Neo Performance Materials Inc

TSX:NEO

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Neo Performance Materials Inc. Third Quarter 2024 Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, November 14, 2024.

I would now like to turn the conference over to Irina Kuznetsova, Director of Investor Relations. Please go ahead.

[Irina Kuznetsova, executive]

Thank you, operator, and good day, everyone. Today's call is being recorded. A replay will be available starting tomorrow in the Investors Center on our website located at neomaterials.com. On today's call 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 the 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]

Thank you, Irina, and good morning, everyone, and thanks for joining the call. Today, we are pleased to report another strong quarter as we continue advancing our strategic goals and implementing substantial changes across our business.

I'll start by sharing some key highlights. For Q3 2024, we delivered solid financial performance, underscoring our resilience and commitment to growth. Adjusted EBITDA came in at approximately $20 million for the quarter, about a 50% increase compared to Q3 2023. And on a year-to-date basis, adjusted EBITDA is approximately $44 million, a 28% increase over the prior year.

As Jonathan will discuss, we have seen strong growth in both our Magnequench segment, up 23% over the prior year, and our Rare Metals segment, up 30% over the prior year. These gains were offset by lower performance in C&O, which is mainly due to the lower rare earth separation business and lower rare earth prices.

Given our robust results for the quarter, we increased our outlook for the full year 2024 adjusted EBITDA from a range of $45 million to $50 million, up to $52 million to $55 million. We slightly improved and increased our outlook for 2025 to be in the range of $53 million to $58 million.

Bear in mind that we also announced the sale of 3 of our manufacturing facilities earlier this year -- earlier this quarter, sorry, our Quapaw gallium trichloride facility, our light rare earth facility in China, and 86% of our heavy rare earth facility in China. Notwithstanding these planned dispositions, our outlook for 2025 remains in this improved range. We will also collect more than $30 million in cash from these dispositions. We expect these divestitures to lower the volatility of our business, improve our geographic footprint and create a better focus as a company.

Look even further into the future, we are very excited to show investors what happens next. We have now seen some stabilization in the existing market dynamics for Magnequench, and are anticipating even further growth from sintered magnets in Europe. We also expect growth from our efforts to get into more magnet assemblies, including the benefits of adding SG Technologies to our portfolio. Our new NAMCO facility is expected to be firing at full speed in the near future, along with the new automation, the new capacity and the lower cost profile.

We will have improved our risk exposure in rare earth separations to reduce the potential impact of negative rare earth price trends, which have severely encumbered our business over the past 2 years, creating much of the volatility in our earnings that has made it harder for investors to see the true value-add nature of our business. We expect our rare metals business to normalize a little bit after several quarters of exceptional hafnium pricing and doing a lot of the heavy lifting for our company.

We talked previously about how we would simplify our business, focus more on downstream value-add businesses and focus on new growth initiatives in high-growth segments. I think we are well on the way on that journey, and I'm glad that our financial results are showing just the beginning of what comes next. To repeat, in a year in which rare earth prices are down, our earnings are up almost 30%.

Moving on to our strategic initiatives. We continue to make significant progress in key areas that will drive long-term value. As we announced 1 year ago, we began a comprehensive strategic asset review across our geographic and operating footprint. Our stated goals, including increasing our focus on downstream and value-add operations, improving our return on capital employed and reducing earnings volatility.

With these in mind, we are pleased to have entered into mutually beneficial agreements to sell both of our rare earth separation plants in China. These separation facilities are world-class assets, supported by top-tier employees, rigorous operating procedures and an industry-leading environmental practices.

That said, the industry has shifted significantly over the past 2 decades. Today, our plants operate at a smaller -- at smaller scale facilities, focused on midstream rare earth processing. And with industry consolidation, it has become increasingly challenging for a multinational foreign investor to grow its position, particularly with respect to asset feedstock.

