Description
Molycorp Inc. Director Brian T. Dolan bought 12,153 shares on 6-13-2012 at $ 20.5
BUSINESS OVERVIEW
Our Business
We are the largest rare earth oxide, or REO, producer in the Western hemisphere and own one of the world's largest, most fully developed rare earth projects outside of China. We also own one of the largest rare earth oxide and rare metal producers in Europe, and the only producer of rare earth alloys in the United States. Upon the full execution of our "mine-to-magnets" strategy and completion of our initial modernization and expansion plan, which we refer to as Project Phoenix Phase 1, and second-phase capacity expansion plan, which we refer to as Project Phoenix Phase 2, at our Mountain Pass, California rare earth mine and processing facility, which we refer to as our Molycorp Mountain Pass facility, we expect to be one of the world's most integrated producers of rare earth products, including oxides, metals, alloys and magnets. Following the completion of Project Phoenix Phase 2 construction, we expect to have the ability to produce, if customer demand warrants, up to approximately 40,000 mt of REO per year by mid-2013 at our Molycorp Mountain Pass facility, or approximately double the amount we will be able to produce upon completion of Project Phoenix Phase 1.
Rare earths are critical inputs in many existing and emerging applications including: clean energy technologies, such as hybrid and electric vehicles and wind power turbines; multiple high-tech uses, including fiber optics, lasers and hard disk drives; numerous defense applications, such as guidance and control systems and global positioning systems; and advanced water treatment technology for use in industrial, military and outdoor recreation applications. Global demand for rare earth elements, or REEs, is projected to steadily increase both due to continuing growth in existing applications and increased innovation and development of new end uses. We have made significant investments, and expect to continue to invest, in developing technologically advanced applications and proprietary applications for individual REEs.
Our Corporate History and Structure
Molycorp Minerals, LLC, a Delaware limited liability company formerly known as Rare Earth Acquisitions LLC, was formed on June 12, 2008 to purchase the Mountain Pass, California rare earth deposit and associated assets from Chevron Mining Inc., a subsidiary of Chevron Corporation. Prior to the acquisition, the Molycorp Mountain Pass facility was owned by Chevron Mining Inc. and, before 2005, by Unocal Corporation. Molycorp, LLC, which was the parent of Molycorp Minerals, LLC, was formed on September 9, 2009 as a Delaware limited liability company. Molycorp, Inc. was formed on March 4, 2010 as a new Delaware corporation and was not, prior to the date of the consummation of its initial public offering, conducting any material activities.
The members of Molycorp, LLC contributed either (a) all of their member interests in Molycorp, LLC or (b) all of their equity interests in entities that hold member interests in Molycorp, LLC (and no other assets or liabilities) to Molycorp, Inc. in exchange for shares of Molycorp, Inc. Class A common stock. Additionally, all of the holders of profits interests in Molycorp Minerals, LLC, which were represented by incentive shares, contributed all of their incentive shares to Molycorp, Inc. in exchange for shares of Molycorp, Inc. Class B common stock. Accordingly, Molycorp, LLC and Molycorp Minerals, LLC became subsidiaries of Molycorp, Inc., which we refer to as the "Corporate Reorganization". Following the Corporate Reorganization, Molycorp, LLC was merged with and into Molycorp Minerals, LLC. Immediately prior to the consummation of Molycorp, Inc.'s initial public offering, all of the shares of Class A common stock and Class B common stock were converted into shares of common stock.
On April 1, 2011, we completed the acquisition of a 90.023% controlling stake in AS Silmet located in Sillamäe, Estonia, which is now known as Molycorp Silmet AS or Molycorp Sillamäe, one of only two rare earth processing facilities in Europe. On October 24, 2011, we acquired the remaining 9.977% ownership interest in Molycorp Sillamäe. This acquisition provides us with a European base of operations and significantly increases our annual capacity to produce REO by approximately 3,000 mt. Molycorp Sillamäe sources rare earth feed stocks for production of its products primarily from our Molycorp Mountain Pass facility. The main focus of this acquired business is on the production of REOs and metals, including production of neodymium metal, a critical component in the manufacture of neodymium-iron-boron, or NdFeB, permanent rare earth magnets. On April 15, 2011, we acquired Santoku America, Inc., which is based in Tolleson, Arizona, and which is now known as Molycorp Metals and Alloys, Inc. or Molycorp Tolleson, the only producer of rare earth alloys in the United States. This acquisition provides us with access to certain intellectual property relative to the development, processing and manufacturing of neodymium and samarium magnet alloy products.
