Neo Performance Materials Inc

TSX:NEO

Earnings Call Transcript 2021-Q2

[Operator]

Good day, everyone, and welcome to the Neo Performance Materials Inc. Second Quarter 2021 Earnings Announcement. Today's conference is being recorded.At this time, I would like to turn the conference over to Ali Mahdavi, Senior Vice President, Corporate Development and Capital Markets. Please go ahead.

[Ali Mahdavi, Capital Markets & IR Executive]

Thank you, operator. Good morning, everyone, and thanks for joining us this morning. Just as a reminder, today's call is being recorded and a replay will be available starting tomorrow in the Investors center of our website located at neomaterials.com. I am joined by Neo's President and CEO, Constantine Karayannopoulos, and Neo's Chief Financial Officer, Rahim Suleman this morning. Rahim will follow-up on the back of Constantine's commentary regarding the Company's second quarter performance, and then we'll open the call to questions from analysts only.Please note that some of the information you will hear during today's presentation and discussion will consist of forward-looking statements, including without limitation, those regarding revenue, EBITDA and adjusted EBITDA, product volumes, product pricing, other income and expense measures, cash returns and future business outlook. Actual results or trends could differ materially from those discussed today. For more information, please refer to the risk factors discussed in Neo's most recent financial filings, which were filed on 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 this conference call. Further information regarding Neo's use of non-IFRS measures is available in Neo's Q2 2021 earnings press release, which is also available on SEDAR and on our website at neomaterials.com.Let me now turn the call over to Constantine for opening remarks.

[Constantine E. Karayannopoulos, President, CEO & Director]