At the core, we had to ask ourselves whether this business aligns with Neo's strategy and if Neo is the best possible owner and operator for these assets. We found a terrific partner in Shenghe Resources, who we believe can help grow these businesses in a manner that Neo simply cannot, given the growing restrictions on access to raw materials in China. These actions are expected to reduce earnings volatility, improve our return on capital employed, improve our geographic distribution, and importantly, allow us to deliver on the high-margin value-add downstream businesses.

It is important to note that Neo will remain a minority partner in JAMR and be the exclusive international distributor for heavy rare earth specialty products outside of China for an initial term of 5 years. This will allow us to continue to service our global customer base, while significantly reducing our exposure to the working capital requirements.

Neo will continue its rare earth separation operation in Europe. This capability is a strategic asset, and we are committed to sustaining and expanding our presence in this space. We are not exiting rare earth separation. In fact, we remain one of the few commercial scale midstream processing facilities outside of Asia.

Rare earth, and particularly rare earth magnetics, are on almost every country's critical material list. There are more mine projects coming online throughout the world and Neo's separation capabilities in Europe will continue to become a more and more strategic global asset.

In addition, we continue to work towards closing the sale of our gallium trichloride facility in Quapaw, Oklahoma. As discussed on our last call, Quapaw's a relatively small operation for Neo and we have decided to sell it to its original founder and current general manager.

We will continue to recycle gallium at our Peterborough, Canada facility. And as part of this transaction, we will supply some of that recycled gallium to Quapaw. This continues to simplify Neo's business, reduce our working capital and focus on areas where Neo can grow its core operations.

At a time when Neo may be viewed by investors as a deep value opportunity, the sales of these facilities represents about CAD 1 per share in cash to Neo without materially impacting our EBITDA outlook.

From a different perspective, these transactions represent an approximately 11x multiple on the average trailing 5-year EBITDA of these facilities, ahead of the median across the materials sector and many, many turns higher than Neo's average trading multiple today.

And maybe just as important as those financial metrics, we said we would, and we did. I think our investors will find this to be a compelling mantra at Neo. These transactions are expected to close in Q4 2024.

As previously disclosed, 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 special committee has retained Barclays Capital and Paradigm Capital as independent financial advisers who are advancing the strategic review process.

At the same time, in the context of the strategic review, we have continued to take steps to optimize Neo's business, including the divestment of noncore assets, executing improvements in operational performance and progressing with major capital programs, both on time and on budget.

There can be no assurance that the strategic review process will result in any transaction or any alternative nor any assurance as to its outcome or timing. There is no timetable for the completion of this process, and Neo does not intend to comment further, unless it determines that further disclosure is necessary or appropriate.

From a major capital project's perspective, in September, we held the grand opening ceremony for our newly commissioned auto catalyst manufacturing plant, NAMCO. This facility will have improved process layouts, additional automation and additional capacity relative to our former auto catalyst facility.

We have already requalified the majority of our products across our largest customers, remaining on track to meet full production levels in the fourth quarter of 2024, subject, of course, to winding down the inventory stockpile we produce to help manage the transition activities. We continue -- and we will continue to invest some of the cash portion of our CapEx against the project through mid-2025 as we run through the completion agreements for equipment through its first year of operations. We essentially finished this project on time and on budget. We said we would, and we did.

Our second large capital growth project, a sintered magnet manufacturing facility in Europe, is on track and on budget. We have recently completed the manufacturing building structure with equipment installation already started. All our critical equipment has been ordered and much of it has already arrived. We target manufacturing customer magnet samples in early 2025 from this production equipment for our customers, including our awarded traction motor business.

I would like to note that there is a particularly large amount of interest in what we are accomplishing here with having both rare earth separation and magnet making located right next to each other in Europe. There are a few players, if any, outside of Asia that can boast the integration, the infrastructure and the experience that Neo has in this value chain.

Although there is much discussion on the slowing growth of battery electric vehicles or BEVs, I would remind everyone that our facility will cater to all forms of electric vehicle traction motors, including HEVs and PHEVs, in addition to just BEVs. For the most part, the magnetic contents of these different variations are not materially different. We are also involved in other technologies and applications, including wind farms and other energy-efficient motor applications.

