MP Materials Corp

NYSE:MP

Earnings Call Transcript 2021-Q2

[Operator]

Hello, and welcome to the MP Materials Second Quarter 2021 Financial Results Conference Call and Webcast. All lines will be on mute unless if you do ask the question on today's call. [Operator Instructions]

I'll now hand over to Martin Sheehan, Head of Investor Relations at MP Materials. Please go ahead when you're ready.

[Martin Sheehan, Head of Investor Relations]

Thank you, operator, and good day, everyone, welcome to MP Materials second quarter 2021 earnings call. With me today are Jim Litinsky, Chairman and Chief Executive Officer of MP Materials; Michael Rosenthal, Chief Operating Officer; and Ryan Corbett, Chief Financial Officer.

Before we get to Jim's and Ryan's opening remarks, I'd like to remind you that during today's call, we will make certain forward-looking statements that do not constitute historical facts under the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements are predictions, projections and other statements about future events that are based on current expectations and assumptions, and as a result are subject to risks and uncertainties. Many factors could cause actual future events to differ materially from forward-looking statements in this communication. For more information about factors that may cause actual results to materially differ from forward-looking statements, please refer to the cautionary language in the earnings release and in our filings with the SEC, including the Risk Factors section in our recent SEC filings.

During the call, management will also discuss certain non-GAAP financial measures, which we believe to be useful in evaluating MP Materials' operating performance. These measures should not be considered in isolation or as a substitute for MP Materials' financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our current report on Form 8-K filed today and can be found on our website, investors.mpmaterials.com. And please check our Investor website regularly and follow us on Twitter, Instagram and LinkedIn, where we often provide news and information on the Company.

With that, I'll turn the call over to Jim. Jim?

[James Litinsky, Chairman & Chief Executive Officer]

Thanks, Martin, and thank you to everyone joining us on the call this afternoon. We've had a busy and very productive second quarter. So let me run down what we will cover on the call today. First, I will recap the highlights of another quarter of outstanding results. Second, Ryan will provide color on our operational and financial performance. Third, I will provide an update on our Stage II optimization plan, including new developments on the heavy rare earth front, then I will share an exciting update on our Stage III plans, after wrapping up the prepared remarks, we will open it up for Q&A.

Let's start with the second quarter highlights on Slide 4. The highlight of the quarter operationally was clearly our production levels. We produced 10,305 metric tons of REO and concentrate. We believe this is the largest quarterly total in the site 60-year history. What is even more impressive about this result is that we had a one-week planned shutdown in the quarter to perform preventative maintenance

Last year, we delayed that plant shutdown due to COVID, puts [indiscernible], the amount of REO produced per operating hour increased 14% year-over-year. Michael and the team continue to do amazing work in fine-tuning and improving our Stage I processes, and while production levels will vary slightly quarter-to-quarter, especially, as we begin Pines of our Stage II assets, this quarter's efficiency, gives us continued comfort in our Stage I processes supporting our guided NdPr oxide production. The combination of solid production and net [ph] sales volume as well as higher pricing resulted in record financials, as our revenue more than doubled year-over-year. This and continued solid cost control resulted in adjusted EBITDA increasing nearly six-fold. Importantly, our adjusted EBITDA margin also hit an all-time high of 64%, demonstrating the leverage we get from strong NdPr pricing.

Ryan will talk more about our sales and production volumes in a minute. I will update you in detail on the Stage II after that, but the headline is we are making steady progress. Despite supply chain and COVID challenges, we remain confident in our goal of achieving run rate production of 6,075 metric tons of NdPr in 2023.

And lastly, we have some exciting news to share on Stage III, but first so I will turn it over to Ryan, for a more detailed rundown of our operational and financial results. Ryan?

[Ryan Corbett, Chief Financial Officer]

Thanks, Jim, and hello, everyone. I'll share some additional color on the quarter, beginning on Slide 6. Our record quarterly production in Mountain Pass of 10,305 metric tons was up 11% from last year and 5% sequentially, despite the maintenance shutdown Jim mentioned. This shutdown was the largest in most complex outage in our history. We completed the maintenance work early and most importantly safely. The driver of our higher production in the quarter was both a higher feed rate of ore into the mill and modestly improve recoveries of REO in our flotation process. Higher feed rate will often negatively impact recovery percentages but improvements in our processes and reagent schemes allowed us to actually increase recoveries compared to last year, while still growing our feed rates.

