Neo Performance Materials Inc. (NOPMF) CEO Constantine Karayannopoulos on Q2 2022 Results - Earnings Call Transcript

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Neo Performance Materials Inc. (OTCPK:NOPMF) Q2 2022 Earnings Conference Call August 12, 2022 10:00 AM ET

Company Participants

Ali Mahdavi - Senior Vice President of Corporate Development and Capital Markets

Constantine Karayannopoulos - President and Chief Executive Officer

Rahim Suleman - Executive Vice President and Chief Financial Officer

Conference Call Participants

Yuri Lynk - Canaccord Genuity Corp.

Frederic Bastien - Raymond James Ltd.

Mark Neville - Scotiabank

David Ocampo - Cormark Securities Ltd.

Ian Gillies - Stifel GMP

Operator

Good day, ladies and gentleman, and welcome to the Neo Performance Materials' Second Quarter 2022 Earnings and Business Update Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ali Mahdavi. Please go ahead.

Ali Mahdavi

Thank you, operator, and good morning, everyone. Thank you for joining us this morning. With me this morning are Neo's President and CEO, Constantine Karayannopoulos, and Rahim Suleman, Neo's Chief Financial Officer. And as a reminder, a replay of this call will be available starting tomorrow in the Investor Center of our website located at neomaterials.com.

Before we begin management's remarks, please note that some of the information you will hear during today's call will consist of forward-looking statements, including, without limitation, those regarding revenue, EBITDA, adjusted EBITDA, product volumes, product pricing, other income, and expense measures, cash returns and future business outlook, including potential expansion plans.

Actual results or trends could differ materially from those discussed today. For more information, please refer to the risk factors discussed in Neo's most recent financial filings, which were filed on SEDAR earlier today and are also available on our website.

Neo assumes no obligation to update any forward-looking statements or other 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 call today. Further information regarding Neo's use of non-IFRS measures is available in Neo's earnings press release, which is available on SEDAR, and on our website at neomaterials.com.

Let me now turn the call over to Constantine.

Constantine Karayannopoulos

Thank you, Ali, and good morning, everyone. For the second quarter 2022, we are pleased to report yet again excellent quarterly performance throughout the company. In the phase of continuing volatility globally, customer demand remain healthy, underpinned by pent-up demand for end consumer product. Pricing for Neo's critical materials remains in favorable levels due to this higher demand. And for the first six months of the year, we delivered our best financial results in the company's history.

Our second quarter sales were a record $168 million with net income of $14.7 million or $0.36 per diluted share and adjusted EBITDA of $26.5 million. I'm very proud of our team's ability to deliver on our plan by reliably and consistently providing innovative products to our customers. We remain thankful to our customers and suppliers and all of our partners for their continuing support.

On the heels of our strongest first half, the perception of uncertainty ahead of us continues, particularly in news headlines and some recent earnings reports. The challenges that have been with us for the past two years largely remain, namely, supply chain shortages, including semiconductor chips, shipping challenges, COVID lockdowns in China and manufacturing disruptions. War in Ukraine continues along with the associated sanctions.

The new challenges are weighing down consumer confidence, such as central bank interest rate hikes around the world to battle back against inflationary pressures. Parsing out the impact of any one of these factors individually can be very, very challenging. For us, we managed through these periods of uncertainty through direct conversations with our customers and by ensuring extraordinarily high levels of customer service and care. Based on continuous feedback from customers, we adjust production plans and inventory positions almost daily.

We have gone through a few very tough years as a result of this pandemic around the world, politics, geopolitics and supply chain disruptions. And many of us have repeatedly said that what we saw over this time has been quite unprecedented. So I hope you bear with me when I again say that the current confluence factors in today's business environment is still very much unprecedented.

These challenges are not equal in terms of severity or duration. While several economies are experiencing negative economic sentiment or outlook, consumers are also clamoring for more cars, electronics, home appliances, and increased travel to spend time with loved ones after global lockdowns. Of course, consumers have to wait a lot longer for their major purchases to be delivered as anyone who has recently tried to buy a new car or a computer knows.

Both discretionary and large durable goods remain in high demand, but manufacturers cannot fulfill purchase orders in a timely manner. Economic case studies haven't really dealt with this scenario before. So we are seeing variability in commercial activity among our customer base. As an example, within the automotive industry, the first six months, it played out hot and cold, depending on the individual OEM. For example, Ford recently reported a surge in sales, while General Motors says 100,000 vehicles are awaiting chips.

In North America, the average car dealer inventory available for sale is about two weeks. That is a slight improvement from the start of this year, but remains at all time low since this type of data was first reported 30 years-ago. Also, hot and cold depending on the geography, Europe automotive sales are down nearly 20% with the war in Ukraine, while China has just recently seen an explosive surge in June. Chinese vehicle demand has dealt with the same effects as North America combined with further intermittent lockdowns for COVID this year that continue to cause market ripple effects.

