Neo Performance Materials

Good morning, ladies and gentlemen, and welcome to the NEO Performance Materials Second Quarter 2023 Earnings Conference Call. At this time, all lines are listed in only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Friday, August 11th, 2023. I would now like to turn the conference over to Ali Madavi, Senior Vice President of Corporate Development and Capital Markets. Please go ahead, sir.

Thank you, Operator, and good morning, everyone. Thanks for joining us for NIO Performance Materials' second quarter earnings call. Just as a reminder, a replay of this call will be available starting tomorrow in the Investor Center of our website at NIOmaterials.com. Joining me this morning are Raheem Sulaiman, NIO's Chief Executive Officer, and Jonathan Bech, NIO's Chief Financial Officer. Please note that some of the information you will hear during today's presentation and discussion will consist on forward-look statements, including, without limitation, Those regarding revenue, EBITDA, adjusted EBITDA, product volumes, product pricing, other income and expense measures, cash returns, and future business outlook, including potential expansion plans. 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 year-end earnings press release, which is available on CDAR and on our website at neomaterials.com. I'll now turn the call over to Ray.

Thanks, Ali, and good morning, everyone. We're excited to speak with you today and speak to our mid-year business update. For a quick roadmap, I'd like to first review some significant updates for NIO. Second, touch on some key industry and market dynamics. And third, revisit NIO's long-term strategy for growth. Jonathan will then provide an overview of our financial and operating results. So first, there's a couple of obvious changes in our conference room this morning. As Constantine retired as NEO's CEO last month, we'd again like to thank Constantine for his more than 30-year commitment to building NEO into the thriving company that it is today. His guidance, his leadership and vision will help continue to shape NEO's growth trajectory for the years to come. The other obvious change is that there's a new face, or at least voice, on the call today, as Jonathan Bakish has been in the CFO seat for nearly two months. We couldn't be more thrilled to have him on board. Jonathan is an accomplished operational CFO, most recently joining us from Celestica, where he was the divisional CFO of a $3 billion manufacturing business. Prior to that, he built a career with General Electric, with a number of financial leadership roles across capital-intensive and highly regulated industries. So turning to NIO. During the second quarter, NIO continued to operate strongly on all fronts. As a leading global rare earth magnetics company, with parallel supply chains inside and outside of China. It was a busy quarter with some notable highlights. One, we made demonstrable progress on our two large capital projects. First, in Narva Estonia, with the groundbreaking of our new European magnetics plant. And second, in Zibo China, where we continued our expansion and relocation of our emissions catalyst business and value-added rare earth business. We continue to navigate very challenging demand trends for magnetic materials and continued softness in rare earth pricing. Three, we achieved record-breaking results in our rare metals business, particularly for products where recycled material is a major input, and most notably our hafnium business. Four, we are continuing to methodically review our working capital employed, particularly as the dynamic pricing environment continues to evolve. to evolve, sorry, achieving a $34 million reduction in inventory balances compared to year end. Five, we made a strategic investment of $4.5 million in Neo North Star resources, taking a strong minority position with an offtake agreement for 60% of the available rare earth feedstock in the Greenland rare earth mining project that we've discussed previously. And six, we closed the acquisition of SG Tech, a premier European magnetics manufacturer in Europe. In terms of SG Tech, we are pleased to have completed the acquisition early in the second quarter, and we are currently in process of integrating our management teams and operations. We are very pleased with the commercial and technical cooperation between our magnetics teams, and the integration of SG Tech is tracking according to plan. On June 28th, we broke ground on our new magnet facility in Estonia, a first for Europe. We were proud to host high-ranking government officials from multiple countries along our supply chain, as well as customers, suppliers, and investors. A highlight of the event was the speech by the European Commission President. President von der Leyen commended the partnership between NIO and the government of Estonia for the fast issue of permits and the rallying of all local stakeholders behind this project. In her words, and I quote, The rare earth magnets that will be produced by NEO are indispensable to growth and innovation in sectors like electric mobility, wind energy, and microelectronics, unquote. We appreciate this specific recognition by the President of the European Commission, citing NEO by name, and we continue to stay the course of our growth strategy with our timeline to bring rare earth permanent magnets to the European supply chain. NIO has manufactured its rare earth magnetic products both inside and outside of China for decades, including our Thailand manufacturing facility, which has been operating for over 25 years, and our Center of R&D Excellence, located in Singapore. We continue to believe in the long-term success of localized magnetic supply chains, and our expanded manufacturing hub in Estonia will