Moving clockwise on the Slide, our sales volumes continue to closely mirror production at 9,877 metric tons of REO. This was down 4% from last year, but up 1% sequentially. As always, shipping causes modest timing differences in our revenue results versus production. I would also point out that in 2020 due to typical seasonality around Chinese New Year, plus the initial wave of COVID-19 in China, our sales in Q1 of 2020 were seasonally low with a big catch-up quarter in the second quarter. This year, we didn't see the usual seasonal slowdown in the first quarter so results across the first two quarters were much more balanced than normal.

On a year-to-date basis, metric tons of REO sold were up 5.7% which roughly equal the 6.2% increase in year-to-date production. On the top right, you can see the bigger impact that demand for NdPr is having on our business, with the realized pricing of REO up 137% to $7,343 per metric ton, also up a strong 25% sequentially. I would point out that there is often a slight lag between observed market prices and our realized price as we ultimately true-up our contract prices to our spot price recognized upon the product sale overseas.

And finally, on the bottom right, you can see our reported production costs were up about 9% versus last year and 4% sequentially. In the quarter, we continue to ramp hiring for Stage II, some of which flows through the P&L and impacted our cost of production by about $130 per metric ton. Importantly, we've made the strategic decision to begin hiring well ahead of Stage II commissioning. We believe that having the people who will operate and maintain our Stage II processes and equipment on-site now allows them to see first-hand the engineering and construction of the facility. We think investing in people ahead of Stage II commissioning will pay off in the long run from both an operating and maintenance cost perspective. So bottom line, a cleaner year-over-year comp excluding the ramp in Stage II related hiring would be about $400 per metric ton, showing our continued execution on cost discipline with our production efficiencies more than offsetting any material cost inflation.

Moving to Slide 7, you can see on the top left, what is for the most part the simple P times Q of our business that is realized price times metric tons sold drove $73.1 million of revenue in the quarter up 141% over last year. And demonstrating the leverage in the business from the price of our concentrate as well as our solid cost management, adjusted EBITDA increased nearly six times to $46.4 million and was up a strong 41% sequentially. This leverage also translated into improving adjusted EBITDA margins as they increased 37 percentage points versus Q2 2022 to 64% in the quarter and increased 7 percentage points quarter over quarter. And adjusted EBITDA performance combined with the very low cost of debt on our balance sheet resulted in adjusted net income increasing significantly, up nearly 6 times to $33.4 million as you can see on the bottom right of the page.

I'd like to point out in the quarter, excluding stock comp and other one-time expenses, we had a slight increase in G&A costs in part [ph] related to Stage III and other growth and development activities. These development activities totaled just shy of $1 million in the quarter. We expect these costs to grow modestly going forward and are considering ways to further delineate these costs for you in the P&L.

Lastly in the quarter, we had a non-cash charge of $1.8 million related to the write-down of unprocessed or inventories. Specifically, we had a stockpile of mind ore that was left from the Molycorp days, our initial inspections of the service of the pile some years ago now let us to believe that this was a typical lower grade stockpile that would eventually be mixed into our mill feed. But recently, we moved the stockpile as part of a new mining phase and upon analysis of the entirety of the pile, we discovered a much higher amount of alluvial material that would complicate efficient processing and recovery in the mill. As such, we wrote off the carrying cost of the inventory since we no longer believe it is of sufficient quality to mix into our normal process. This one-time write-off is removed from our results we're looking at adjusted EBITDA and adjusted net income.

Moving to Slide 8, you can see that Stage I continues to produce strong normalized free cash flow from operations. Here we've updated this chart for the first six months of 2021. Like last quarter, in the appendix section of the slides, you will see a detailed walk of how we get from our adjusted EBITDA to our reported operating cash flow and then our reported free cash flow. But looking at Slide 8 on the left side of the chart, you see our year-to-date free cash flow for the company was a positive $3.3 million after a total spend of about $45 million on CapEx.

Now adjusting for offtake paydown of $23 million, $43 million in growth CapEx in deal expenses and one-time items. Our Stage I process generated $70 million of normalized free cash flow so far this year. That's more than double the $34 million Stage I produced for all of 2020, that's also a tremendous 53% free cash flow margin, up from 25% for full year 2020. Keep in mind, the reason we adjust out our offtake pay down is that the offtake balance is essentially debt, but per US GAAP the impact of the paydown of that agreement runs through operating cash flow instead of financing as we've discussed in prior quarters.

