Neo Performance Materials Inc

TSX:NEO

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Neo Performance Materials Second Quarter 2024 Earnings Call.

[Operator Instructions] I would now like to turn the conference over to Ali Mahdavi. Please go ahead.

[Ali Mahdavi, executive]

Thank you, operator, and good morning, everyone. Thanks for joining us this morning for our second quarter 2024 financial results.

Just as a reminder, a replay of this call will be available starting tomorrow in the Investor Center of our website located at neomaterials.com. Joining me this morning are Rahim Suleman, Neo's President and Chief Executive Officer; and Jonathan Baksh, Neo's Chief Financial Officer.

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, adjusted EBITDA, product volumes, product pricing, other income and expense measures, cash returns, operational changes and future business outlook, including potential expansion plans and contracts. 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.

Let me now turn the call over to Rahim.

[Rahim Suleman, executive]

Thanks, Ali, and good morning, everyone. We are pleased to speak to you this morning and to share our second quarter operating results and business update. I'd like to touch on several strategic initiatives and accomplishments, and then Jonathan will take you through our quarterly results.

It has been an extraordinarily busy and productive year thus far, and I'm tremendously proud of our teams and their work to build a better, stronger and more enduring Neo. During the first half of the year, Neo generated $230 million in sales and $24 million of adjusted EBITDA. This represents a 25% decline in revenue over the first half of 2023, but driven primarily by lower rare earth prices, which have generally dropped by about 20% to 40% this year.

But our adjusted EBITDA of $13 million in this quarter and $24 million year-to-date is a rare sighting in the rare earth industry as most industry players have reported significant declines and losses this year due to falling in lower rare earth prices. Neo's year-to-date adjusted EBITDA is up about 20% over the prior year.

As we've been saying over the past year now, Neo is focused on our downstream operations and our value-added margins. Our rare earth separation business produced losses again this quarter. However, you can see the strength of our larger downstream businesses coming through in our stronger results as our downstream businesses are significantly less impacted by rare earth prices.

We will elaborate on this shortly, and I think the unique strength of the Neo business model will become more apparent to all. What is obvious is that with lower rare earth prices, Neo reports lower revenues. Yet, we reported improved EBITDA and improved EBITDA margins.

We announced late last year that we would be conducting a business and asset review with potential changes to our operating footprint and driving focus and accountability across our organization. I'm pleased to report that we continue to make tremendous progress to simplify our operations and improve our business fundamentals.

Thus far, we have discontinued operations at our light rare earth separations facility in Zibo, China. We discontinued the hydrometallurgy portion of our Rare Metals plant for tantalum and niobium. And just this week, we announced that we have executed an agreement for the sale of our Rare Metals facility for gallium trichloride at Quapaw, Oklahoma.

On the growth side of changes, we have almost completed commissioning our new modernized auto emissions catalyst facility in China, and we are on schedule with building construction for our new Sintered Magnet facility in Europe. And of course, I won't miss the chance to note the recent award of the Magnet program for this new facility, I believe the first such award, actual award, in Europe.

As a management team, we are steadfast in taking a disciplined approach to strengthening all of our businesses. These efforts have distilled its specific targets and improvements within each of our 3 business units. The common lens to evaluate our strategic opportunities is to create a more focused business in the highest growth areas: to reduce the volatility in our earnings and dependencies on commodity price; to improve our return on capital; and to generate strong, repeatable cash flows, all leading to investing our time and resources into the best prospects for Neo's long-term, sustainable and high -quality growth plan.

To complement these internal transformation efforts, on June 14, Neo announced the formation of a special committee of independent directors to lead a comprehensive strategic review process to consider strategic alternatives and opportunities to maximize shareholder value. The strategic committee has retained Barclays Capital and Paradigm Capital as independent financial advisors in connection with this review.

In addition, the Compensation and Human Resources Committee has retained Hugessen Consulting, an independent compensation consultant, to advise the company on compensation matters. There is no timetable for completion of the strategic review process, and Neo does not intend to comment further until it determines that such disclosure is necessary or appropriate. There can be no assurance that the strategic review process result in any transaction or other alternative, nor any assurance as to its outcome or timing.

The Board and our management team are aligned and committed to exploring all opportunities to maximize shareholder value. And as a management team, we will help coordinate in the evaluation of the company's current strategy, assets, operations and capital structure. We appreciate your understanding that we will not be taking questions in respect to the strategic review process.