Notwithstanding persistently strong EV demand, near-term demand for new internal combustion engine cars in China dropped significantly at the start of the second quarter and lockdown-related disruptions to various automotive component supply chains reach havoc in global automotive volumes. Yet we have already started to observe a strong rebound of sales of light duty vehicles in China exiting the quarter after [indiscernible]. We will see if the current new vehicle acquisition tax incentive sustains this improved demand through the end of the year.

The manufacturing sectors particularly automotive in Korea and Japan have languished longer than in other economies. Indications from automotive OEMs show that unit volumes are down 10% to 15% this year and will likely continue to decline through the back half of the year. Both Honda and Toyota have recently signaled semiconductor chip challenges that will further reduce anticipated production in the coming quarters reflective of a softer market in Japan.

In the balance of these supply chain disruptions, rare earth pricing remains substantially higher compared to last year. Our product average selling prices were about 50% higher compared to the previous year as to the prior year as longer term trends discussed last quarter remain intact. For magnetic rare earth, such as neodymium-praseodymium pricing has eased through the second quarter and recent prices are down about 10% to 15% compared to the start of the year.

This is largely reflected to the diminished demand within in China during the second quarter, as the intermittent shutdowns related to COVID created some artificial drag across the industry. COVID impacts are continuing here as just this week China was forced to scramble to stem new Omicron outbreaks in the hubs of Tibet in the province of [indiscernible] Tibet and Hainan.

We are seeing reports of magnet production being down 20%, 30% with some of the smaller producers facing serious questions on their survival. Motor manufacturers that fell victim to the ups and downs created by the semiconductor chip shortage are still sitting on inventories that led to some decreased magnet buying during the quarter with prices for rare earth precursor materials slipping in step.

Taking a broad view, we will continue to see some demand for all of our internally produced neodymium-praseodymium molecule. At current pricing levels, innovation from our end customers continues. So what does this mean for Neo, our employees, our shareholders, and all of our stakeholders? Our manufacturing operations around the world remain efficient, but fakeness of the second half of this year's means that a sales pipeline has inherently a bit more risk today compared to the first half of this year. While we acknowledge there is increased uncertainty, we repel back the layers, we are still finding general positivity from many of our customers.

What this looks like is that orders are not being canceled, but customers may request to delay partial shipments as they catch up to downstream supply chain disruptions. Although raw material costs, reagent costs and other general input costs have been increasing over the last few quarters, we have been able to maintain our margins despite these cost pressures. And with operating leverage across our P&L, we have been able to expand our adjusted EBITDA and overall profitability by more than 200 basis points versus the previous five-year average. Most of that has come with the automotive industry, remaining down 10%.

It's important to note that our operating model is intact and our strategic growth initiatives remain on track. With substantial exposure to the automotive, aerospace, electronics and consumer good sectors, we adamantly believe long-term demand for advanced product remains robust. As the automotive industry reverts back to producing more than 90 million units per year, and electric and hybrid vehicles maintain their [indiscernible] growth rates, we believe that Neo will continue to be the preferred supplier of innovative materials that will outcompete and will be designed into our customers technologies over the next decade and beyond.

One effect of the current macro challenges is that normal seasonality can be thrown to the wind. Some of you will recall previous conversations on earning call after a quarter where we stress the seasonality that seems to be gone by the wayside as we speak. While European summer holidays are still in effect, production lines are operating if and when semiconductor chips arrive at the assembly door. Consumer electronics productions expected to moderate through the back half of the year, rather than wrapping up to meet normal Q4 holiday demand. Recent industry estimates have revised personal computer demand to be down about 10% this year as schools and offices reopened globally and the at-home surge for electronics in 2020 and 2021 eases.

Demand for hard disk drives and associated motors for servers that acquire a bonded permanent magnet solution will likely be needed as well. Yet our Magnequench volumes continue to grow for those consumer home appliances, improve deficiency technologies for automotive applications and thermal management devices for electronics, including 5G stations, servers, laptops and gaming devices.

Let me give you one highlight. Thermal management in both electric vehicles and hybrid vehicles is a big thing and a good casing point. There are a number of sophisticated motors beyond drive-trains that use rare permanent magnets. Within both electric and hybrid drive-trains, if various battery system components do not operate on optimal temperatures, battery performance and vehicle range can be adversely impacted. Systems need to be actively cooled or heated depending on the required function. All of this is done by synchronizing the refrigerant circuit with the coolant circuit to transport heat to and from different components.

