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Neo Performance Materials Inc. (NOPMF) Q3 2022 Earnings Call Transcript

Neo Performance Materials Inc. (OTCPK:NOPMF) Q3 2022 Earnings Conference Call November 11, 2022 10:00 AM ET

Company Participants

Ali Mahdavi – Head-Investor Relations

Constantine Karayannopoulos – President and Chief Executive Officer

Rahim Suleman – Chief Financial Officer

Conference Call Participants

David Ocampo – Cormark Securities

Mark Neville – Scotiabank

Ian Gillies – Stifel

Operator

Please stand by, we’re about to begin. Good day and welcome to the Neo Performance Materials Third Quarter 2022 Earnings Call. Today’s conference is being recorded.

At this time, I’d 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. As a reminder, a replay of this call will be available starting tomorrow in the Investor Center of our website located at neomaterials.com. Joining me this morning are Neo’s President and Chief Executive Officer, Constantine Karayannopoulos; and Neo’s Chief Financial Officer, Rahim Suleman.

Please note that some of the information you will hear during today’s presentation and discussions 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 this morning 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. 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.

I’ll now turn the call over to Constantine.

Constantine Karayannopoulos

Thank you, Ali, and good morning everyone. Pleased to have the opportunity to update you today on several strategic initiatives on which Neo has made significant progress this year as well as our quarter. While global economic sentiment appears to be pivoting downward in the near-term, we are confident in our ability to effectively manage our business through every stage of the business cycle, just like we’ve done so many times over the past three decades.

More importantly, we’re building upon the strong businesses to generate significant growth in the future. Before I get into the quarterly results, let me first provide an overview and context to some of the strategic announcement we’ve made over the past few months. Over several years we’ve been working to develop an integrated plan that builds upon Neo’s legacy strengths of product quality, innovation, and customer service. Ensuring our customers have visibility into the security, reliability and sustainability of critical materials is more important than ever.

These qualities are essential to winning the next piece of business, but also to building long-term mutually beneficial relationships with our customers. As we pursue various avenues of growth, one thing is abundantly clear. We must expand our operating infrastructure in order to meet rapidly growing demand for the critical rare earth and rare metal materials that are needed by hybrid and electric vehicles, new energy storage and distribution, clean air and clean water technologies and responsibly source components for consumer goods.

For Neo, the global energy transition presents a once in a lifetime long-term growth opportunity. To take full advantage of this, we must be able to position ourselves and scale rapidly in three key areas. First, upstream raw material diversification. Second, expansion and modernization of existing plant and infrastructure and third, downstream expansion of Neo magnets both sintered and bonded.

Through each of these and through our legacy product innovation and customer service efforts, we can assemble the errors in advanced materials infrastructure to establish the secure ESG focus supply chains that our customers need to meet the challenges of customer climate change.

Regarding raw material diversification, as many of you know, we’ve been discussing the importance of raw material diversification. These calls for a number of years, having long-term committed suppliers and diversity of supply is paramount to the strength of any well-functioning supply chain.

Our customers and their customers have made it clear that they want localized supply chains. When long-term legacy feedstock suppliers to Neo are at or near capacity, we must encourage our suppliers to further expand our operations and to influence them to adopt a stronger ESG – and influence them to adopt stronger ESG practices. It’s not enough to have troubles on the ground ready to deliver material. We must build our business relationships to a prism of respect and a shared understanding of sustainably sourced materials. That includes working with partners who fully believe in the importance of our carbon neutral future.

Securing off-take rights at an early stage of development provides Neo and our customers with additional optionality. It also allows Neo to help influence strategic decisions in the development of new rare earth resources. Decisions that align with our vision for sustainability and minimal impact on the environment. During the quarter, what would have continued a dialogue with number of promising emerging producers, we recently made particular progress with three potential upstream partnerships. First, Sarfartoq, in Greenland, the former Hudson Resources rare earth project; Yangibana, Australia owned and operated by current largest shareholder, Hastings Technology Metals, and Koppamurra in Australia, a heavy rare earth ionic clay deposits owned by Australian Rare Earths.

On Sarfartoq, first, during the quarter, we announced that we are in the process of acquiring the exploration license and rights for the Sarfartoq rare earth deposit in Greenland from Hudson Resources. There’s been renewed interest and clarity provided by the local Greenland government related to the exploration, mining, and processing of the mineral deposit.

This is help to alleviate prior concerns around potential developments of this project. Our team visited Greenland to meet with the local community to better understand its needs and what this development means to them. We also engaged further with the government to understand its willingness to support the project. The team conducted a site visit to get visibility on the available resources and was strongly encouraged by Sarfartoq development potential.