One other update related to our Board of Directors is the recent appointment of Dr. John McGarva as an Independent Director. We are thrilled to have John's leadership on our Board and to help benefit from his decades of experience in global manufacturing companies that represent many of Neo's end markets, including companies that utilize Neo's advanced and specialty products.

We also thank Yadin Rozov for his contributions to our Board over the past several years and as a valued contributor to our Audit Committee and Corporate Governance & Nomination Committee. Yadin has always provided excellent counsel, provided unique perspectives drawn from his experience as a successful executive, banker and entrepreneur. As Yadin takes on new commitments and reduces his board service accordingly, we wish him continued success.

Turning back to our strategic initiatives. Today, we will elaborate on 2 new accomplishments in the quarter, in addition to updates on other ongoing initiatives. First, we are pleased to report that we have won a significant automotive platform for our new Sintered Magnet plant in Europe. This is a substantial contract that addresses one of our key commitments that we targeted for completion earlier this year. The award is for magnets for a new electric vehicle traction motor for a major European OEM. And at its peak, will account for about 35% of our annual Phase 1 capacity.

The OEM program is anticipated to run from 2027 to 2033 with a peak year in 2029. And Neo anticipates revenues to start in the back half of 2026 for this program as we begin to fill the supply chain. In winning this award, we demonstrated our successes in detailed design work, demanding magnet compositions and specifications, the value of a deeply integrated supply chain and our proven track record of customer collaboration on exacting drawings, parts and programs.

The importance of our European supply chain, quality control programs and decades of experience for both supplying the automotive industry and manufacturing magnetic materials were critical decisions for both our T1 customer and the OEM, and we are proud to provide magnets that are fully aligned with the European Union's Critical Raw Materials Act.

While much has been made of the relative slowdown in the adoption of electric vehicles, as OEMs and motor manufacturers push out potential new EV models, the ultimate need for EVs has not dramatically changed. In Europe alone, about 2.5 million EVs will be produced and sold this year. That number is expected to quadruple in 2030 to more than 10 million electric vehicles. That's nearly a 30% annualized growth rate.

Neo's capacity in Phase 1 and what we plan to build in Phase 2 remains just a sliver of the total demand and capacity required for OEMs in Europe and North America. The market opportunity is immense, especially with the additional forces at play with the European Critical Raw Materials Act and the recent 25% tariff announced by the U.S. government on magnets made in China. These, along with the intrinsic motivation for OEMs to have both a globally diversified supply base as well as local capabilities, means what is in front of us is truly a generational opportunity in the energy transition movement.

Several other entrants have announced their desires to get into this market, along with the very small number of incumbents. This is absolutely needed, as today, over 90% of all sintered magnets are produced in China. We will continue our focus and our efforts on successfully winning specific automotive platforms, where Neo's positioning as a long-term supplier of rare earth magnetics, a supplier to the automotive industry, and our deep vertical integration and global operations are all highly valued.

Second, and subsequent to the end of the quarter, we announced the transaction to sell our Rare Metals' gallium trichloride facility located in Quapaw, Oklahoma. Gallium has been part of the Neo Rare Metals product portfolio for over 10 years. And that said, as we've continued, through our strategic asset review, it has become clear that the gallium trichloride products manufactured in Quapaw are at a scale that makes it difficult for Neo to have the appropriate focus for growth.

It is a niche business relative to the rest of Neo's portfolio. And at about $1.4 million in expected total proceeds, the sale price reflects at approximately 9x EBITDA multiple, considering Neo's unallocated costs and efforts. Kevin Reading, the Founder and current General Manager of the business, is purchasing Neo's stake. Kevin has always been a valued partner and a great business leader, and we are excited for Kevin and the team at Quapaw and for the continued growth opportunities for this facility as a focused entity. Neo's gallium recycling facility in Peterborough, Canada will continue to be owned by Neo and will continue to supply recycled gallium units to Quapaw facility and other customers in the coming years.

With our aims to simplify Neo's business globally and to focus on key portfolio assets that reflect our scale and growth ambitions, selling the Quapaw facility is the third significant change to our operating footprint over the last year, and that excludes the 2 large capital projects that are targeted at growth. So let's talk about those.