Thank you, Ali, and good morning, everyone. We're pleased to report pretty strong financial and operating results over the last quarter. Neo booked a record $135 million plus of revenue with very strong profitability. Adjusted net income was $14.1 million and adjusted EBITDA was $22.2 million.When you look at the business purchase orders are pretty high, and many of our plants are operating at near-record production levels. Dialogue with existing and new customers and product innovation remain very active as we continue to collaborate on the next-generation of our products and their products. As some of you may have noticed in the recent press release we issued with Energy Fuels, we are continuing to diversify our sources of rare earth feed materials to include material sourced from North America.Our research and development pipelines are full. Recent market dynamics have created a premium pricing environment that in the first half of the year helped strengthen our financial performance. Our talented teams around the world have diligently managed their operations, and we're winning new business because of our product innovation partnerships with customers, our extraordinary customer service and the geographic diversity of supply chains we can offer. We always knew that climbing out of last year's shutdowns would provide ample demand growth. It's no surprise that our product volumes have increased 60% year-over-year, given that the second quarter of 2020 bore the brunt of COVID's direct impact. As CEO, of course, I keep this stellar performance in perspective. Unusual and complex supply chain factors remain for every industry where we sell our engineered materials.Over the past 6 to 9 months, we have observed outpaced demand as our customers attempt to refill supply chains. And then customers in Greater China, North America and Europe are clamoring for goods. Often, our customers earmark and use materials for inventory safety stock only to have those units placed into production ahead of time. Those same dynamics also influenced commodity spot input pricing, which has been running near 5-year highs for select rare earth materials primarily neodymium and praseodymium for our Magnequench division. The increase in our net working capital for the third consecutive quarter is reflective of that higher price environment.It's not a simple matter to juggle expanding production against the global shipping crisis, semiconductor shortages, extreme weather events wreaking havoc in localized geographies and the resurgence of COVID in many jurisdictions. We just recently started to feel these impacts in the back half of Q2. Some of this see-saw demand flow is reflected in the second quarter numbers as evidenced in sequentially lower volumes from Magnequench. In addition to the inventory pipelines refilling in the first quarter, this was also driven by the semiconductor shortage and further exacerbated by other global issues such as shipping and weather impacts. While we anticipate much of these volatility trends to continue in the second half of the year, our Tier 1 customers and OEMs are indicating that demand will likely eventually increase to make up for some of the recent shortages tied to the semiconductor availability problems. Our customers do not expect to see any significant permanent loss of demand from this temporary shortfall.From a strategic perspective, what I continue to think about is the fact that Neo's innovations sit atop supply chains that are continually changing. Our teams, our materials and our mode of operations must also change to meet these demands. It's a topic that we discuss regularly, and it informs our strategic vision to first protect and grow our core business. The advanced materials we manufacture and sell today are meeting the challenges of clean air, clean water and more efficient motor and energy processes. Our execution of this strategy has led to outpace growth as the global manufacturing environment finds its footing.We've observed this increased demand across our Magnequench business unit for thermal management of electronic devices such as 5G stations, servers, laptops and gaming devices. Factory automation remains on the upswing as a megatrend. The consumer appliance business remains strong and is seeking higher performance materials, which has led to the business successfully winning new product lines. And despite the semiconductor issue within automotive, we continue to see substantial order volumes for auto pumps, sensors, thermal management systems and ancillary motors such as trunk motors and seat motors for both internal combustion and electric vehicles.On the midterm outlook, we remain in the middle of global economic -- the middle of a global economic recovery. And while production manufacturing indices remained in expansion mode, we're far from a typical operating environment. In another 12 to 18 months, we anticipate that much of the current volatility will subside. Over that time frame we expect semiconductor supply chains will be reconfigured with these decentralized regional production centers. And we're hopeful that increasing vaccination rates will help starve COVID of the conditions it needs to flourish. The major competitive advantage at Neo is our flexibility to procure diverse raw material inputs.We value our long-term supply relationships with strategic sources around the world. Rather than being tied to a specific ore body or held to a single source supply for critical materials, we've built an extensive portfolio of relationships. We are continuing to build upon those. The addition of a new critical material supplier requires methodical discipline, and we're pleased with the progress made by our development partners in Colorado-based Energy Fuels. We expect to receive commercial quantities of monazite-derived rare earth feedstock to our European-based processing facility in Sillamae, Estonia in the third quarter. We see this fueling growth of our processing capacity for our global customers.Ensuring the responsible sourcing of all key raw material inputs has always been the assured practice at Neo. More recently, we have noticed increased interest from global customers attesting to those statements as well as investors. While we have a significant successful experience related to our tantalum programs and ensuring that we do not process any conflict materials, we're encouraged to see similar interest and initiatives related to all of our key materials.Our separated rare earth business continues to perform strongly with multi-year high order volume at all locations. This volume strength is further aided by higher pricing related to strong demand for magnetic applications and short-term interruptions for -- from a supply perspective. These higher cost raw materials have begun to flow through our working process and finished goods inventory directionally tightening our margin profile in that business as expected. Underlying trends indicate strength across automotive, consumer electronics and healthcare, all of which continue to show favorable demand.Our specialty mixed oxides business continues to outpace the general automotive trend as our newest products and strong customer service continue to gain market share. We have observed some near-term impact of the semiconductor shortfall, although again we see that as a temporary condition that should not lead to permanent loss of demand. Our specialty water treatment business is building momentum, and we have sold record volumes into the strategic growth arm