Neo's Magnequench product development team has been working closely with major Tier 1 automotive suppliers in Europe, China and Japan on the supply of magnets for two very complex sophisticated small motors for these systems. One is a coolant proportional valve, which performs temperature regulation in the coolant circuit while interconnecting the battery and electric axle. The other is a coolant valve, which controls the refrigerant flow to switch from heating to cooling loads. Together with another controlled mechanism enable the design of an intelligent thermal unit for electric and hybrid drive-train.

Our Magnequench rare earth magnets are vital to these systems operational precision, size and weight, all of which help to optimize battery performance and extend vehicle range. And we have the critical know-how and credibility with customers to help them develop these next-generation technologies. We see sizable growth opportunities for our materials in vehicle micro motors, which should nicely complement our plans to expand more significantly into vehicle traction motors.

Similarly, we are developing next-generation mixed oxides with new functionalities for hybrid and internal combustion motors. While the transition towards the 2050 net neutral, glide path is in front of us, improvements are also required for traditional gas, diesel and hybrid platforms. We continue to believe that there will be a place to decade and beyond for those new products. Our portfolio for aerospace and electronic rare metals continues to outperform our internal expectations despite aerospace also observing supply chain disruptions for key components.

By diversifying our new product applications, we adapt into a strong value add portfolio that contributes meaningfully to our bottom line. And now that aerospace production and next-generation electronic chip technologies continue to improve. Our rare metals team is working ideally to meet those needs with both primary and recycled metals for super alloys and other critical applications.

Operationally, we continue to make strides in improving our manufacturing sites and enhancing our customer relationships. We are pleased to report that our Magnequench facility located in Tianjin, China was recognized with an advanced safety production award this past month. We are selected as one of 10 companies to receive this honor, out of more than 1,200 eligible enterprises in the area.

Our teams have been building the culture of accountability and safety for years in everything we do and we are proud of the systems we have implemented. These systems focus on worker safety, identifying dual prevention methods, ensuring continuing maintenance and improvement and effectively managing and communicating risks and preventive measures with both our employees and local government authorities.

It's a tremendous honor for the teams who have received this recognition. It also sets the tone as we further implement and integrate ESG tracking systems as we continue to outperform our chemicals and metals industry peers on health, environment, safety and sustainability metrics.

Our Magnequench and rare metals teams have quickly moved forward to set up ESG working past teams to help investigate and implement our strategic initiatives following our published sustainability report. In the same manner that our teams have organically built strong safety systems, we are methodically working through a long-term planning for sustainability systems, which are the frequent subject with customer and other stakeholder inquiries these days.

In Europe, we also continue to make headway with our sintered magnet expansion plan. Our Magnequench teams are progressing rapidly on engineering, permitting, and construction planning for a greenfield Neo magnet manufacturing plant in Estonia to serve European automotive OEM and Tier 1 customers, who clearly want us to make these products there as they ramp up electric vehicle production. Estonian government leaders also continue to express the support for assembling the financial packages necessary for us to make a final commitment to proceed. We very much appreciate their continuing support.

The key reason that we expect Neo will continue to outcompete is our proven commitment to ESG principles with traceable and diverse supply chains that operate across every major region, Asia Pacific, Europe and the America. Advancing our ESG agenda is not only a matter of corporate citizenship, it is an integral part of our long-term strategy to increase the profitability of our business.

While some skepticism, perhaps even cynicism is evident as examples of ESG [indiscernible], we like to differ with our peers. In fact, we are finding that the world's leading OEMs and Tier 1 component suppliers not only require adherence to more rigorous and responsible principles, but they are backing it up with higher price commitments to secure responsibly sourced materials and components.

When lowest cost is no longer the primary determinant, then the real glide path towards decarbonization can be accelerated. Were we not bound by confidentiality obligations, I'd love to share with you specific conversations with large global customers clearly expressing their view, which is a marching order for us and should also be for the rest of the industry that they will reward, and I quote, “competitiveness beyond total cost ownership.” It is for this reason that our European expansion strategy included identifying a site that would be largely independent of Russian gas supplier disruptions, increasingly powered by renewable energy, expanding optionality of upstream resource feedstock from more jurisdictions and pursuing end-to-end circular vertical integration for magnetic materials.

We are confident that Neo sintered magnets will be produced in Europe with some of the industry's lowest carbon footprint and adhering to the highest ESG standards in our industry. This will result in Neo’s magnets being the most long-term competitive option for European EV manufacturers and other permanent magnet motor producers, as it will help our OEM customers to continuously improve their lifecycle assessment, which is an increasing priority for them. We believe that this set of value differentiators will drive long-term growth and profitability for Neo. We also aim to further diversify our sources of raw materials, and we have significant experience in assessing strategic mineral resources around the world.

I'd like to share that we are in the late stage efforts for potential transaction that would provide Neo with rights to very attractive magnetic materials rich mineral resource. This type of diversification would further and ideally complement our current European rare earth magnet growth strategy. This is in addition to our current supply agreement for rare earth concentrate that is being shipped from the United States by Energy Fuels out of Utah.

