Neo Performance Materials Inc. (OTCPK:NOPMF) Q1 2022 Earnings Conference Call May 13, 2021 10:00 AM ET
Company Participants
Ali Mahdavi - SVP, Corporate Development & Capital Markets
Constantine Karayannopoulos - President and CEO
Rahim Suleman - CFO
Conference Call Participants
Yuri Lynk - Canaccord Genuity
David Ocampo - Cormark Securities
Operator
Good day and welcome to the Neo Performance Materials' First Quarter 2022 Earnings and Business Update Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Ali Mahdavi. Please go ahead.
Ali Mahdavi
Thank you, operator, and good morning, everyone. Thank you for joining us this morning. As a reminder, this call is being recorded and a replay will be available starting tomorrow in the Investor Center on our website located at neomaterials.com.
I am joined this morning by Neo's President and CEO, Constantine Karayannopoulos, who will provide opening remarks and Rahim Suleman, Neo's Chief Financial Officer, who will then follow with a short overview of the company's first quarter financial results.
Please note that some of the information you will hear during today's presentation and discussions will consist of forward-looking 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 SEDAR 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 the 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 SEDAR, and again, on our website at neomaterials.com.
Let me now turn the call over to Constantine.
Constantine Karayannopoulos
Thanks Ali, and good morning everyone. We're pleased to report record financial and operating performance during the first quarter of 2022, driven by continued strength in end consumer demand, an increased price environment, and a favorable mix. All three of our business units are performing well and have built a healthy head start on our full year plans.
Nel's first quarter sales were $166 million, net income was $23 million or $0.54 per diluted share, and we delivered adjusted EBITDA of $33.1 million. All three of these metrics represent records for quarterly performance since we reemerged as a public company in 2017. Our EBITDA growth is nearly 50% over the prior year period.
The strength of our business model rests in our customer service and technical development skillsets. These unspoken heroes of our operating model may not be evident when reviewing our financial performance, however, but they are critical to our ability to gain new business and to retain existing customers. It's also the cornerstone of our growth strategy as we continue to strengthen our foundation for future growth.
While our financial results are largely driven by recent favorable market and pricing dynamics, you can only take advantage of these current prices through a consistent high quality product offering that is sought after and valued by our customers.
The rare earth and rare metal price environment and has continued its somewhat volatile journey over the past year and a half. Magnetic elements such as neodymium-praseodymium, terbium and dysprosium appears to have said high watermarks in the late February and early March timeframe, right about when were reported full year 2021 results.
Since then, pricing for neodymium-praseodymium, or NdPr has eased about 15% to 20% from those highs and is now approaching just under $140 per kilogram. At $140, these pricing levels remain supported by higher demand for higher efficiency, permanent magnet motors, particularly for electric vehicles and other new energy technologies.
Pricing for specialized terbium products has shown to be even more resilient and remains near its peak earlier this year and continues to be supported by current buying.
At these prices, there is sustained profitability throughout the supply chain without a significant risk from higher prices, motivating a significant switch to competing materials or technologies by the downstream customers.
While the elevated price environment -- excuse me, confers obvious benefits, it also presents significant near term operational challenges that must be managed, our pass-through pricing mechanisms, such as in our Magnequench division, mitigate this risk and provide transparency to our customers. Inventory management remains a top operating priority, but working capital requirements are naturally higher in this environment.
In the event that pricing for magnetic materials continues to soften, we could face a scenario where a lead/lag position shifts with higher cost inventories countered by a decreasing market price environment.
While we're not making a call on the market price direction, we are prepared to manage through these volatile price environments. We have done this many times before in our nearly three decades in this business.
Amidst the opportunities and challenges of the market, we continue to see significant supply chain disruptions, particularly in China and other Asian countries as the recent COVID variant has instituted further lockdowns.
Last week, the preventive endemic measures in parts of China caught up to us and our high purity heavy rare earth operations facility in Jian Ying [ph] is currently subject to a citywide lockdown. This is the first direct interruption at one of our manufacturing sites and follows on from spillover cases in other larger cities in Jiangsu Province and further from the cases in Shanghai last month. None of our employees at the site have currently tested positive for the virus.