within chemicals and oxides.Our rare metals business has seen strong performance in its specialty materials, and we have also observed the directional improvement in our traditional aerospace business. Although this is growing at a slower rate related to automotive and consumer electronics, the restart of the industry is an encouraging sign. Equally, if not more important, our strategic decision to further diversify beyond the aerospace sector is starting to yield favorable results. Our teams are diligently working on expanding operating capacity to help accommodate new market development, particularly premium applications within our existing core product portfolio. And our electronic materials business continues to outperform our expectations.Couple of words on climate and sustainability. Longer term, we continue to be optimistic about Neo's growth prospects. At the end of 2022 and into 2023 and beyond, we expect to be much further along on the massive industrial transformation in response to climate change. We all saw in the headlines from this week's release, the United Nations' Intergovernmental Panel on Climate Change Sixth Assessment Report renewed emphasis on decarbonization. Electric vehicles, alternative energy generation and energy efficiency will continue to drive demand for our products at increasingly higher rates. With the sobering IPCC conclusions in mind, Neo's Board recently approved our commitment to continuously pursue the advancement of the United Nations' Sustainable Development Goals and make them part of the company's strategy, culture and day-to-day operations.Neo has always taken a responsible approach to ensure that our teams and our facilities are in the leading edge of environmental practices. We are proud of our sustainability track record. In order to more effectively communicate our contributions to sustainability, I'm pleased to report that we're working toward our inaugural sustainability report. On behalf of our Board's Health, Environment, Safety and Sustainability Committee, I'm proud of our team's efforts to methodically approach this massive undertaking in a thoughtful way. Sustainability is truly in our company's DNA and more formally incorporating best sustainability practices further into our operating culture will become a new norm. We already see the benefits internally, and we look forward to sharing more information with you.On the electric vehicle front, the climate change trajectory we now face tells us that macro trends such as the growth in electrified vehicles will only accelerate. And the bottom-up actions from industry around the globe are more telling than the headlines. With $270 billion already committed to electrification efforts by the major OEMS, the direction has been set through both public policy and industry objectives. The major questions that remain in consumers' minds, price parity with internal combustion engines, the EV charging infrastructure and range anxiety are falling away. Neo's innovative product portfolios are currently under testing and qualification for several new electrification platforms, both with magnetic applications and next-generation emissions platforms.We agree with many analysts' views that 25% to 30% of new passenger vehicles produced and sold will be pure battery electric vehicles at the end of the decade. And those estimates are before the most recent policy proposals this summer such as the European Union's recent Fit for 55 campaign to revise CO2 emissions targets and the recent executive order from the U.S. targeting 50% EV penetration by 2030. While formal targets have not been set for Greater China, current actions suggest that China will continue its aggressive transition to electrified transportation.Irrespective of the precise figure of EVs at the end of the decade, one thing is clear. More efficient electric motors will be required to propel both electric and next-generation hybrid vehicles. These vehicle platforms are anticipated to require nearly 8x the amount of permanent rare earth magnets. Neo's technical development teams are intimately familiar with the trajectories and goals of our customers. This type of trust of development partnership is critical to successfully commercializing our advanced performance materials into OEMs and motor manufacturers. Interestingly, public policy proposals in the U.S. and elsewhere are also catching up to the increased demand trends for magnetic materials with an emphasis on localized production to help de-risk some of the global supply chain impacts we have observed over the past 18 months.As a leader in rare earth and rare metal performance materials, we're very familiar with the benefits of having diverse production facilities located across Asia, Europe and North America. Our customer service model and innovation for next-generation products are unmatched, and we will further utilize our diverse geographic asset base to meet our customers' demands. While the trend for more electrified vehicles is positive for Neo, it's worth noting that a majority of all vehicles in 2030 will likely still contain emissions catalysts. The catalyst of 2030 will be more advanced and complex to achieve emerging emission regulations. As the final iterations of a Euro 7 set of emission standards take shape, we're actively qualifying new materials to achieve improved performance and overcome design challenges. The electrification, light weighting and improved efficiency of electric and alternative fuel vehicles continue to paint an improved picture for Neo's core business.In summary, as we enter the back half of the year, there are some clear signals for short-term volatility. We feel the impact of a semiconductor shortage, and there may be more timing uncertainty in the next several quarters, but the longer term trend with automotive is very favorable through both the general economic recovery and the acceleration to electrify drive trains. Similarly, continued high demand for consumer electronics is now relenting and will bring further pressures upon tight supply of integrated circuits. Our teams are ideally situated to manage and grow through short-term volatility as we have successfully done for many years. Our emphasis on innovation will take advantage of long term megatrends and position Neo to grow through the next major industrial transition to a more decarbonized global economy.Operationally, we will leverage our unique technical capabilities to further grow our core business and expand our product portfolio over that time frame. We will continue our focus on developing new products and innovations that take advantage of macro trends throughout the remainder of the decade. This disciplined approach to managing our business generates robust free cash flow, and we will continue to reinvest in our business to pursue further growth. As we align our strategic initiatives with those of our customers, our supply chains and the megatrends of the coming decades, we will also opportunistically continue to evaluate partnership and acquisition opportunities to strengthen our core product offering and accelerate our technical know-how. In short, with the organic growth we're seeing across all business units, the significant macro tailwinds both in the entire rare earth sector and a number of strategic growth opportunities on the radar screen, we remain confident in the sustainability of our long-term vision and growth strategy.I'll now turn the call over to Rahim for a detailed review of our financial performance in the quarter. Rahim?