We have been especially pleased with the cooperation by Energy Fuels to improve the quality of their feedstock, heavy mineral sand base concentrate that skews favorably towards the magnetic elements. We are also very supportive of their efforts to secure raw material resources globally, as evident by the latest deal in Brazil. The global rare industry is being remained and we are happy to be working with the right partners in both directions of our supply chain.

It is also important to note that we have not experienced any supply disruptions from our rare earth material suppliers related to the conflict in Ukraine. The ongoing sanctions programs around the world continue to evolve and we are diligently monitoring the situation. Our raw material sourcing from outside of Europe continues on its course for both rare metals as well as chemicals and oxides.

From an operations planning perspective, we anticipate that a potential natural gas shortage to the chemicals industry may tighten the supply of certain processing reagents and other materials that we utilize, but we do not expect to have any direct or lasting impact on our ability to operate a rare metals facilities. There is also minimal usage of Russian natural gas in our European operations, either directly on site or indirectly as a primary source of energy generation as electricity generation is now primarily derived through local biomass.

While we continue to monitor the situation we pulled back on sales and ancillary products to certain firms that might indirectly ties to sanction Russian enterprises. We believe and overly cautious approach is prudent given the highly opaque and fluid ownership structures of many private enterprises in Russia.

I'm proud of our team's ability to navigate the current supply chain headwind and I'm confident in our ability to continue to deliver exceptional products to our customers in any region. We have seen challenging price and supply demand environments before and we know what it takes to deliver innovation and new technologies. Our current operating profile remains strong and we remain acutely focused on further diversifying our upstream while material supply and delivering environmentally sustainable materials for our customers.

I’ll now turn the call over to Rahim for financial details on the quarter.

Rahim Suleman

Thanks, Constantine, and good morning, everyone. Through the first six months of the year, we are pleased to report that our product sales and operations perform largely within our expectations and at significantly higher levels in past performance. The second quarter continued to show very strong sales performance driven by sustained elevated pricing environment. Customer demand for our products mostly remained healthy during Q2 noting that Constantine elaborated on the overall macro events that have led to heightened uncertainty across several industrial sectors.

In particular, our geographic sales profile during the quarter was underweight toward Japanese customers as the supply chain interruptions of semiconductor chip shortages more acutely impacted some automotive component manufacturers there. This is particularly true as the driver for our lower Magnequench volumes, but we remain confident in our relationships with our customers and the programs that we have secured that the lower volumes are related to macro effects rather than company specific issues.

For a review of the quarter, we reported a record sales figure of $168.2 million driven primarily by increased pricing, which is about 50% higher compared to the prior year. This improved pricing profile for our value-added products helped offset volume declines the causes for which were discussed earlier.

As a reminder, the first half of 2021 had unusually high volumes as the advanced material space refilled downstream supply chains following the 2020 COVID year. We reported net income of $14.7 million or $0.36 per diluted share, an improvement of 13% over the prior year, and we reported adjusted EBITDA of $26.5 million and 19% improvement over the prior year.

On a sequential basis, our profitability remains near all-time highs, but declined relative to the prior quarter related to the lead-lag effect as our cost of sales began to catch up to a slowing pricing environment. General rare earth pricing remains at recent historically high levels, which continues to provide enhanced topline and additional dollar value margin in our income statement. Pricing for the magnetic materials, such as neodymium, praseodymium, terbium and dysprosium moderated a little in the quarter while remaining significantly higher than recent previous years, while other key rare earths were largely stable.

Although our pass-through pricing mechanisms and focus on our value-added margins are largely agnostic to these price movements over the longer term, the second quarter had a mix of some positive and some negative impacts related to lead-lag. These dynamics make it paramount for us to be more selective in our raw material sourcing and is a testament to our ongoing focus on strategically expanding our base of raw material suppliers. There remains adequate raw material feedstock in the market today and our local teams remain perfectly positioned to pursue the most economically beneficial sources available.

We are diligently managing our inventory volume levels and seeking whenever possible to convert higher priced inventory units into cash. The fundamental economic model remains intact and our free cash flow position improved in the quarter. This is entirely normal following a relatively volatile pricing environment. In a rising pricing environment, we will see the benefit appear first on the topline as shown by the recent quarters record performance and then cash generation flows through as pricing stabilizes.

Our cash flow from operating activities improved sequentially from the first quarter by nearly $14 million and our additional investment in overall working capital slowed substantially. If current pricing environments remain stable, we would expect to not to continue to build working capital as we have in the last year, but rather we would convert more earnings into cash.