On August 22, 2011, we opened an office in Tokyo, Japan to provide customer support as well as consulting and technical services to our customers in Japan.
We have three operating segments: Molycorp Mountain Pass, Molycorp Tolleson and Molycorp Sillamäe. Each of the segments has only one production and shipping location. Sales to external customers by geographic area are based on the location in which the sale originated. Please refer to the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K for financial information about our operating segments, and to the Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Annual Report on Form 10-K for information about sales by product and by operating segment.
Rare Earth Industry Overview
The Rare Earth Elements
The REE group includes 17 elements, namely the 15 lanthanide elements, which are cerium, lanthanum, neodymium, praseodymium, promethium (which does not occur naturally), samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium and lutetium, and two elements that have similar chemical properties to the lanthanide elements—yttrium and scandium. The oxides produced from processing REEs are collectively referred to as REOs. Light and heavy REEs are contained in all rare earth deposits, including in our deposit at our Molycorp Mountain Pass facility. Heavy REEs generally command higher sales prices on a per pound basis than light REEs because heavy REEs are not as prevalent. Cerium, lanthanum, neodymium, praseodymium and samarium are considered "light REEs" that are more predominant in bastnasite, while europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium and lutetium are considered "heavy REEs" that are more predominant in monazite. Our reserves are bastnasite, but there are also known monazite occurrences near our Molycorp Mountain Pass facility. In December 2011, the U.S.
Our Mine Process and Development Plans
We and SRK Consulting (U.S.), Inc., or SRK Consulting, estimated total proven reserves as of February 6, 2010 of 88.0 million pounds of REO contained in 0.480 million tons of ore, with an average ore grade of 9.38%, and probable reserves of 2.12 billion pounds of REO contained in 13.108 million tons of ore, with an average ore grade of 8.20%, in each case using a cut-off grade of 5.0%, at our Molycorp Mountain Pass mine. As a result of increased REE prices during the three-year period ended December 31, 2011, the estimated economic cut-off grade for the deposit at our Molycorp Mountain Pass mine is less than the 5% cut-off grade initially applied by SRK Consulting. In addition to REE pricing, the cut-off grade calculation includes other technical inputs, such as process recovery and operating cost information. We continue to evaluate our operating cost and cost recovery information. Currently, we do not propose a change to the 5% cut-off grade that defines our reserve estimate. Accordingly, as of December 31, 2011, our estimated proven and probable reserves remain 88.0 million pounds of REO and 2.12 billion pounds of REO, respectively. Upon the completion of Project Phoenix Phase 1, which we expect to be completed by the end of the third quarter of 2012, we expect to have the capacity to produce approximately 19,050 mt of REO per year at our Molycorp Mountain Pass facility. Following the completion of Project Phoenix Phase 2 construction, which we expect to be by the end of the fourth quarter of 2012, we expect to have the ability to produce, if customer demand warrants, approximately 40,000 mt of REO per year by mid-2013 at our Molycorp Mountain Pass facility, or approximately double the amount we expect to be able to produce upon completion of Project Phoenix Phase 1. Based on our estimated reserves and an expected annual production rate of approximately 19,050 mt of REO under Project Phoenix Phase 1, the expected mine life of our Molycorp Mountain Pass mine is in excess of 30 years (SRK Consulting has preliminarily indicated, however, that doubling the amount of production pursuant to Project Phoenix Phase 2 would reduce the current mine life by half, assuming no additional exploration, conversion of known mineralized material to reserves, no realization of anticipated improvements in recoveries, and all other factors, such as cut-off grade, remain constant.)