[Rahim Suleman, Chief Financial Officer]

Thanks, Constantine, and good morning, everyone. Our second quarter performance extended the positive momentum from late 2020 in the first quarter of this year. Our business managed through a highly dynamic operating environment and delivered favorable financial and operating results. Comparison of our results to prior year periods provides some large growth percentages to be sure. Yet these metrics are not terribly meaningful as we lapped the lowest performing quarter due to the onset of the global pandemic. What is more helpful is to evaluate the fundamental strengths of our business and product lines relative to trajectory for the end user markets we sell into and the exciting trends that those end markets entail.So a quick summary of our results. Our year-over-year sales performance doubled in the quarter. This was driven by a 60% increase in product volume shipped during the quarter and a higher pricing environment, particularly related to magnetic products and magnetic rare earth elements. Gross margin as a percentage of sales expanded by more than 8 points versus the prior year period. This was aided by improved rare earth pricing set against lower cost inventory on hand. Higher product volumes in the quarter also improved fixed cost absorption and drove more dollar value margins. This lead lag benefit of price versus inventory slowed as we exited the quarter, and as the higher cost raw materials began to flow through the income statement particularly going into Q3, while at the same time rare earth prices for magnetic elements decreased throughout Q2. Assuming a more stabilized pricing environment moving forward, we'd expect our margin profile to normalize as well.For the second quarter of 2021, we reported adjusted net income of $14.1 million or $0.37 per share -- per diluted share, and we reported adjusted EBITDA of $22.2 million more than an 18fold improvement from the prior year period. For the 6-month period ended June 2021, we reported adjusted net income of $29.2 million or $0.76 per diluted share, and we reported adjusted EBITDA of $44.6 million being the strongest first half adjusted EBITDA performance in the company's recent history. Q2 and Q1 were undeniably strong quarters. In addition to the pricing and lead lag dynamic, the primary trend underlying our performance was again, the general economic recovery as indicated through the resurgent manufacturing environment and the strength of customer demand in many parts of the world. While the strength of improved volumes across all 3 business units is well understood, I'd like to provide some additional context on the recent pricing dynamics affecting our business.There has been substantial volatility over the past 12 months in rare earth market pricing. The price increases that began in the fourth quarter of 2020 appeared to peak at the second -- at the start of the second quarter of this year. On our last quarterly conference call we were in the midst of a gradual decline for magnetic materials and heavy rare earth pricing. The impact of this price decline ranged from down 15% to down 35% from the end of March. Yet very quickly since the start of July, these same prices have rebounded and are now either approaching or even exceeding the high-water mark set earlier this year. On an absolute dollar basis, many of these prices have fully doubled compared to 1 year ago.As I mentioned earlier, assuming a more stabilized pricing environment moving forward, we'd expect our margin profile to normalize in the future. As we have discussed in the past, Neo's focus is to be a value-added technology-based producer that does not rely on commodity price movements for our longer term profitability outlook. Most of our contracts are tied to pass-through provisions and market dynamics allowing Neo to keep a longer term focus on the value-added products and enabling the best performance of our customers' products. Having said that, higher rare earth prices do allow for more dollar margin in addition to the value that we add to our products.Shifting to the detailed business unit results. Magnequench again reported a strong financial and operating quarter as strategic initiatives within new programs aided a surging manufacturing environment. Following on to a first quarter that saw substantial inventory restocking, Magnequench's product volume improved 47% over the prior year driven by growth across most of the Magnequench product portfolio as Constantine discussed earlier. Magnequench's emerging growth initiatives also performed well in the quarter with the compression molded magnets outperforming expectations on the strength of consumer electronics.Our magnet manufacturing business is quickly earning a reputation for quality and consistency that we have been known for across our bonded magnetic powders. There have