Our balance sheet remains healthy with $66.2 million of cash and cash equivalence and our net cash position improved sequentially. During the quarter, we also invested $2.6 million into plant, property equipment and distributed $3.2 million in dividends to shareholders. As we pursue our strategic growth initiatives, including the expansion of our Magnequench portfolio into sintered magnets outside of China and the relocation and expansion of one of our primary mixed oxide production facilities, we anticipate that we will fund these initiatives primarily through a combination of our existing balance sheet strength, cash generated from operations and debt financing, both existing and anticipated.

We remain committed to pursuing our long-term strategic growth initiatives and are well-positioned to take advantage of long-term trends for new precision motor innovation, next-generation catalyst technologies, and further improvements in aerospace and the electronics industries.

I'll now turn the call back to Constantine for closing remarks. Constantine, are you with us?

Constantine Karayannopoulos

Sorry, Rahim. I was on mute. Thank you. There is a lot of positive momentum occurring throughout the company and we look forward to continuing to update all of you on our strategic growth initiatives. While I usually prefer not to comment on Neo’s relative valuation in this forum, it is obviously a key piece of information that myself, our Board of Directors and our shareholders are keenly aware. Suffice to say that we do not believe that Neo’s underlying value proposition and growth potential are adequately reflected in our market value today.

We are proud of our accomplishments over our past 12 months, and we keenly focused on locking additional growth through our sintered magnet expansion plans within Europe and whatever comes next after that. Yet the trading range of Neo’s common shares over the past quarter, in my opinion, is more reflective of mature, conservative value oriented companies rather than a growing advanced materials, specialty materials leader that is supplying some of the largest high profile companies in the world.

For those of you who know me and our management group, as well as our company's history and culture, you very well know that we are not stock promoters. So shamelessly plagiarize our friend and partner, Mark Chalmers, CEO of Energy Fuels, we're doers, we're not talkers. We have a longstanding record of executing to plan in order to build sustainable value. Yet at least in trading levels, we are entering territory where we as management and the Board were fiduciaries are required to evaluate strategic alternatives. We believe adamantly in the underlying value of our business. And if partnering with others that also recognize that value or otherwise pursuing new path will help to accelerate our growth then we will strongly consider it.

Listen, I thought long enough, I appreciate your understanding and neither I nor the company will be taking additional questions on this specific topic, but we'll be happy to open the lines for other questions at this time. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We will take our first question from Yuri Lynk with Canaccord Genuity. Please go ahead.

Yuri Lynk

Good morning. Constantine, you talked about being in the late stages of a transaction to secure some rare earth feedstock. Can you provide any more detail on that? Are we talking about an investment in a mine or is it a byproduct type of deal and any comments on the geography?

Constantine Karayannopoulos

Yes. Thanks, Yuri. I've hinted at this in a previous call in the last couple of months, we've gotten into the details and we're getting pretty close as I said in my comments. It's a deposit. It's not a mine. It's a primary deposit in a friendly jurisdiction, high ESG jurisdiction. And also one that would allow us to have fairly limited carbon footprints with regards to supplying that material to either our plant in Europe and Estonia or through North America.

Beyond that, given that there is some – a few more conditions to come together. There's a couple more shoes that need to drop before I can openly speak about it, but we're very pleased with what we managed to do. And this is again part of our vertical integration strategies, both downstream and upstream, but we're certainly very pleased with the state of affairs and how much progress we made here, but I can't really comment much more on that.

Yuri Lynk

Okay. And what type of capital commitment are we talking and source of funds?

Constantine Karayannopoulos

Sure. It's shockingly low. I mean, we're certainly not betting the farm and we're funding that of cash flow. It's not going to put a dent in our working capital or anything like that. So I do expect that we should be able to comment in the near future about it. Right now, I really can't provide any more information.

Yuri Lynk

Understood. One for Rahim, just with rare earth prices leveling off, declining slightly in the last few months, should we be expecting Q3 margins to kind of approximate your historical run rate?

Rahim Suleman

Yes. I think there's probably a mix in there. So I think that generally as prices have now been at least reasonably stable for six months, that's a true statement that things will return to normalized margin levels without the lead-lag. But as we've mentioned before higher pricing levels, and we certainly are at higher pricing levels do allow more dollar value margins. So we’ve been independent of lead-lag certainly I think that the benchmark is higher than historicals.

Yuri Lynk

Okay. I'll turn it over there.

Constantine Karayannopoulos

Yuri, before you go, let me jump in and also want to stress that the deal that I'm referring to – the upstream deal that I'm referring to just because it's not going to put a dent in our cash balance is not going to be a diluter. We're not going to use stock to do it either. So it will be a non-dilutive fairly with a very strong security of access to the material. But again, we should be able to talk more about it the next little while. So we'll have a lot more to say at that point.

Operator

We'll take our next question from Frederic Bastien with Raymond James. Please go ahead.

