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Edited Transcript of SYR.AX earnings conference call or presentation 20-Oct-19 11:00pm GMT

Q3 2019 Syrah Resources Ltd Earnings Call

Oct 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Syrah Resources Ltd earnings conference call or presentation Sunday, October 20, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Julio C. D. Costa

Syrah Resources Limited - COO

* Shaun Verner

Syrah Resources Limited - MD, CEO & Director

* Stephen Wells

Syrah Resources Limited - CFO

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Conference Call Participants

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* Michael Slifirski

Crédit Suisse AG, Research Division - MD

* Rahul Anand

Morgan Stanley, Research Division - Equity 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 Q3 quarterly update. (Operator Instructions) Please be advised that today's conference is being recorded.

I'd now like to hand the conference over to your speaker today, to Mr. Shaun Verner. Thank you. Please go ahead.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [2]

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Good morning, everyone, and thanks for dialing into the call this morning. With me on the call today, I have Julio Costa, our COO; and our new Chief Financial Officer, Stephen Wells. Stephen is an experienced finance executive with almost 25 years of broad financial expertise built up across institutional and investment banking, resources and international financial services. We're pleased that Stephen has joined the team.

The format of our call will be a little different today given the announcements we pre-released late on Friday, facilitating the commencement of our operational restructure changes in response to the adverse change in market conditions we communicated earlier [in September]. I'll work through the slide deck we released on Friday, and I'll start on Slide 3, which summarizes our third quarter performance.

Our safety record remains strong, with a total recordable injury frequency rate of 0.6 as of the end of September, noting as well that operational safety statistics now incorporated from Vidalia, the band facility in the U.S. as well as Balama. At Balama, we produced 45,000 tonnes of natural graphite during the third quarter. Although this is broadly similar to Q2 production, we've strategically commenced ramping down our production volumes in response to pricing conditions in September.

Our production improvement plans are really building on the initiatives implemented to date. Recovery improved to 69% for the quarter, and we achieved 71% in September. And importantly, we believe the step change has been achieved in recovery improvement as volume from hereon. Our product quality also improved strongly with a Q3 average fixed carbon grade of 96%, and the percentage of coarse flake in the product mix increased from 16% -- to 16% in Q3 from 12% in Q2.

For the 9 months year-to-date, 2019, we produced 137,000 tonnes, which equates to an average of around 15,000 tonnes per month or about 15% production capacity utilization at a 9-month year-to-date C1 operating cash cost of USD 577 a tonne.

On sales and marketing, we sold 45,000 tonnes compared to 53,000 tonnes in Q2, with the major change a fall in weighted average price to USD 391 per tonne versus $457 a tonne in the prior quarter.

As previously advised, the lower pricing in Q3 reflected the sharp deterioration of graphite prices in China, with China accounting for 80% of our sales volumes for the 9 months year-to-date. With our planned ramp-up beyond 20,000 tonnes per month negated at this point and the ability to drive down our unit costs through volume unavailable, the need to instigate a significant structural review at Balama was immediately clear.

With our Battery Anode Material project in Louisiana, the construction of the batch purification circuit is complete and final commissioning and initial production of purified spherical graphite is underway, with the delay from Q3 primarily due to availability of specialist supplier of technical support during commissioning. At the end of September, we had cash of USD 65.5 million and proceeds from the convertible note issued to AustralianSuper of USD 38 million equivalent is expected on the 28th of October.

Slide 4 provides a summary of the outcome of the structural review carried out since September 10. In response to the sudden and sharp decline in pricing that we saw at the end of the quarter, we revised our production volumes for Q4 2019 to minimum levels of around 5,000 tonnes per month, and we initiated a review of the structural costs at Balama across the company. Our current plan for production in 2020 is between 120,000 and 150,000 tonnes, which will be strongly driven by market conditions and which is lower than the previously foreseen; however, it's facilitated by a restructure of the cost base and changes to the operating philosophy at the site. We've identified reduction in the Balama C1 operating cash costs of more than 20% when compared with our 9-month year-to-date average monthly production run rate, which is around 15,000 tonnes, and we'll reduce corporate overhead by more than 20% mainly through executive team headcount reductions and proposed changes at quarter-end. We remain committed to the strategically important BAM project activities to capitalize on our investment to date and the significant development of capability, and we'll deliver product samples for qualification and development to facilitate ongoing customer and strategic engagement.