Mine-to-Oxides
At our Molycorp Mountain Pass facility, we have the ability to mine, crush, mill and separate rare earth ore to produce individual REEs. Since our acquisition of the Molycorp Mountain Pass facility, we have been producing and selling REOs from stockpiled feedstocks to significantly improve our solvent extraction technologies and capabilities. As of December 31, 2011, we had achieved greater than 98% recovery in our solvent extraction units at commercial scale for cerium, lanthanum, and didymium, which we believe is one of the highest recovery rates in the world. We have also developed the expertise to produce the following REEs in many usable forms: bastnasite concentrate; cerium; lanthanum; neodymium; praseodymium; europium; samarium; gadolinium; dysprosium; and terbium. When used to describe the current recovery rate for our solvent extraction units, the term "commercial scale" means that the solvent extraction units are operating at such a production rate that the scale-up factor required to achieve the desired production rate is less than 10 times the current production rate.
Processing at our Molycorp Mountain Pass facility entails mining the bastnasite ore followed by crushing and milling it to a fine powder. Milled bastnasite ore is then processed by flotation whereby the bastnasite, which is a mineral containing light and heavy rare earth elements, floats to the surface and is separated from the waste material, which sinks in a series of flotation cells. The resultant bastnasite concentrate is then processed by leaching (cracking) with acid solutions followed by a series of solvent-extraction separation steps that produce various individual REO minerals, generally in a high purity oxide form.
Oxides-To-Metals/Alloys
We sell and transport a portion of the REOs we produce at our Molycorp Mountain Pass and Molycorp Sillamäe facilities to customers for use in their particular applications. The remainder of the REOs are processed into rare earth metals and rare earth alloys. We produce rare earth metals outside of the United States through third-party tolling arrangements and through tolling at our Molycorp Sillamäe facility. A portion of these metals is sold to end-users, and we process the rest into rare earth alloys at our Molycorp Tolleson facility in Arizona. These rare earth alloys can be used in a variety of applications, including but not limited to: electrodes for nickel metal hydride battery production; samarium cobalt, or SmCo, magnet production; and NdFeB magnet production. A portion of these rare earth alloys will be manufactured into NdFeB magnets as part of our alloy and magnet production joint ventures described below, and we expect to sell the rest to end-users.
In August 2011, we entered into a preliminary agreement with Hitachi Metals, Ltd., or Hitachi, for the supply of magnetic rare earth products and lanthanum. Under the three-year agreement, we will initially provide the rare earth products to Hitachi from our current commercial scale operations at our Molycorp Mountain Pass facility. Following completion of Project Phoenix Phase 1, we can supply the rare earth products from our Molycorp Mountain Pass facility or our other facilities (including Molycorp Tolleson and Molycorp Sillamäe) for the remaining term of the agreement. Prices under this agreement are based on international market price indexes published by third parties and typically used by the rare earth industry.
On November 28, 2011, we formed a joint venture, Intermetallics Japan Joint Venture or IJJV, with Daido Steel Co., Ltd., or Daido, and Mitsubishi Corporation, or Mitsubishi, to manufacture and sell next-generation NdFeB permanent rare earth magnets using a technology licensed from Intermetallics, Inc., a partnership between Mitsubishi, Daido and Dr. Masato Sagawa, co-inventor of the NdFeB magnet. Concurrently with the formation of this joint venture, we entered into a supply agreement with Mitsubishi (acting as the procurement agent) and Daido to sell to the joint venture certain rare earth products at the conditions set forth in the supply agreement.
Molycorp Mountain Pass
In November 2010, we entered into a contract to supply one of our largest customers with a significant amount of our REOs, primarily lanthanum concentrate, through mid-2012 at market-based prices subject to a ceiling based on market prices at June 1, 2010, and a floor. This contract was amended effective July 1, 2011 to increase the price ceiling. Under a second contract, we agreed to supply this same customer with approximately 75% of our lanthanum product production per year, following completion of Project Phoenix Phase 1 at market-based prices, subject to a floor, for a three-year period commencing upon the achievement of expected annual production rates under Project Phoenix Phase 1, which may be extended at the customer's option for an additional three-year period. In February 2012, this same customer exercised a volume reduction right that lowers its purchase obligation for lanthanum products from approximately 75% to approximately 58% of our lanthanum production per year, following completion of Project Phoenix Phase 1. Accordingly, we intend to secure other customer contracts for our lanthanum products in replacement of the volume reduction from our current customer.