Frederic Bastien

Good morning.

Constantine Karayannopoulos

Good morning, Frederic.

Frederic Bastien

I know you have provided some goal posts in the past, but I'd like to go over your expansion plans in Estonia again, and what sort of capital requirements you're looking at. Perhaps let's start with the easiest one, your ambitions to increase rare earth processing capacity, which obviously is natural expansion of what you're already doing at summit. What are your ultimate capacity goals and whether it's doubling or tripling capacity and what kind of investments are you contemplating to get you there?

Constantine Karayannopoulos

Thanks Frederic. Yes, it's a multifaceted question. Our expansion in Estonia and whatever upstream deals we put in place will continue to be driven by our magnet expansion. At this stage, Phase I of what we're planning to build for magnet capacity can be adequately serviced through our existing capacity, Phase II will require either buying more NdPr and DY, TB in the market, or putting together an expansion something in the order of doubling perhaps a bit more of our existing capacity, a rare earth separation capacity in Estonia and even more so expanding into heavy rare earth production that we expect will be in the tens of millions of dollars in order to achieve that. And for us, of course, it's a lot easier to expand an existing facility than to build a grassroots or greenfield rather facility somewhere where the infrastructure doesn't exist.

So perhaps the cost – the capital cost of an expansion in rare earth production around Estonia will be significantly lower than any other greenfield projects that you maybe familiar with. However, the progression of that development will be Phase I magnet production first followed by Phase II magnet production and a simultaneous expansion in capacity or additional arrangements to provide that security of supply through external suppliers. Does that make sense?

Frederic Bastien

Yes. It's important to not put the cart before the horse now. Now turning to the magnet plant, do you have an estimate of what it will cost and how long it would take to build from the moment you break ground, perhaps starting with that first phase and then moving onto eventually a second phase?

Constantine Karayannopoulos

Yes. Phase I, we're looking to do something in the order of 1,500 tons a year of alloys, which would translate into something in the order of 400 tons a year magnets. That number keeps creeping up given the feedback from customers, both Tier 1 and OEMs in Europe. So I wouldn't be surprised if by the time we break ground, the final design is even higher than that. But round numbers, that's sort of the ballpark that we're looking at. Phase I, we expect it will cost in the ballpark of 50, perhaps with inflation and material price pressures, raw material price pressure rather $50 million to $60 million to put it all in place. And Phase I plus Phase II, which would see this go to something around the 5,000 ton a year magnet capacity should be in the $200 million ballpark.

Again, now we would have access to a number of funding mechanism both grants and low interest loans in addition to our own balance sheet and other more market loans reflecting ongoing rates. But we maintain pretty confident that we can finance this capacity extension in this new plant production – new plant construction adequately. In terms of timing, I think what we're talking about is a construction period of the better part of the year. We have the major components identified. We have been having conversations with the key component suppliers and I do expect that if we were able to break ground by the end of this year, we should be in a position to start production or ramping up by the end of next year. So it would be a 2024 ramp up event, that would allow us to hit the ground running at full capacity by 2025, which is really the objective that we're trying to meet as expressed in terms of demand by one of the largest OEMs in Europe that really need us to be in place and operating by 2025.

Frederic Bastien

Okay. That's super clear. Thanks so much. And then maybe my last one, how much of government assistance are you looking for with respect to partly funding that expansion?

Constantine Karayannopoulos

In Phase I because that's – we are engaged with folks on these discussions for Phase I. We're looking, at least what we anticipate and what is been expressed in terms of all the discussions we're having is something in the order of about a 20% capital grant. So out of the 50 or so will we expect to get something in the order of $10 million or just north of 10, anything more than that would be a pleasant surprise, will be welcome, of course. But we think that this is very doable and it’s well within the parameters of the granting mechanisms in Europe as part of the various funds that have been designed to promote green technology and supply chain resilience.

Now for Phase II, I would expect – yes, Phase II would be a bigger project and they would qualify for grants under different programs that we expect could be even larger than the 20% ballpark that I mentioned. But that's another ball of wax. I don't want to get too far ahead there on this.

Frederic Bastien

Yes. That's great. Thanks. And it's pretty exciting. Good luck with everything.

Constantine Karayannopoulos

Yes. Thanks Frederic. We're definitely excited ourselves.

Operator

We'll take our next question for Mark Neville with Scotiabank. Please go ahead.

Mark Neville

Hey. Good morning, Constantine. Hi. Good morning, Rahim.

Constantine Karayannopoulos

Good morning, Mark.

Mark Neville

Hey, good morning. Do you mind just repeating, sorry, what you said about the strategic alternatives?

Constantine Karayannopoulos

Sorry, the strategic. What?

Mark Neville

Yes. Do you just mind repeating sort of what you said about the strategic alternatives? I just did catch what you said, sorry.