While this is a long-term project that would be aligned with long-term growth for rare earth materials in Europe, we have a high level of confidence in the technical team involved, which we have assembled. Due diligence efforts related to the transfer of the exploration license from Hudson Resources to New York continuing but importantly, we believe this project can be fully supported by a renewable hydroelectric power with minimal disruption to the environment.

Next, our Neo’s major shareholder, Hastings Technology Metals is currently developing a rare deposit in Western Australia, Yangibana. We have been monitoring the team’s progress at Yangibana for a number of years and this projects used very attractively towards magnetic materials. It has the potential to be a competitive producer of mixed rare earth carbonate materials for our facility.

They aim to have initial rare earth off-take available in three to four years based on current timelines. We welcome Hastings as a shareholder and we look forward to further evaluating their asset as a potential source of raw material for our plants in the future.

Last, we also signed an MOU/joint development agreement after the quarter’s end with Australian Rare Earths Limited or AR3. Regarding its Koppamurra heavy rare earth clay deposit. AR3 and Koppamurrais one of four known heavy rare earth clay deposits outside of China. There’s a notion in the world of magnetics that there will be enough or at least there’s an expectation that there will be enough neodymium and praseodymium for anticipated adoption carriers or permanent magnetic motors in things like electric vehicles and wind turbines.

But the heavy rare earth elements that help maintain magnetic properties or high temperatures have less visibility to adequate supply. This problem will need to be addressed from multiple angles. It includes the – it includes continuing to minimize the heavy rare earth content and magnets as Magnequench and Daido have done in producing highly engineered magnetic powders and [indiscernible] magnets for Honda’s electrified drive trained systems that contain zero heavy rare earths.

It also means bringing online new heavy rare earth deposits that can be developed in an environmentally responsible manner. We see AR3 as having a high potential for success and we look forward to developing this relationship further.

The common theme around these three potential resources that they’re led by strong technical resources and advisors who have been involved for in the rare earth industry for years. Substantial work remains to be done with all of them, but we will continue to explore new arrangements that can produce responsibly source materials with a desired ESG footprint.

Each of these projects can help take a step forward in providing additional raw material optionality for our customers and build upon our current supplier arrangements. We continue to reliably purchase material for our separations plant in Estonia from our legacy suppliers Solikamsk Magnesium Works as well as from energy fuels in the United States.

Energy fuels continues to make substantial progress towards expanding its access to primary monosite raw materials. Last, we’re continuing to evaluate and expand a recent supply of relationships in Southeast Asia to support growth in both Asia and in Europe.

With regards to our center magnets efforts, in addition to substantial steps regarding raw material diversification and growth across our supplier base, we announced earlier this week that we have been awarded a significant grant from Europe’s just transition fund, which I’ve talked about before.

For the construction of our centered rare earth magnet manufacturing plant in Estonia, this is the culmination of terrific efforts from our senior executive team, our local team in Estonia, our Magnequench innovation team and government leaders in Estonia. Each of these stakeholders sees the powerful potential of the vertically integrated rare earth manufacturing hub in Estonia to drive the transition to electric and hybrid vehicles, more offshore, wind turbines and other innovative de-carbonization technologies.

I want to convey my personal gratitude and thanks to Estonians Prime Minister Kaja Kallas, Entrepreneurship and Innovation Technology Minister, Kristjan Järvan and all the other government officials in Estonia for their leadership in this joint investment with Neo. We look forward to further building upon the shared vision to create new jobs and economic opportunity for the citizens of Estonia and to serve as effective agents for climate resiliency.

Our Phase 1 production capacity target is 2,000 tons per year of centered magnet block, which will produce around 1,500 to 1,600 tons a year of magnets depending on size and shape. Although, it’s early at current market levels would believe this Phase 1 capacity would indicate potential incremental revenues of $135 million to $160 million at current prices.

This is obviously a meaningful contribution to Neo’s long-term plans and recent discussions with current and potential customers have indicated strong support for further growth beyond these Phase 1 levels and with the benefit of the JTF funding grant, we’re accordingly developing plans for Phase 2 and beyond.

The Just Transition Fund financial commitment from the EU and the government of Estonia further de-risks Phase 1 of our centered Europe project and it adds to our confidence level. As we develop a long range planning for Phase 2, will also very encouraging to hear the President of the European Commission call on the urgency for localized rare earth supply chains established in her state of the European Union address on September 14. Her announcement of the launch of the Raw Materials Act and the creation of the EU Sovereignty Fund to support projects of strategic European interest in critical raw materials creates policy tailwinds that can only fast forward a growth efforts.

