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Edited Transcript of NEO.TO earnings conference call or presentation 12-Mar-20 2:00pm GMT

Q4 2019 Neo Performance Materials Inc Earnings Call

Mar 30, 2020 (Thomson StreetEvents) -- Edited Transcript of Neo Performance Materials Inc earnings conference call or presentation Thursday, March 12, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ali Mahdavi

Neo Performance Materials Inc. - Capital Markets & IR Executive

* Geoffrey R. Bedford

Neo Performance Materials Inc. - President, CEO & Director

* Rahim Suleman

Neo Performance Materials Inc. - CFO

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Conference Call Participants

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* Frederic Bastien

Raymond James Ltd., Research Division - MD & Equity Research Analyst

* Steven Arthur

RBC Capital Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Neo Performance Materials Fourth Quarter and Full Year 2019 Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Ali Mahdavi, Head of Capital Markets and Investor Relations. Please go ahead.

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Ali Mahdavi, Neo Performance Materials Inc. - Capital Markets & IR Executive [2]

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Thank you, operator, and good morning, everyone. As a reminder, a replay of this call will be available starting tomorrow in the investor center of our website located at neomaterials.com.

Speaking first today will be Neo's President and Chief Executive Officer, Geoff Bedford, followed by Rahim Suleman, Neo's Chief Financial Officer, who will then provide additional details regarding the company's Q4 and full year 2009 (sic) [2019] performance. Finally, we will open the call to questions from analysts only.

Please note that some of the information you will hear during today's presentation and discussion will consist of forward-looking statements, including without limitation, those regarding revenue, EBITDA and adjusted EBITDA, product volumes, gross margin, other income and expense measures, ROCE, cash returns and future business outlook. Actual results or trends could differ materially from those discussed today. For more information, please refer to the risk factors discussed in Neo's most recent financial filings, which were filed on SEDAR earlier today and are also available on our website. Neo assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. Financial amounts presented today will be in U.S. dollars. Non-IFRS financial measures will be used during this conference call. Further information regarding Neo's use of non-IFRS measures is available in Neo's Q4 2019 earnings press release, which is available on SEDAR and on our website at neomaterials.com.

Let me now turn the call over to Geoff Bedford for opening remarks. Geoff?

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [3]

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Thanks, Ali, and good morning, everyone. Last year proved to be a challenging market environment for Neo and for the advanced materials industry. I want to commend our team's resiliency and ability to navigate through a down cycle that has endured longer than expected. Despite a prolonged economic slowdown within China and across the automotive sector, I am pleased that we were able to generate strong free cash flow, grow our market share in key product applications, strengthen our year-end cash position, return significant capital back to our shareholders and make strategic investments that will help drive our future growth. Neo's economic model has been tested through industry cycles in past years, and we continue to emerge stronger through these downturns.

Last year, we faced a slowing global automotive industry, which collectively is Neo's single largest end market. Light-duty vehicle sales in China declined in 2019 for the second straight year, which was emblematic of the general economy within China. And that slowdown existed prior to the current COVID-19 situation, which I will address in more detail at the end of my remarks. Compounding the soft economic environment, underlying commodity prices slipped downward in the double-digit percentage range, which placed additional pressures across some of our product lines.

In the face of these challenges, it is all the more important that we prudently manage our business profitably for our shareholders. Specifically, for the fourth quarter, we produced -- we reported adjusted net income of $6.1 million, or $0.17 per share. We closed the year with cash and cash equivalents of $84.7 million, up nearly 20% from a balance of $71 million at the end of 2018. We paid $2.9 million in dividends to shareholders in Q4 and a total of $11.5 million in dividends over the year. We also repurchased $3.7 million of stock in Q4 under NCIB program.

Total share repurchases during 2019 were $16.9 million. Our disciplined economic model and free cash flow conversion allowed us to reinvest $21.4 million in the business in 2019 while we returned $28.4 million to shareholders. And given that we are cash flow positive and a slowing economic environment, we are pleased to emphasize that we have no debt on the balance sheet.

Such financial flexibility is truly a competitive advantage. As an example, it fuels our ability to make strategic investments and undertake growth opportunities, such as when we purchased the Asia Mag facility last year for $9.7 million. That acquisition reinforces our expansion and growth into compression molded magnets, where we are already seeing positive results.