Substantially all of our lanthanum production in 2011, which accounted for approximately 46% of our actual production in the year, was sold pursuant to the contract with one of our principal customers described above under which our pricing is subject to a price ceiling. We expect that production of our remaining materials will generally be sold based on prevailing market prices.
As of December 31, 2011, we had written agreements with customers covering 58% of our expected Project Phoenix Phase 1 production. The lanthanum contract volume reduction described above represents approximately 6% of our expected Project Phoenix Phase 1 production. Prior to commencing full production at our Molycorp Mountain Pass facility, we intend to enter into short-term and long-term sales contracts in advance with existing and new customers for amounts not in excess of our actual planned Project Phoenix Phase 1 production. For certain REEs where the market demand is high, such as europium, we do not expect to enter into letters of intent or contracts, because we believe these REEs can be easily sold.
During the third quarter of 2010, we completed our initial sale of XSORBX® to the water treatment industry, and, as of December 31, 2011, we have allocated 20% of Project Phoenix Phase 1 output to production of XSORBX®. In addition, we are in discussions with multiple large companies regarding the sale of XSORBX®, which will expand demand for cerium in times when it is in surplus and low priced. We have begun to sell XSORBX® for commercial use in the wastewater, recreation, pool and spa, industrial process and other water treatment markets.
Sources and Availability of Raw Materials
Energy (including electricity and natural gas), hydrochloric acid, sodium hydroxide and water are the principal raw materials used in our Molycorp Mountain Pass operations.
In connection with Project Phoenix Phase 1, we are building a new 24 megawatt Combined Heat and Power or co-generation power plant that will use natural gas to provide reliable electricity and steam to our Molycorp Mountain Pass facility to allow us to achieve our anticipated annual production rate of approximately 19,050 mt of REO. In connection with Project Phoenix Phase 2, we expect to add two additional turbines to the co-generation power plant to increase the plant's capacity to 49 megawatts.
We use significant amounts of hydrochloric acid and sodium hydroxide as chemicals to process REOs at Molycorp Mountain Pass. We ultimately intend to produce and recycle our own hydrochloric acid and sodium hydroxide at our Molycorp Mountain Pass facility; however, the technology we are developing to internally produce these chemicals to significantly reduce our dependence on external supplies has not yet been contructed at our Molycorp Mountain Pass facility. Accordingly, we purchase hydrochloric acid and sodium hydroxide in the open market through multiple suppliers and, as a result, could be subject to significant volatility in the cost or availability of these chemicals. We may not be able to pass increased prices for these chemicals through to our customers in the form of price increases for our products. A significant increase in the price, or decrease in the availability, of these chemicals, before we produce them on site could materially increase our operating costs and adversely affect our profit margins from quarter to quarter. Our operations at Molycorp Mountain Pass also require significant quantities of water to process REOs.
In addition to natural ores and REO concentrates, we utilize energy (electricity), hydrofluoric acid, nitrogen acid, sulphuric acid, tributylphosphate and water for our Molycorp Sillamäe operations. We purchase these raw materials, including chemicals, in the open market through multiple suppliers and, as a result, could be subject to significant volatility in the cost or availability of these materials. We may not be able to pass increased prices for these raw materials through to our customers in the form of price increases for our products. A significant increase in the price, or decrease in the availability of these chemicals could materially increase our operating costs and adversely affect our profit margins from quarter to quarter.