been several new business wins in this area, and sales of magnets is close to 3x larger than the prior year period. The business began to observe the impact of certain delayed orders near the end of the second quarter related to the semiconductor chip shortage within the automotive sector and other manufacturing environments. That said, our automotive product portfolio continued to outgrow reported vehicle production output from the OEMs through the first 6 months of the year. From a unit cost perspective, denoted pricing dynamics created a positive lead lag effect for Magnequench during the second quarter. We would anticipate this benefit potentially reversing given the downward trend for magnetic prices during Q2, but it remains to be seen whether the recent uptick will stabilize through the third quarter. Magnequench's strategic pass-through pricing generally will normalize within 1 to 2 quarters after commodity prices stabilize.Within the chemicals and oxide business unit, there's a similar strong volume trend across the sale of magnetic rare earths, environmental catalysts and special water treatment products. Volume and sales growth were in line with consolidated results as revenue more than doubled and product volume grew by more than 60% compared to the prior year. Similar to Magnequench, our emissions catalyst portfolio continued to outperform the general recovery trend across the automotive industry. Our innovation efforts are continuing to make progress within environmental catalysts as new product lines to meet the increasing complexity of next-generation emission regulations are outcompeting based upon performance.And while still relatively small, our specialty environmental water treatment business has been building momentum with larger customers and strong customer retention. During the quarter, the pricing lead lag effect provided a net benefit to C&O similar to the trends as Magnequench and in line with the comments we made earlier on the impact of changes in rare earth prices. Also similar to Magnequench, C&O began to see softening in the order pipeline related to the semiconductor chip shortage, particularly in the automotive space.Our Rare Metals business segment reported $20.1 million in revenue and improved upon its profitability within the first quarter reporting $2.5 million of adjusted EBITDA. Within rare metals, 2 interesting dynamics have been at play through the second quarter. First, the economic recovery observed within Magnequench and C&O is just starting to catch up in the aerospace industry where rare metals typically sell as superalloys. Second and more importantly, a number of the strategic initiatives at work in the background are starting to show results, including a shift to increased exposure to non-aerospace end markets. Our commercial and technical teams have been diligently evaluating new product formulations, expanding into premium product applications and refurbishing existing production lines to expand our capacity with minimal capital investment.Aligning our production facilities toward a more diversified end customer base has started to show signs of growth. We look forward to further growing this new revenue generation model. Rare metals is experiencing some benefits from pricing dynamics in the quarter, although on different products than Magnequench and C&O. In particular, we saw improvements in tantalum and rhenium prices. With this increased pricing and increased demand, the rare metals segment was able to reverse some of the lower cost or market provisions that we discussed in previous quarters and sold many of those products on a profitable basis in Q2.Shifting to our consolidated results. We reported SG&A expenses of $13.6 million, a decrease from $14.7 million in the prior year period and a decrease from $14.1 million in the first quarter. Our R&D expenditure was $4.9 million, an increase from $2.9 million in the prior year period and $4 million in the first quarter. Our investment for R&D remains around strategic products and new growth opportunities that meet our customers' needs. We closed the quarter with $59.6 million in cash, an increase from the $55.6 million at March 31. Our overall increased profitability helped contribute to this environment while we still required a $14.5 million investment in net working capital during the quarter for higher cost raw material inventory and increased receivables from higher sales. We invested $2.5 million into maintenance and growth-related capital projects, and we continued our cash dividend to shareholders of $3.1 million during the quarter. Our free cash flow conversion remained strong at 89% during the quarter, and we remain confident that our cash balances and balance sheet provide ample liquidity to operate and grow the business.With that, I'll turn it over to the operator to open it up for questions.