Given that this is an unplanned shutdown, our local management is doing everything in its control to get back to normal operations and we're limited in the types of maintenance we can perform until the current government measures are relaxed.
We have managed, however, to prepare sufficient volumes of product for export shipments and we managed to send good volumes to the port of Shanghai ahead of the lockdown.
That said, we're currently in discussion with all of our top customers for specialty products manufactured at Jian Ying [ph] and we're confident that this disruption will be both short-lived and have minimal impact. There may be minor timing shifts for product deliveries from May into June, but we have ample safety stock to cover the sales with finished goods ready to be shipped the moment traffic lanes reopened as well as other volumes awaiting shipment at the port of Shanghai as I mentioned.
Shifting to Europe, we've continued to manage through the contentious environment resulting from the war in Ukraine. Our rare earth and rare metal production facility in Estonia continues to operate without interruption, largely driven by the strength of our long-term supplier relationships, and our ability to continue to diversify our suppliers.
Through recent visits with employees, shareholders, and government officials, I'm confident in our European team's ability to manage your operations through this turbulent time. We will always place our employees' well-being first; that is particularly the case with our employees who have family and friends affected by the conflict.
Our plan to expand rare earth production in Europe and launch our manufacturing of sintered rare earth permanent magnets to help meet the rapidly growing demand continues to move forward.
The government of Estonia formally included Neo's proposed project on a short list of candidate projects for funding by the European Commission's Just Transition Fund. The application process for such funding is expected to open in Estonia on June 1st, 2022. And not only will Neo to apply for such funding, but were encouraged by the strong and vocal support for our initiative from leading members of the Estonian government.
For example, Mr. Andres Sutt, Estonia's Minister of Entrepreneurship and Information Technology recently noted that our rare earth permanent magnet project is, "the priority for Estonia, as it not only helps fulfill the EU's commitment to develop domestic and resilient supply chain, but also to transition towards climate neutrality." Neo looks forward to partnering with the Estonian government in this effort.
My senior colleagues join me in another series of meetings across Europe in April to gauge market demand for Neo's expansion into sintered rare earth permanent magnets.
I'm pleased to report that we continue to receive strong validations of interest from current and prospective customers for this expansion. Based upon the level of prospective customer interest we're receiving today, I'm increasingly confident that our planned Phase 1 production of 1,200 tons per year of magnets will be confirmed and committed relatively quickly, and that we will soon look to be expanding those operations further into Phase 2 as market and economic conditions dictate.
With both market and government support continuing to build for this initiative, I look forward to providing further updates on the project in the next few weeks and months.
Also important to our expansion in Europe is our focused effort to diversify our upstream sources of rare earth feedstock. Colorado-based Energy Fuels continues to ramp up its production in Utah of rare earths carbonate that feeds plant in Estonia and to expedite shipments as much as possible. We're very grateful to them.
Energy Fuels, processes rare earth rich monazite that is generally produced as a byproduct of heavy mineral sands mining. Both primary and secondary monazite resources are available in many parts of the world, and Energy Fuels and ourselves are exploring further options.
We're also working in a very concerted effort with a number of other rare earth projects around the world that can further diversify the geographic distribution of our feedstock supply.
As the lessons of the past two years have demonstrated, maintaining diversified operations across all levels of the supply chain yields tremendous benefits. As we expand the relationship with Energy Fuels and other historic suppliers, we will also continue to further expand our supplier base, diversifying the geographic distribution of our feedstock supply and ultimately, grow our business with a much more diverse and secure raw materials base.
Our long-term strategy for growth remains rooted in our customer service and technical development, which remain inextricably linked with the other pillars of our growth plan, which I have discussed before.
So, let me repeat first, protect, strengthen, and grow our core business. This includes expanding our existing market share in magnetics, emission control, catalysts, electronic materials, and aerospace technologies.