At our Molycorp Tolleson facility, we use didymium, neodymium, samarium and praseodymium rare earth metals, dysprosium iron metal, and a number of non-rare earth metals including iron, ferroboron, cobalt and copper. Except for didymium, we purchase these raw materials in the open market through multiple suppliers and, as a result, could be subject to significant volatility in the cost or availability of these raw materials. We may not be able to pass increased prices for these materials through to our customers in the form of price increases for our products. A significant increase in the price, or decrease in the availability, of these raw materials could materially increase our operating costs and adversely affect our profit margins from quarter to quarter.
Competition
According to IMCOA, global production of rare earth oxide products was approximately 112,000 mt of REO in 2011, and China accounted for approximately 94% of this total. The majority of the remaining production in 2011 was from Molycorp Mountain Pass and Molycorp Sillamäe. Although exploration programs for REEs exist outside of China and Mountain Pass, none of the deposits that are the subject of these programs are currently in production. In addition, at a April 2010 U.S. Government Accountability Office briefing, titled "Rare Earth Materials in the Defense Supply Chain" (Publication No. 111-84), government and industry officials stated that, for a typical exploration-stage mine, once a company has secured the necessary capital to start a mine, it can take from seven to 15 years to bring a property fully online, largely due to the time it takes to comply with multiple state and federal regulations. The time to bring a mine fully online may vary depending on the country and jurisdiction where the property is located.
CEO BACKGROUND
Brian T. Dolan , age 71, has been a director since September 2008. Until December 31, 2011, when he retired, Mr. Dolan served as a partner of Resource Capital Funds, a series of private equity funds investing in the mining and minerals industry, and RCF Management, L.L.C., a company that provides management services to the several Resource Capital Funds, from January 2002 until December 2011. Mr. Dolan is currently serving as a member of the board of directors of Connors Drilling LLC, a provider of diamond drilling and reverse circulation drilling services to the mining industry, and Rolling Rock Minerals, Inc., a privately held industrial minerals company. From 1970 to 2001, Mr. Dolan practiced law with the firm Davis Graham & Stubbs LLP of Denver, Colorado, specializing in natural resources law. Mr. Dolan's extensive and ongoing experience as a director of a wide spectrum of companies makes him a vital part of the Board.
John Graell , age 57, has been a director since March 2012. Since 1992, Mr. Graell has served as the chief executive officer of Molibdenos y Metales S.A., or Molymet, a manufacturer and processor of molybdenum. Mr. Graell serves on the boards of directors of several private companies in the metals and mining industry. Mr. Graell also served as president of the International Molybdenum Association, a non-profit trade association, from 2001 through 2005. Mr. Graell holds a degree in Industrial Engineering from Universidad de Chile. Mr. Graell brings to the Board extensive and ongoing experience as a chief executive officer of a company and director of several private companies involved in the global mining and mineral processing industries.
Mark A. Smith , age 53, has been our Chief Executive Officer and has served as a director since October 2008 and as our President since March 2010. From April 2006 until October 2008, Mr. Smith was president and chief executive officer of Chevron Mining Inc., a wholly-owned subsidiary of Chevron Corporation engaged in coal and mineral mining operations, and from August 2005 until April 2006, he was vice president of Chevron Mining Inc. In his positions at Chevron Mining Inc., Mr. Smith was responsible for 1,500 employees, approximately $500 million in revenue, three coal mines, one molybdenum mine and the Mountain Pass rare earth mine. From June 2000 until August 2005, Mr. Smith was a vice president for Unocal Corporation, an oil and gas exploration and production company, that previously owned the Mountain Pass facility, where he was responsible for managing all real estate, remediation, mining and carbon groups. Mr. Smith has served on the boards of directors of Avanti Mining Inc., a molybdenum mining company, since November 2009 and Talison Lithium Limited, a global producer of lithium, since September 2010. Mr. Smith received his B.S. degree in agricultural engineering from Colorado State University in 1981 and his J.D., cum laude, from Western State University College of Law in 1990. Mr. Smith's broad experience in the rare earths metals and mining industry and deep understanding of the operations at the Company's facilities make him a valuable member of our management and the Board.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
Presentation
Molycorp, Inc. was formed on March 4, 2010 for the purpose of continuing the business of Molycorp, LLC in corporate form. On April 15, 2010, the members of Molycorp, LLC contributed either (a) all of their member interests in Molycorp, LLC or (b) all of their equity interest in entities that held member interests in Molycorp, LLC (and no other assets or liabilities) to Molycorp, Inc. in exchange for Molycorp, Inc. Class A common stock. Accordingly, Molycorp, LLC and its wholly owned subsidiary, Molycorp Minerals, LLC, or Molycorp Minerals, became subsidiaries of Molycorp, Inc., which we refer to as the Corporate Reorganization. On June 15, 2010, Molycorp LLC was merged with and into Molycorp Minerals.