help address the growing need for rare earth magnetics within Europe. Taking a step back for an overview of the market environment, rare earth pricing continued to decline through the second quarter. Magnetic rare earth pricing for neodymium and presodymium are down approximately 35% from the start of the year and are down almost 50% compared to the same quarter last year. Terbium, a critical rare earth material also used in permanent magnets, is also down nearly 50% from just the start of this year. This is reflective of a sluggish demand environment for magnetics in nearly every geography and maybe offsetting some of the rapid price increases in 2020 and 2021. We've covered much of this dynamic in the past, but suffice to say, the magnetics industry is currently in a market lull, despite the favorable long-term trends. There are very consistent views across the rare earth industry and automotive industry that this is a short-term market lull, and nothing has fundamentally changed the long-term demand and requirement for more rare earth magnets. Rare earth magnetic elements remain high on the critical material list of just about every jurisdiction and remain a very high priority for customers to have options inside and outside of China for this material. This is also evidenced by the continued announcement of other players desiring to enter the rare earth magnetics space. a place where NIO has operated within for the past 25 years, understands well, and is complemented by NIO's rare separation business. The declining price environment has somewhat slowed over the past two months, although we believe that this is just a temperate demand recovery at present. On another market topic, we've received numerous questions about the global dynamics for Gallium after the announced regulatory changes within China. To be clear, our Gallium recycling business is located in North America across two operations in Canada and the US, and we do not have Gallium operations in China. To date, there have been no discernible impact on our Gallium business operations, and we do not source feedstock from China. Customer inquiries are clearly increasing, and we continue to seek additional waste streams that we can recycle into valuable material. Our galleon business is a relatively small component of our rare metals business and to NIO as a whole. Yet trade policies can change quickly, and this is a primary reason that we have mature, dual supply chains for NIO's rare earth magnetics and separated rare earth products inside and outside of China. This is a key competitive advantage for NIO that we will continue to build upon. Before I turn the call over to Jonathan, I've been getting a number of questions from shareholders and customers relating to my view of NIO's long-term vision and strategy. I've had the pleasure of working with our business units for the past six years, and my vision for NIO's future is fundamentally aligned with our core vision over those past six years, with some adjustments that will become evident in the periods to come. NIO is a global rare earth magnetics company with operations inside and outside of China, Our core values remain the same. Our core value proposition to our customers remains the same. And it grows with the expanding size and breadth of our business. Yet there are areas of opportunity upon which we intend to capitalize. In terms of our upstream raw material strategy, we will continue to focus on enlisting more suppliers with more geographic diversity. NEO already receives the most geographically diverse rare feedstock, and this will continue to grow. And we will continue to evaluate strategic partnerships for long-term cooperation. But you should not expect NIO to become a mining company. It is not part of our core business model. What you should expect is for NIO to continue to develop strategic relationships for additional supply outside of China. NIO has a unique capability of separating light and heavy rare earths and transforming that material into high-value products including magnetic materials. These high-value opportunities will remain the focus of the company. In terms of style, we will continue to invest in building a culture of continuous improvement and to have a defined focus to execute our key projects. Top of mind for me is executing our growth plans, and the European magnetic strategy is the first piece that puts NIO on the offensive. Developing keen awareness and forethought to ensure that the Estonian Magnetic Project comes to fruition is one of the highest priorities for our company, and it exemplifies the philosophy of ensuring that we allocate more resources to our top projects. I refer to this as having the right focus. And so having the right focus for each of our teams is where I have been and will be spending my time. That focus needs to be on the highest growth and highest value activities in front of us. And I believe We have a generational opportunity in things like rare earth magnetics, driven partly by the electrification of automobiles and other energy efficient applications. NEO is operating at the right time, in the right geographies, with the right technology and expertise in a market that is on the cusp of exploding. We will focus on executing our part toward making the world a more sustainable place and capitalize on the immense demand and growth opportunities that everyone believes is on the horizon. I will have more to share in terms of NEO's long-term roadmap, but in the meantime, you can expect us to operate our business profitably, execute key milestones on our growth projects, add data tools to improve operations and metrics, like the return on capital, and ultimately drive more shareholder value. With that, I'd like to turn the call over to Jonathan.