In order to deliver the raw material inputs for these centered magnetic plans, there’s an obvious connection back to increasing our localized upstream raw material relationships, but it’s also essential for us to review our rare earth separations capacity in modernization. The rare earth requirements for 2,000 tons per year of centered magnetic block are larger than our historic production and our Sillamäe plant in Estonia, which is currently the only commercial industrial scale rare earth separations facility operating in Europe.

We anticipate that we will supply the new centered magnet plan with both rare earth inputs from Sillamäe and from other sources, but we remain in early planning stages to evaluate the timing coordination of potential expansion efforts for rare earth separations at Sillamäe.

Of course, we’ll approach this project with the same rigor and methodical approach to ensure an appropriate ROI for growth capital, but all three phases upstream raw material diversification, expansion, modernization of our existing infrastructure and expansion into centered permanent magnets will be a part of our long-term roadmap for growth.

It is still a very exciting time for us at Neo and we’re very busy implementing these plans and assuring that we’ll have the adequate human and financial capital to execute on these plans. For the capital requirements related to center magnets, we intend to fund this project through a combination of grants like the European JTF funding as well is accessing various options in the European debt markets as well as with cash on hand.

During the quarter, we announced the $75 million project loan agreement for the modernization and relocation of our auto emissions catalyst facility in Zibo, China. We proceeded to groundbreaking on that new facility this past summer and we’re currently in process for early works construction activities. Our legacy plant remains operational in the meantime within COVID restrictions, of course, and we intend to operate the old plant into next year is we qualify products from the new facility. We also completed a $50 million – US$50 million bought deal equity offering at $15 per share during the quarter. After the recent transaction announced between Oaktree Capital and Hastings and we decided to shore up our balance sheet.

It’s no surprise that the current capital market environment is tighter than it’s been in recent years and in that tight market, the Oaktree deal opened the window for us, which provides several benefits for the company and its shareholders, which primarily the additional capital enabled us to move ahead with our centered magnet strategy prior to the completion of any potential public financing or grants like the joint – Just Transition Fund grant. Having a clear site on near-term capital availability allowed us to establish specific timing commitments.

This is a critical step toward bringing on a new supply chain and balancing the coordination of upstream and downstream expectations. Pursuing this new capital allowed us to accelerate our plans and significantly de-risk our internal timelines. Second, Neo has historically maintain adequate flexibility through free cash flow to allow us to be opportunistic in terms of new technologies and potential acquisition opportunities.

In today’s market, we do see such opportunities that we’re in the process of evaluating them. I expect to be updating you on these discussions in the near future. As we move forward with each of these strategic growth projects, I want to convey my own excitement over the strategy that we’ve outlined. It’s also important to note that we have dedicated operations teams around the world to ensure that our strategic growth strategies are not getting in the way of our legacy at day-to-day operations.

Let me now turn to the third quarter results. As you likely saw in our announcement and filing this morning, we reported $146.7 million in revenue during the third quarter. While we enjoyed mostly tailwinds over the past couple of years, the latest quarter was a mix of strategic tailwinds and pricing – short-term pricing volume headwinds. The P&L indicates a mix story as the industry work through some relatively lower market pricing conditions as compared to the start of the year.

In addition, these financial results are largely reflective of today’s broader microeconomic trends. With some new challenges currently indicating potential temporary slowing consumer demand patterns across all regions, our top line sales remained strong relative to Neo’s historic norms. They are, however, weighted against the complicated backdrop that more frequently points to potentially softer demand environment. While pricing remains relatively attractive compared to pre-pandemic norms, it has been more volatile over the short-term and retreated about 40% over the past six months. That volatility is placing short-term pressure on our margin levels is higher cost inventory and LCM adjustments flow through our P&L.

Rahim will provide greater color in his comments on this. I will remind shareholders that this lead lag volatility is more or less normal in our industry, and when pricing stabilizes, which appears to have started over the past six weeks, our unit economic model usually stabilizes intern over the next several quarters. There were some positive themes in the quarter such as decreasing shipping costs, excuse me, and strong volumes across Europe and North America. But these were overshadowed by the continuing uncertainty in the western world. The war in Ukraine continues and ripple effects are growing, particularly related to energy programs and they’re related cost impact as Europe prepares for winter. This reverberates through the food production, advanced chemical supply chain as key processing reagents are limited in production and driven to higher prices.

Couple words about COVID. Regional supply chain disruptions are unfortunately still a common occurrence, particularly in China. Just this month, we observed another more pandemic related disruption, we – I apologies. Just this month we observed more pandemic related disruptions in China, including in Zibo where we have one of our facilities for our environmental emission control catalyst and separated rare earth products.