We have three operating segments: Molycorp Mountain Pass, Molycorp Tolleson and Molycorp Sillamäe. Each of the segments has only one production and shipping location. Sales to external customers by geographic area are based on the location in which the sale originated.
Recent Developments
In the first quarter of 2011, we completed a public offering of 5.50% Series A Mandatory Convertible Preferred Stock, or Convertible Preferred Stock, $0.001 par value per share. In connection with this offering, we issued 2,070,000 shares of Convertible Preferred Stock for $100.00 per share. Total net proceeds of the offering were $199.6 million after underwriting discounts and commissions and offering expenses payable by Molycorp, Inc. Each share of the Convertible Preferred Stock will automatically convert on March 1, 2014 into between 1.6667 and 2.0000 shares of Molycorp's common stock, subject to anti-dilution adjustments. At any time prior to March 1, 2014, holders may elect to convert each share of the Convertible Preferred Stock into shares of common stock at the minimum conversion rate of 1.6667 shares of common stock per share of Convertible Preferred Stock, subject to anti-dilution adjustments. The Convertible Preferred Stock is not redeemable.
On April 1, 2011, we completed the acquisition of a 90.023% controlling stake in AS Silmet located in Sillamäe, Estonia, one of only two rare earth processing facilities in Europe. We acquired 80% of the outstanding shares of AS Silmet, which is now known as Molycorp Silmet or Molycorp Sillamäe, from AS Silmet Grupp in exchange for 1,593,419 shares of Molycorp common stock, contractually valued at $80 million based on the average closing price of our common stock as reported by The New York Stock Exchange for the 20 consecutive trading days immediately preceding April 1, 2011, the initial acquisition date. AG Silmet Grupp retained a 9.977% ownership interest in Molycorp Sillamäe. We acquired the other 10.023% from Treibacher Industrie AG for $9.0 million in cash. The total purchase price for the acquisition of the 90.023% controlling stake was $81.7 million for accounting purposes, which reflects the fair value of the 1,593,419 shares of our common stock as of the initial acquisition date. On October 24, 2011, we acquired the remaining 9.977% ownership interest in Molycorp Sillamäe for $10.0 million in cash. The Molycorp Sillamäe acquisition provides us with a European base of operations and significantly increases our current rare earth annual production capacity by approximately 3,000 mt REO equivalent. Molycorp Sillamäe sources rare earth feed stocks for production of its products primarily from our Mountain Pass, California rare earth mine and processing facility, which we refer to as our Molycorp Mountain Pass facility. The main focus of this newly acquired business is on the production of rare earth oxides, or REOs, and metals, including didymium metal, a critical component in the manufacture of neodymium-iron-boron, or NdFeB, permanent rare earth magnets. Molycorp Sillamäe's manufacturing operation is located in Sillamäe, Estonia and Molycorp Sillamäe currently sells products to customers in Europe, North and South America, Asia, Russia, and other former Soviet Union countries.
On April 15, 2011, we completed the acquisition from Santoku Corporation, or Santoku, of all the issued and outstanding shares of capital stock of Santoku America, Inc., which is now known as Molycorp Metals and Alloys, or Molycorp Tolleson, a corporation based in Tolleson, Arizona, in an all-cash transaction for $17.5 million. The acquisition provides us with access to certain intellectual properties relative to the development, processing and manufacturing of neodymium and samarium magnet alloy products. Pursuant to the stock purchase agreement, Santoku provides consulting services to us for the purpose of maintaining and enhancing the quality of our products. On the same date, we entered into a five-year marketing and distribution agreements with Santoku for the sale and distribution of neodymium and samarium cobalt, or SmCo, magnet alloy products produced by each party. Additionally, we entered into a rare earth products purchase and supply agreement through which Molycorp Tolleson supplies Santoku with certain rare earth alloys for a two-year period at prices equal to the feedstock cost plus the applicable product premium as such terms are defined in the agreement.