Thanks, Rahim, and good morning, everyone. As I run through our financial performance for the quarter, I'd like to underscore the strength in our current financial position, as well as the key factors shaping our results, which include continued headwinds in rare earth pricing and mixed market demand dynamics. With top-line sales of $170 million and adjusted EBITDA of $19 million, we had a strong quarter despite a tough market environment. From a cash generation perspective, we delivered $24 million in cash from operations during the quarter, and $43 million year-to-date. That represents NEO's fifth consecutive quarter of positive cash from operations. This financial strength allowed us to fund growth initiatives and further return capital to shareholders in the quarter. We invested $14 million into the acquisition of SG Tech and contributed $4.5 million into upstream ventures. We also began to execute against our NCIB share repurchase plan while continuing to fund our shareholder dividend. Combined, the share repurchase and dividend were $4.5 million during the second quarter. With $127 million of cash and cash equivalents and no short-term debt, we are well positioned to execute our growth initiatives. Operationally, we continue to convert higher-cost inventories into cash. As our inventory balance declined to $178 million, an improvement of $34 million from the start of this year. We are continuing to work towards our established working capital targets. Managing the appropriate amount of inventory in a declining price environment is always a challenge, but it is a primary focus, and we are making incremental improvements. NEO's long-term fundamental value contribution, despite the direction of rare earth pricing, is starting to become more prominent in today's market environment. The impact of negative lead lag compresses our margins in the short term, but ultimately this will free up cash given the current trajectory of price trends. Now looking at the performance of our three business units starting with MagnetQuench. Rahim discussed some of the key trends within the magnetics industry. The lower demand environment continued through the second quarter reflecting the macroeconomic headwinds impacting most of our magnetic end markets. Although we still believe the long-term trends supporting this business are strong, the short-term demand challenges do create uncertainty, giving us very limited visibility into volume levels for the second half of 2023. With that said, MagnaQuench took action early in the year with cost-cutting measures to right-size the business. These actions, combined with the continued operational improvements, have allowed the business to effectively and proactively manage its cost base in a declining market environment. In addition, we continue to secure new winds and manufacture record numbers of magnets. This organic growth, combined with the high-value magnet business in SG Tech, is allowing MagnetQuench to build a strong book of long-term business. It is worth noting that both the cost-cutting measures and the SG Tech acquisition included some one-time expenses, which caused our SG&A run rate to be a little higher than historical trends for MagnetQuench. Despite the current soft market environment, we continue to believe that we have the correct assets in service around the world to meet the needs of our magnetics customers. Shifting to C&O, the business unit delivered $71 million in revenue, up 39% versus prior quarter, driven by demand for high-value products, including environmental emission catalysts and dysprosium, which goes into the multi-layer ceramic capacitor market. However, the overarching headwind within C&O remains the rare earth market pricing, as finished goods around the world today were originally purchased using rare earth feedstock when pricing was 35% to 50% higher. This flow-through has resulted in downward pressure on C&O's margins, which will continue until rare earth market pricing stabilizes. From a demand perspective, I'd like to emphasize that there remains regular buying for the non-magnetic products, and C&O benefited from having strong spot sales during the second quarter. Value-added materials continue to have strong and consistent buying patterns. However, the softness in magnetics and the impact of lead lag continue to have an outsized impact on C&O's performance. Last, but certainly not least, rare metals continue to outperform in Q2. It outperformed relative to our expectations, and it made substantial contributions to the total company's bottom line. This was driven by the strong demand and upward pricing trend in the half-year market, which has seen higher end-use demand within the memory chips and aerospace industry against a short supply scenario. While we try not to establish commodity pricing predictions on these calls, it's worth noting that we do expect hafnium pricing to moderate as the normal laws of supply and demand play out over the coming quarters. However, we believe we still see stronger margins than historical periods as NEO capitalizes on its unique capabilities to use scrap material and recycle it. This strategy provides for better utilization of critical materials, is better for the environment, and provides additional margin to NEO as input costs for scrap materials are not rising at the same rate as finished goods. Our rare metals team continues to make progress on optimizing its business model and economics for tantalum and niobium products, which we believe will be another growth driver for the business over the long term. Lastly, on a personal note, I'd like to talk about the underlying culture that truly differentiates NEO. As I went through my journey of joining the company, I was impressed by the talented and capable people, as well as the technical expertise and compelling strategy for growth. After two months in the company, I can tell you that my already high expectations have been exceeded. I'm thrilled to be part of the NEO team, and I look forward to spending more time with our shareholders to tell NEO's story and to talk about the company's vision for the future. With that, I'd like to open it up to the line for questions.