Mandatory shutdowns or limited operating days in China continue and while downtime usually doesn’t affect our finished good shipments in a significant way, it can impact our operating schedules, operating efficiencies, and our ability to receive raw material. While such impacts tend to be shorter today than in the previous couple of years, there’s still challenges that consume resources and attention. Regarding automotive, the automotive industry, inflation has more than crapped into the automotive sector. Higher price new vehicles are the norm, and the average price vehicle stored more than 30% over the past few years in North America. The used car market jumped accordingly as new cars simply weren’t available.

There is still less than one month’s worth of available inventory on many dealer lots. Even with some of these impacts – even while some of these impacts have started to ease, semiconductor chip shortages still plague the industry. Regional temporary shutdowns within China remain all to commonplace and these inhibit the movement of critical automotive parts and assembly. When you add higher consumer interest rates to the mix, large portion of consumers are simply getting priced out of the new car market.

For the full year 2022, automotive production is anticipated to be about 80 million to 82 million units, which is about 3 million to 4 million units lower than last year’s forecast. The industry is not expected to get back to 90 million units until 2024 at best. While automotive OEMs reduce output forecast for internal combustion engine vehicles, clearly, one of the obvious areas for growth and innovation is the industry – is the fact that the industry’s developing resilient critical material supply chain for electric vehicles.

In the near-term, as EVs continue to gain market acceptance, especially in China, throughout the first nine months of the year, Chinese consumers purchased more than 3 million pure battery electric vehicles. They’re now on track to purchase more than 4.5 million of these vehicles per year. Chinese automobile tax rebate incentive program for low displacement vehicles institute this past June has clearly had a strong impact. EV sales increased nearly 50% since the advent of this policy and more Chinese producers are opting for new energy vehicles either battery powered or plug-in hybrids at a dramatically higher rate. These combined electrified vehicles are on pace to achieve a 20% plus penetration rate this year, three years ahead of the original 2025 policy target date.

While China has taken a clear edge in EV adoption, similar dynamics play plain Europe as battery and hybrid vehicles steadily improved market share. For the first nine months of the year sales of EVs and plug-in hybrids achieved a 19% market share in Europe, just barely trailing China. While the Scandinavian countries continue to lead from a market penetration perspective, Germany has moved past the 25% electrified threshold. North America remains a little bit further behind, but it is growing quickly off a smaller base. The sales of EVs year to date have increased 70%.

These trends are not new, but to support the continued growth and adoption of EV technologies, the rare earths industry needs to provide a stronger, more resilient base for electric motor manufacturers and the confidence to OEMs to continue to design in these permanent magnet motors. In other words, the industry needs orders of magnitude more extraction, refining, magnet motor and drive-train production in order to meet the 2035 targets for decarbonization and electrification.

In closing, the near-term business environment has a lot more uncertainty than any of us want to see, now that we’re 2.5 years into the global pandemic. That said, our operations have remained strong in the face of these past and present challenges. Our employee’s dedication resulted to do the right things on parallel in the industry in my experience, our unique business model positions us very well with dual supply chains both within and outside of China, and the strategic positioning to capitalize on the major tailwind trends.

On a base of strong foundational operations I’m both very excited and confident in our long-term growth plans, provide us and our customers with powerful flexibility also have allowed us to carve out a commanding lead in product innovation and help to ensure that we’re delivering for our customers day in and day out. We look forward to keep you updated of these developments in the coming quarters.

I’d now like to turn the call over to Rahim for a detailed review of the quarter.

Rahim Suleman

Thanks, Constantine. The third quarter and the start of the fourth quarter have taken on somewhat of a transitory field. After posting record earnings in Q1 and Q2 of this year, we are now posting a significantly lower quarterly earnings result for Q3. We have on numerous occasions talked about the value-add nature of Neo’s operations and we have noted that we are not a commodity player, but rather a value-add producer. Our contracts and prices are designed with pass-through clauses that increase our price when rare earth prices rise and decrease our price when rare earth prices fall.

We seek to maintain a spread between our selling prices and the input commodity costs that covers our conversion costs and provides a healthy margin. This is a strategic and long-term value proposition and it’s proven to be an excellent value creation model. However, in short-term periods, it does cause fluctuations in results and that can be tied to commodity price changes. This isn’t the fundamental change in profitability, but rather just a timing impact that you commonly hear me refer to as lead lag.

As mentioned earlier, we recorded our two strongest quarters in Q1 and Q2 of this year, and that was aligned with the rise in rare earth prices from 2021 to Q1 2022. As Constantine mentioned earlier, rare earth prices declined significantly in Q2 and Q3 and this has resulted in this lower earnings quarter. Despite our Q3 adjusted EBITDA of just over $7 million, our year-to-date adjusted EBITDA is $66.6 million.