Moving to Slide 6. Let me provide context to the challenges we're currently facing in the natural graphite market. During the latter part of Q3, there was a sudden and significant drop in the natural graphite prices across all flake sizes in China. This had a significant impact on our contractual pricing renegotiations and contract renewals, noting that our sales volume agreements remain in place for some of these contracts subject to pricing being agreed. The primary impact on the grade prices for Q4 was the depreciation of the Chinese yuan against the U.S. dollar, as far as U.S. dollar-denominated pricing competing with Chinese domestically priced production. This was exacerbated by concurrent negative factors, including increasing Chinese inventory level, concerns due to supply growth from ourselves and Madagascar and seasonal Chinese production. At the same time, we're seeing cuts in Chinese EV subsidies and the general environment of trade tensions impacting consumer and industrial market sentiment.

These market conditions and near-term pricing indications are difficult for all producers across the cost curve and indicate that any additional new supply is highly unlikely in the short term to medium term given unutilized capacity available in the market. Notwithstanding the near-term market challenges, we do not see major implications for the positive lithium-ion battery demand outlook in the longer term.

Moving to Slide 7. And the key point to note here is that China has experienced rapid EV growth, June 2019, despite a continual program of rolling back government subsidy since 2016. We, therefore, expect the market to recover from current weaker -- from the current weaker period of year-on-year growth, which is being seen in the context of weaker overall global and Chinese auto growth and generally weaker consumer sentiment.

EV demand advanced strongly to June this year, ahead of the Chinese government subsidy changes. Overall, Chinese auto sales have declined over the last 15 months. But it's important to note that Chinese EV sales for the 9 months year-to-date have increased 21% to 870,000 units versus the same period in 2018 despite a 15% decline year-on-year in the third quarter.

On Slide 8, as we've outlined previously, one of the challenges in the graphite market is visibility of trade data and price information. And the chart on this slide shows data that we've recently been able to aggregate, which demonstrates that the major supply growth in times has predominantly been driven by Syrah and additional coarse flake has grown from Madagascar mainly through a privately funded, Chinese-funded operation. Since Balama commenced operations at the start of 2018, we've sold approximately 220,000 tonnes with significant export volumes into China.

Supply growth of coarse flake and exports to China from Madagascar have been more significant than previously forecast into the industrial market, which has a lower base volume and lower growth, and that is clearly having an impact on coarse flake pricing. China remains the largest producer and consumer of natural graphite. Overall, annual Chinese production has been declining in part due to environmental restrictions and mine depletion, noting that the average Chinese mine head grade is between 5% and 7% compared to Balama's 16%. And nothing changes our view of the criticality of Balama to future global natural graphite supply.

Moving to Slide 9 and some further trade data visibility that we've been able to generate over the last couple of months. The chart on the right-hand side shows the actual import/export position for China from the beginning of 2018 to date in 2019. On the left-hand side, we see the proven position of not importing at all historically. China has indeed become a significant net importer of natural graphite for the first time. This is a fundamental shift in international trade flows driven by high quality, consistent availability as far as fines material and growing demand.

In the 9 months year-to-date, China imported 136,000 tonnes of natural graphite with more than 75% of this from (inaudible) from Syrah whilst exporting 75,000 tonnes over the same period. This change has been driven by battery demand growth and the EV adoption and needs to be supported by Chinese EV and battery manufacturers' clear commitment to near-term expansion of EV product ranges and the continuing increase in the average battery capacity per vehicle. China is the leader of global EV adoption, with government policy supporting higher battery energy density and longer vehicle ranges, and we, therefore, expect this trend to continue.