[Operator]

[Operator Instructions] We will take our first question from Mark Neville from Scotia Bank.

[Mark Neville, Analyst]

Good job of managing the volatility in the quarter, guys. Maybe just first, just on Magnequench, just the pricing growth there, is that all just the lead lag or is there any sort of mix benefit as well?

[Constantine E. Karayannopoulos, President, CEO & Director]

Yes. The -- whatever mixed effect was there, Mark. It would have been secondary. Clearly, the -- that improvement is not necessarily lead lag. I mean we -- when our cost for the inputs go up, we have very strong pricing power reflected in our contracts. So we put prices up or down depending on the traction of the price changes. So of course when prices go up, our percent margins don't necessarily go up but our dollar margins go up. So I think that's part of what you're seeing. But there's no question that there is -- there continues to be some lead lag benefit. Rahim, do you want to add to that?

[Rahim Suleman, Chief Financial Officer]

Yes. I agree to everything Constantine said, maybe the only thing that I maybe further emphasize of what Constantine said is the higher prices do lead to more higher dollar value margins. So there is definitely improvement there, and we have been working with all of our customers to raise prices. So we've been very successful in all those dynamics.

[Mark Neville, Analyst]

Okay. And just on -- I guess clear on the communication for margin or profit going forward, I mean there would be some expectation of margin compression just getting -- given the higher cost inventory, but again it sounds like pricing going back up, so -- for rare earth. So just -- again, I appreciate it's -- you don't have a crystal ball but it sounds like the messaging is probably down a bit in Q3 and Q4, we'll see. Is that sort of the messaging?

[Rahim Suleman, Chief Financial Officer]

Yes. I think that's reasonable, Mark. Clearly, the absence of the price increase that has happened here in July, we probably would have seen some compression to provide higher cost inventory flowing through or at least I'd say, normalized margins. So if prices remain where they are I think there's additional benefits still to be had. If they come down a little bit kind of to where they were, call it, the middle of July you'd probably see normalized margins, and if they shrink below that then you would see some kind of compression.

[Mark Neville, Analyst]

Okay. And maybe just on the semiconductors. I would have thought that you would have seen a bit more impact in the quarter, so I'm just sort of curious of your thoughts on that? Is it -- do you think there's some inventory building with customers for your products, maybe you saw pretty significant impact in the latter half of the quarter? Just your comment on that.

[Constantine E. Karayannopoulos, President, CEO & Director]

Yes. Perhaps -- again, I don't want to be flipping but perhaps if we didn't have the semiconductor problems, our volumes would have been closer to the first quarter volumes because, yes, that inventory rebuilding has continued into the quarter. We are getting feedback from customers about the challenges that they have. At the same time they're implementing short-term solutions. We understand that some Tier 1 motor suppliers to the OEM, to the automotive industry are doing away with smart circuits, and they're just selling on/off systems without the optimization that comes with an integrated circuit. But these are all really temporary fixes. As this thing persists, I do expect and our customers expect some degree of negative impact. I really -- we really don't have a very good sense of what that all means. But this sort of volatility, whether it's semiconductors, whether it's COVID, whether it's lo and behold shipping challenges, are part of the norm in the industry and we always figure out how to respond. It's not going to be all smooth sailing, all the time. At some point we will be giving up some of the gains weather because of semiconductor issues or other disturbances in the supply chain, but the long-term trajectory of the industry given all the megatrends driving and we'll continue to be positive, Mark.

[Operator]

And we have some questions from Yuri Lynk from Canaccord Genuity.

[Yuri Lynk]

Looking for a little more color, I guess on the potential volume impact of the chip shortage, can you -- is there any way you can kind of talk about how volumes evolved throughout the quarter, and kind of your exit rate as you entered Q3?