And also as discussed last quarter, you should expect that our CapEx spend on Stage II will begin ramping through the last two quarters of 2021 and into 2022. However, in light of our recent and expected cash flow performance and assuming continued strong NdPr pricing, it's worth pointing out the significantly higher proportion of Stage II costs we expect to fund with operating cash flow versus our original expectations, which maintains the significant firepower we have on our balance sheet. Furthermore, this is all in the context of rapid progress on paying down our offtake advances, which will provide an additional free cash flow tailwind in 2022. More on that on the next slide.

So on Slide 9, a quick balance sheet update. Our adjusted diluted shares outstanding at the end of the quarter were roughly 178.2 million. This includes the shares exchanged for warrants, which we completed in early June, but excludes shares associated with the convertible notes that are out of the money. We no longer have any earn-outs or warrants outstanding, so this is a clean number. And having put all of this behind us, we will likely no longer show this slide in future quarters.

I should note that in our GAAP financials, for the diluted share count, we do include our green convertible bond as if it were converted into shares. This results in a share count of 193.1 million, which we use to calculate fully diluted EPS, again per the recent ASU requiring full as converted treatment for convertible notes regardless of whether they are in the money. Obviously, if we were using as converted shares to build to our enterprise value calc, we would also need to remove the face value of the notes. Also in the quarter despite steady progress on Stage II, our cash balance actually grew by $15 million and now stands at just south of $1.2 billion.

Lastly, we paid down our Shenghe offtake advances by approximately $11.7 million in the quarter with the balance now is just under $49 million. Importantly, we believe we will pay down the full balance of the offtake advances over the next 12 months and you'll see when we file our 10-Q that we've thus classified the entire obligation as current on the balance sheet. Obviously, our ability to meet that timeline is subject to REO pricing.

In wrapping up, the headlines are exceptionally strong performance, a good story on production efficiency and costs, and a strengthening cash flow and balance sheet picture owing to our execution and a favorable pricing environment. That's expected to result in accelerating the paydown of our offtake advances and preserving more of our balance sheet for the future, including Stage III and beyond.

Now, I'll turn it back to Jim.

[James Litinsky, Chairman & Chief Executive Officer]

Thanks, Ryan. Most of you know that our Stage II project is the optimization of our site to move beyond today's profitable concentrate production to separating rare earth oxide at [ph] Mountain Pass. Our success is critical to the global industry and supply chain security since today nearly 90% of all rare earth separation is done in China.

Stage II is also expected to provide significant upside to our financial profile as we've spoken about on prior calls. Let's turn to Slide 11, to see recent photos of our progress, including some of the key equipment being installed. The top left shows the rebar being laid for the foundation of our Salt Crystallizer and below that one of the key crystallizer components being delivered to the plant. I guess it looks like a space capsule, but it actually does water treatment. On the top right, you can see the inside of our new concentrate dryer. It's now [ph] beautiful inside, I love this photo. And lastly on the bottom right. You can see the steel structure for our new concentrate filter press has gone up, and is shown surrounded by two cranes, the rest of the picture is our existing facility.

Moving on to Slide 12. One of the big upgrades for Stage II is installing a roaster back into the process. Here you can see a picture of our roaster also referred to as a calciner. It has officially arrived at Mountain Pass, and as of yesterday, has been placed on its foundation frame. This roughly 90-foot long rotary oven will evenly feet our concentrate without the need for any chemicals. The oxidation process will allow us to cost-effectively remove roughly 20,000 metric tons annually of lower value cerium concentrate from the process. While we're moving the majority of the cerium, the remaining processes to isolate the high-value NdPr will operate at much lower cost with a much improved environmental profile, while also allowing us to get higher levels of first pass on spec production of NdPr.

In addition, we continue to make nice progress across Stage II. Structures for filtration, drawing and roasting are starting to take shape. The foundation for the Salt Crystallizer is advancing as the picture on the previous slide demonstrated. Improvements to our leaching impurity removal and separation processes are underway as well. Vertical construction is happening and the start of installations is anticipated to follow later in the year.

I am very proud of what our team is accomplishing particularly at such a challenging time. We all see the press reports about shortages of things like semiconductors or labor, hotels, restaurants and stores are struggling to find staff steel and resin among many other materials have huge backlogs. Already this earning season, we have seen a number of companies talking about stress supply chains, bottlenecks labor costs and/or shipping issues.