To the back half of the year, our teams across Magnequench have been diligently integrating the Asia Mag plant into the fold. The addition of this magnet manufacturing facility is helping us improve both our existing Magnequench power operations as well as the Asia Mag business itself. While integration efforts are ongoing, we are seeing increased customer interest for these magnets and improving commercialization rates under the combined Magnequench banner. As a result, we are underway on a magnet capacity expansion at our Tianjin facility with a targeted completion in 2020. This positive momentum is real and growing.

For example, we have also successfully qualified a new magnet product at a major European automotive precision motor supplier. While these volumes are relatively small compared to the core Magnequench business, we are encouraged at how quickly and passionately our teams have taken to integrate magnet manufacturing. As we talk to our local team, there is tremendous energy for launching new projects and addressing new challenges.

One example is our team's [corporatization] with customers in developing and launching a new anisotropic magnetic powder product called MQA. The successful launch of this product is the result of many years of research and development. We are currently introducing MQA powders to customers, and we believe that it will compete in some traditional centered permanent magnet applications.

Despite macro softness in the auto sector, demand for Magnequench powders used in vehicle traction motors and pump motors grew in the 40% to 60% range in 2019. We see demand for these products continuing to grow over the long term. Notably, they are helping to offset the decline of some legacy bonded powder applications, such as hard disk drives and electronic power steering. We are deliberately identifying high-growth markets across the business and actively investing capital, time and resources in these opportunities. That's why seeing these new advances across Magnequench is very encouraging. We believe they are critical to helping us successfully qualify new long-term programs and high-growth applications.

In our Chemicals & Oxides business, sales of our gasoline automotive emission catalyst products grew by 8% during the year, which is outsized growth, given the softening automotive market. This volume growth continues to be driven by Neo's technical leadership to design materials that efficiently address more stringent emission standards and protocols. Our gasoline auto catalyst market share has continued to grow over the past several years as customers rely on Neo's consistent quality and ease of incorporation of our products.

Car engines and emission systems are increasingly complex. And Neo's advanced materials are specifically engineered to help our customers achieve these more aggressive emissions targets. We continue to work closely with our customers to improve the performance of these materials which in turn, helps our customers improve their products.

Within diesel vehicle platform, the overall decline of the diesel industry over the past several years appears to have leveled out. The remaining diesel vehicles in production still demand more stringent catalyst products and testing for next-generation diesel engine is underway. Accordingly, we recently introduced a new diesel catalyst product aimed at our customers' needs, given that diesel still has a part to play in lowering emissions, particularly for European OEM.

As we expand our product portfolio, we are also investing to expand and diversify production capacity. During 2019, we successfully added capability of manufacturing auto emission catalyst products in Europe, and we will continue to build our capabilities to serve our customers for multiple geographies. We also continue to grow sales of other recently introduced specialty chemical products, such as in our wastewater treatment business. 2019 was a pivotal year for Neo within wastewater. We added a number of new employees to our commercial wastewater team. And our sales volumes grew by more than 70%. Revenues more than doubled over 2018. Our team's expertise and our product reputation continue to accelerate and we are very pleased to be approaching operating profitability in this business in 2020.

Last, in our rare metals business unit, we have been addressing both operational and strategic priorities during 2019. And we will continue these efforts in 2020. Our high-temperature metals business has benefited from product diversification over the past several years. When commodity pricing has been soft for products such as tantalum and niobium, we have benefited through the strategic introduction of hafnium in our portfolio. All of these high-temperature refractory metals displayed positive long-term growth trends as demand within aerospace applications continues to grow. To meet our customers' demand successfully over the long term, we have initiated an organizational review with initial strategic planning efforts for our rare metals business.

Over the past several quarters, we have made key leadership hires and have already begun to implement improvements to make our rare metals business more nimble and more profitable. We are also continuing to consolidate our electronic metals recycling operations at our Peterborough facility in Ontario. We expect the transition to be complete in the first half of 2020. We're encouraged to see these steps to date, and we will continue to further assess our economic model to respond quickly to changing market conditions and to ultimately deliver improved profitability.