On August 22, 2011, we opened an office in Tokyo, Japan to provide customer support as well as consulting and technical services to our customers in Japan. Total capital invested for the opening of the office in Tokyo was $0.7 million as of December 31, 2011.
In August 2011, we entered into a preliminary agreement with Hitachi Metals, Ltd., or Hitachi, for the supply of magnetic rare earth products and lanthanum. Under the three-year agreement, we will initially provide the rare earth products to Hitachi from our current commercial scale operations at Molycorp Mountain Pass. Following completion of our initial modernization and expansion plan at our Molycorp Mountain Pass facility, which we refer to as Project Phoenix Phase 1, we can supply the rare earth products from our new facility at Molycorp Mountain Pass or our other facilities (including Tolleson and Sillamäe) for the remaining term of the agreement. Prices under this agreement are based on international market price indexes published by third parties and typically used by the rare earth industry. Molycorp and Hitachi have suspended negotiations concerning the formation of a joint venture for the production of rare earth alloys and magnets in the United States, and for Molycorp to acquire a license from Hitachi for certain technology related to the production of rare earth magnets.
The negotiations were suspended due to the inability to reach agreement on certain key matters affecting the value of the joint venture to each party.
On November 28, 2011, Molycorp, Daido Steel Co., Ltd., or Daido, and Mitsubishi Corporation, or Mitsubishi, formed a joint venture, Intermetallics Japan Joint Venture or IJJV, to manufacture and sell next-generation NdFeB permanent rare earth magnets. The joint venture will manufacture sintered NdFeB permanent rare earth magnets with technology licensed from Intermetallics, Inc., a partnership between Mitsubishi, Daido, and Dr. Masato Sagawa, co-inventor of the NdFeB magnet. The new company will take full advantage of Daido's commercial-scale magnet manufacturing technologies, Mitsubishi's domestic and international marketing and sales network, and Molycorp's REO, metal, and alloy manufacturing resources and capabilities. The capital contribution ratio of the newly formed company is 30.0% by Molycorp, 35.5% by Daido, and 34.5% by Mitsubishi. We will contribute, upon achievement of certain milestones and subject to our Boards' approval, Japanese Yen (JPY) 2.5 billion in cash (or approximately $32.7 million based on the JPY/ U.S. dollar exchange rate as of January 31, 2012), in exchange of ordinary shares of the joint venture over a period of twelve months starting in January 2012. Additionally, the joint venture will be financed by a government subsidy sponsored by Japan's Ministry of Economy, Trade, and Industry. The joint venture plans to construct an initial 500 metric-ton-per-year magnet manufacturing facility in Nakatsugawa, Japan (Gifu Prefecture), with operations expected to commence by January 2013. The joint venturers began working on the new facility in late December 2011 and expect to eventually expand operations in the U.S. and elsewhere. The technology to be used by the joint venture is a new and novel approach that does not depend on the use of patents held by other magnet companies. This technology allows for the manufacture of permanent rare earth magnets that deliver greater performance with less reliance on dysprosium, a relatively scarce rare earth. The process also results in higher production yields. Target markets for the joint venture are the automotive and home appliance markets. These markets, as well as other markets for environmentally friendly technologies, are forecast to be significant drivers of demand growth for permanent rare earth magnets. The joint venture has been provisionally awarded a supply agreement for a next-generation electric vehicle with a major automotive manufacturer.
Concurrently with the formation of the joint venture, we, Mitsubishi (acting as the procurement agent) and the newly formed company entered into a supply agreement by which we will sell to the joint venture certain rare earth products at the conditions set forth in the supply agreement.