Second, innovate into next generation technologies. Historically, bringing the next improvement to meet our customers operating and regulatory needs has been the lion's share of our R&D work. Key examples would be co-engineering toward modern technologies for new applications of energy, efficient pumps, ultra-high speed motors, and working towards complex catalyst systems that meet more stringent regulatory demands, while performing in hybrid vehicles.
Third, expand and diversify our geographic footprint in order to capture growing demand for our specialty rare earth products in Europe and North America. Assuring stable supply for our customers comes from having established partnerships to improve the diversity of supply. As we continue to have ongoing dialogue with our Tier 1, Tier 2 and OEM customers, this is paramount given today's supply chain challenges.
And fourth, improve our global sustainability leadership. Let me take a minute to elaborate on what sustainability means for Neo. Over the past several years, we've been engaged with numerous stakeholders, shareholders, customers, employees, and our local communities, as well as governments to address a number of topics that fall under the umbrella of ESG.
As such, many of you are aware of our efforts with award-winning plant operations as indicated through EcoVadis survey. And for the second year, Neo has committed to the United Nations Global Compact, which directly expresses our commitment to the UN Sustainable Development Goals. In addition, we're also a member of the Responsible Minerals Initiative or RMI.
In particular, we're active participants in helping to establish industry standards as they relate to rare earth and rare metal supply chains. With a 30-year history as leaders within the rare earth space, we take our responsibility seriously to develop an appropriate framework that allows our industry to flourish and to enable our industry to accelerate the adoption of energy-efficient and climate-friendly technologies.
Meanwhile, in the background, we have been compiling, analyzing and implementing a more formalized, ESG program. I'm proud to note that we are in the final stages of preparing to issue our first companywide sustainability report.
I am proud of our company's culture of integrity and willingness to do the right thing without taking shortcuts. That discipline has translated into extraordinary quality, technology breakthroughs, and a stronger organization. We look forward to starting the next round of dialogue with all of our stakeholders regarding sustainability and we adamantly believe that this will further strengthen Neo's value proposition in the market.
I’d like to thank all of our employees around the world for their continued dedication and thank our customers and suppliers for continuing to put their trust in Neo. Despite the headwinds from multiple angles in the market, we continue to grow our core business, expand our market share, and are setting up the foundation for further growth.
I'll now turn the call over to Rahim for details on the quarters on the quarter. Raheem?
Rahim Suleman
Thanks Constantine. Good morning, everyone. We are pleased to again report record quarterly financial performance to begin our 2022 year. The strength of end customer demand, combined with the current pricing environment, has led to superior financial results. And the opportunistic timing of specific spots fills near the end of the quarter help to exceed our expectations for the quarter.
As we've discussed in the past, Neo's focus is on value added markets, taking rare earth and rare metal feedstock and converting that into high value high need finished good products. This includes producing high purity oxides, high performing magnetics, environmentally advanced catalysts, and other related products, and these all being driven by high growth end markets.
Ultimately, we rely on our advanced engineering skills and in-depth customer relationships to create differentiated products that enable our customers products to succeed in the marketplace.
We are pleased with the direction of our value added market, the increasing mix of higher value added sales opportunities, and the continued operational efficiencies that we see in the efforts throughout the organization. When combined with the end market trends and electrification and sustainability, we are excited about Neo's continued growth prospects.
Our quarterly and short term financial results do vary depending on rare earth price movements, the lead lag impact, which is the difference between current pricing and our inventory cost. So, I must dedicate some time to the topic of rare earth price movements as we speak about quarterly results, notwithstanding our longer term strategic focus on higher value added markets.
The recent dynamic pricing environment created a scenario where many of our products are sold at higher prevailing market prices using lower cost inventory. As Constantine mentioned ,some of the rarest prices peaked in mid-March, declined in April, before rebounding a little bit now. Although prices today are lower than their March peaks, they remain significantly higher than they have been in the past several years.
A dynamic pricing environment is not new for us and we are accustomed to managing all aspects of our business in these environments. Our teams are heavily embedded in both the rare earth feedstock environment, as well as the high value add finish good marketplace.