We spoke openly about the positive impact of lead lag in Q1 and Q2 that we were selling at higher prices in the moment, while utilizing inventory that was purchased historically at lower costs. In Q3, the opposite is true. We are selling at lower prices in the quarter, while utilizing inventory that was purchased in an earlier quarter and at higher costs.

If we could buy inventory and self finish goods on the exact same day, one would see that we have an embedded spread that drives our margins. However, the timing of inventory purchases and the conversion period causes these quarterly fluctuations in results. And as we have noted in previous discussions, Neo’s strategy is a long-term value-add margins and results are always best understood just one or two quarters.

As Constantine mentioned, key magnetic rare earths fell by approximately 40% over the last six months. This follows a trend whereby prices tripled from about two years ago. Let me provide a little more specific detail on this current change at least with respect to magnetic elements. The prices of neodymium and praseodymium decreased particularly rapidly in Q3 with pricing bottoming out at about $85 per kilogram. This is a substantial decline from about $140 per kilogram earlier in the year.

So far in October and the start of November these prices have somewhat stabilized in the $90 to $95 per kilogram range. Despite the recent drop prices remain about 2x higher than they were two years ago. This bodes well for the industry and we believe this is a healthy range to provide assurances to both the upstream and downstream verticals. This also leads to more dollar value margins available for certain products where there are some spread available in the pricing formula.

This level of fluctuation is a little bit unusual, but there is – whether there is a lot of fluctuation or a little, the Neo strategic direction to pursue pass-through pricing and focus on reliable margin spreads should be evident, particularly in the longer-term. With the current macroeconomic environment, we did see lower volumes, particularly for Magnequench powders in the quarter. This was offset by continuing strength in our Emissions Catalyst business and growth in our Water Treatment business.

We are especially proud of the turnaround in the results of our Rare Metals business. Our Rare Metals business posted a record quarter and is having a record year in earnings. There is some lead leg benefits in these year to date results, but that should not overshadow the impact of higher selling prices and the diversification to higher margin products. This has been part of the team’s focus for some time now.

Shifting to the balance sheet. We increased our cash and cash equivalents to $123.9 million in the quarter, primarily as a result of the primary equity raise, which yielded $47.7 million after transaction costs. Year-to-date, we have invested $11 million into property, plant and equipment and we distributed $9.9 million in dividends to shareholders. The corresponding impact of the recent decline in rare earth prices is the overall reduction in working capital during the quarter of about $11 million, which further improved our cash position during the quarter.

Digging one level deeper, one would see higher AR balances presently, which will quickly convert to cash in the coming quarters and lower inventory balances, which will generate more cash now as our inventory replacement costs are lower than our existing inventory costs. Over the last two years, we have seen a significant increase in our inventory balances due to the rapidly rising rare earth prices.

And as prices stabilize following this drop, we expect that we can reduce inventory balances from the 2022 levels generating even further cash. At Neo, we maintain a balance of both short-term and long-term focus areas. We need to be vigilant with managing our cash, constantly looking for continuous improvement opportunities and efficiencies in our manufacturing operations, and a focus on growing customers and key product volumes. We also maintain a long-term view of value-added margins, environmental sustainability, creating a resilient global supply chain and working closely with our customers, develop products for the future that come with our unique and deep rare earth and rare metals knowledge and expertise, including furthering a complete magnet to mine strategy.

With that, we’d like to open up the call to questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we’ll take our first question from David Ocampo with Cormark Securities.

David Ocampo

Thank you. Good morning, everyone.

Constantine Karayannopoulos

Good morning, David.

David Ocampo

Constantine, I think on the last call you called out Phase I is being able to produce around 400 tons of magnets, but the CapEx number is probably half of where the current Phase I CapEx is going to come in at. I’m just trying to get a better sense on how you’re going to spend $100 million, but get essentially 4x the annual tons of sintered magnets. Is that just primarily from scale?

Constantine Karayannopoulos

I’m sorry, David, I don’t recognize the numbers that you’re talking about 400 tons.

David Ocampo

I think that was the number that you gave on the previous call and this call, you’re calling for 1,600 tons, but it seems like your CapEx number is higher.

Rahim Suleman

Let’s go on the assumption that that’s not accurate, but if we can clarify.

Constantine Karayannopoulos

Yes. We’re going with a 2,000 ton a year block facility. We’ve increased – initially we’re looking to produce about 1,000 tons of magnets, which would’ve required something, the order of 1,300 tons of magnet block where we’ve opted that to 2,000 tons a block, 1,500 to 1,600 tons of magnet as I said in my comment.

