I don't think we see that type of inventory in the system and are required for an adjustment there, right? That was related to kind of China Automotive slowing down in the 20 half and 19, which folks hadn't seen for a while. So we're not seeing that kind of systemic slowdown. What we're seeing is just the ebbs and flows of production. So I think we do know that in various parts of the world, there might be inventory that are sitting at a fork that a customer hasn't moved real quickly to claim because the customer hasn't used it. But I wouldn't say that it's a broader issue like the issue that we had, I would say, in the first half of 2019. That makes sense. Thank you.

Steve, let me sort of add one more point here. Rahim's absolutely correct. This slowdown started way before COVID, and adjustments had already been taking place. I think the trade war that was ignited last year had an obvious and visible effect in supply chains, especially around automotive. And then COVID hit, and that forced further supply chain adjustments and inventory reductions. So we're at a point that a rational observer would probably call it bottom or close to the bottom, but I don't think anybody should in their right minds stick their necks out too far and claim that this is bottom or that it's a V. shaped recovery. We don't know. We have not gone through anything like this, and some of us have been through a number of crises, and we have the scars to show for that, but this is very new, and I think we're all making it up as we go along, and we're trying to react to whatever changes we see as we see them. Sorry, I'm not trying to be evasive, but we really don't know.

No, no, it's all good color, and I guess navigating through what you dealt right now and focusing on 21 and beyond makes sense.

Well, all I can say for the company is what we said back in 2008, 2009, as we went into that recession that, you know, our balance sheet, saved NIO and saved, and then really we took advantage of the crisis and we restructured the company and we emerged stronger than we were going into the crisis. I think we were probably looking at the same playbook right now and we're keeping that behavior in mind. And we expect that we'll come out of this crisis stronger than going into it.

One final one, just on the nature of the cost control measures that you've been taking. Are these mostly short-term cuts that kind of get you through the emergency and the downturn, or are there more permanent things that you're taking now that should have longer-term margin implications?

I'd say the vast majority is short-term. There are some long-term improvements to product, but I would say that those improvements are kind of the natural DNA of the business. So I would say that the short-term things that we're talking about here are, by their nature, short-term. They'll continue through Q3 and maybe get deeper as we go.

but they're short-term okay thanks very much your next question comes from scott fromson from cibc your line is open hi sorry about that having a few problems with my fingers on the phone um just a question on r d has there any has there been any change in spending or product focus since COVID-19 and perhaps Jeff's departure? Like, is there more focus on EV, fleet EV, wastewater, green energy?

Yeah, Rahim, we'll start and then I'll jump in.

So I would say substantially, you know, in terms of priorities, no, I think that we continue to invest in R&D As a priority, we continue to have the flexibility to do that. You do see a lower spend this quarter, but that's not really indicative of a change in philosophy. It is kind of project-based type stuff. Constantine mentioned kind of additional products that we're working at as a result of COVID. And I think that those are additional opportunities. But there's actually a number of products that are kind of under the R&D shelf. of new formulation for advanced materials that will affect all kinds of industries that are kind of in their early stages. So some of those products have an ebb and flow to their spend. I think that they continue to be strategic investments, but I think certainly, and maybe Constantine will elaborate, there will be a continued view of what we see as the strongest end market areas, the strongest areas around sustainability, the strongest areas around growth, and where our functional materials can apply best.

Are there particular – sorry, go ahead. Go ahead, Scott. Well, I was just going to ask, are there particular opportunities in fleet EV, particularly in Europe, where, as you said, they're ahead?

Well, opportunities specifically on fleets versus private vehicle sales, I don't I haven't thought about it. However, what I can tell you is, again, in the conversation I had recently with client CEOs, they made it very clear that in Europe, their fleets are going electric simply because of the lowest cost of ownership of EVs versus internal combustion. In terms of specific opportunities in that, I doubt it. I think when we introduce new products, they tend to apply across platforms and models as opposed to the type of fleet versus private sale. Some of the products that we're working on, and specifically the question about R&D, keep in mind that we had our largest R&D facility in Singapore closed for about three weeks. according to the government directives, people are back there, not in full complement, but they rotate in and out of the lab to maintain appropriate distancing. So to the degree that people are not physically in the lab, you saw a somewhat modest reduction in spending, but the research focus continues I mentioned some of the areas. We're seeing some very interesting effects by certain inorganic compounds that I mentioned. We were seeing some other very interesting behavior, non-COVID related, but as performance would apply to EV battery materials and consumer materials. So that work has been accelerating, so we're spending money in more of those areas. But the overall COVID pressures are affecting the spend. I mean, if we had access to the labs of our partners the same way we had, say, a year ago, I think our spend, our R&D spend would have been at or above where you see it on our P&L.