We have a deep and multifaceted understanding of these market trends and we certainly capitalize on opportunities to buy additional feedstock at lower prices, and at the same time, execute additional spot sales at favorable prices. A key characteristic of Neo is to flourish in these highly volatile pricing environments.
In the bigger picture, rare earth and rare metal prices remain at relatively high levels. This provides for more dollar value margins across many of our products. This also requires elevated investment working capital, which increased by $66.8 million in the quarter. Our inventory levels will slightly lag current pricing trends as we work through some material purchased in the previous quarters.
From an end market perspective, we generally see strength in the macro economic recovery despite the current challenges related to COVID shutdowns, discrete supply chain interruptions, global shipping delays, and geopolitical conflicts.
Within the automotive industry, there are multiple competing dynamics that create a somewhat fuzzy picture on the one hand for your estimates for 2022 light vehicle duty production has been revised down, semiconductor chip shortages continue to delay final assemblies by the OEMs.
At the same time, new energy vehicles hybrid and electric vehicles continue to grow their burgeoning market share. We also see traditional internal combustion engines and hybrids continue to become more efficient and complex, and continue to require more advanced rare earth formulations to meet these ever increasing demands.
The net result of these factors is that base demand for many of our products sold into the automotive change remain fairly strong. We do see some regional differences in that demand trend. COVID has been more impactful to China and some parts of Asia in early 2022, which is affecting the free flow of people and products. This has led to some customers slowing down production levels and changing in their purchasing patterns. The aerospace industry continues its recovery, while consumer electronics and household appliances remained in high demand despite inflationary cost pressures.
Translating these trends into volumes, we saw lower volumes in Magnum Blanche than what we would expect to be our normal run rate. Our volumes [indiscernible] for Auto Catalysts catalyst were stronger than we expected, given the impact of semiconductors on the autos industry, but we saw lower volumes in Q3 and Q4. So this is likely just timing related to certain sales and how customers are adjusting their inventory levels.
We saw strong volumes in our highest value rarest products, driven particularly by the demand and price for magnetic materials. As for rare metals, our volumes are generally within the expected range, but a distinct tilt toward higher value added products which we have been focusing on for a while now.
Bear in mind that pure volume metric numbers for each business unit is not the best indicator of progress and profitability. The mix of which products we are selling is very important to understand our growth.
In the first quarter, we reported a record $166.3 million in revenue and a record $22.7 million in net income. These reflect annual growth rates of 27% and 198% respectively.
Our adjusted EBITDA contribution of $33.1 million in the quarter increased by 48% over the prior year period. Our net cash position of $43.5 million decreased in the quarter despite our very strong earnings. The decrease is related primarily the increase in working capital, inventory levels are higher due to the trend of higher rare earth prices throughout the quarter.
Receivable values are higher due to the particularly high level of sales in March, as we capitalize on the market dynamics that we spoke about earlier. And our payables balance decreased as well. We generally expect payables to decline in the first quarter of each year, but this decline was also more pronounced by the higher purchases made in Q4, again taking advantage of strategic purchasing activities in a highly volatile pricing environment.
We invested $6.8 million of capital expenditures in the quarter with some early work related to the relocation of our Zibo [ph] production facility. We also distributed $3.2 million in dividends to our shareholders in the quarter.
As we think through our strategic plans for the year, we are encouraged by the record results in strength at the start of 2022. This is overall the continuation of the positive recovery trends over the past year and a half and it's emblematic of the increasing demand for new applications of Neo's advanced materials and specialty products. While pricing introduces volatility and challenges in managing working capital, we are cautiously optimistic that this end market strength will continue.
Thank you for your time today and we're happy to turn the call over to Jake and take your questions.
Question-and-Answer Session
Operator
[Operator Instructions]
We'll take our first question from Yuri Lynk with Canaccord Genuity.
Yuri Lynk
Good morning, guys. Nice quarter morning.
Constantine Karayannopoulos
Good morning Yuri. Thank you.