Moving to Slide 10. We're still in the early phases of this fundamental market change. China transitioned to a net importer of natural graphite fairly quickly, with import growth predominantly driven by Syrah's production and directed to the battery supply chain. Imports are competing with Chinese domestic material with the relative value of products being priced in a well-supplied market as China is also adjusting to the first full year of consistent high availability as far as production combined with seasonal domestic production highs.

In the short term, a pricing and volume challenge is evident. In the next phase of evolution in the Chinese natural graphite market, we expect our pricing to increasingly reflect the rebalancing and net import drivers with greater value and used pricing differentials becoming evident between product qualities. The pricing premium is expected to continue for higher carbon grade material, and Syrah's consistent quality and volume from the long-life Balama assets will be a clear differentiator.

To recap on general pricing dynamics, graphite pricing negotiation remains bespoke and primarily negotiated through bilateral agreement with customers. And current graphite price reporting remains regionally differentiated and ex China-focused, with prices reported anecdotally rather than consistent within the IOSCO price reporting principles. As far as the only listed graphite producer selling globally at volume and the only producer reporting an integrated China and ex China basket price, which will ultimately be reflective of the true global market price since regional differentiation is increasingly arbitraged down.

Moving now to our operational review and restructure from Slide 12. The safety of our people and sustainable operations for enduring value to our stakeholders in Mozambique are key priorities. And as we move into our operational review, this was at the forefront of our decisions in relation to the announced restructure. Some sustainability highlights through the third quarter included our review and upgrade of our ISO certification for health, safety and environmental management of Balama; maintenance of the Balama workforce at 96% Mozambican nationals, which will be the same after the restructure; and during Q3, we were honored to accept an award for Best Innovation in Corporate Social Development at the inaugural Australia-Africa Minerals and Energy Awards for our Balama Training Center development.

Moving to Slide 13 and the details of the restructure and the immediate operating philosophy. In response to market conditions, we've taken clear and immediate action. We announced the strategic reduction in production volume in Q4 to 5,000 tonnes per month, and we've completed structural and operational review. The C1 operating cash cost of USD 577 a tonne at 15,000 tonnes a month is not workable in the current price environment. Our cost reduction initiatives announced are expected to achieve $22 million or more than 20% C1 operating cash cost savings at Balama in 2020. Regrettably, this will involve a 30% headcount reduction at Balama, and the consultation process commenced over the weekend with the affected employees. And we'll continue to engage with Mozambican government, local communities and other key stakeholders to ensure we achieve a smooth transition. This change is facilitated by a more flexible operating methodology that can be undertaken given the operational stability achieved and the increased experience and capability demonstrated recently by the Balama

Team. We've also taken a decision to reduce corporate overheads with an annualized saving of USD 1.5 million mainly due to executive headcount reduction. We'll incur one-off implementation costs of USD 1.5 million for the full change program across the group, with the majority of implementation completed by the end of this year. The benefits of the cost savings are expected to commence from January 2020.

I'll now pass you over to Steve to provide some further detail on how the Balama cost will look post restructure.

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Stephen Wells, Syrah Resources Limited - CFO [3]

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Thank you, Shaun, and good morning, everyone. As Shaun mentioned, for the 9 months year-to-date 2019, the Balama graphite operation produced 137,000 tonnes of natural graphite, which equates to an average of 15,000 tonnes per month or roughly 50% of the production capability of the plant. For that 9-month period, the C1 operating cash cost was USD 577 per tonne.

Following the structural cost review undertaken through September, we are expecting a reduction in C1 operating cash cost of over 20% or approximately USD 22 million per annum when compared to the run rate established so far in 2019. The key drivers of the cost savings at Balama include a 30% headcount reduction and reduction in associated staff costs; contract reviews and renegotiations across mining, transport, processing materials and support services; and changes to mining and processing configurations to achieve the best outcome across the entire process.