With that, let me turn it over to Rahim at this point to go over the details of our Q4 and year-end results. Rahim?

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Rahim Suleman, Neo Performance Materials Inc. - CFO [4]

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Thanks, Geoff. Let's summarize our consolidated results for the quarter and year-to-date.

Q4 revenue totaled $94.6 million, which compares to $109.4 million in the prior year period, and full year revenue was $407.5 million versus $454.2 million in the comparable period. Net income for the quarter totaled $4.5 million or $0.12 per share, and adjusted net income in the quarter was $6.1 million or $0.17 per share. On a full year basis, net income totaled $23.1 million or $0.59 a share while adjusted net income was $24.1 million or $0.62 per share. On an adjusted EBITDA basis, the company earned $12.5 million in the fourth quarter and $53.8 million for the year. This compares to $13.2 million and $67.1 million, respectively, in the prior year periods.

Let's discuss some of the details on a segment-by-segment basis. In the Magnequench segment, 2019 volumes and revenues were adversely affected by the slower economic activity in various regions globally, including in the automotive sector and by some customer inventory adjustments. Exclusive of our legacy electronic -- electric power steering program, Magnequench volume in automotive applications grew by approximately 9% year-over-year despite the slowdown in the automotive industry generally. In terms of specific traction motor applications in hybrid and electric vehicle drivetrains, volumes grew by about 45% year-over-year. Magnequench is benefiting from the growth in precision and efficient motors and the increased utilization of its magnetic materials on a per vehicle basis. Growth in those applications continues to be driven by larger global macro trends for increasing electrification of various vehicle systems.

In Q4, adjusted EBITDA for Magnequench was $9.5 million, an increase of $0.5 million compared to the prior year. For the year, adjusted EBITDA totaled $37.1 million compared to $50.5 million in 2018. And aside from volume and its impact on margins and overhead absorption, the decrease in adjusted EBITDA was largely driven by the impact of the timing of our pricing pass-through mechanism on material inputs and in changes in foreign exchange rates. This pass-through mechanic, which updates selling prices on a lagged basis, generally monthly and quarterly is a key feature of Neo's strategic focus on value-added margins. And as we have discussed in the past, this timing difference in material inputs and pricing affects comparisons of margins per unit for the prior year.

In our C&O segment, Q4 revenue was $33.7 million as compared to $38.2 million for the prior year period, and full year revenue was up $158.2 million, which compared to $161.4 million in 2018. Adjusted EBITDA of $22.9 million for C&O in the full year rose 23.7% over 2018.

As Geoff mentioned, our three-way or gasoline auto catalyst business continues to see growth year-over-year despite the slowdown in the automotive markets. This growth was offset by a large decline in our now smaller diesel catalyst product set. The overall product mix between these 2 product groups is now more reflective of market mix considerations.

In C&O's rare earth separation business, the continuing decline of rare earth commodity prices led to a lagging impact of higher cost inventory relative to current selling prices. This had a negative impact on margins in the rare separation business in 2019. So on the other hand, C&O benefited from increased spot sales in 2019 compared to 2018.

In our Rare Metals segment, our 2019 results were lower across both revenue and adjusted EBITDA, and adjusted EBITDA was down to $5.1 million for the year. The change was driven by the negative lead lag impact associated with the pricing decline for our hafnium -- for our tantalum based products. The segment had considerable material on hand in the production system in 2019. So when material prices change, yet there is a lead lag impact in the current period results, as the operation is processing and selling material on hand that was purchased in the prior period.

The inventory in the system at the beginning of 2019 was particularly high. And given the large price decline in tantalum-based finished products throughout the year, the negative lead lag impact was particularly strong in 2019.

As of the end of 2019, there is considerably less inventory in the system and both raw material inputs and finished goods and pricing have been relatively stable since July of 2019. The Rare Metals segment continues to focus on new product development, value-added margins and to mitigate these short-term variations in earnings due to material price volatility.

Here are some just additional results and activities for the full year 2019 to note. The company strengthened its financial position in 2019, finishing the year with $84.7 million of cash and nominal debt which compares to $71 million at the end of 2018. Our stronger end of year balances comes after returning $28.4 million to shareholders in 2019 via dividends and via the Normal Course Issuer Bid or NCIB.

