Neo Performance Materials Inc.

Thank you, operator, and good morning, everyone. As a reminder, today's call is being recorded, and a replay will be available starting tomorrow in the Investor Center of our website located at neomaterials.com.

Thanks, Ali, and good day, everybody. I hope everyone is safe and well.

We are pleased to report our first quarter results, showing a very strong start to the year. Neo reported sales of $130.9 million in the quarter, adjusted net income of $15.1 million, adjusted EBITDA of $22.4 million, which more than doubled from the first quarter of last year.

The momentum and trajectory that we described on our third and fourth quarter earnings calls have pretty well remained in force. The resulting aggressive product demand within our Magnequench and Chemicals and Oxides business units fueled our financial performance to record levels.

Many of our production lines are operating at what is essentially full capacity and we are carefully managing incoming order flow and production planning to ensure the reliable supply to our customers continues. In some of our key sectors, such as automotive, home appliances, consumer electronics, we anticipate this strong demand will likely remain at elevated levels for some time.

Neo's growth this year is reflective of what has been reported in recent production manufacturing indices. PMI numbers out of the Eurozone have indicated the fastest pace of production growth in more than 20 years, particularly in Spain, Italy and Germany.

Of course, all economies are rising from the figurative ashes of the worst global pandemic in a century, but the growth trajectories we are seeing are clearly and nevertheless impressive.

Thanks, Constantine, and good day, everyone. The powerful volume trend with Magnequench and Chemicals and Oxides continued throughout the first three months of this year and contributed to our strongest quarterly financial performance since becoming a public company again in 2017.

We saw very strong demand in our magnetic powders, our compression molded magnets, our environmental auto catalyst products, our gallium trichloride products and several other rare earth products, generally tied to magnetic applications and semiconductor markets. As a result, our product volumes shipped during the quarter set new records for both Magnequench and Chemicals and Oxides since Neo relisted as a publicly traded company.

Product volumes were supported by an increasing trend in pricing for rare earth elements in the global markets. This trend with the higher average selling prices in our Magnequench products and many of our Chemicals and Oxides products.

As we noted in our Q4 2020 call, global prices for magnetic elements were up some 70% to 100% over Q3 2020 before retreating some 15% to 20% in recent weeks. The combination of higher volumes, higher prices supported by positive mix attributes, benefits of lead-lag on material costs and the benefits of better absorption from higher volumes, all led to the stronger results achieved this quarter throughout our business.

In this morning's overview of our results, I'll provide a comparison to both the prior year quarter and the recent sequential trend from the fourth quarter of 2020, given the current state of recovery in many of our end markets, the sequential trend is likely more important to ascertain the current state of our business. It's worth noting that strong growth year-over-year is based upon a mixed first quarter from 2020.

At that time, the adverse impact of COVID-19 was just beginning to be felt and was mostly limited to the specific geographies within China and Asia. Accordingly, our first quarter 2020 volume outcomes were mixed as the COVID epidemic transitioned into a full global pandemic.

The second quarter of 2020 realized the full brunt of shutdowns and stay-at-home orders, and as such, in the second quarter of this year, as we begin to lap the worst period related to COVID, we expect to report extraordinary growth in our financials. However, our key expectations and targets is to continue to grow from other historically normalized quarters.

Turning to the quarterly results. On a consolidated basis, during the first quarter, we reported $130.9 million in revenue compared to $90.7 million in the prior year period and $110.4 million during the fourth quarter of 2020.

We reported net income of $7.6 million or $0.20 per diluted share, our adjusted net income in the quarter was $15.1 million or $0.39 per diluted share. We reported adjusted EBITDA of $22.4 million, which compared to $9.6 million in the prior year period and $12.3 million in the fourth quarter of 2020.

Layered on top of this fundamental strength and demand, innovation across many of our product portfolios is resonating with our customers. We believe we are continuing to gain increased market share in both magnetic and catalytic applications.

This is evident in our Magnequench volumes, which reported a record 1,725 metric tons during the quarter. This compares to 1,271 metric tons in the prior year period and 1,626 metric tons during the fourth quarter of 2020.

We have observed many of our customers working diligently to refill their inventory pipelines as general economic activity recovers. While this strength was almost across the Board, I'd highlight the continued growth in automotive pumps, hot water circulation pumps, advanced electronics and home appliances.

We continue to be encouraged by the progress made in electric motors across the automotive platform, regardless of drivetrain. That said, our EV specific product portfolio is trending in the upward direction.