The cost savings impacted both fixed and variable costs at the lower production levels. We have reduced annualized fixed cost by $7 million per annum. And based on a 15,000-tonne per month run rate, our fixed to variable costs are 50-50. You can see that in the bottom right-hand chart and how that fixed cost percentage falls further at the higher production rate.

Of course, the total cost will vary at different production volumes in the context of the near-term strategic reduction to 5,000 tonnes per month at very low plant utilization levels of only 17% of plant capacity. Fixed costs for the size of the plant mean that unit cost increased significantly. But this work is aimed at driving down costs to enable a lower per monthly production volume at which Balama can breakeven. Clearly, should the market facilitate an increase in production volume at forecast or higher price levels, the benefits from the cost reduction exercise will increase.

The work done to date has been considerable in a short space of time. And the cost initiatives announced today represent the opportunities that we are able to execute in the short term. In addition to the initiatives announced today, through this process, we have identified further cost reduction opportunities that are difficult to quantify at this point in time or assign a reasonable level of certainty. We will continue to work on those and identify further cost reduction possibilities that we will review as we test lower volume plant operating configurations in the fourth quarter and into 2020.

I'll now pass you back to Shaun.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [4]

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Thanks, Steve. Moving on to Slide 15 and the Balama outlook. Balama's 21 months of ramp-up and improved operational performance provide visibility of trends in operational metrics and a very good understanding of the ore body and process controls. Our near term targets have been adjusted for performance achieved to date based on the current plan for a lower production utilization and altered ramp-up profile from what was previously expected. Producing at these minimum levels in Q4 will allow us to continue to optimize production, quality and mix and investigate further configuration options whilst maintaining the ability to quickly ramp back up to 15,000 tonnes per month run rate and beyond as the market dictates. As Steve alluded to, at 5,000 tonnes a month, we're at only 17% capacity. And in general, continuous processing plants are not designed to be operated cost effectively at such low utilization levels, so building back to a minimum 50% utilization level is important for quickly reducing cash operating cost.

So well, we'll exit this year at 5,000 tonnes per month production run rate, and our currently planned 2020 production is between 120,000 and 150,000 tonnes. And the monthly ramp-up profile and total amount produced for 2020 will be significantly driven by market conditions. We'll manage our production volumes in a disciplined way to facilitate quarterly price negotiations that reflect our cost of production as well as the market balance.

We'll continue to focus on increasing our average fixed carbon grade distribution in the range of 95% to 97%, with a pricing premium for higher carbon grade embedded in our customer agreements. And we'll look at our ore blending strategy to increase the percentage of coarse flake production in conjunction with our screening processes and manage the impact on recovery outcomes with these initiatives. At this stage, it's too early to gauge the market response to our lower volumes as inventory continues to be consumed from product that was moving to market. We'll monitor market conditions closely and be nimble in adjusting our production volumes accordingly.

From now, I'll move on to Slide 17 and the criticality of our Battery Anode Material project and some background and context. In Europe and China, in addition to commercial development and consumer interest, policy is driving a transition from ICE vehicles to EVs, fuel economy and emission standards enforcement are driving planning and implementation of automaker fleet design changes, and direct and indirect government support is driving incentives to change consumer behavior. And as this occurs, the importance of raw materials to the battery technology value chain is becoming more broadly understood. The Department of Energy in the U.S. and a number of EU-sponsored consortia are highlighting the need for sourcing alternatives for the current reliance on China in a number of key areas.

Moving to Slide 18. And regardless of whose forecast you choose to believe, lithium-ion battery demand growth is driven by EV and is expected to be significant over the next 5, 10 and 20 years. Automakers are implementing aggressive EV growth targets across the board in order to make a plan for considering both design and manufacturing platforms to gain exponential momentum in volumes, with partnerships and alliances springing up across some unlikely quarters. Whilst China is leading the way in EV adoption as the major consumer, producer and supplier of some key battery raw materials, its pace of development is driving reaction and competitive positioning across the U.S. and Europe.