During the second quarter, we continued commissioning our NAMCO environmental emissions catalyst facility in Zibo China, and we have started to receive customer approvals for the requalification of specific products. Our primary focus is to complete the requalification of all products and then return to a laser focus on improving operational efficiencies.

For certain products that have been successfully qualified, we have already begun testing our abilities to run at full program speeds as we prepare for the full facility ramp-up. We expect it to take a couple of more quarters to have all of our products be qualified and for us to start running at full production scale. As Jonathan will outline, at current course, we expect this major project to be completed on time and under budget.

In Europe, we are on time and on budget for our new Sintered Magnets facility. We are actually riding slightly ahead of budget on the shop floor construction, and we will be able to pull forward some of our initial timelines for equipment installation, as major pieces of equipment have started to arrive on site. Customer interest remains very high and we continue to produce new samples, meeting new customer specifications.

We have been very successful in attracting a brilliant and experienced team and our finances remain strong, including the support of the Just Transition Fund in Europe. Our localized vertical integration offering remains a key factor and we benefit from the infrastructure we already have placed in Estonia.

Stepping back, the market environment, particularly the rare earth commodity pricing, has been difficult for the rare earth industry over the past 2 years and magnetic demand remains soft in nearly all geographies. Our value-added operation model differentiates Neo as a specialty manufacturer within the rare earth and magnetics industry, and we have been able to generate growing EBITDA in the face of these market conditions. This is notable when many of the largest players in the rare earth industry have reported operating losses in recent quarters.

Our separations business faces a similarly challenging predicament to rare earth miners, and we continue to sustain gross margin and EBITDA losses in the current pricing environment through the first half of 2024. Our separations business must continue to solve for the largest impacts on profitability, pricing, scale, higher-value products, and reduced conversion costs. There are no easy solutions for some of these issues, particularly as price is an industry-wide consideration and scale is dependent on additional sources coming online.

We are deeply engaged in cost reduction programs and focusing on higher value products and mix benefits, and we will continue to seek to improve these things and their impact on our financial results. But as you can see from this quarter and this year's result, Neo is much more than a rare earth separator that is tied to these constraints. Neo is a much stronger value-add downstream business and this is what is driving our strong EBITDA results.

Given that EBITDA is negative in the separation portion of our business, the value-added portion of our business is even stronger than what might first appear. And Neo will continue to focus on growing this value-added portion of our business in the quarters and years to come.

Across our value-add businesses, including magnets and assemblies, emission catalyst and specialty rare metals, we have performed generally above our expectations for the first half of this year. And with that in mind, we stated earlier this year that we expect double-digit EBITDA growth for the full year 2024 compared to 2023. And we started this year with even further declines in rare earth pricing, meaning our double-digit growth rate was going to have to fight through the headwind of further declining rare earth prices.

But based on our strong results in our downstream businesses, we update and increase our expectation to achieve an EBITDA in the range of $45 million to $50 million for the full year 2024. That is a growth rate of 20% to 35% over 2023. And at this point, we continue to believe that we will generate double-digit EBITDA growth percentage in 2025, assuming that rare earth prices demonstrate some stability.

In May 2024, we laid out about 8 short-term accountable goals. I am proud to say that with the recent sintered magnet award, we have now successfully completed each and every one of those goals.

With that, I will now turn the call over to Jonathan.

[Jonathan Baksh, executive]

Thanks, Rahim, and good morning, everyone. Second quarter performance was relatively strong, aided by another solid quarter in our Rare Metals business unit. Our sales during the second quarter were $107.5 million with adjusted EBITDA of $13.4 million. We reported adjusted net income of $5.3 million or a diluted adjusted earnings per share of $0.12. The market dynamics at the start of April this year largely continued through the end of July.

Magnetic rare earth elements, neodymium and praseodymium remain down about 20% compared to the start of the year. That said, these prices have somewhat stabilized during the second quarter. From a lead/lag perspective, the second quarter was still adversely affected by higher cost inventory that is running through our system. If rare earth prices remain stable, we would expect that adverse impact to moderate in the third quarter, notwithstanding the fact that price is sustained at these low levels will continue to be challenging for our C&O separation business.

Looking at year-to-date performance, you'll notice that revenues are down 25%, yet operating margins and adjusted EBITDA are higher. This is because our top line revenue will track more closely with the underlying rare earth pricing movements, but most of those rare earth price changes are passed to customers with pass-through pricing mechanisms, so our margins are more closely tied to the value-add nature of our business.