Like other companies that you are hearing from these challenges along with the COVID Delta reemergence have our full attention, and therefore, we are more focused than ever. Our team is managing these variables closely. Engineering and construction project is large as ours is actually a good window is the general challenges the industrial economy is facing. We've had to manage through some friction around the work product of vendors and subcontractors, who are also struggling staffing and resources. And a lot more workers are still expected to be deployed at Mountain Pass in the coming months as construction efforts accelerate. Many kinds of materials, some still in short supply are utilized in making our final design a reality.

As we work towards completion, we may ultimately have to make decisions between cost and schedule as issues and change orders come up. Overall though, we are optimistic as Stage II is already visibly taking shape at Mountain Pass and we believe our goal to achieve production levels of 6,075 metric tons of NdPr in 2023 remains on track. Moreover, I would argue that the current environment enhances the expected return of our project investment and confirms the increasing importance of our mission. Potential incremental costs pale in comparison to the excess free cash flow we already generated. And then of course we expect a significant uplift in our cash flow potential once we complete Stage II.

To put some further color on why the global situation makes me very bullish about our business prospects, I would like to analogize today's COVID shock with the 1973 foil shock. I encourage you all to study the history if you're interested, but the main takeaway is that an unexpected and significant global economic supply shock can end up reverberating for years, not months. In fact, then many people expected the event to be transitory or short-lived yet instead psychology around prices in supply chain shifted. Rising prices and fear over supply became a further self-fulfilling prophecy across the economy.

The COVID shock has happened in the backdrop of an already weary geopolitical environment with respect to supply chain security. In the material space, I previously mentioned demand backlogs for some things that stretch in the next year and of course that assumes limited incremental demand in the coming months and no acceleration from an infrastructure bill [ph] What might happen if we believe that hundreds of billions of dollars of projected investment across new and legacy OEMs on EVs alone in the next few years.

I believe that if you do the math on some of the quantities implied by these projected investments, shortages and shocks are here to stay for quite some time. In fact, I'll make a bold prediction. I believe that at some point in the next five years, we will see at least one major global household name auto OEM as well as many other small ones, fail or need a bailout due to failure to gain access to a critical material. By the way I do not mean that prices went up on them. I mean that they will be one of the ones. who realized too late that the new market regime means the supply chain is existential in the fourth industrial revolution. In this kind of world, our assets and our opportunity set are more strategic and valuable than ever.

Moving on to the bottom half of the slide, to achieve our mission to restore the full rare earth supply chain in the United States, we need to manufacture permanent magnets here. Some of the key elements needed for Stage III will be derived from the separation of heavy rare earths. NdPr is the primary ingredient by far in the cost of goods in most rare earth magnets, but small volumes and heavy elements like dysprosium and terbium are also often added as they keep the magnet magnifies at higher operating temperatures. The current design of Stage II calls for producing a concentrate of heavy rare earths, but our ambitions have always been higher as separating heavies onsite meaningfully enhances our ability to fully produce magnets in the United States. Over the last 12 months in part with funding from the Department of Defense, which we previously disclosed, we have been doing R&D and significant piloting to analyze separating those heavy rare earths ourselves, as has been done during the maturity at Mountain Pass' 60 year-plus history.

We were also happy to host a senior leadership team from DoD last week to see our progress. The heavy rare earth piloting work has yielded positive results and we believe demonstrated the commercial feasibility of the project. As such, we are gaining confidence that there is a high return opportunity to separate heavy rare earths at Mountain Pass. Doing so would be strategic to our mission, while also generating an attractive return on capital. We expect to share more details with you in the future. But with that as a segue, let me share with you some exciting news on our Stage III progress on Slide 13.

As we've talked about previously, the interest from potential magnet partners and customers has really begun to accelerate over the last six to nine months. These discussions were also an important driver in us pursuing last quarter's green bond offering. Many of these conversations have come to the vein of how can we help you get to magnet making faster? These potential customers and/or partners are clearly focused on getting a western and importantly environmentally sustainable supply chain for magnetics. We have been busy behind the scenes building an extraordinary team. We've been hiring key engineering and operations talent with expertise in alloy, metal and magnet science and manufacturing, all of whom are dedicated full times at the Stage III project. The team is diverse and motivated and the progress we are making gives us the confidence to accelerate the timetable. Therefore, I am pleased to announce that we are moving forward with building a metal, alloy and magnet manufacturing facility here in the United States, and we expect to share the location before year-end.