On Slide 19, our latest research indicates that natural fines graphite demand from anode active material is expected to increase by 170% from 2019 to 2023 to almost 600,000 tonnes and taking the overall natural graphite market to well over 1 million tonnes. Balama scale, quality and low production costs at full production capacity are, therefore, key enablers in the delivery of Syrah's integrated BAM strategy. Pursuing BAM now provides us the opportunity to produce value-added products and capture additional cash margin earlier by establishing a core position in the battery supply chain, provides an alternative and complementary source of ex China Battery Anode Material supply, and it will drive the potential for strategic operating and technical partnership in our project.

Most importantly, continuing the investment in BAM demonstrates the credibility and investment commitment that continues to differentiate Syrah from a number of competitors in the effort to develop first large-scale integrated natural graphite anode material facility outside of China. And it is that reality of investment and production of material which is absolutely critical as a driver of meaningful industry engagement. It's also worth noting that the work that we have underway is a culmination of a 5-year program of work.

Moving on to Slide 20. We've invested much effort and capital in our BAM project since 2015 and built significant product development and proprietary technology and are progressing on qualification volumes of precursor materials, particularly purified spherical graphite. We must leverage the significant investment made and capability developed to date to maintain customer engagement momentum.

From now and into 2020, we'll continue to focus on strategic partnership opportunities through purified spherical graphite qualification, and importantly, the minor remaining investment for production of final anode active material for coated spherical graphite and customer qualification. This will facilitate the completion of the optimized feasibility study during 2020 for an investment decision in a potential commercial scale and facility.

With that, I'll pass you back to Steve to discuss our cash and liquidity position.

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Stephen Wells, Syrah Resources Limited - CFO [5]

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Thank you, Shaun. Turning to Slide 22. We finished the third quarter with USD 65.5 million compared to our forecast during the September 10 update of USD 60 million largely due to a repair to refund recovery of over $4 million. Added to that, we have executed on a convertible note with AustralianSuper for AUD 55.8 million or approximately USD 38 million with proceeds received on October 28.

Clearly, the fourth quarter is a transition quarter as we execute on our cost-out initiatives combined with lower production and sales volumes. In the fourth quarter of 2019, we forecast Balama net cash outflow of approximately USD 17 million, reflecting a higher cash draw as we operate at low production and sales levels while retaining a higher cost production base for a large part of the quarter and execute on the cost-saving initiatives for a greater benefit into 2020.

We will also incur one-off restructuring costs of USD 1.5 million as the cost-saving initiatives are implemented through the quarter. At BAM, we forecast a spend of USD 6 million in the fourth quarter. Total BAM spend until the end of 2020 is forecast at approximately USD 13 million, including the fourth quarter spend, which is higher than anticipated due to the delay in completing construction and commissioning in the third quarter. As a result, our cash forecast at the end of the year is approximately USD 78 million.

Our balance sheet and cost-reduction initiatives have allowed the flexibility to temporarily release -- reduce production volumes to allow for the market to rebalance while we execute on cost reduction plans. We are well positioned to quickly ramp up to meet future demand should market conditions eventuate. However, we will continue to assess our cost base as the plant stabilizes with the lower production rates in the fourth quarter and into early 2020 in order to identify further cost-reduction opportunities and continued progress towards an operating cash flow positive position as quickly as possible.

We anticipate that the combination of reduced costs, completion of major BAM construction spend and improving revenue conditions will see a significant reduction in quarterly cash outflow in 2020, but it is too early to provide guidance on that at this stage.

I'll now pass you back to Shaun to wrap up.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [6]

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So just to sum up, I guess, on Slide 24, we've taken clear action to address the current market conditions with significant cost reductions, and we continue to engage with employees and key stakeholders to make sure that, that transition is as smooth as possible.