[Constantine E. Karayannopoulos, President, CEO & Director]

Yes. Well, the short answer is we can't really be much more -- we can't quantify it much more than we have. We are getting warnings that some of our customers or more importantly, their customers and their customers are feeling the pinch. I would expect if this gets worse to see to some orders getting pushed out to the next period or whatever, however, what this means is that we'll get all of this back because it will continue to create pent-up demand. Just like we saw with COVID we had a miserable second quarter last year, but eventually it all came back. I apologize. We're not as intimately involved and familiar with the -- with supply chain steps 5, 6 links away from us. But all we do -- all we can do is keep talking to our customers and sort of internalize the feedback that they're giving us. So all we're seeing is so far, so good. They hope to do -- to solve this problem sooner rather than later, but as the problem persists -- especially outside of China as this problem persists there will be an impact. The quantity and the timing we couldn't possibly be able to estimate in any better way.

[Yuri Lynk]

Okay. That's fair. Just switching to the U.S. supply chain, have you received any product yet in Estonia?

[Constantine E. Karayannopoulos, President, CEO & Director]

Well, we announced a few weeks ago that the container -- the first container was loaded at Energy Fuels. I was there for that as well as Kevin Morris, our Chief Operating Officer, and Jeff Hogan, the EVP that runs the chemicals and oxides business. We're all in Utah at Energy Fuels' plant in White Mesa. So the container left on time. I got a note this morning that it has not arrived in Estonia yet. Shipping -- all containers have been delayed, so we expect to receive it mid-September. So again, the global supply chains are under a bit of pressure not only because of the semiconductors, but also because of logistical challenges. But it's -- this is not that big a deal. In our conversations with Energy Fuels, and we do have weekly conversations, they are preparing the next set of containers as part of the first batch of monazite shipment that they got from Chemours. So I do expect the pipeline to start getting pretty full from White Mesa to Sillamae. But I do -- I was hoping that the monazite would start being would -- we would start feeding that mixed rare earth carbonate from monazite into Silmet separation batteries by the end of the third quarter. It still looks like that's doable and possible, but because of the logistical challenges we're probably running a couple of weeks late.

[Operator]

[Operator Instructions] We have a question from Ian Gillies from Stifel.

[Ian Brooks Gillies]

With respect to some of the COVID lockdowns that appear to be having an impact in China currently, do you expect it to have much of an impact, if any, on any of your production capabilities or is it going to change your operating parameters at all?

[Constantine E. Karayannopoulos, President, CEO & Director]

Thanks, Ian. Well, nobody expected that this COVID mass was going to be dealt with in a step change, so it will be spotty. Variants are popping up. A lot of people are battling with Delta. I don't know what the next one will be, but we're not -- clearly, we're not out of the woods yet. Having said that, none of our customers in China have shut down because of this. We're all being a lot -- we continue to be very careful and very diligent with tests, masks, protective equipment. We monitor cases and we haven't had cases for a while now anywhere in our organization. So I -- so far, we have not but let's face it. If there's a massive outbreak in the Shanghai area, which is the center of automotive or further down in Guangdong province or in the Shenzhen to Dongguan corridor, I could tell you that that will be an impact because that's where every -- almost every iPhone is getting assembled. I know -- well, for example, Foxconn has a big plant in Wuhan and Hainan. They had some -- sorry, Hainan where they had the floods recently. We didn't get word of any slowdowns in the output. So that was a fairly major disaster with the floods where -- it was actually pretty tragic where people lost their lives, and we didn't see a direct impact to this. But there's no guarantees in life. COVID will take an awful lot of effort by an awful lot of people and pretty well everybody around the world, so -- to deal with it. So we'll -- we do everything we can. I mean, that's our strategy. We'll maintain safe practices and I'm -- all the customers that we talk to do the same thing. So there's a lot that has been learned over the last year. And I expect that any localized impact, any localized events will not have the same degree of impact that would have had a year ago when this mess started 1.5 years ago. So we remain optimistic but continue to be diligent and so far so good.

[Ian Brooks Gillies]

Understood. That's helpful. With the plants running at near-record output, could you maybe provide some updated thoughts on how you're thinking about an expansion of the Silmet facility at some point, and perhaps even adding Magnequench capacity at that location?