We are doing detailed work on the potential project and are engaged with several jurisdictions when choosing a site. Our first Magnet facility will be modest relative to the scale of the resource at Mountain Pass and our capital structure and will be scalable in nature. And we expect it to achieve a high ROI. And while the initial facility will be modest relative to the scale of our business, it will be of enormous commercial and geopolitical consequence.

The last scaled and vertically integrated domestic magnet producer ceased operations and relocated to China in 2003. We've had a strategic void in our supply chain for nearly two decades and we are racing to fill it as quickly as possible. We plan to share the details around the timing, the cost of the facility and how we are thinking about production volumes and economics at a later date. Needless to say, we are very excited to be taking this first concrete step towards our vision of restoring that last piece of the full rare earth supply chain to the United States.

So to sum it up on Slide 14. Stage I execution continues, demand for NdPr remains strong, driving both sales and pricing which is flowing through to our bottom line. Stage II construction is progressing nicely through a challenging global landscape. Our piloting on separating heavy rare earths is giving us increased confidence we can do this profitably at Mountain Pass. And Stage III is now taking shape much earlier than originally anticipated.

I would like to take a moment to thank our employees, we now exceed 350. Everyone is working really hard and it shows in our results. Let's keep up the great work.

With that, I would like to reiterate we are uniquely positioned to restore the full rare earth supply chain to the United States and are proud to be a Western champion of the electrification and sustainability revolution.

With that, let's open the lines for questions. Operator?

[Operator]

Thank you, gentlemen. [Operator Instructions] Our first question today comes from David Deckelbaum of Cowen. Your line is open. Please go ahead.

[David Deckelbaum, Cowen]

Thank you, and thanks, Jim for taking my questions this afternoon.

[James Litinsky, Chairman & Chief Executive Officer]

Sure. Hey, David. How are you doing?

[David Deckelbaum, Cowen]

Hi there. So just a couple from me, just one, the price that you received for your rare earth basket this quarter was inordinately high, obviously, we've seen strength recently in the price of NdPr. It looks like you had a higher yield of NdPr in terms of your typical basket. Is that fair to say and what would be driving that? Or what would have driven such a high sales realization this quarter?

[James Litinsky, Chairman & Chief Executive Officer]

Ryan, why don't you take that?

[Ryan Corbett, Chief Financial Officer]

Yes, sure. Hey, David. Really no difference in NdPr yield, obviously, selling the concentrate and we're producing a consistent basket in line with the elemental distribution in the ore body, and so no change there. I would say that concentrate tends to occasionally have discrete supply and demand drivers that are not perfectly aligned with what you see in market data for NdPr as an example. And so obviously given the inordinate proportion of supply that we represent. In our opinion, it just, it shows the very, very strong demand for our product.

And so while our pricing does tend to mimic very closely the movements in NdPr that you can observe and tends to do so with some amount of lag, which could explain some of the higher pricing in Q2. That's really the driver here nothing having to do with the mix of products sold.

[James Litinsky, Chairman & Chief Executive Officer]

Yes, David, and that's why we're rushing to get Stage II done as quickly as possible. Because we certainly give up revenue by selling an intermediate product.

[David Deckelbaum, Cowen]

Yes. Absolutely. Understand that, that margin uplift potential. Just - and thanks for outlining some of the ambitions around Stage III. I'm just curious just on Stage III, I'll let some others ask around Stage II. But you said that you would announce the location of the facility this year. I guess that then means the operations there in still take the form of the potential to JV or build or buy somebody else that could potentially be housing that facility. And I'm just curious as you look at some of the Biden Administration's initiatives particularly around desires to refine rare earths and secure that supply chain here. If you think that Stage III would be qualifying for some additional government grants to help you financing or something like that?

[James Litinsky, Chairman & Chief Executive Officer]

Sure. Well, so I'm sure you saw a lot of the coverage all day today with the executive order out of the White House and all the big automakers or most of the big automakers talking about getting to 50% EVs by 2030. You can imagine that with all of that behind the scenes, there is also a big push in the supply chain, particularly given everything that's happened with semiconductors. And I think you can see that - you can see it actually an earning season. If you look at some of the calls for example, Tesla called it out and some of the others called it out.

If you have - if you're missing one piece of the supply chain, you can't produce. And it - we'll see what the final infrastructure builds and we'll see what comes out of DC. We do - we hear a clamoring on all sides to make sure that we have this supply chain here and obviously you heard my comments about how important this is and I think that when people start to do the math of how much investment is coming this way and what that means as far as the upstream. We need a lot of investment and obviously one of the leaders in that and expect to make that investment. But I do think we will see a lot of support from both sides of the aisle. What exact shape or form that takes is still unknown, we've sort of heard some interesting things behind the scenes, there could be various credits or benefits or other grants, who knows, again what shape or form it will take, but I do think that we're going to see something. Because they're just - there needs to be as you've heard me say this is a fourth industrial revolution, it's a total transformation. And the scale of investment is not there yet and it needs to come.