Thank you, sir. Ladies and gentlemen, we now begin the question and answer session. If you'd like to ask a question, please press star, followed by the number one in your telephone keypad. If your question has been answered, you would like to withdraw from the queue, please press star, followed by the number two. And if you're using a speakerphone, please lift your hands up before pressing any keys. One moment, please, while we compile the roster. The first question comes from David Ocampo with Cormac Securities. Please go ahead.

Thanks. Thanks for taking my questions, everyone. Rahim, maybe we could start on the lead lag component of your business. I think in previous calls, you talked about a three to five month lag. I'm just curious, you mentioned on the call or Jonathan mentioned that you were able to drive it lower. Just curious by what order of magnitude and maybe you guys can explain why you need to keep so much feedstock on your books.

Sure. So the lead lag continues to be an issue and I, and I, and, It is driven partly by the, let's say, unusual level of volatility of rare earth prices over the last, call it 24 months, even 30 months. So the way that we need to manage that, and I think we're on a journey of continuing to manage that, is twofold. One is we need to think about our overall inventory levels and our overall inventory turns, and how do we actually improve kind of the turns and the cycle and the speed upon which our business will operate. To do that will be a series of data tools that we will put in place that are managing where we see demand fluctuations, how we can accurately see customer forecasts better and how we can react our planning cycles to match those in a much more closely aligned method. The second thing that we would need to do is to think about better alignment between customer POs and our existing buying patterns. We are naturally long on all inventory, obviously, because we have three to five months of inventory. And historically, we have received lesser kind of fixed price contracts for customers. And when we do, we tend to hedge against those fixed price contracts. I think we need to review inventory matching as a duration over the entire book of business to just think a little bit about how we can do that differently. So it's a journey, David. I think we're just at the beginning of that journey. I mean, we've been talking about reducing inventory for some time. The team has done some excellent work. I think the next step of that journey is just to take advantage of the data tools that are available so that we can make better decisions and react quicker.

Got it. I guess we'll keep a closer eye on that one and see how that unfolds over the upcoming quarters. But maybe on rare metals, I mean, that's a business that's done extremely well, and you guys called it out in your prepared remarks. Just curious if that business is entirely on spot or is there some contract element as it relates to the metals that are doing extremely well at this time?