Yuri Lynk
Good morning. Constantine I just want to make sure I understand the order of play here with regards to the European expansion. It sounds like we could get some announcement on the funding this year sometime the plant could conceivably be in production by 2023, correct me if I'm wrong, the customers seem to be lined up. But I guess the question mark I have is on the feedstock, like, do you go in to construction without having feedstock locked up? I'm just not clear on the strategy there.
Constantine Karayannopoulos
Sure, let me start that, 2023, I expect we will be building the plan. We're aiming for 2024 production, which will give us enough time to make sure that the facility is fully ramped up and producing by 2025, which is really the target that some of the big OEMs have given us, as well as they're given to their Tier 1 and Tier 2 supply chain partners. So, that's really the end goal.
It is an aggressive target, but we've done sort of more aggressive things before, so we're not too concerned about it. But it'll take good execution. So, the order of play. Firstly, we need it, we need to start with -- I've been talking about over the last little while, we need to manage the different risks. The financial risk, I believe will be addressed by the Just Transition Fund contributions by the EU and Estonia, we expect that announcement, as I indicated earlier, Estonia is starting the Just Transition Fund process earlier than the rest of Europe. So, they starting June 1st, so I expect sometime in the summer, certainly in the third quarter to have news of a final decision by the Estonian government. That then will trigger our funding commitment in collaboration with the Estonian government and we really like to break ground and start building things by the end of this year.
Feedstock, we are producing currently, in Estonia, enough of the magnetic materials that Magnequench will need, for instance, or magnet project. So, we don't need to really do anything else in the near-term other than continue our long-term discussions with both Energy Fuels as well as other possible partners for additional feed materials and additional diversification. So, this is not really on the on the critical path.
We will -- once we get the commitment by the Estonian government, we will announce our plans and we'll go ahead and the rest of the raw material supply commitment will fall in place.
But as I said, Phase 1 is not a risk, I believe that we will need to have those supply arrangements in place in order to commit bigger capital numbers for Phase 2. And just to remind you and everyone else, we're talking about a 1,200 ton a year magnet plant as Phase 1, and Phase 2, adding another 3,800 to make it a total of 5,000 or perhaps even bigger than that based on the types of levels of demand and commitments that we're expecting from customers. Does answer your question Yuri?
Yuri Lynk
Yes, that's helpful. So, I guess, the feedstock that you're going to get from the Estonian facility, the existing facility now, currently, you're selling that to third-party customers, is that right? And you'll just redirect it internally?
Constantine Karayannopoulos
Well, some of it is going to third-party customers, some of it is already going to Magnequench in support of our parallel supply chain strategy for key customers in Europe and perhaps that could be diverted. Don't forget that we are already a very large net buyer of NdPr from Western suppliers, as well as Chinese suppliers. So, we do have sufficient flexibility to put the strategy -- our Phase 1 strategy together, without really any risks.
One of the potential risks might be the access to heavy materials. But we are in the middle of planning an expansion of our Sillame separation capacity to into heavies. We're fortunate that the material that we're receiving from Energy Fuels has not only higher levels of Nd and Pr but also much higher levels of Dy and Tb, which currently we can't take advantage of Sillame, Estonia because we don't have the capacity to separate heavies. So we're putting together an analysis of what we need to be doing. And I would expect, within the next few quarters to be making a decision to expand Sillame, into heavy separation primarily to in order to supply DY and TB, to the center magnet project by 2024. In addition to also securing additional heavy rare earth raw materials from either our existing one of the newer existing suppliers that we've that we've been working with in Vietnam, or emerging producers in South America and Australia.
Yuri Lynk
Okay. Okay. That's helpful. I'll turn it over. Thanks.
Constantine Karayannopoulos
Thanks, Yuri.
Operator
David Ocampo with Cormark Securities as the next question.
David Ocampo
Thank you. Good morning, everyone. I just wanted to continue the theme on the Estonian facility here. I mean, it looks like you guys have some pretty good commitments from your customers. Is it more of the case that you guys, I guess, won't go through with the expansion if you don't get the government funding? And is that primarily just due to kind of return requirements that you guys are looking for? Whether it's a hurdle rate or what have you?