Our intended capacity is just a sliver of the total market opportunity, but it is meaningful in the context of outside of Asia capacity and supply chains. I am confident that there will be more exciting news and developments regarding this integrated rare earth separation and magnet strategy in Europe in the quarters to come.

Taking a step back, 1 year ago, we announced our plans to pursue significant changes in our approach to managing our business. In that time, we have exited several businesses, shortened our working capital cycle and have decreased our exposure to volatile rare earth cycles. We have more work to do, but we feel very, very good about our current trajectory. The foundation is set to build powerful growth programs in the years to come.

Despite lower ASPs and less absolute dollars on the top line today, we have created significant margin expansion and adjusted EBITDA growth over the past year. Part of that is the short-term outperformance in our Rare Metals business, but part of it is exiting a rare earth commodity cycle in a much stronger position than when we entered the cycle.

This quarter's outcomes reinforce our confidence in our long-term goals. Moving forward, we will continue to focus on operational efficiencies, volume growth and business optimization, enabling us to maintain momentum and deliver sustainable value to our shareholders.

I'd now like to turn the call over to Jonathan for a review of the quarter.

[Jonathan Baksh, executive]

Thanks, Rahim, and good morning, everyone. As reported in our press release this morning, the drivers of our third quarter financial and operating results were relatively consistent with our Q2 report. Our top line reflects some mixed performance across our businesses, but overall, points to some stabilization across permanent magnetics and rare earth. And our bottom line was driven higher by near-record performance within our Rare Metals business and stronger results in Magnequench.

We reported revenue of $111.3 million during the quarter, with adjusted EBITDA of $19.6 million. We reported adjusted net income of $1.1 million or a diluted adjusted earnings per share of $0.03.

Compared to the prior year, our consolidated revenue increased 19%, driven by significantly lower rare earth and permanent magnetic pricing. We've discussed this dynamic previously, as we expect our top line to directionally trend along with commodity rare earth prices due to pass-through pricing mechanisms in most of our contracts. That was again the case with Magnequench and C&O pricing down both sequentially and year-over-year.

From the start of this year, neodymium and praseodymium prices are down about 7% and dysprosium and terbium prices are down about 30%.

Despite the market headwinds putting downward pressure on revenue, our margins expanded significantly. Gross profit was up 950 basis points and adjusted EBITDA as a percentage was up approximately 800 basis points. This was driven by operational and commercial actions to improve profitability and quality of our earnings, including an exceptionally strong quarter for our Rare Metals business.

On a sequential basis, the fact pattern from the second quarter largely held true into the third quarter. Commodity rare earth prices appear to have stabilized over the past 6 months, which has allowed us to effectively catch up into a normal range of working capital cycles.

Realized prices during the third quarter were lower due to a sustained lead lag effect. And with a small uptick at the end of Q3 and into Q4, our realized pricing should further stabilize.

Magnequench continues to deliver solid results based on improved fundamentals. 2024 year-to-date volumes increased 10% compared to the prior year, and third quarter volumes increased 15% sequentially.

Many of our products and program trends held strong into the third quarter, including improved performance for bonded magnets and for magnetic powders used in electric vehicle traction motors. We also saw areas of strength regionally in China, despite the highly competitive market and some uncertainty tied to macroeconomic conditions.

Our year-to-date adjusted EBITDA of approximately $19 million reflects strong performance, with a 23% increase compared to prior year. This increase was achieved despite the lower pricing environment, and this is a testament to the flow-through economics of the business as well as efforts to improve our operating cost structure and clearing out some of our higher-cost inventories. We are nearing a stabilized working capital cycle for much of Magnequench, which allows the value-add nature of our business to reflect in our financial results.

While we had favorable momentum in Magnequench, there was some lingering demand softness across our chemicals and oxides portfolio during the quarter. Absolute volumes were down both year-over-year and sequentially for our auto catalyst portfolio and specialty rare earth, and we continue to suffer negative margins across our rare earth separation business.