[Constantine E. Karayannopoulos, President, CEO & Director]

Sure. Strategically, this is our goal to -- as we have discussed before Silmet in our view is the most strategic asset in our industry in Europe. It's the only facility that produces rare earths. And as you have perhaps seen from the announcement of our results, it's doing a lot better both producing rare earths but also producing tantalum and niobium where we're now making money again in that business. It took a lot of work and it's paying off. On the other hand, Europe continues to stay absolutely determined to ensure the regional stability and resiliency of supply chains relating to automotive. We continue to have a lot of conversations with the European Union, European Union member states and perhaps more importantly, with a number of Tier 1s whose -- Tier 1 manufacturer who supply the drive trains as well as the OEM customers who buy these drive trains for their EVs. And there's clearly a desire and a commitment to have a large portion of the electric motors, drive trains and the magnets that go into them made in the European Union. So there are challenges. The margins are thin because that's another industry that's dominated by commodity manufacturers out of China. But as we have proven in our current business, we can make money by carving out smart, profitable niches and that's the direction we're going to. I do -- I am pretty hopeful by some time in the next year we will have reached some conclusions about the expansion of rare earth production in Silmet and perhaps even the establishment of the Magnequench facility either at Silmet or somewhere in the EU to supply -- to produce metals, alloys and even magnets. But we still have a lot of discussions ahead of us in order to deal with the -- with all the structural challenges that this strategy needs to see addressed before we can make that decision. Again, to summarize because I've been laboring on for a while here, this is definitely the direction we're trying to go but there's some pretty serious challenges on the way. But we're dealing with them and we're knocking each one at a time. So we do expect that sometime 2022 we should be in a position to make the call. Yes or no, either way I'm not promising that we will do that. But I mean it's -- we remain pretty optimistic and positive about it, but still there's a lot of work to be done.

[Ian Brooks Gillies]

No. That's helpful as is the time line. The last question I wanted to ask was around there seem to be some new tax credits related to rare earth magnets being introduced this week, it doesn't appear to be law or anything along those lines yet. Do you have any initial views acknowledging the details seem to be incredibly light and confusing?

[Constantine E. Karayannopoulos, President, CEO & Director]

Well, welcome to the world of government legislation and bills, trying to make their way through the legislative part of government. Yes, it is confusing but at the same time when you look at the summary and the highlights, $20 to $30 per kilogram magnet tax credit could ultimately make the difference between having a magnet infrastructure in the United States versus not having one. When we look at -- I referred earlier to structural challenges when you try to make magnets in Europe, it's a similar situation in the United States. And there are permanent disadvantages that making magnets in these jurisdictions have against the large SOE type manufacturers of magnets in China. The most obvious parts are the VAT treatment on rare earth inputs into magnet production and the VAT treatment on magnet exports from China. However, as I said, a $20 -- even a $20 stop gap or incentive on some basis would eliminate those structural disadvantages at least on a cost basis. So it's definitely from a regulatory point of view as far as manufacturing of magnets in North America goes, I think this is definitely a positive step and it could help a great deal. But as I -- not to repeat myself, as I said, in Europe there's still a lot of work to be done. Tax credits is one thing however, the supply chains have been absent from the United States for 20, 30 years and the skill set isn't there in the form that it needs to be. So there's still work on a lot of other fronts. However, these tax credits definitely, absolutely help recreate the magnet -- rare earth to magnet supply chains in the U.S.

[Operator]

[Operator Instructions] It appears we have no further questions in the queue. So I will turn the conference back over to Ali Mahdavi for closing remarks.

[Ali Mahdavi, Capital Markets & IR Executive]

Thank you very much. Once again, we'd like to thank everyone for joining us this morning. On behalf of the team, should you have any questions, by all means and as always, feel free to reach out. That concludes today's call and we look forward to speaking with you all again on our third quarter 2021 earnings call. Operator?

[Operator]

Thank you. Once again, ladies and gentlemen, that concludes today's conference. We appreciate your participation today.