Our near-term operational targets have been conservatively rebased to reflect the lower production volumes and optimization outcomes achieved to date. And we'll continue to monitor the market response to our temporarily reduced volumes and manage our production ramp-up in 2020 in accordance with market conditions and demand.

We're doing what has to be done internally and externally in providing a clear message around the intent in the way that we wish to run Balama. We're focused on maintaining balance sheet strength in achieving positive cash flows as soon as we possibly can. We continue to operate the world's best natural graphite asset in a safe, sustainable and responsible manner to build the sustainability of the Balama operation and the Syrah business.

We're in the early phases of a fundamental market shift, with China being the most important graphite market transitioning to a net importer status. And Balama's scale, its quality and its low production costs at full capacity are key competitive enablers of the BAM strategy, which is critical we continue now to provide ongoing momentum and progress towards qualification and engagement in the supply chain.

The long-term macro trends remain very positive for battery demand growth, and our balance sheet allows the flexibility and operational response to work through this period of challenge and to quickly ramp up again to meet future demand growth as market conditions stabilize. Most importantly, Syrah is increasingly uniquely differentiated as we've done the right work and we're moving through what we now know to be a long and challenging path, and that provides a long period of competitive advantage against potential competitors as market conditions improve.

And with that, I'll hand you back to the operator and I'm happy to take...

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Questions and Answers

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Operator [1]

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(Operator Instructions) Now first question in queue is from Rahul Anand from Morgan Stanley.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [2]

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I'd like start to with, firstly, recoveries and coarse flake splits. If we can talk about -- is there a volume impact here? I mean if we're holding back volumes in terms of production, is that somehow constraining you guys to reach the medium-term target of recoveries of 88% and then also the production splits? Because looking into next year, we're still lower on recoveries in terms of the medium-term plan and also the core splits don't look too different to this year. So I just wanted to understand if there's a volume impact there. That's the first one, and I'll come back with the rest.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [3]

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Yes. So I'll make some initial comments, and I'll let Julio make some comments as well. I think what we've done here is provided a fairly conservative set of forward views around recovering coarse flake splits and growth based on continuing to work through the program of operational improvement. And I think in Q3, we started to see some very good progress on that front. I think the challenge that we face is that as soon as we started to see that improvement embedding, we had to make a production volume reduction. And I think as we do that, we need to continue to work through the trade-offs around recovery costs like split and grade, noting, of course, that product, carbon growth is at the moment the most definite pricing differential that we've seen because there are already price differentials built into our contracts on carbon growth.

Julio, do you want to make any commentary around...

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Julio C. D. Costa, Syrah Resources Limited - COO [4]

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Yes. I think I can add that the recovery of 75% at 15,000 tonnes has been consistently demonstrated, so as Shaun said, we opted for a plan that has been demonstrated physically on site. We have [still recovery rates] increased to the above 80s, and we actually -- the lower volume allow us to optimize that and improve the way to deliver to that.

In terms of the split, the configuration of the plant for the first half of the year impacts a bit on the split so some of that is related to this because we try to operate at minimum energy consumption. And that the decision was actually for us to reduce some of the usage of the split system that we have in the plant given that we have that flexibility now moving towards the second half of the year. Then we'll go back to the performance that we have demonstrated so far, which is above 16%, and then continue to grow towards the 24%, 2021.

The other option that we still have in our hand, the use of the Balama East, which certainly contains much more coarse flakes, so that's not being incorporated in this plan yet.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [5]

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Thanks, Julio.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [6]

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Okay. Understood. So I guess just to have a quick follow-up then, it would seem that the cost splits are somewhat impacted by the volumes, but the recoveries can still improve despite the constrained volume at the moment?

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Julio C. D. Costa, Syrah Resources Limited - COO [7]

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Yes. The split just impacted by the configuration of the plant in the first half of the year, right? The volume does not negatively impact on the split. Actually, it only makes easier from a control standpoint to deliver a better efficiency in terms of the split. But obviously, when you operate the plant without the flake circuit, then we do not separate as much as we should.