There are a few dynamics at play, including a difficult automotive environment within Europe. Year-to-date, European volumes have been the most significant driver of volume declines. While in the third quarter, we also saw pockets of weakness within both China and North America.

We are focused on what we can control, driving cost-saving measures and innovating new products to enhance customer value. With our new auto catalyst manufacturing facility, the business is well positioned to attract new customers and grow market share.

As Rahim mentioned, we are on track to requalify most products at this point and aim to reach ramp production levels in the coming months. After building an excess inventory stockpile to help transition into the new plant, we are working that excess inventory down and are approaching normal operating levels.

Irrespective of the near-term automotive cycle, we believe strongly that Neo is positioned to have an industry-leading cost structure for these highly engineered materials, and we have a high level of confidence around the need for emission control catalysts for next-generation hybrid vehicle platforms.

In Rare Metals, we again saw a very strong performance across all facilities. The strength of our hafnium recycling business continued to drive improved financial performance at both the top and bottom line.

With strategically secured hafnium inventory, the business continues to benefit from its strong order book of contracted volumes at favorable prices, while also taking advantage of spot sales opportunities. This strategy has been successful, and the business continues to evaluate the pricing environment, while starting to secure long-term hafnium volumes for 2025 and 2026. Although we expect hafnium pricing to normalize over the long term, the fundamentals of this business remain strong in the short to intermediate term.

Shifting to the balance sheet and cash flows. You'll see a change in our balance sheet associated with pending manufacturing plant dispositions. Our China rare earth separation facilities and our Quapaw gallium trichloride facility are now placed into assets and liabilities held for sale, pending the closure of these transactions. The net impact of these assets and associated liabilities is approximately $30 million that would convert to cash upon closing.

Our cash balance remains strong at $64.9 million, even as the business continued to fund its major capital projects with cash on hand. For the 9 months ended September 30, we generated $30 million in cash from operations and invested $52 million in plant, property and equipment, primarily for our 2 substantial growth projects, our auto catalyst facility and our new permanent magnet facility.

Related to our permanent magnet growth project in Europe, we have recently entered into a new $50 million credit facility with EDC to be advanced in 2 tranches of $25 million each. The successful securing of additional project financing provides us with enhanced flexibility and confidence, enabling us to strategically invest in our growth and pursue new opportunities with greater assurance.

This credit facility supplements the EUR 18.7 million grant secured from the government of Estonia. This $50 million credit facility with EDC is in addition to the existing $75 million loan from EDC for our modernized NAMCO auto catalyst facility. The $75 million loan was broken into 3 tranches of $25 million, and we've drawn the first 2 tranches.

For many years, Neo has maintained minimal leverage with strong free cash flow across our cooperations. As of September 30, we currently have total debt of less than 1x trailing adjusted EBITDA, and we are remaining in a positive net cash position.

We consider this to be a prudent use of our balance sheet while safeguarding against potential volatility tied to critical materials space. It also allows us further flexibility to pursue our strategic initiatives and growth plans as well as to take advantage of potential inorganic growth opportunities.

Overall, we continued to perform well in a challenging market environment. We're pleased with the rate of progress across our strategic priorities, and we believe in the long-term earnings power of our business.

With that, I'd like to open the call for questions.

[Operator]

[Operator Instructions] And your first question comes from the line of David Ocampo with Cormark Securities.

[David Ocampo, analyst]

Just the first question on your 2025 guidance. You guys talked about a normalization of rare metals to occur in 2025. Just wondering what we view as normal today since it wasn't too long ago that this business was generating, call it, $5 million to $10 million of EBITDA at a normal run rate basis.

[Rahim Suleman, executive]

Yes. I don't know that we're in a position where we're talking about specific EBITDA levels of each of the components in terms of our outlook. But certainly, we don't anticipate -- we believe this business is much better than the historic levels of earnings that have occurred there. I think the end markets are better and they're performing well. I think the introduction of other tariffs and other geopolitical impacts have provided some strong foundation for this business to continue to grow in international markets.