Traction motors and motors related to thermal management, such as active grill shutters and cooling pumps have an important significance as electric vehicles continue to dominate the engineering bandwidth of the OEMs. I think it's worth pointing out that Magnequench powder solutions that are specific to hybrid and electric motor applications have grown tremendously over the past few years even growing through the COVID riddled 2020 period.

Our emerging magnet business continues to exhibit strength in electronics and has now been expanded to focus on additional automotive applications. As Constantine pointed out, our magnet business albeit still relatively small has more than doubled the volumes since Q1 2020, and we will continue to invest in further capacity to accommodate this continued growth that we see from a number of customers and across a number of applications.

The long-term macro growth trends around electrification, lightweighting, increased use of sensors and actuators and improved performance remain long-term tailwinds for this business. Over the short-term, we expect the recent pace of inventory restocking to temper along with the potential adverse impact of the semiconductor shortage on the automotive sector.

Regardless, we are encouraged to start the year with an aggressive showing. Shifting to our Chemicals and Oxides business unit.

Revenues for C&O were $54.4 million in the first quarter compared to $33.5 million the prior year period and $48.4 million during the fourth quarter of 2020. The increase in revenue was driven by both improved pricing and improved volumes.

Pricing across rare earth separations business was higher during the quarter compared to the prior year, again, as the magnetic and heavy elements continued the upward progression that we have seen since the fourth quarter of 2020 and continued through most of March. This general upward trend in pricing leaves more opportunity for margin in providing rare earth solutions to our customers as well as provides a lead-lag benefit in the current quarter.

Within our auto catalyst portfolio, our new innovative products continue to gain momentum with customers and overall product volume outpaced the recovery trend in light-duty vehicle sales. While we encourage the adoption of electrified vehicles, the reality is that the next-generation emissions technology for hybrid vehicles will continue to have a significant share of the market for consumer vehicles over the next 10 years.

The challenges of meeting emission standards when a hybrid internal combustion engine is in fact idle during part of the vehicle runtime, requires a much more complex catalyst emission system. We believe this is a key opportunity of growth within our catalyst portfolio, and we continue to develop innovative products to meet these needs.

Many of our customers are working to rebuild inventory and safety stock amidst the challenging global supply environment. While we are carefully monitoring semiconductor shortage and plastics resin shortage, potentially delaying customer's orders, we have seen a little impact on our orders to date.

Our Rare Metals segment reported $16.7 million in revenue during the quarter, a decrease from $20.5 million in the prior year period and an increase from $12.1 million during the fourth quarter. Comparison to the prior year quarter here for rare metals is a little different than for Magnequench in chemicals and oxides.

Rare Metals sales products, primarily the customers outside of China and Asia, and primarily into the aerospace industry among other end markets. When COVID began to impact China and Asia markets in Q1 2020, this was less the case for rare metals, but the impact to rare metals occurred in later quarters.

And in a sense was much deeper than Magnequench in chemicals and oxides. In the first quarter of 2021, we continue to see a slower aerospace market.

Although there are encouraging signs of recovery as Constantine mentioned. Our non-aerospace markets have demonstrated more recovery trends as well, including for products going into advanced electronics industries and the healthcare space.

Rare metals reported adjusted EBITDA of $900,000 in line with the prior year result and an improvement from our fourth quarter results. The loss during Q4 was related to a lower of cost or market adjustment related to inventory purchases during the first half of 2020.

When the full-year 2021 prospects for rare metals, we will largely be influenced by the direction of the aerospace industry. Our commercialization efforts to identify new products and applications is beginning to yield results.

Rare metals has made some key progress with expanding its customers and markets, so that even for products that were traditionally focused at aerospace, those products are now being qualified with new customers that have growth exposures to non-aerospace markets. While with this progress, we continued to see a path for our rare metals business that is non-adequately conveyed by the current level of financial performance, and we look forward to seeing these key initiatives having some impact in future quarters.

Returning back to our consolidated results, we reported SG&A expenses of $14.1 million, an increased from $12 million from the prior year period and a decrease from $16.1 million in the fourth quarter of 2020. They remain slightly elevated costs related to the secondary offering announced and completed during the quarter, and we incurred elevated legal defense fees in the quarter.

In the first quarter, we took a charge of approximately $7 million, which is shown in the other expense line item on our income statement. This charge is our estimated damages that could be awarded in the future because of a recent court decision in Germany to uphold a competitor's patent, which a lower court had previously invalidated.