Constantine Karayannopoulos

Well, I'd be happy to read my script.

Mark Neville

Sure. Yes. That's fine.

Constantine Karayannopoulos

Yes. Perhaps there was some frustration that was coming through in my comments that given the performance of the company, we look at the share price and there's disconnect there and we can't really bridge that. All I was saying is that as we're being approached by folks who want to do things with Neo, we will be a bit more receptive than we would've been say year-ago, simply because if we see opportunities to do something a bit unconventional to increase value for our shareholders, we will look at alternatives that perhaps we were not willing to look a year-ago, simple as that, whether those are private equity, private taxation, M&A, whether it's the whole range. There are a number of conversations taking place, but of course, I can't say much more than that, but all I'm saying is that we are much more receptive to approaches and those approaches are materializing.

Mark Neville

Okay. Fair. Maybe just on the following the Yuri questions on the upstream. It sound clear, you're not looking to get into mining, correct? Like it's you said it's a – yes, sorry.

Constantine Karayannopoulos

Yes. We're not looking at an existing mine, but we are looking at a deposit that could become a mine. Again, it will become a lot more clear when we are able to talk about it, but honestly, when you have mining companies looking to become magnet companies and enjoying multiples that are in the stratosphere, I think it only makes sense. From a business point of view, beyond markets and shareholder expectations, I think it makes all sense in the world from an operating perspective to be looking to secure our upstream. This is what our customers need. If we could – we are buyers in the market, which means we cannot control either our cost of raw materials, or we cannot control – we cannot fix our prices or make our pricing a bit more predictable. And this is something that supply chains desperately need.

The OEMs, the Tier 1s are screaming for price predictability, and unless we own the dirt in the ground, we cannot give them that, that's all we're saying. And this is really an effort not only to diversify away from resources that have to come a long way from a long way away, but also to create a cost structure that is a bit more predictable and we have a bit more control over it. That as simple as that, Mark.

Mark Neville

Okay. The grants that you're waiting on or you're talking about Phase I, is that with the Estonia government or is that with the EU?

Constantine Karayannopoulos

Well, it's EU funds that have been awarded to Estonia to distribute as they see fit, but also every grant needs to be blessed finally by the EU on ESG and other grounds. So it's a bit of both. The Estonia government needs to pick the project that they will fund, but then ultimately those projects need to be also approved by Brussels. So it's a bit of a circular approach.

Mark Neville

Yes. Okay. And do you – or could you share with us sort of where you're at on the process or where the application is if it sits with Estonia or EU.

Constantine Karayannopoulos

Yes. Originally, as I said in previous calls that process – the file submission is opening up for all of Europe at the beginning of September. Estonia through their efforts and our efforts opened the process a little sooner. We had filed that we've gone back and forth to the various officials in the government. We are getting feedback. We think we're in an excellent position to qualify for that support. But again, as I said the decisions by the Estonian government have not been made other than we've only received encouraging signs and positive feedback on the quality of our file, but no decisions yet. And once the Estonia government makes that decision or that recommendation, that decision needs to be approved by Brussels, so we're still in the early parts of the process, but we're way ahead from where we were three months ago.

Mark Neville

Could you start construction work before the grant, or would that disqualify you from the grant?

Constantine Karayannopoulos

No, no. We can start today, if we wanted to. Just that given how politics works and how priorities tend to shift in Europe, I would rather have iron cloud assurances that the support will be there. I mean, if the support is not going to be there, I think we'll need to make our decisions. And frankly, the project is attractive enough that we would eventually go ahead on our own without grant support, it’s just that in order for the economics to make sense. And as I said, I think on the previous call, this is part of managing the financial risk of the project because the market risk and the technology risk we’re pretty comfortable with.

The financial risk needs two unknowns to come together. One is, the pricing and the whatever premium to less attractive alternatives exist for European customers. And the second is CapEx support, which is this, I think when it all comes together, it makes for a very attractive project. If one of those two parameters is not there, the project is not as attractive, but still doable. So we would prefer to make sure that all of those conditions are in place before we start. But if things get too delayed, we might – as you said, we might decide to go alone without grants that would not be our preference.

Mark Neville

And the pricing arrangements you would negotiate with the OEs or the clients, the customer sorry. How exactly would that work? Again, you made the comments a few minutes ago, but not controlling your feedstock and the price. So I'm just curious, how would you – how the long-term pricing arrangements work?