Thanks, that's good detail. Just one more quick question. Have relations with Chinese SOEs and government officials, such as permitting and environmental relations, have those changed with increased political tensions with both the US and Canada?

Well, to be brutally honest, we haven't really noticed. I think... I don't want to say the wrong thing, but at times when we deal with the regulators in Beijing or with the state and local government regulators, I have to say that the Canada-China relationship seems to be below the radar screen. It's a headline in Canada, but it's not really a headline in China. Whether that's good or bad, I'll claim to be agnostic or I'll keep my own private views private. However, we were not really seeing a deterioration in our relationship with the regulators and the SOEs and so on as a result of the two Michaels and Madame Meng from Huawei in Vancouver. Now, I'm not saying that That's exactly how it's going to be, but I would also say that over the last three decades that we've been doing this sort of thing in China, we find the regulators to tend to be very pragmatic. When issues of larger political importance come to the surface, they make their comments and then they get back to business. You know, it's a very difficult time overall, given the Canada-China relationship, given the U.S.-China relationship, given COVID, and given the rethinking of supply chains. There's so many issues that are bubbling to the surface, and over the next few years, that will have an effect on our supply chains and what we do, how we do it, and where we do it. But for the time being, no, the short answer, Scott, is that no, we're not seeing an awful lot of effect from the relationship deterioration.

And maybe, Scott, if I can just add one comment that's maybe neocentric, which is to bear in mind that we've been in China for a very long time. And the way that we've been in China is, of course, with the development of our team members in China. So the primary interface with many of the governments kind of relationships for regulators and the like in China are with our member, our Chinese team. So I think that there's less of a dynamic that maybe some other companies that use expats in these various roles. We have long, long history with some of our Chinese team members that have elevated and are in senior positions in China.

Yeah, I'm sure when I show up in Beijing, whenever we can travel, I'm going to get an earful. But our chief representative in Beijing,

It's business as usual. Well, that's a good thing you got thick skin. Thanks, gentlemen. I appreciate your detail and candor.

Your next question comes from Mac Whale from Cormark. Your line is open.

Hi, good morning. Just concentrating quickly on a couple things. You seem encouraged by the non-automotive demand and opportunities there. What, just long-term, do you see this as a viable way to balance demand from different industries so that you, could it ever be as big as the automotive? I mean, how do you view the long-term prospect?

Thanks, Matt. Good question. There was a time if you recall maybe a decade, decade and a half ago, when our exposure to electronics was bigger than our exposure to automotive, and we made a conscious effort to expand our exposure to automotive. So within the larger trends, we have some flexibility to sort of direct efforts and calibrate direction, but I think there is no question that the primary driving force for the industry as a whole is sustainability, whether you translate that into EVs, whether you translate that into wastewater treatment, still catalytic converters. are going strong and they will be part of the solution for automotive. However, I don't see us really moving away from automotive. As long as you include EVs in automotive, I can't see our focus on automotive and the overall industry's dependence on automotive growth as a driver anytime soon. That I expect will inform our strategic recalibration, especially around some of the European initiatives that we're examining and contemplating. But I think it will be very difficult for automotive to become a lesser force in the growth of the rare earth and magnetics and rare metals business. Now, in the rare metals, clearly, with our tantalum and high-temperature alloys that we produce, aerospace is a critical market, but automotive also has its influence. Again, not trying to be evasive, but I just don't see over the next, say, five years, how automotive is not going to continue to be the driver for our industry and therefore our dependence on automotive for roughly half of what we sell.