In Magnequench, sales volumes were up 15% versus the prior year and were in line sequentially with the first quarter. Magnetic powders and traction motor applications continue to outperform through the first half of this year. Quarterly volumes for traction motors are sometimes affected by customer inventory cycles, but overall, this is an important market for Neo, particularly now that we have a combined offering of a heavy rare earth free traction motor solution and the sintered magnet capability currently under development in Europe.

Despite the volume growth and strength in select end markets, the overall market for magnetic materials remains relatively soft, particularly for [ neomagnetic ] powder volumes going into circulation pumps, automotive electronic power steering and factory automation applications.

Operationally, Magnequench continues to make steady improvements in reducing operating costs. Our teams are actively managing the challenge of operating at slightly lower than optimal levels and adjusting to continue to manage capacity utilization. We also continue to make steady progress with our new Sintered Magnet facility. The project remains on budget, and with the building structure substantially complete and all critical equipment ordered, the risk of budget overrun has been reduced.

During the second quarter, we received $1.2 million in cash funding under our grant from Europe's Just Transition Fund. This was our first meaningful amount of cash funding received through the program, and we've established a quarterly process to continue to recover funding as eligible costs are incurred.

Within C&O, our auto catalyst business has been a little slow due to demand softness and customer destocking, but margins remain strong and we're very pleased at the pace of customer requalification at the new modernized NAMCO facility. The new facility continues to be commissioned and is expected to be completed $5 million under budget.

We aim to steadily ramp production through the second half of the year, and we're having success in launching new products, many of them tailored towards new hybrid vehicle platforms that are expected to be a stable part of the future drivetrain mix.

The C&O rare earth separation business continued to face notable headwinds. The second quarter saw the continued effects of declining rare earth prices and slower demand for high-purity oxides that go into specialty electronic applications, as customers are currently going through an inventory destocking cycle.

With these dynamics, our C&O rare earth separation business continues to deliver negative gross margins. We've been on the downside of a lead/lag dynamic for the better part of 2 years. However, as mentioned earlier, if rare earth market prices remain stable, as they did in the second quarter, that stabilization will begin to flow through our inventory and appear as improved operating profitability. That said, we are continuing to take a hard look at ways to mitigate some of the structural challenges that Rahim mentioned to further accelerate potential margin expansion.

Our Water Treatment business continues to deliver excellent growth from a small base. Our sales force on the ground continues to grow its expertise and know-how, which after many years, is successfully growing and converting larger customer opportunities.

In Rare Metals, we saw strong performance across all facilities, with the largest contributor to margins continuing to be strength in our hafnium recycling business. As discussed at the beginning of the year, our contracted hafnium volumes in 2024 have provided a stable foundation for robust financial performance in Rare Metals. With that said, margins were below prior year, which saw high hafnium spot sales volumes as customers built inventory amidst rising prices.

This abnormal level of spot sales volume in the second quarter of 2023 pulled volume forward from the third and fourth quarter of 2023. 2024 spot sales volumes have been very stable, so we do not expect this 2023 issue to repeat. For the full year, we continue to believe that hafnium performance will drive strong results within Rare Metals. Longer term, we do expect the hafnium business to moderate as prices normalize, and we consume our remaining lower cost inventory.

Operating margins in our niobium business are also substantially improved versus prior year due to operational efficiencies coming from the fourth quarter of 2023 action of shutting down hydrometallurgical processing. The change in operations has allowed us to focus on critical elements of our downstream value-add process, improving machine utilization yield and product mix. We expect to see continued benefits as these changes are still in the early stages.

In terms of the sale of the 80% equity interest in the Quapaw, Oklahoma specialty gallium facility, we expect the transaction to close during the third quarter of 2024, with a purchase price of $1.4 million plus cash and working capital adjustments.

Taking a closer look at the balance sheet. In the first half of the year, we generated $26 million in cash from operations and invested nearly the same amount into plant, property and equipment. Of the $27 million invested in plant, property and equipment, $15 million related to the NAMCO relocation, $10 million related to building our Sintered Magnet Plant in Europe and $2 million related to sustaining CapEx.