We have appealed the previous infringement ruling, which is still pending and we intend to prosecute our appeal vigorously. The recent ruling will not have a material impact on future sales because Neo has not sold the effected products into the related markets for several years.

These expenses were slightly offset by some restructuring benefits within the Rare Metals business. We closed the quarter with $55.6 million in cash, a decline from $72.2 million at year-end.

And as noted, we anticipated a substantial investment in working capital with a combined $27.4 million investment in working capital balances. As we discussed earlier, we observed a substantial increase in rare earth costs and prices in the quarter, and these increases impact working capital requirements, both the costs for accounts receivable and inventory.

These higher inventory costs have started to work through the system and we anticipate an appropriate flow through in the cost of goods sold over the next several months. We invested $1.6 million into maintenance and growth-related capital projects and we also paid a dividend totaling $3.1 million during the quarter to our shareholders.

Our free cash flow conversion was 92% during the quarter and we remain confident that our cash balance and balance sheet provides ample liquidity to operate and to grow our business. With that, I'll open it up for questions.

Hey, everyone.

Hi, David.

I just wanted to zero in on your cost pass-through provisions here. Since, we've heard from several other companies that they've moved to annual pricing or even monthly pricing just given the amount of movements that they're seeing in raw material costs and freight costs.

So with that said, are you starting to see any customers pushing back against that? Or are you pushing your customers to reduce the lag time that you may have in your contracts?

Let me start with that Rahim, and I'll hand it over. David, the bulk of our business is on price adjustment formulas whether monthly, quarterly, semi-annually or even annually, but most of our business is on relatively short-term price adjustments.

Our customers are used to it. The markets are used to it.

We haven't had any significant pushback. There's always growling and then so on, but we've been able to put price adjustments through and we've done so whenever we've seen volatility and we've been quite successful.

So I expect that situation to continue. So perhaps Rahim can provide some additional color in this.

I think that covers most of the country unless David wants to go anywhere else. I mean, maybe the only other thing that I'd add is kind of – this has been strategically important for Magnequench for many years.

The one difference I would say in Magnequench now is the magnet business, which as you know we acquired a small magnet business last year that had grown that significantly. So for that business, it has been much more as you've described it where we are having to have more dialogue with our customers is as you know, the company that we bought didn't have pass-through provisions necessarily in all the parts, but our competitors are facing the same price dynamics that we are and we've been successful that having frank discussions with customers, they understand the market.

So it hasn't been an issue, but it's always something that we have to focus on. We have to be mindful of it.

We always work with our customers proactively and collectively on.

That's great. And then maybe just on the inventory that you moved this quarter, I imagine it's lower cost.

Is it possible to parse out what the margin improvement was from that? I'm just trying to get a sense on what the sustainability of the dollar contribution per ton is going forward?

Yes. I hear you, David.

But honestly, it's quite a difficult exercise. I think that we're all acknowledging that there's a significant benefit of pass-through of the timing of the lead-lag in the business.

We don't quantify it specifically quite honestly because it depends on how old every piece of inventory that you had was, what particular customer and what particular region bought inventory. So for example, a sale in China is actually pretty quick in terms of the turnover of raw material, whereas the sale in Germany would be coming out of inventory for several months back.

So we don't necessarily quantify the specific impact of lead-lag. But I think that we watched the trends and we watched the general movement, we understand the flow in our business.

So it's a healthy contributor to the quarter, but we don't have any number.

And do you have a sense on how much of that low-cost inventory is left on your books? Is it largely done in the quarter?

Price increases happened actually throughout the quarter. So even when we talked about prices that have come down in the magnetics and disposing in the like of 10% to 15%, maybe 20% since they are all-time highs.

The inventory we have in our books is not necessarily purchased at the time of the all-time high. So the inventory that we have in our books is at a lower average cost than the average selling price in Q1.

So therefore, we actually do expect that we would still see some lead-lag benefits at least through the first part of this quarter as we worked through some kind of the average purchases in Q1. And then maybe as we get to the end of the quarter or into Q3, we probably start seeing a little bit more normalization there.

That's great. That's my two questions.

I'll hand the call over.

Thanks, David.

Hey. Good morning, guys.

First off, great quarter.

Thanks.

Maybe just try to close the conversation on the margin. Just so I understand, again, the Q2 will see some compression, but the Q3 is probably when you see a more normalized number.

Is that correct?

Yes.

It is plausible whether it’s absolutely correct. I think directionally it makes sense, but if rare earth – it all depends what rare earth and therefore raw materials will do in the next couple of quarters, but I think what you expect makes sense.