It makes sense, particularly with the amount of material that those applications use versus typical electronics applications. My second question was around the choppiness with these closures. When you talk about the end demand markets being really not synchronized, whether it's Europe or North America or Asia, there's different cadence to those closures. Over time, do you think you will move production capacity closer to the demand center so that if there's closures you're sort of you're more synchronized or is it an advantage to be the way you are now more um a different sort of your supply chain not really being totally aligned with your end market or is that unfair as a characterization well i don't know if it's unfair but you know i i don't think we have a a problem with synchronicity uh mac uh listen we

I've said this before in different circles, but we will be where our customers need us to be. So if, and to be sort of flippant and facetious, if our biggest customers build a plant on the moon and tell us you need to be on the moon, well, guess what? We're going to the moon. You know, we exist. at the pleasure of our customers. If they stop buying from us, we don't exist. So we want to make sure that we make their businesses as efficient as possible. Now, when you look at some of our bigger customers, they're very global. They have plants in Europe, they have plants in the States, they have plants in China, they have plants in India, in South America, everywhere. So we need to be able to supply them without any interruptions. So, you know, we're not responding to, and in the effort to recalibrate our strategy, we're not looking at geopolitics because it could get very, very dangerous if you get caught up in that. We're seeing, we're listening to our customers, in other words. We're not necessarily listening to what Brussels says Tokyo and Washington, D.C. say, but we're listening to what our customers in those regions are saying. And our supply chain capabilities will unfold according to our customer requirements. Again, I don't know if I'm being too cryptic, but if our big German automotive customers say to us If you build X, we will buy Y from you, and we need you to be in, I don't know, Poland, Slovakia, Estonia, whatever. Well, it's our responsibility to respond to those requests. And, you know, the last thing I say, because this thing keeps coming up around North America with various governments trying to – to figure out how to respond to this and to respond to the various geopolitical pressures and supply chains. You know, at the end of the day, demand, every policy with regard to supply chains need to be demand pulled, not supply pushed. And that's also the operating principle that we utilize at NEO. When our customers ask us to do something, we do it, and we do it well.

Okay, that makes sense. The reason I ask is more on the side of in the EV space, when you're dealing on the battery supply chain, you see a lot of focus on that supply chain not having a lot of Chinese exposure for a bunch of different reasons that we can get into. but it sounds largely on the, at least in the magnetic materials, on the motor side, you haven't really seen those discussions. It's not like, I guess because one of them is a supply chain that hasn't been created yet, and you're very much embedded into a supply chain that's real and exists today.

Yeah, listen, you know, we all read the analysis that the German Automotive Industry Association has done that is raising the demand the danger of the automotive industry in Germany being decimated because of EVs. First, because EVs are simpler to build, there's fewer moving parts. And second, because the critical components, the critical value added, difficult to build components are mostly coming from China, Korea, Japan, and Asia in general. Therefore, the EU is putting some pretty large amounts of money as incentives on the table to attract battery supply chains. Well, we're not in that business. Only peripherally, let's say, at this stage. But you see Chinese battery producers, CATL, for example, building plants in Germany. I think eventually, if we could remove trade friction Ultimately, global companies throughout these supply chains are rational operators, and they will respond the way I described. They have to do what their customers need them to do. So if that means Tesla building a plant in Shanghai, well, so be it. If it means CATL building a battery plant in Germany, well, that's what makes sense for that business. You know, I don't want to make too much out of it. There's certainly pressures on supply chains to become much more localized, and to the degree that that is possible and efficient, you will see some of that taking place over the next five years. Okay. Great. Thanks, Konstantin.

Again, if you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from Frederick Bastion from Raymond James. Your line is open.

Good morning, everyone. Nice to have you back, Konstantin. First question, very simple, perhaps for Rahim. Within the chemicals and oxide segment, which business experienced the biggest sequential or year-over-year decline? Based on your comment, it would lead me to conclude it's the separations business, but just wanted to confirm.

Yeah, that's correct. The separations business, as well as we had some spot buying in the previous year that didn't recur this year. But that's really separations business.

Okay. And then the catalyst business would have held up okay?

Yeah. I mean, it's still declined, but as we said, less than the automotive industry declined generally.

Okay. All right, Constantin. Obviously, conventional car manufacturers are finally seeing the light and they seem to be rushing to accelerate the rollout of EVs pretty much everywhere. But where does that leave the hybrid model? Does that change the economics or the fundamentals around the hybrid model?