Cash provided by operating activities was $71.3 million, including generating $29 million from working capital reductions. Neo capitalized expenditures of $21.4 million in 2019 compared to $13.5 million in 2018. The CapEx in 2019 includes the $9.3 million in assets that we acquired as part of the magnet business.

SG&A expense was $41.8 million compared to $49.9 million in 2018. R&D expense was $14.3 million, down from $16.8 million in 2018.

In 2019, Neo paid $14.3 million in cash taxes. All of these metrics reinforce Neo's free cash flow conversion rate, which excluding the magnet business acquisition, stood at 78% for 2019.

A quarterly dividend of CAD 0.10 per common share was declared on March 11, 2020, for shareholders of record at March 20, 2020, with the payment date of March 31, 2020.

Our balance sheet is strong. Our financial position is further strengthened by relatively low Capex, low long-term commodity price exposure and rapid potential scalability. We are well positioned both to make strategic investments in high-growth areas and to continue to deliver returns to shareholders through dividends and share buybacks.

Geoff, back to you.

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [5]

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Thanks, Rahim. Before we go to questions, let me provide an update on COVID-19. Given the nature of our global business, we have been managing through this new challenge since the first warning signs of this virus appeared in China earlier this year. As many of you know, Neo operates 4 facilities in China across our Magnequench and Chemicals & Oxides business units. While none of these operations are either in Wuhan or Hubei province, we employ approximately 1,100 people in China. To date, none of our employees or their families have been directly affected by the virus. The safety and well-being of our employees and their families remains our first priority.

In response to the virus, we have implemented new operational safety protocols at these and other production sites. We have limited all noncritical travel to highly effective areas of the world, and we will take additional precautions as necessary. After an extended shutdown following the Chinese New Year, all of our facilities within China are currently manufacturing and shipping goods. Although Neo has not observed interruptions in procuring raw materials to date, we are seeing signs of slowing downstream demand from our customers, particularly for supply chain that are located within China.

From a market perspective, more than 60% of our sales are related to the downstream automotive industry, including vehicles manufactured for the Chinese domestic market. Most news reports have indicated a near-term slowdown in both auto sales and production volumes. For our customers, we are doing everything in our control to maintain reliable, consistent supply of our advanced industrial materials. We have been in direct communication with our major customers to both learn what their end demand looks like and to inform them of our business continuity practices. Fortunately, Neo's ability to manufacture products has redundancies built around the world. We have the ability to manufacture specialty chemicals and bonded magnetic powders, both in and outside of China and our Chinese facilities have excess capacity if needed. We have been communicating these capabilities when appropriate to our customers.

The situation continues to evolve and our customers' visibility is limited at this point. As such, it would not be prudent to try to estimate specific impacts near-term and beyond. We simply don't know at this time, the magnitude of how long this may last.

The safety of our employees and supporting our customers remain our top priorities. Our global manufacturing footprint and capacity, combined with our very strong liquidity position will enable us to weather this storm. We are communicating with our customers and suppliers daily, and we will continue to evaluate ways in which we can help our customers navigate any potential supply chain challenges.

Now while the near-term outlook remains uncertain. We have been through market disruptions like this before. And Neo has always emerged stronger than when we went in. We remain committed to our fundamental business strategy, which has served us well for more than 2 decades. We identify growth markets driven by global macro trend, and we produce highly engineered industrial materials for those markets that are critical to performance.

And executing on this strategy, we focus on doing 3 things better than anyone else in the advanced materials space: we build world-class technical know-how; we maintain strong and long-lasting customer relationships and development partnerships; and we invest in a global cost competitive manufacturing footprint. This unique combination makes Neo extremely well positioned to serve these markets and provide unique value to customers.

Our robust balance sheet and cash flow generation enables us to build on this strategy while returning value to our shareholders through dividends and share buybacks. I am pleased with where we are headed. I'm very excited about our prospects for future growth.

With that, let's open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Steve Arthur with RBC Capital Markets.

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Steven Arthur, RBC Capital Markets, Research Division - Analyst [2]

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Just to follow-up on a couple of things, Geoffrey, just chatting about the facilities in China. Just wondering, just a little bit more color there, just in terms of how many employees are back -- the level of capacity you're running at today? And I guess how's the transportation looking -- raw materials coming in, finished product going out, is that impeding things?