But again, going back to the steady state, which is the 15% and beyond, we have demonstrated already 16% and above, and then there's no -- the plant is designed to get that performance even at higher volumes. So we don't see any constraints in that space.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [8]

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Okay. Understood. I might move on to the next one then. If we look at costs for next year, despite the cost-out, we're sitting at around [435 to 465] is what I calculate roughly. So I mean if prices stay here, what's the strategy? Is it still to produce at these levels? Or can we make further constraints or have a period of maintenance shutdown or something else?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [9]

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I think there's a number of effects, the answer to that question, Rahul. I think the first one is that we've taken a pretty clear production path based on that change in pricing and the historical pricing at significantly higher volumes and where we currently are was a lot better. So the first thing to say is that as the market rebalances, I think we have a good degree of confidence around where prices might recover to. The possibility or the ongoing likelihood of producing at 5,000 tonnes a month is not part of the forward strategy. And clearly, we've taken a decision here to make a meaningful rebalancing impact as quickly as possible to assess that impact and move forward once that impact comes through.

The last thing that's important is that, as we mentioned during the call, there is a continuing focus on further cost-reduction initiatives, and I think there's 2 phases to that. There's one that there are items already identified for which further work that needs to be done. And I think there is also a view that as we settle into a different operating philosophy and reason that Balama may well continue to generate further opportunities for us to pursue.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [10]

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Okay. The final question for me is around the Madagascar product that we see in the market. So 2 questions around that. Firstly, where do they sit on the cost curve in reference to Syrah? And then secondly, where do they sit on the margin curve, in your opinion?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [11]

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So I think first thing to say about Madagascan production is that it's privately funded, Chinese-driven and the addition of that material to the market was not something that we anticipated coming in the volumes that did. The other aspect of the -- that material is that it's about 70% of coarse flake, 30% fines. So clearly, as that material come to market and hit the coarse flake segment, which is smaller, slower growing and offer lower basis had a more significant impact on pricing.

As to where the operation sits on the cost curve and the margin curve, I think the fact that it is private limits our ability to assess that. We know that they have slightly more attractive logistics costs than we do given the location of the operation compared to the port. But importantly, we see that over the last 2 months, according to the data that we've been able to collect and break down, that the imports into China have significantly decreased. And I guess we see that aligning with the period at which prices began to fall, and we draw the conclusion there that the profitability or ability to continue to produce high volumes at those lower prices is extremely challenging. But we don't have visibility of that, of course, and it's something that we're clearly taking into account as we think about our own coarse flake fines split and the ramp-up that we will pursue in 2020.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [12]

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Okay. That's quite interesting. Given the 70% coarse flake, despite that, given the prices that volumes have dropped off, so that must mean much higher cost production in that case? Okay, that's pretty much it for me, I'll pass it on.

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Operator [13]

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The next question is from Michael Slifirski from Crédit Suisse.

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Michael Slifirski, Crédit Suisse AG, Research Division - MD [14]

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First of all, Shaun, Q4 pricing outlook, how does it look compared to Q3? Do you have sort of a direction compared to what you've achieved in Q3?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [15]

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I think it's early to comment on it from a spot perspective, Mike. The September production from Balama is still making its way to market, and we're just starting to see some feedback from current conditions as we look forward to potential further cost-out. We do have, obviously, the existing contractual commitments and price tonnes in Q4. And obviously, the reduction of delivery of material into very low price Chinese sales, we'll see some recovery in stock price with some of that contract mix. But I'm not prepared to comment any further at the moment on the direction of the stock price at the moment.