Sure. I guess, I'm thinking directional because not really sure what normal is in your market.

Mark we’ve been notoriously unsuccessful in predicting what rare earth prices will do even in the short-term. So we don't want to stick on part of this.

Yes. Understood.

I guess a couple of questions just around volumes. I guess maybe just – the semiconductor shortage, it actually doesn't sound like – as it really hurt your business at all or you've seen any disruption, and actually it sounds like an accelerator.

Am I sort of hearing that right or reading that right?

Yes. The short-term effect appears to be almost contradictory to what you hear, what you read in the press.

As I said, our factory automation segment has done really well with increased orders for those high precision torque motors that go into the robotic arms, mostly in Japan and in Asia, of course. But also in almost a perverse way, the conversations we've had with our Tier 1 customers in the automotive supply chain have suggested that the OEMs facing a semiconductor shortage would probably end up shifting the available semiconductors to higher end luxury models where they make more margins than the entry level sort of stripped down model as well.

The reason why this might have a perverse effect is we sell a lot more magnets and magnetic materials and more catalysts for bigger engines in the higher end models. So almost in a bizarre way, we may end up doing better in that application.

However, let me not downplay the seriousness of this. If there's 10%, 20% slowdown across the board in automotive output, I do expect that everybody OEMs, Tier 1s, Tier 2s and the entire supply chains will see that effect.

But within that context, it may not turn out to be as bad for us as it would be for a lot of other people. Rahim, I don't know if you'd like to add some more color on this.

Nothing to add Constantine. Thank you.

That's super helpful. Maybe I guess just staying on the volumes, obviously is a very strong Q1.

I don't think there's a ton of seasonality in your business. But again, I appreciate there were some sort of inventory rebuilding.

I'm curious just to hear your sort of thoughts on sort of what the cadence of volumes through the year might sort of directionally look like. So we don't get sort of too far ahead of ourselves here?

Sure. Let me say something about seasonality because historically the first quarter of the year is not our best quarter and there are two fundamental reasons.

On the electronics side, supply chains are digesting Christmas. So they tend to be a little slower and more importantly, manufacturing across the board, you have two to three weeks of a shutdown in China and to a lesser degree in the rest of Asia over the Lunar New Year.

Well, that didn't happen this year. Plans by and large ran pretty well flat out through the Lunar New Year for a number of reasons, demand-driven, of course, but also I think in China, return of the workers back to their towns and villages for the Lunar New Year was discouraged.

So they continue to work and they didn't take holidays because of COVID. So it wasn't unusual first quarter in that regard as well.

So volumes, yes, typically at least in the electronic part of our business, as I mentioned, the first quarter is the slowest, second quarter is better, third quarter is the strongest as the electronic supply chains are running flat out to put smartphones and PS5s and the like on shelves for Christmas. And then fourth quarter starts to slow down, hits bottom in the first, and then it picks back up, after that.

So this clearly isn't what happened, but we had a multitude of impacts because of COVID because of automotive demand and so on and so forth that clearly masks all the things we would normally expect to happen in the quarter.

If I can just ask one last question again, thanks for that. But last question just around CapEx, seems like there's growth coming from a lot of places here.

I'm just curious for your thoughts around capital investments. Again, I think you mentioned sort of running at sort of full capacity, so just maybe thoughts around that?

Thank you.

Sure. The one area that we flag that is probably more likely that we will make some CapEx investment decisions this year is expanding magnet capacity.

We've already expanded that business, and couple of times we're running flat out. We're seeing very heavy order book across the board, whether it's automotive or electronics or household goods.

And by the way, next time anybody's looking for a massage gun, go for the more expensive model because it's likely to have an electric motor that has one of our magnets in it. So this is really the area that hurts where we're managing our order book very carefully to match our capabilities to produce.

We don't want to disappoint customers. So this is clearly an area that we will need to reevaluate our capital investment strategy there.

On other issues, I mean, we see perhaps the continuing product line diversification between China versus outside of China. So we could be making some modest investments in Thailand and in Silmet in Europe to continue to diversify, as I said, our capabilities there.

But other than – the most pressing needle, as I mentioned, is magnet production.

All right. Thanks a lot for taking my questions.

These are not investments in the tens of millions. I mean we're talking about the low single million – the single digits and millions.

All right. Thanks again.

Appreciate it.

All right. Thanks, Mark.

Thanks, everybody.

Thank you all.