Yeah, actually, more of the business is on long-term contracts than any of our other businesses, quite honestly. The other businesses, and I would say particularly the rarer separation businesses where The vast majority of the volatility exists, and the vast majority of the product that actually gets sold on spot gets sold on spot. It's all on the rare separation side. The magna quench side, again, has long-term contracts with customers, just demand changes and pricing moves through pass-through agreements. But the rare metals business is one where we get longer-term contracts for customers, and I think Hathim is probably even on the longer term of those. So the upside here is that we've got contracts for the balance of this year that reflect good pricing. We've got contracts going into next year to reflect good pricing. And I'll tell you what, the pricing that we're seeing today is higher than the pricing that's going through our average book today because those contracts would have been entered into, you know, six months ago and the like or 12 months ago even. So rare prices were actually lower. Sorry, rare metals prices and haptium prices were lower. So our realized ASP in our P&L from our haptium business is lower than the current POs that we're signing up for. So we still see continued opportunity there. We have good demand profile there. I'll tell you this quarter's demand, like just number of shipments of haptium product was really high. So, you know, in terms of, you know, is that number as repeatable as folks would like it to be? I think margin expansion will continue to be a positive trend. But we did have an extraordinary amount of volume of this high-value product in the quarter.

Out of curiosity, is the lead lag component of that also kind of in that three- to five-month ballpark?

Yes and no. The strategy there is a little bit different. And actually, take it for good or bad, it actually causes us to hold more inventory. But because we have customers that are willing to agree to long-term contracts, We are much more inclined to actually just take physical. So we actually have a significant amount of inventory locked in against those sales contracts that we've talked about. So the benefits in rare metals is less about lead lag in the period and it is more about just the lead portion, I guess. It is a fundamentally increasing pricing environment and it's not about inventory necessarily being mismatched because we bought that inventory at the time that we entered into the sales field with the customer too. So it's not a mismatched lead lag, but because it's higher finished good prices and we're using scrap material as our input, there's more margins available. So it is a fundamental improvement in the business. Okay, got it. That's my questions.

I had to call back. Thank you, David.

Thank you. Ladies and gentlemen, as a final reminder, if you have any questions, please press star one. Your next question comes from Yuri Link with Canaccord Genuity. Please go ahead.

Hey, Rahim. Just following up on rare metals, since it was such a strong quarter from an EBITDA perspective, how is Q3 shaping up, or how has it been to date? Anything you can give us to help form expectations for the current quarter?

Yeah, I think that rare metals will have a difficult time repeating that level of EBITDA in future quarters, whether that's next quarter or the quarter beyond. As I said, it was a very high volume quarter. I don't think that means it returns to kind of historical norms. As you know, that business had much lower EBITDA levels for between 2017 and 2020-ish years. I don't think it returns to those levels. I think it remains fundamentally higher and fundamentally better. But certainly this quarter is outsized, as I said, due to volume. But margins will remain healthy and the business remains healthy.

Just on MagnaQuench volumes, I mean, it's some pretty easy comps. in the first half of last year, and we're down materially on those. I mean, is there something else fundamental going on to explain besides inventory destocking? Like, is there substitution from other magnetic materials that might be more attractively priced, some kind of demand destruction, anything there to explain the pretty weak volumes?