[David Deckelbaum, Cowen]

Absolutely. Thanks for the responses guys.

[James Litinsky, Chairman & Chief Executive Officer]

Sure. Yes. Of course

[Operator]

Thank you very much. Our next question today comes from Carlos De Alba, Morgan Stanley, your line is open, please continue.

[Carlos De Alba, Morgan Stanley]

Hello, Jim, how are you doing?

[James Litinsky, Chairman & Chief Executive Officer]

Hello, Carlos.

[Carlos De Alba, Morgan Stanley]

Hey, good very strong results congratulations.

[James Litinsky, Chairman & Chief Executive Officer]

Thank you. Thank you.

[Carlos De Alba, Morgan Stanley]

So just what - it seems that on a Stage II, you are sort of hinting that your CapEx may have to go up or maybe there could be some delays under the schedule. Is there too early to say sort of a magnitude of the potential trade-off, and if you had to make it given your strong balance sheet, is it fair to assume that you would up to potentially increase the CapEx but still complete the project on time. So you can use produce a full capacity around 23?

[James Litinsky, Chairman & Chief Executive Officer]

Well, I think you heard the statement I made about there's certainly any time you're building a project, there is a trade-off, and scheduling cost. And we certainly - I think the statements I made really sort of speak from the cells in that. We we're humans just like you reading the newspaper and we see all of these things happening around the world. And we've experienced them. I think that we've done a really great job managing the things that come up and whether it's in labor, whether it's vendors. There all of these things that things are disrupted out there.

And so what we want to do is we obviously just want to make sure that we're level headed about the work that we have to do to get this job done and that we're very focused on, we want you to know that we're very focused as far as putting something specific on. It's so hard Carlos, because we just - again we don't know what's around the corner with Delta and with the labor situation all these things. But we're - again we reiterated our confidence in our 2023 run rate target. And you can see from the photos that we continue to make a lot of progress and it's really exciting out there and there's a lot of people working. And so we feel really good about it, but we just want to obviously be realistic that we just don't - don't know what may unfold in the world and obviously given my views about how we see the coming months and years, we hopefully around head out of thinking about these things.

So I'll give you one small example Carlos, resin is a hard thing to get right now, if - you know if you're out there trying to buy something with resin, you basically can't get it. And we had a vendor that wanted to give us a delay and we were able to get a Defense Production at focus on getting that sooner and so those are the kinds of things that we're managing. And so we obviously will - hopefully DoD will be able to help us with things like that. And so we feel really good that we'll continue to kind of do the blocking and tackling to get this job done. But we also just we're - we see what you see. So we're just trying to be careful.

[Carlos De Alba, Morgan Stanley]

No fair enough. That makes sense. And then just in terms of the maintenance downtime that you're experiencing in second quarter. How much did that impact in terms of volumes and perhaps in terms of your cost? How much lower cost would you be able to achieve had you been producing at 100% without the maintenance. And also given the accumulation of REO that you experienced in the last quarter and given the sequence of shipping that you or shipments that you have already for the third quarter

Do you expect to reduce that inventory in the third quarter, or you may take a little bit longer?

[James Litinsky, Chairman & Chief Executive Officer]

Ryan, why don't you take that?

[Ryan Corbett, Chief Financial Officer]

Sure. I'd say Carlos, the way we think about the business and I think you hinted at, this is REO produce per operating hour, right, which will drive the - our view of efficiency of production. So to your point if we were producing without that we shut down our production number would have been even higher than it was. Jim, I think called out the number of his prepared remarks of 14% year-over-year growth in the per hour production number. And so we're not going to get into specifics on the production cost impact given the fact that we may take shut downs here and then all the time for a variety of reasons. But suffice to say, it has an impact, it absolutely has an impact on the production cost

And so that incremental efficiency would have flowed through much more clearly in our reported number to the extent we didn't have that shut down. And then on the inventory number, if you're talking about finished goods inventory. The finished goods inventory in Q2 was not significantly higher. As we've mentioned, the 10,305 versus the 9,877, It does imply some build, but those shipments are lumpy and it's purely just a matter of securing bookings on outbound chips.