Constantine Karayannopoulos
Well, that's a tough question to answer, David. But as I was saying earlier, the funding that we're looking for, in combination with a premium that we have communicated with all of our customers that we would expect to have for these products really allow us to achieve a rate of return for this project that is acceptable, I won't take a project to my board for funding with a rate of return that doesn't meet our internal threshold.
So this is really what this is aimed to do. So again, it's the combination of capital contributions by the governments in Europe, plus the premium compared to the Chinese to the price of Chinese magnet for the -- for our products. So the combination of those two key factors is what really allows us to achieve a greater threshold rate of return target.
On the other hand, if one of these falls away, the other one will have to increase. So if we don't get the funding, we will need to have a higher premium. Or if we can get the premium, we might have to go back to the welcome additional funding.
Although, given the number of discussions and the level of negotiations that we've had, over the last year, with, as I mentioned, before Tier 2, Tier 1 and OEM customers, we have a very high degree of conviction that we will be able to hit our targets on both the capital as well as pricing levels that we're looking to get. So in other words now, still works to be done, but we expect that we'll get that we might have to get more creative, but I think everything's going in the right direction.
David Ocampo
Yes, and I guess for the investors on the call, or are you comfortable sharing what your return thresholds are? Is it like a mid-teens IRR? I'm guessing is what it is.
Constantine Karayannopoulos
That -- you're not that far away? I you know, I can't really talk to that. But, I'd say, it's in the double digits. And you're not -- you're not too far from what we need to be in order to commit our capital. I mean, you can look through our disclosures, you can you see what our return on capital invested capital employed is so we -- we need to maintain and improve on that performance or otherwise, we will not be earning enough to keep going and growing like this.
David Ocampo
Yes. And I guess as you move further downstream here, has there been any concern from the customers that you're dealing with now, if you're if you're going to be consuming most of that feedstock?
Constantine Karayannopoulos
Not really, the only customer that I would be concerned with is our very large customer in Japan where we dominate the market for premium dysprosium oxide that goes into dielectrics, actually Japan and Korea where we are the largest supplier into that environment. So, if we needed that dysprosium for magnet quench that could potentially create a problem. However, that product is meticulously engineered, highly customized product that fetches a premium to the market, the commodity price.
So if push came to shove, we can always buy more dysprosium in the market, process it to our specs, manipulate molecules control physical properties, that allows this oxide to go into a nano structured dielectric formulation and continue to sell it.
So as I said, we could get very creative with these. So I don't expect to get into conflicts of sort of internal supply versus customer supply. And don't forget, we don't sell a lot of neodymium, praseodymium or dysprosium into the magnetic market, we tend to sort of go into other niche higher value applications. So the short answer is, yes, that's an unlikely scenario.
David Ocampo
Okay. Thank you so much. I'll hop back in the queue.
Constantine Karayannopoulos
Thank you, David.
Operator
And ladies and gentlemen, this will complete your question and answer session. I'll turn the call back to your host for any additional closing remarks.
Constantine Karayannopoulos
Well, thank you all for attending the call today. I guess, I'll take the fact that, there's no more questions as an indication that the numbers speak for themselves. We're happy with a quarter, we’re bullish on the outlook. And we'll continue to stay focused on what it is that we need to do. The volatile environment has made everybody's life a lot more difficult. But I'm really grateful for the very creative and hardworking folks that are part of our team around the world. And I expect will continue to surprise on the positive side, or at least I hope so.
But clearly, we're happy with the performance. And I think, it's really laying the stage perfectly for us to take advantage of all the opportunities that we're seeing in EVs, other key development areas. And, we will continue to capitalize on all of these on the strength of an exceptional team of people around the world. So thank you all for listening in. And Yuri and David for asking questions. And I look forward to talking to you all again, another three months or so. So, you all have a good weekend, and we'll talk to you soon. Thanks.
Operator
Ladies and gentlemen, this will conclude your conference for today. We do thank you for your participation. And you may now disconnect.