And then I also think that the changes that we made in our tantalum and niobium business, with respect to closing the hydromet facility there, is going to yield long-term results. So I think normalization is kind of closer to where we are now than where we were in the past. But I do think that where we are now is benefiting from additional price, and as I said, we want to be clear on when we're driven by price and when we're driven by value add. So I think that this long-term business is a value-add business.

I think short term, there are additional price benefits in these numbers, but I don't think we're talking about a return to what it was. I think it's just a new version of what it will become.

[David Ocampo, analyst]

Okay. That makes sense. And then just on the $50 million credit facility from EDC to finish the sintered magnet facility. Curious why you guys are taking that on since you guys do have the cash on hand now with the divestiture of your separation businesses. It does add a little bit more dry powder to the balance sheet. Are you guys trying to suggest here that there's larger capital projects on hand that you haven't disclosed or not in a position to disclose yet?

[Jonathan Baksh, executive]

No. So we have the debt facility available. I mean, how and when we decide to draw on it, that is left to be determined, but we did believe that having the debt available is important.

We look back at Neo's strong balance sheet, and we do not believe historically, we've had enough leverage. It hasn't been maybe the best or most capital efficient way to run our business. And so having that debt available allows us to get to leverage levels that we think are appropriate.

But as you said, we do have that cash available. We'll have cash coming in from the sale of our businesses. And it just puts us in a strong financial position moving forward.

[David Ocampo, analyst]

Okay. And then last one, Jonathan, maybe for you. I mean, you guys have done a pretty good job at releasing working capital through the year, kind of hitting your targets on the inventory side. But just curious if there's going to be another working capital build as sintered magnets comes online. Is that largely going to get eliminated in '25?

[Jonathan Baksh, executive]

For sure. So as sintered magnets ramps, there will be working capital tied to that business that will need to definitely come on to the balance sheet. I think the timing of that ramp, we wouldn't say is all going to, say, come back in 2025 necessarily, but you would expect working capital to grow in line with growth of that business.

[Rahim Suleman, executive]

But overall, David, I think working capital is still on the decline. I think we still have more working capital than we need. I think there'll be areas of the business that we will continue to reduce working capital and generate cash. But yes, to Jonathan's point, we will also be adding working capital for that particular plant. But I think in other plants, we will see reductions in working capital.

[David Ocampo, analyst]

And I may have missed it, what's the lead lag component now? Is it still 3 to 5 months? Or have you guys reduced it to the lower end of that range or maybe even lower than 3 months?

[Jonathan Baksh, executive]

So I think that's right. It's still 3 to 5 months, and it really just depends on which products and which parts of the portfolio. I do think that we've had now, let's say, 5 to 6 months of rare earth price stability, so we've worked through quite a bit of that lead lag effect in our financials.

[Operator]

[Operator Instructions] And your next question comes from the line of Ian Gillies with Stifel.

[Ian Gillies, analyst]

I'm just curious, is there anything embedded within the EDC facilities that would preclude you from executing a large return on capital to shareholders, whether it be a special dividend or a substantial issuer bid?

[Jonathan Baksh, executive]

Yes. So we would require EDC approval for any type of special dividend or new NCIB program or anything as such that would require EDC approval. We're allowed to obviously maintain our current dividend under the program.

[Operator]

[Operator Instructions] I'm showing no further questions at this time. I would like to turn it back to Irina Kuznetsova for closing remarks.

[Irina Kuznetsova, executive]

Thank you, operator, and thank you, everyone, for joining us today. Should you have any follow-up questions, please feel free to reach out to me, Irina Kuznetsova. This concludes today's call, and we look forward to speaking with you during our fourth quarter and year-end conference call. Have a good day.

[Operator]

Thank you. And this concludes today's conference call. Thank you all for participating. You may now disconnect.