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Michael Slifirski, Crédit Suisse AG, Research Division - MD [16]

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Okay. Secondly, with respect to pricing and contract commitments, what -- at your lower production rate, what portion of your volume for calendar year '20 is contractually committed versus what's exposed?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [17]

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Well, I guess the key answer to that question is what happens with the pricing under the volume-based contracts that we have in place for China. From a technical contract perspective, there's probably more volume contracted than what we're currently forecasting to produce, but the execution of those contracts is dependent on quarterly pricing agreements. And obviously, you see in Q4, we've chosen not to proceed with the full volume under those contracts given the prices that were available to us at that point in time.

So the second aspect to it is that, as we mentioned during the volume of the call, there's a number of contract renewals underway, discussions underway with Chinese consumers, which are, again, predicated on the pricing that we achieved.

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Michael Slifirski, Crédit Suisse AG, Research Division - MD [18]

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Okay. With respect to the cost base reduction, how much of that is permanent and how -- up to what volume is that good for? So is there -- does that cost cutting cap you at 150,000 tonnes? If you produce more than that, is there an increase in fixed cost?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [19]

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The majority of the initiatives that have been put in place are permanent initiatives. So the labor reduction doesn't inhibit our ability to lift production beyond 150,000 tonnes. We have some transport-related and processing-related cost reductions, which are, again, structural but at higher volumes. We've seen some of that impact coming back into variable cost. But I would say the majority of what's been implemented here by far is a permanent restructure of the cost base.

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Michael Slifirski, Crédit Suisse AG, Research Division - MD [20]

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Terrific. The countering of production, if you're going to sell less into contracts than maybe what those customers had anticipated, what's the risk that you're creating an opportunity for your competitors to take market share that you're otherwise perhaps controlling?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [21]

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Yes. I think it's a very good question, Mike. It's one of the reasons that we've continued to produce through this period rather than stop altogether because one of the things that we want to make sure is that we have the ability to respond should market conditions be there for it. I look at it a little bit from the other perspective in that I think about how much market share Syrah has taken in China. In the last 12 months, in particular, it's been enormous. So there might be some encouragement as Chinese domestic production is at seasonal tick at the moment, but it's not something that we didn't anticipate. We've always understood the seasonality of that production, so we're very, very cognizant of ensuring that we don't open that gap. And as we said, we will manage the production levels dynamically to ensure that we're keeping that market gap well managed.

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Michael Slifirski, Crédit Suisse AG, Research Division - MD [22]

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Okay. And with respect to your observation of natural graphite versus synthetic graphite, with the price collapse in natural, has synthetic pricing adjusted? Or has the spread between synthetic and natural for an equivalent product opened up? And then how do you think about that? Or how do you think your customers -- sorry, how do you think the end users think about that price differential in terms of their longer-term intentions?

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [23]

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I think the first aspect of it is it's probably not a sustainable cost differential because, clearly, we're not going to produce these types of -- significant volumes at these types of prices in the future. There's no doubt, though, that the feedback from anode material producers is that the cost focus of automakers and battery cell manufacturers continue to drive them to look at every possible cost improvement that can be passed through the chain, so it's very much top of mind.

And in our most recent discussion last week, it's something that was very evident to some major battery anode material producers that the transition to a greater proportion of natural graphite is still a significant opportunity from a cost perspective. I think the other thing that is clear, however, is that it's not switches that are made in the short term, and they're not switches that are made with the possibility of moving back, so they are very considered decisions. And that is something that reinforces why we feel so strongly that continuing the BAM work that we have underway at the moment.

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Operator [24]

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There's no further questions at this time. I'd like to hand the call back to the speakers for any closing remarks. Please go ahead.

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Shaun Verner, Syrah Resources Limited - MD, CEO & Director [25]

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Thank you all very much for the attention today. Obviously, some significant changes as part of this process. We look forward to keeping the market updated on the progress with those initiatives and we look forward to some positive movements in the market to support a ramp-up from here. Thanks very much.

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Operator [26]

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Ladies and gentlemen, that does conclude the call for today. Thank you for all participating. You may all disconnect.