The CapEx, again, I don’t recognize your numbers, David. You may be confusing the grant parameters let say €18.75 million of grant for up to €100 million of capital investment. That doesn’t mean that the capital investment today is planned for €100 million. It is a bracket that the Just Transition Fund has said, regardless of what our own CapEx requirement is for whatever we do in Estonia, they are providing this grant for up to €100 million total investment. Is that clear?

Our investment is still much more in line with what we talked about before, which is the original CapEx estimate was about $50 million for 1,000 tons of magnets. Clearly, as we move capacity up, we’re inching that CapEx estimate up, but it’s not $100 million. I hope that makes sense.

David Ocampo

Yes, that’s clear. That’s my fault there. And then on the revenue guidance you gave for Phase I, how, how should we be thinking about EBITDA and margins from that $135 million to I think it was $160 million that you quoted?

Constantine Karayannopoulos

Yes. The easiest way to think about it is that the EBITDA generation would be somewhere in the same, again, without being too explicit and for competitive reasons, we don’t – we can’t really talk too much about the granularity of the business. But we should expect the sintered magnet expansion in Europe and eventually North America to generate margins similar to what Magnequench is generating today. So perhaps a little bit better than that given the fact that the supply demand dynamics in Europe are what they are. But that’s what the objective is here.

David Ocampo

Got it. And then Rahim, next question is for you. I know we’ve always asked this in the past, and you alluded to this in your prepared remarks. But how should we be thinking about kind of the sustainability of EBITDA? Like what’s the earnings power of the business if pricing does hold in steady at these current levels?

Rahim Suleman

Well, I think the statement that I’ve talked about in the past is again, referring to long-term trends. And look, honestly, every given quarter has some movement one way or the other. And clearly over the last couple of quarters it’s been offered since it’s only been rising rare earth prices for kind of three or four quarters. So I think you probably have to find a balance between those rising quarters and kind of where we were before that. Now bearing in mind where we were before that was also COVID. So even if you go back a little bit further, I know talking about something that’s so historical sounds awkward. But I think that it still provides kind of the right reasonable range with some growth in the overall business.

David Ocampo

Okay. That’s helpful. And then just as a clarification, you guys took a $8 million write-down on the inventory and I see that $6 million went into chemicals and oxide. Where’s the balance of that?

Rahim Suleman

$1 million of it is in rare metals, then $1 million of it is in Magnequench. And it’s honestly, it’s a little bit awkward for Magnequench to take that kind of a write-down because Magnequench’s margins and gross margins are quite healthy. It is really only because there’s a certain portion of the Magnequench supply that is let’s say, longer in its route in order to get to the customer for various reasons. So that particular material was really purchased back in the March timeframe, which was the peak of the rare earth prices. So it’s a $6 million in C&O, $1 million in rare metals, and $1 million in Magnequench. And as I said, Magnequench is unusual. It has enough margins to usually handle any sort of fluctuation.

David Ocampo

And that number isn’t reflected in the adjusted EBITDA number is $7 million, right. So the write-down is reflected in there?

Rahim Suleman

That’s correct. It’s not added back. It’s a cost.

David Ocampo

Yes. Got it. Okay. Thanks so much, guys. I’ll hand the call over.

Operator

[Operator Instructions] We’ll go next to Mark Neville with Scotiabank [ph].

Mark Neville

Hey, good morning, guys. Can you hear me?

Constantine Karayannopoulos

Yes, Mark.

Mark Neville

Hey, sorry about that. Just I guess if I look at your – it looks like you keep about three, four months of inventory in the business. Is that about right?

Constantine Karayannopoulos

Yes, it’s different by business unit. Rare metals is actually a little bit longer. Magnequench in China is much, much shorter, so it does change business unit to business unit, but I think overall probably it’s four to five months, yes.

Mark Neville

So five months. Okay. So yes, I’m just trying to think about normalizing earnings here. It’s probably like Q1, Q2 before you sort of get to like whatever a normalized number would be, say Q2.

Constantine Karayannopoulos

Yes, I think by Q2 I think we’ll start seeing, Look, I think that this quarter is particularly difficult and David just mentioned the LCM and understanding what the LCM does, right. It takes margin challenges from Q4 and pulls them forward. So this quarter is abnormally affected, I think by Q1. Probably second half of Q1 and Q2 is when all that inventory would flush out.

Mark Neville

Right. Okay. Okay. Sorry, and just to follow up on one or two of David’s questions, so the seven – the 8 million write-down, like that’s not adjusted for, so again, if we wanted to adjust to that and you closer to 15, is that right?