Constantine Karayannopoulos

Well, not too differently from what our pricing arrangements are now, where we do have a formula with pretty well every one of our magnet customers – our Magnequench customers that the price gets adjusted either monthly or quarterly or semiannually or annually given what happens to the prices of our raw material inputs. I would expect to see that formula continue until because – and that's the reason. The main reason for that is none of the major raw material produces, none of the mining companies [indiscernible] not Lynas or MP Materials are willing to provide long-term predictable pricing, it's all spot. And of course, that cuts both ways, mind you. But I believe that if a company like us eventually controls its raw material cost, then we would be much more willing to at least a portion of that output, sell it at much more predictable longer term pricing contracts.

Mark Neville

Got it. And sorry, just last sort of digging up all the time. But one last question, Constantine you mentioned, I think mixed oxide capacity relocating, some of that. I think that's new, maybe not, but can just maybe talk with that?

Constantine Karayannopoulos

Yes. This is a project in China that we've referred to in the past and talked about in the disclosures. We are upgrading and moving our mixed oxide capacity within the same area to a new industrial park. And that's something that we've been working on it for about a year or so. We are in the process of doing that.

Mark Neville

No, sorry. I thought you were referring to something else, so that's clear.

Constantine Karayannopoulos

Yes. Cancel the project; we talked a little bit in the past about it.

Mark Neville

All right. Yes. Thanks again for all the time. Really appreciate it. Good luck guys.

Constantine Karayannopoulos

Okay. Yes. Thanks, Mark.

Operator

We'll take our next question from David Ocampo with Cormark Securities. Please go ahead.

David Ocampo

Thanks for taking my questions. Just a couple of quick headers, Constantine, just to follow-up on the pricing dynamic that you're talking about there. Are your customers willing to pay a premium for diversifying their supply chains and sourcing material from Europe as opposed to China?

Constantine Karayannopoulos

The short answer is, yes. However, that premium comes with a lot of strings attached. It comes with high ESG performance. It comes with low carbon footprints. It comes with a circular operation. It comes with supply chain resiliency and so on and so forth. So it's not – they're not going to pay us the premium just because they like us or just because we're neighbors in Estonia. We need to put all those things together in a way that make sense and allows them as I refer to like comments to continue to reduce their life cycle carbon footprints, life cycle effect and so on. So it's not a simple case.

And please don't take my comments wrong. This is not clearly, it's not an effort to lessen dependence from one particular jurisdiction – on one particular jurisdiction. Although, at any time you have a supply chain concentration in one jurisdiction that comes with inherent risks, as we are finding out continuously with lockdowns and so on and so forth. So I think it's not healthy for the industry to be reliant on one particular jurisdiction for the vast majority of its purchases. So I think supply chains are coming together perhaps in slightly different ways in order to make those supply chains much shorter, much more local and much more resilient. And we are trying to take advantage of that. But at the same time, that performance needs to come together with an extremely high ESG set of practices that allow all these OEMs to deliver on promises and expectations that they have been making and withstanding over the last few years. David, I don't know if that answers your question, but…

David Ocampo

No. That was good. And I'll leave it there, since we're coming up on the hour. Thanks so much guys.

Constantine Karayannopoulos

Okay. All right. Thanks you.

Operator

We'll take our next question from Ian Gillies with Stifel. Please go ahead.

Ian Gillies

Good morning, everyone. With respect to funding of Phase I in Estonia, you mentioned a $10 million grant, potentially coming in. Is there additional government financing outside of this through a loan as well? Because if we go back in the course of time, I think at one point this was thought to be funded kind of 50% through government funding and 50% through cash on hand or some other source of funds?

Constantine Karayannopoulos

Yes. Listen, in addition to the grants there, both EU and the Australian government made it very clear. We have been in discussions with funding agencies in Europe, whether it's the European Bank, EBRD and so on, who've made it very clear that the project we qualify for low interest loans. To what extent, that will be the case. We will go soon enough. But yes, the idea is to provide a financing package that includes grant, low interest loans, perhaps some market loans and their own cash.

Ian Gillies

Okay. That's helpful. And just I wanted to get one last clarification on the comments around potential strategic alternatives. Are you able to say whether you're actively engaged or would you just qualify what's going on right now is interesting conversations.

Ali Mahdavi

Yes. It’s Ali. We've made it clear that there is no questions on this. Obviously it's not the forum to discuss anything material like this. But it was just more indicative of our view on valuation. So we'll leave it at that.

Ian Gillies

Okay. Thank you. That's helpful.

Operator

We have no further questions in the queue. I would like to turn the conference back to the presenters for any additional or closing remarks.

Ali Mahdavi

Thank you, operator. On behalf of the Neo team, again, we'd like to thank you for dialing in today, getting the update on the quarterly results. If you have any questions as usual, please feel free to reach out to any one of us, I'm available. And we look forward to further updates, which will be coming out. And as Constantine said, stay tuned. We've got a lot of good things that we're working on. That concludes today call. Have a great weekend. And I’ll pass it back to the operator to close the call.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s conference. We appreciate your participation. You may now disconnect.

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