Thanks, Frederic. That's a tough question. In Europe, it's clearly still the preferred bridging technology from internal combustion to EVs, but that narrative has started to change over the last few quarters, simply because when you look at some of the more successful examples, you look at Tesla, I mentioned about Tesla in China, Tesla, within a year, went from standstill to becoming a very large player in China. And they were able to do that by taking advantage of existing supply chains in China. They're sourcing batteries, they're sourcing drivetrains, traction motors, everything, because that supply chain had capacity and it was ready to do that. To the degree that the Europeans are feeling more comfortable with regards to key supply chains for their EVs, you will see an acceleration in adoption. I was reading that last quarter, the Nissan Leaf was the most popular vehicle, period, in Europe, and you were able to buy it. at a discount to its equivalent, which is the Nissan Qashqai, or I don't know how you pronounce that, but you know what I'm talking about, I assume. So we are at a point where we're reaching a tipping point between EVs and internal combustion, especially in Europe, which I think will force the hand of the European automotive manufacturers to accelerate the transition into EVs. And that probably means that instead of taking two decades that was the original thinking to transition from internal combustion to EVs and use the hybrid, the plug-in hybrid model as the bridging technology, you're probably shortening that to half, if not less. There's no question, though, that all the European manufacturers are talking about electrified models, which includes plug-in hybrids. So I think you will continue to see plug-in hybrids. However, I think you're also seeing the acceleration of EV adoption, again, especially in Europe.

And from your perspective at NEO, do you have a you know, do you see this as a, as a good thing or potentially, I mean, cause you do, you do work with Honda, a lot of hybrid platforms. So I was wondering if you're, you're comfortable that this is a, it's a great, great option for, for Neo.

Yeah. Well, it's, it's always a great opportunity if we can figure out how to make money at it. And I think we were well down the road to, to figuring it out. Honda, will continue to make its Accord and Civic hybrid. And it's a brilliant technology, and we're proud to have a small hand in that. At the same time, there are other opportunities that are emerging. And we're looking to capitalize on those. So I tend, you know, when things happen that are way beyond our control, whether it's COVID, whether it's the trade friction or geopolitics, I think our responsibility is to figure out how we can take advantage. of those crises and make money as a result by also doing good in the process. So I'm not concerned about what I see. I think there are and there will continue to be a lot of ways and opportunities to grow the company in that environment. And you see, as we go on, this is an industry that demands higher performance out of its materials. And we are in, you know, in a pretty good seat. We're in the front row and we're looking at a lot of the things that are happening and we have the skills and capabilities to deliver materials that make, again, that make a lot of our customers' lives a lot easier.

Okay, thanks for that. Last for me, what is the single biggest lesson you're taking away from COVID?

Well, well,

I think you have to be prepared. It's a contradiction in terms, I guess. They have to be prepared for the unexpected. And the only way you can be prepared is to run a well-balanced conservative organization. Again, in 08, 09, I said that the thing that saved us was our balance sheet. I think in this crisis, our balance sheet is clearly one of our greatest assets. It means, you know, the balance sheet means two things. We can survive pretty well whatever gets thrown at us, and we have the means to take advantage of what opportunities cross our path. So the lesson is not to overextend, because you never know which way the wind is going to blow. I guess from what I'm saying, you'll probably deduce that whatever we do, we're not going to be betting the farm, especially in a period of uncertainty. But we'll be making some pretty meaningful, interesting debts where the odds are in our favor. However, you know, as long as you have the right people around the world close to their customers and the financial structure of the company, is more conservative than otherwise. I think the company will continue to be successful. We'll hit some snags here and there, but overall, this is a good, robust business with a great, strong balance sheet.

So we'll take advantage of that.

Thank you.

Thanks, Brett.

There are no further questions. At this time, I'll turn the call back over to the presenters for final remarks.

Thank you, operator. On behalf of the NEO team, I would like to thank you for joining us today on today's call. Since everyone has been so enthusiastic about Constantine being back, maybe I'll also say welcome back, Constantine. With that, we look forward to reporting back to you on our third quarter conference call, and that concludes today's call. If you have any questions, please feel free to reach out to myself. Have a great day. Thanks, everybody. Thank you.

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