Constantine Karayannopoulos

That would be correct.

Mark Neville

Okay. Okay. Okay. Then on the, again, like I guess following up to one of these questions, again, if we look back to 2019, like you did, I think you’ve averaged for the year, about $13.5 million of adjusted EBITDA, your rare prices to your point, or like 2x that. So how would you tell someone to think about again, the earnings power of the company relative to 2019 when rare earth prices are 2x? I assume it’s – I’m not suggesting either to double EBITDA, but like how should we think about that, I guess in…

Rahim Suleman

Yes, certainly a healthier EBITDA margin and EBITDA results than what you would’ve than the period that you would’ve referenced, because as I said, although, we do focus on pass-through, there is still some, a couple of percentage points spreads in how the pass pass-through mechanism works and portions of our business that don’t have pass-through. Certainly there’s more dollar value margin spread there. So certainly from that baseline, it’s 10% to 15% more. And then plus you’re talking about the business other dynamics of the business growing, and you don’t necessarily always see growth if you just look at the line called pure volumes, which is why we try to help you with kind of differentiating where that growth is because some volume’s worth a dollar and some volume’s worth $500.

So we try to talk about where we see value growth and I think we have seen more growth in the higher value areas rather than just units going out the door. So I think you start with, there’s a bump in the rare of pricing dynamic, which is helpful, but I think there’s also a bump in the fundamental business.

Mark Neville

Got it. That’s helpful. Thanks Rahim. On the zero expansion or relocation, when does that start, and roughly how long does that take or are you expecting it to take?

Constantine Karayannopoulos

Well, margin has started, as I pointed out we expect to be constructing through 2023 and starting things up later in the year, but it should be a late 2023 startup and commissioning.

Mark Neville

All the spend would happen over the next 12 months give or take, or the big chunk of that CapEx spend?

Constantine Karayannopoulos

Yes. The biggest portion that’s the same assumption.

Mark Neville

Okay. Can you – sorry, can you remind us again? I’ve got in my notes, so just remind the number around that was like $100 million, $75 million.

Constantine Karayannopoulos

$75 million, yes. $75 million is the right number.

Mark Neville

Okay.

Rahim Suleman

And we’ve already spent some of that $75 million and some of that $75 million is related to some inventory build and some contingency. So not all the $75 million just gets flushed out from where we are today. Some of it will go out the door, but some of it will get recovered when we lower inventory balances too.

Mark Neville

Okay. So it’s not all sort of capitalized. Some of its goes through inventory.

Rahim Suleman

Yes. From where we sit today, it’s not a net new or a net $75 going out the door. It’ll be less than that. I mean, it’ll be close to it, but it’ll be less than it somewhere between.

Mark Neville

Okay. Somewhere between.

Constantine Karayannopoulos

Yes. And the inventory build, David is – sorry, Mark, the inventory build is a necessary part of it. There will be some time when the old plan will stop operating and the new plan will be teething. So we’re trying to be conservative here and make sure we don’t run any customers zone.

Mark Neville

Got it. All right. Thanks for the time. Appreciate it.

Constantine Karayannopoulos

Thanks, Mark.

Operator

We’ll go next to Ian Gillies with Stifel.

Ian Gillies

Good morning, everyone.

Constantine Karayannopoulos

Good morning, Ian.

Rahim Suleman

Good morning, Ian.

Ian Gillies

I just wanted to confirm that the 2010 plans in Estonia is the expected capital cost a $100 million or is it going to be slightly less? And two, would you consider that project formally sanctioned yet or do you still need customer commitments to move ahead?

Constantine Karayannopoulos

Yes. The easy part first, we are moving ahead. Customer commitments will come only after magnets have been fully qualified, which is going, I mean, we’re going through the qualification process now with magnets from our pilot plan, but ultimately the full commitment is contingent on making the right magnets that perform the way that they’re specified.

However, we are having all kinds of conversations with, I would say five major Tier 1 drive-train producers who are screaming for capacity and we’re entering into non-binding type of arrangement. I guess that’s the way the automotive industry works, which is still in addition to the conversation we’re having with the Tier 1s, conversation we’re having with the actual OEMs, their customers are also extremely encouraging.

So we expect that the reason we moved up the scope of Phase 1, Ian, is that the original design of 1,500 tons of alloys 1,000 – 1,200 tons of magnets was too small, given customer indications. So we’re going with a larger capacity plan that, that we’ll be able to at least satisfy some of the initial needs of those five Tier 1 drive-train producers.