Our total cash balance remains at $100 million and net cash of $51 million reflects the $49 million drawn on our credit facility for the relocation and modernization of NAMCO. We continue to have a very healthy balance sheet, which enables us to pursue our growth plans and strategic initiatives.

During the quarter, we further reduced our inventory levels by $7 million and we continue to work to reduce our working capital levels in the current environment. We also repurchased $2.3 million of common shares through our NCIB program and returned $6.2 million in dividends to shareholders.

Despite lingering market headwinds, Neo's unique value-add business in magnetics, rare earths and rare metals is driving outstanding performance in the first half of 2024. We continue to believe in the power of our business model and look forward to maintaining that momentum in the second half of the year.

I'd like to now open the call for questions. As a reminder, we appreciate your understanding in that we will not be taking questions on the strategic review process.

[Operator]

[Operator Instructions] Your first question is from David Ocampo from Cormark Securities.

[David Ocampo, analyst]

My first one is just on the '25 guidance for the double-digit growth over 2024. I'm just trying to figure out what assumptions are baked into that projection. Can you guys still achieve that double-digit growth in the face of flat rare earth pricing? And any expectation on a regression of Rare Metals just given the profitability that you guys are seeing this year?

[Rahim Suleman, executive]

Yes. Look, I think that there's several moving parts that cause us to get comfort around where we see the business going. I think we're going to see continued improvements from a number of the transformation projects with respect to our operations. You got to remember, things like our niobium and tantalum transformation. This is the first year, right?

We did it in 2023. So, it does take some time for us to see the full benefit of that transition. So, I think those things will continue to progress through 2025. I do think there will be a stronger market that we see for some of our end products. We'll be through our NAMCO relocation project. That facility will be more efficient than our existing operations.

I think our Rare Metals business, some of the hafnium pricing that we've talked about has been longer-term spot sales, and I think we are benefiting from some of those. So there'll be some pluses and minuses, and I think on the Rare Metals side, there'll probably be a little bit of pressure on the hafnium margins. But I think that the rest of the business, the magnet business, the catalyst business and our separation business will all perform better than it's performing in 2024.

[David Ocampo, analyst]

Okay. That makes sense there. And then just curious, as we're thinking about your Sintered Magnet facility, you guys have sold out 35% of the order book before even commencing operations. Are you guys trying to keep some flexibility in there just in case the pricing environment or demand environment changes in a more favorable position as we get closer to first production?

[Rahim Suleman, executive]

Yes, I think -- but maybe I'll say it slightly differently. I don't think that it's about holding capacity for a pricing environment change. I think that we are -- we have an economic model. We do have a sense of where we think the market price is for the services that we offer, and that will remain our focus. Having said that, I think that the thought process is really just to be thoughtful about how to execute a launch plan responsibly.

I think that it would not be something that I would promote for us to try to ramp every piece of business that we saw and try and ramp it into the building in the first 2 or 3 years of production. So, I do think there'll be -- I expect that there will be more awards for that business. I don't expect we'll announce every single award as they come into play. But I do think that we want to be thoughtful with respect to the number of programs, number of different parts, and the kinds of commitments that we're making for the first 3 years of the ramp curve.

It's just -- my experience has been to ramp and launch automotive facilities on the other side of the world. And I think that the key to when you're ramping up new facilities is to do so in a responsible way. So, I think we will be tempered in how we fill the capacity, but I'm not worried about it from either a price perspective or a demand perspective.

[David Ocampo, analyst]

Okay. And just curious on your thoughts on Phase 2. Is that a decision that comes closer to '29 when you're running at full production? Or do you make a decision before then?

[Rahim Suleman, executive]

I think we make a decision before then. I won't give you the exact timeline, not because it's a secret, but because I think that there's so many other variables that are at play here. But, yes, I think it's not one where we are worried about there being ultimate demand. I think it's just one where there's a prudent aspect to how to do it.

[David Ocampo, analyst]

Okay, that's it for me. I'll hop back in the queue.

[Operator]

[Operator Instructions] There are no further questions at this time. Please proceed.

[Ali Mahdavi, executive]

Thank you, operator, and thank you, everyone, for joining us today. Should you have any follow-up questions, by all means, feel free to reach out to myself, Ali Mahdavi. And this concludes today's call, and we look forward to speaking with you during our third quarter conference call. Have a great weekend.

[Operator]

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect your lines.