So it's not anything out of the ordinary certainly we've called out in the past and call out further in our filings COVID makes the shipping situation, a bit more difficult than it normally would be. But we've had very good luck moving our product to the extent that we need to. And so I don't think there is anything unique to call out in the future just keep in mind, as we've mentioned many times before the lumpiness that could be possible. But given the sales structure and contracts that we have it's purely a timing impact and nothing further.

[Carlos De Alba, Morgan Stanley]

All right. Okay. And then last question for me is on what will be the implications of basically the announcement to go ahead with the Stage III probably earlier than anyone expected. What are the implications of that regarding your Shenghe agreement?

[James Litinsky, Chairman & Chief Executive Officer]

Implications as far as what - remember that once the offtake will be paid down pretty soon as Ryan said, it's around - as of the end of the quarter it's around $48 million. We expect that to be paid down. And as you said, it's now in sort of our short-term, we expect that to be paid down within the year.

So I think there's really no impact because that will be gone. And I would stress again that there a distribution party, they don't have - we're certainly free to sell any product anywhere that we want, they don't have any special rights or anything like that. So there is really - there is no impact we're going to proceed with our mission as we've clearly stated.

[Carlos De Alba, Morgan Stanley]

Fair enough. And they would potentially remain as shareholders, right?

[James Litinsky, Chairman & Chief Executive Officer]

Well, we're a public company. I mean, I don't know if they're going to buy Apple or Tesla or Boeing or GM next. the questions for them, but obviously we appreciate all our shareholders and we're going to - we're working for our shareholders. So whoever they are.

[Carlos De Alba, Morgan Stanley]

Fair enough, Thank you very much. Good luck.

[James Litinsky, Chairman & Chief Executive Officer]

Yes.

[Operator]

Thank you very much. Our next question comes from Tyler Langton of JPMorgan. Please continue.

[Tyler Langton, JPMorgan]

Hey, good afternoon, thanks. Just a follow-up question on Stage II, I think of the sort of the is a little over $200 million of CapEx, could you remind us, maybe how much is left to be spent and maybe sort of how much of that is kind of walked in from a price perspective. And then also for if the separate everywhere else do you have a kind of a rough sense on what the CapEx profile could be for that?

[James Litinsky, Chairman & Chief Executive Officer]

For heavy, one of our - we haven't broken a lot of that. Why don't I - Ryan, I'll give it to you to do the best that you can do on that, and then you can cover heavies if you want, which and I'll finish up.

[Ryan Corbett, Chief Financial Officer]

Sure. Yes so our original estimate Tyler on Stage II was $220 million of growth capital for the specific optimization project. As of the Q2 results of growth CapEx, we spent a little over $40 million but not all of that is Stage II, recall and we had called out in our filings that we have some other chunkier projects that make up some of that capital spend including the re-commissioning of our combined Heat and Power plant and several other growth initiatives.

So, I would not kind of pull that out and assume that that's all Stage II. Obviously, there are other projects that are ongoing growth projects on-site in preparation for Stage II. So there is still a good ways to go on that sort of original number.

What I'd say on heavies and on all of this is obviously, we are managing this project and whatever potential incremental high return opportunities come to Pass for the long-term success of the business. We're obviously not - we're not managing it for a short-term headline on what the CapEx number is. So, I think it's safe to bet that they're going to be other high return opportunities that heavies as a perfect example to enhance the project as we go along. And that's one thing to keep in mind as you think through modeling out CapEx over the next little bit here. But I think that's really all that we've disclosed. I don't know, Jim or Michael if you have anything to talk [ph] on to that.

[James Litinsky, Chairman & Chief Executive Officer]

No. I think that sums it up, and I just might - I would go back to Slide 8, and look at the free cash flow power of what we've already accomplished just in Stage I and obviously recognizing the significant uplift that we have, and I think it's a really impressive thing that we've been able to achieve operationally, that we can make all of these high return on capital investments still generate - pay down debt and still generate cash flow for the business.

And so we certainly - we've obviously made clear that we have a mission to get all the way to complete the full supply chain. And so these are a component and magnets are a component and - but I think we're certainly going as fast as we can in also with recognition that we ultimately work for our shareholders and our job is to make sure that we're making investments that have a very high return on capital. Because ultimately that's what we're here to do. We are a public company.