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [3]

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Yes, sure, Steve. So generally, we've been able to get all the employees back that we need. And we have been able to procure the raw materials. They're having a bit of logistics challenges at times, sort of delaying some shipments here and there. But generally, at this point, we've been able to get our facilities back and running. Quite frankly, Magnequench was able to catch up on some orders because we extended our shutdown in Tianjin for an extra week in a bit. So I think on that front, we sort of are running the plant as hard as we would need to, given the demand that we're seeing in front of us.

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Steven Arthur, RBC Capital Markets, Research Division - Analyst [4]

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Okay. Yes. And on that demand, I guess, just in your conversations with the customers, I realize everything is within target at this stage. But what kind of visibility do you have, typically? And then if they were looking at some sort of a slowdown in Q2 or later in 2020, would you be seeing that at this stage in your demand forecast? And as that evolves, what kind of cost flexibility do you have to match that?

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [5]

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So we are seeing demand changing, both for Q1 sort of immediately and then also into Q2. And I would say that it's happening faster on the Magnequench side than on our auto catalyst side. And I think that has to do with sort of the markets that are supplied China versus rest of world. I mean but keep in mind, our production costs are fairly high variable costs with raw materials, et cetera. So slowing down volume gears our costs down pretty quickly just naturally. But there is obviously the volume that's coming out, would be coming out of contribution margin as opposed to gross margin because there still is a fixed cost impact there.

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Steven Arthur, RBC Capital Markets, Research Division - Analyst [6]

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Okay. And I guess, just more broadly on the Magnequench business, you pointed a slowdown in legacy programs in the EPS motors, in particular, what proportion of Magnequench revenue is the power steering application at this stage and I guess, hard drives for that matter as well? Just trying to get some sense of how much they contributed and how much further they might fall over time?

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Rahim Suleman, Neo Performance Materials Inc. - CFO [7]

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Plus/minus, Steve -- plus/minus HDD is about 10% and EPS is probably 15%.

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Steven Arthur, RBC Capital Markets, Research Division - Analyst [8]

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Okay. So it has come down quite a way already, okay.

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Rahim Suleman, Neo Performance Materials Inc. - CFO [9]

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They have, yes.

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Operator [10]

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Our next question comes from the line of Frederic Bastien with Raymond James.

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Frederic Bastien, Raymond James Ltd., Research Division - MD & Equity Research Analyst [11]

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Obviously, a lot of uncertainty out there. But just wondering, you have a great balance sheet. I think one of the questions that have been asked in the past few years is, your ability to act strategically and do some M&A. What sort of pipeline, I guess, were you seeing couple of months ago? And then has that dramatically changed with the market realities we're facing now?

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [12]

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Yes. So we're always -- in fact we're always out there actively looking for acquisitions. We made 1 small in last year, as you know. I would say, having been through these cycles before, quite frankly, for an acquisition to make sense, a few things need to come into line, evaluations and the need for the other side to be acquired, et cetera. So sometimes through these downturns, opportunities present themselves. So I think that we're in a very good position. Sitting here today, we have, as you said, a very strong balance sheet. There's a number of companies that we've been had our eye on or had discussion whilst in the past, et cetera. And given everything that's going on, we may see opportunities open up that weren't there 6 months ago.

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Frederic Bastien, Raymond James Ltd., Research Division - MD & Equity Research Analyst [13]

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Okay. And can you expand a bit more on the opportunities you're seeing in the rare metal space. Obviously, it's tied in with some of the acquisitions you're going to be looking at. But you had prepared comments related to that and I missed some of that.

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Geoffrey R. Bedford, Neo Performance Materials Inc. - President, CEO & Director [14]

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Yes. I think the -- where we're focused really is we think that there continues to be improvements available, operational improvements in Silmet. And we've done a lot there already. But we think that there's opportunities there. And we also think that there's some product development opportunities as well on the rare metals side that could help with profitability and move a little more into a value-add type space and less commodity like.

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Operator [15]

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There are no further questions in queue at this time. This concludes today's conference call. Thank you for participating. You may now disconnect.