Yeah, I don't think there's demand destruction. If anything, given where rare earth prices are now, it's a benefit to magna quench, right? When neodymium and presidinium was twice the value that it was, there was a lot more concern and rightly so about customers looking for substitution of alternative solutions. Where prices are now, customers are less motivated because the energy efficiency factor is just that much more important. And, you know, we've talked about it in the past that, you know, it's a rare earth magnet 10 times stronger than a ferrite magnet. There's just different applications that can afford to do that. And I think the majority of the growth in the applications are going to continue to need rarest magnets, and I think that's why you're seeing kind of the whole market looking in that direction. Having said that, your comments about the past are absolutely correct, right? There's less volume this year than there was last year, and there's certainly less margin this year than last year. I think the volumes are going to return. I think that the volumes are this, what we see as still being a temporary lull. They're probably still low in Q3, although I think that they're better. Everything that we're seeing is better than the existing quarter. but it's probably not ramping up to our, our expectation relative to the book that we expect from our customers still for another couple of months. So I think that the volume ramp is slower. The volume return is slower than we would have liked to see, but I still think we're on that path in terms of the margins though. I mean, you're looking at EBITDA margins per kilo. I think we've talked about MagnaGwench having benefited from, despite being on pass-through, there is still a quarter to quarter dynamic and, When rare earth prices went up for six consecutive quarters, magna quentas make an outsized gross margin per kilo or EBITDA per kilo metrics. When rare earth prices have declined six consecutive quarters, magna quentas making lower EBITDA per kilo metrics. As the business is on pass-through, it's actually not going to be terribly dissimilar to the EBITDA margins per kilo that you would have seen in more steadier times, 18, 19, and 20. And if you look at it that way, you'll see that the margins should be higher than they are today. but not as high as they were in 2021.

Given that you control such a large portion of that market in MagnaQuench, can't you negotiate better terms on reducing the impact of the lead lag, like I think in some of your AIF and some of the prospectuses, you've said you've got upwards of 70% market share. So I would just think that you'd be able to negotiate better commercial terms to have a more predictable business.

Well, we have the larger market share in kind of the outside of China environment. We have a much lower market share inside of China just depending on, I think, the specificity of the application. And the challenge... For us, honestly, in the outside of China market is we have to keep inventory for customers in those jurisdictions. So it does hurt us a little bit on working capital. It does hurt us a little bit then on lead lag because we have a longer cycle when we have to keep the material outside of China. Inside of China, we see much less variability on margins. It's because our business is so slated toward outside of China customers that we have a little bit more variation But magnification margins are healthy. When we look at it from a conversion cost to gross margin type ratio, it's a very healthy, a very strong business. We are getting paid for our technological leadership, the quality of our product, and the availability to our customers. So I don't know that I think that it is a lack of a dominant pricing position with customers that can change, or let's say a creation of a dominant position with customers can really change lead lag. I think it is more us just kind of sharpening our pencil to get the right amount of inventory in the right jurisdictions and maybe analyzing customer behaviors a little bit closer and making tougher decisions on how much inventory to carry in each of those foreign jurisdictions. Like I said to David, I don't think it goes away. I just think that we get better at it and hopefully I would not expect rare earth prices to jump around the way they have in the last 24 months. You know, we did talk about lead lag a little bit in 2017, 18, 19, but certainly not the way that we've had to talk about it over the last two years.

And just last question on the magna quench volumes. What would have SG Tech have contributed to the 1,037 tonnage?

A really tiny amount, and that's not because SG Tech is a really small business, but because SG Tech does more than bonded magnets, so that number in there is generally a bonded magnet type number. So it is a couple of percent off the top of my head. I'd say like 5%. So we're trying to figure out what the right reporting structure will be with SG Tech because some of what they do would be in the kind of rare with magnetic space and some of what they do is in the soft magnetic space. So how do we kind of now start combining the multiple metrics together? So overall their contribution, look, we're really thrilled with how they are operating, how we are operating with SU Tech. They are also seeing in terms of their customers and now our customers demand challenges. So we think that there's much more opportunity for that business than its current contribution. But today I'd say it's like 5% of Magniquench volumes.

but their contribution to MagnaCoin's revenue would be above that, if I understand.

Above that. We haven't been specific on providing kind of location-by-location information in the quarter. Less than 5% of EBITDA, and I'd say significantly less than 5% of EBITDA came from SG Tech.

Okay. Okay. Thanks very much. I'll turn it over.

Thank you, Yorick.

Thank you. There are no further questions at this time. You may proceed.

Once again, on behalf of the NEO team, thank you for joining us today. If you have any follow-up calls, questions, feel free to reach out to myself. That concludes today's call. We look forward to speaking to you on our third quarter conference call. Have a great weekend. I'll hand it over to the operator to close the call.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.