And so I think it just suffices to say that to the extent that as we're going to come out with some kind of heavy thing or whatever, we might come with next. We'll do our best to convey to you kind of the economics as best we can on a go-forward basis. So I'm not - we are managing to making sure that as we invest incremental dollars that those dollars have a high return on that capital. And so that's how we think about it.

[Tyler Langton, JPMorgan]

Okay. Great. That's helpful. And then, you can't I get into too many specifics, but just I mean, are your customers or sort of potential customers and sort of like the EV supply chain kind of expressing more interest I guess in finding sort of long-term supply agreements. Just sort of any color you could provide there will be helpful?

[James Litinsky, Chairman & Chief Executive Officer]

Yes. Well, I would say that we've had dialog with a variety of parties and it's broad, it's not just EVs, right. And certainly as it is intensely, but is also - there is, you've heard me say all of the things that are out there wind turbines, drones all of these exciting things. And there is standard other industrial items that you wouldn't think of and so as part of this transformation for electrification magnetics are really important. So there is a lot of industrial customers that we are pretty I would say engage with and figuring things out.

I think that there is a lot of demand. It's certainly the semiconductor issue I think created a lot more - trying to think of the right word here, but a lot more excitement or urgency with a greater sense of urgency to make sure that there is supply chain security, and then obviously, I think when people start to really look at the numbers of what we're talking about. Again that urgency will only increase and then as I've made clear I think that I do believe that some of the last companies to realize that supply chain is existential. It's going to be existential and there'll be two ways. So I think that there'll be those who don't figure out how to lock down deals with us or someone like us, they're going to regret it. And so we're having all of those conversations and also realizing that we're in an outstanding strategic position. And so the last thing we want to do is make a bad deal for ourselves, we obviously want to make the right deal. And if it means being patient to make the right deal, we'll be patient but we can certainly have what I believe are a lot of options on the table and will continue moving forward until we ultimately do something. But again, the growth prospects are pretty exciting.

[Tyler Langton, JPMorgan]

Okay, great. Thanks so much, that's it for me.

[Operator]

Thank you very much. Our final question for the moment is from Matt Summerville of D.A Davidson. [Operator Instructions] Matt, your line is open. Please continue.

[Matt Summerville, D.A Davidson]

Thanks, just a couple of quick ones. I just want to be clear has output taken a permanent step function move higher here with Stage I given that 14% year-over-year growth metric you talked about in REO tons per hour. And it sounds like you may be fine-tuned sort of the process involving reagents such that you're not getting slowed down as you increase the feed rates. So can you just put all that together and help me out a little bit there?

[James Litinsky, Chairman & Chief Executive Officer]

Sure, Michael, do you want to chime in and talk operations?

[Michael Rosenthal, Chief Operating Officer]

Sure. Yes, thanks for the question. I would say that over the last three years, we've been consistently working to increase the mineral recovery of our filtration process. And then as we get to a stable level we try to increase the throughput and so that, that process is ongoing, I don't think I'd necessarily say the 14% is representative of the step function that we'll see for the full year. But I think we're quite pleased with how the last quarter has gone and hope we continue to see stable growth.

[Matt Summerville, D.A Davidson]

And then per one of the slides Ryan, you pointed out the $130 I think per time incremental cost from onboarding folks ahead of Stage II, going into production is there another incremental wave of hiring we should be thinking about as we model out production cost going forward from here?

[Ryan Corbett, Chief Financial Officer]

It's a good question, I'd say for the rest of the year obviously, we don't give specific guidance. But I again using your term on step change, I wouldn't expect one for the rest of this year. Certainly, we're going to continue to make the right long-term decisions when we find the right candidates for certain roles that make sense to bring on obviously significantly ahead of commissioning.

So you could see tick up some, but I don't expect a step-change. Obviously, we can talk more about 2022 when we get closer. But 2022 is certainly a year of transition, as we onboard full suite of folks to get ready to get Stage II, up and running and so that's a bit of a different story, that's kind of how I think about it.

[Matt Summerville, D.A Davidson]

Great. Thanks guys.

[Operator]

Thank you. [Operator Instructions] We have no further questions on the line. So I'll hand back to the team.

[James Litinsky, Chairman & Chief Executive Officer]

All right. Well, thank you, everyone. Again, we are really proud this was a very productive quarter and we will keep at it. And we look forward to chatting with you all soon. So, thank you and see you soon.

[Ryan Corbett, Chief Financial Officer]

Thanks, everyone.

[Operator]

Thank you all for joining today's conference call. The call is now concluded, and you may now disconnect your lines.