On the CapEx, as I explained earlier, the $100 million was an indication of the parameters of the grant. We expect originally anticipated Phase 1 with a 1,000 tons of magnets was going to be in the order of $50 million Phase 1 plus 2 for 5,000 tons was going to be in the order of $200 million. We expect that Phase 2 – Phase 1 that we’re designing now was – is going to come in a little bit higher than 50, but well under the a $100 million threshold that, that the grant specifies. So we expect that this is going to be sort of closer to between $60 million and $70 million, probably closer to $70 million for Phase 1 for 2,000 tons of blocks.

Ian Gillies

Okay. That’s really helpful. And then just one last clarifying point on that, that question. So you’re now – it was a 1,000 tons of magnets, and if I think back to an earlier comment, you’re now at 1,500 to 1,600 tons of magnets. Is that the – I just want to make sure I’m carrying apple to apples.

Constantine Karayannopoulos

Correct. So the Phase 1 capacity is in the order of 50%, 60% higher. And I’m only – and I’m – I guess this is a directional comment because depending on what magnets you make, what size, what shape, you have significantly different yield losses, right? So for small – the smaller the magnet, the more complex the magnet, the higher the yield loss. So for simple geometries, large magnets, you could have 20% yield losses or perhaps even less for the large wind turbine magnets, which are very simple magnets. But as you get smaller and more complicated, you could be losing as much as 30%, 40% of the material that comes out of as a block before it gets shaped into the final magnet.

Ian Gillies

That’s helpful and it’s really useful in try and understand kind of CapEx dollars per unit produced. I apologize that I missed this in your prepared remarks, but at the last call you thought there may be some interest free loans that you may be able to access while building this facility, and I get not everything moves along the same timeline. Is that something still in the works and in play?

Constantine Karayannopoulos

Yes, I don’t know about interest free. Yes, I think I talked about low interest loans from several banks and – yes – that’s still part of the discussion and the negotiation, yes, definitely.

Ian Gillies

Understood. Sorry for the misrepresentation.

Constantine Karayannopoulos

Yes, no worries.

Ian Gillies

At the risk of stating the obvious, would it be fair to presume that Magnequench’s margins will return to more normalized levels quite a bit quicker than C&O just given what we saw in the quarter? Or is – I’m just trying to reconcile that given the inventory write downs and so forth?

Rahim Suleman

Yes. If we talk about return, let’s say, in Q1 – second half of Q1, as we talked about earlier in the call to avoid kind of minor moving around. C&Os pricing dynamics, so normalized pricing will return their inventory lag is longer, but the pricing dynamics will return quicker. Magnequench will get to the right margin per ton levels faster, but is more affected by, let’s say, slowdowns in volumes. So in terms of which one actually returns to more dollar – normalized dollar value margins faster, I couldn’t really tell you, because I think it really depends on how quickly the volume side recovers for Magnequench as well.

Ian Gillies

Okay. And then I’m going to try here, I’m not sure if you guys will give me the answer, but are you willing to provide any guidance around capital spending in fiscal 2023, given you’re now moving forward with these two large projects?

Rahim Suleman

I appreciate the question and I’ll say maybe we could talk about it in another quarter or so. I mean, clearly it’s going to be a big capital spent year as Constantine just outlined with respect to the Zibo relocation in the auto catalyst expansion project. In terms of the magnet project, the timing of when we lay out deposits for equipment versus receiving the equipment and paying the full payment on all those things, I think that’s still a little bit hard to make a specific comment on for 2023.

Ian Gillies

Okay. I appreciate that. I’ll turn the call back over. Thank you for the detail.

Constantine Karayannopoulos

One other comment on this. As I’ve outlined in my comments and in various one on ones, we now given the last equity raise, given the EDC loan, we now ending the cash flow generation. We have enough cash to execute on all of these fronts. And that was, I guess, one of the reasons why we did the equity raise back in August to allow us to do, especially the magnet project expedited fast forward and start ordering longer lead items and doing preliminary work and making commitments. So we have enough cash on hand and we’re generating enough cash that will allow us to finance both of these projects without accessing the capital markets together.

Ian Gillies

Okay. Fair enough and understood.

Constantine Karayannopoulos

All right,

Ian Gillies

Thank you.

Constantine Karayannopoulos

We’re mind of this being Remembrance Day and 11:00, we need to shut things. So are there any other questions? I know, operator, we’ve got another five minutes at the most.

Operator

At this time, there are no further questions.

Ali Mahdavi

Right. That concludes today’s call. Thank you for joining us. As usual, if you have any questions, please feel free to reach out. I’ll hand it back over to operator to close the call.

Operator

Thank you. This does concludes today’s conference. We thank you for your participation.

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