In January 2012, we entered into an agreement with Molibdenos y Metales S.A., or Molymet, the world's largest processor of the strategic metals molybdenum and rhenium headquartered in Santiago, Chile, pursuant to which Molymet has agreed to purchase 12.5 million shares of our common stock for $390 million, which amount was determined based on the average daily volume weighted average price of our common stock on The New York Stock Exchange for the 20 consecutive trading days immediately preceding the date of the agreement, plus a 10% premium. Pursuant to the agreement, we are obligated, at closing, to increase the size of our Board of Directors, or Board, and have given Molymet the right to nominate a member of our Board for so long as Molymet owns a certain percentage of our common stock. Additionally, the agreement provides Molymet with three demand registration rights for the shares of common stock it is purchasing pursuant to the agreement.
The consummation of the offering, which we anticipate to occur in the second quarter of 2012, remains subject to the satisfaction of certain customary closing conditions, including the receipt of certain governmental regulatory approvals. Proceeds from the Molymet investment will be retained by us for general corporate purposes and are expected to be used to finance our future growth, including pursuant to our vertical supply chain integration business model.
As a result of our acquisitions of Molycorp Tolleson and Molycorp Sillamäe, we added facilities and equipment for metal conversion and alloy production within the Molycorp organization. We transport cerium, lanthanum, neodymium, praseodymium, dysprosium, terbium and samarium oxide products from our Molycorp Mountain Pass facility to Molycorp Sillamäe and Molycorp Tolleson to produce rare earth metals and alloys.
Upon the full execution of our "mine-to-magnets" strategy and completion of Project Phoenix Phase 1, and our second-phase capacity expansion plan, which we refer to as Project Phoenix Phase 2, we expect to be one of the world's most integrated producers of rare earth products, including oxides, metals, alloys and magnets. Rare earths are critical inputs in many existing and emerging applications including: clean energy technologies, such as hybrid and electric vehicles and wind power turbines; multiple high-tech uses, including fiber optics, lasers and hard disk drives; numerous defense applications, such as guidance and control systems and global positioning systems; and advanced water treatment technology for use in industrial, military and outdoor recreation applications. Global demand for rare earth elements, or REEs, is projected to steadily increase both due to continuing growth in existing applications and increased innovation and development of new end uses. Our goals:
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develop innovative rare earth technologies and products vital to green energy, high-tech, defense and industrial applications;
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be commercially sustainable, globally competitive, profitable and environmentally superior;
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act as a responsible steward of our rare earth resources; and
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use our technology to improve the daily lives of people throughout the world.
We have made significant investments, and expect to continue to invest, in developing technologically advanced and proprietary applications for individual rare earth elements, or REEs. Under our "mine to magnets" strategy, we plan to integrate the rare earths supply chain: mining; oxide processing; production of metals and alloys; and production of rare earth based magnets. We are in the process of modernizing and expanding our production capabilities at our Molycorp Mountain Pass facility, and our recent acquisitions of Molycorp Tolleson and Molycorp Sillamäe provide us with additional capacity for the production of rare earth oxides as well as the ability to produce rare earth metals and alloys.
Our vision is to be the rare earth products and technology company recognized for its "ETHICS"—Excellence, Trust, Honesty, Integrity, Creativity and Safety. Since July 2005, the Molycorp Mountain Pass facility has not had a lost-time accident and has received the coveted "Sentinels of Safety" award from the Mine Safety and Health Administration, or MSHA, for three of the last six years. Additionally, the Molycorp Tolleson facility has not had a lost-time accident for the past 15 years and the Molycorp Sillamäe facility has had three lost-time accidents during the second quarter of 2011, and one during the 12 months prior to the acquisition by us.
Key Industry Factors
Demand for Rare Earth Products
Global consumption of REEs is projected to steadily increase due to continuing growth in existing applications and increased innovation and development of new end uses. For example, the integration of rare earth permanent magnet drives into wind power turbines has reduced the need for gearboxes, which increases overall efficiency and reliability. We believe that this anticipated market dynamic will underpin continued strong pricing. If Molycorp Mountain Pass and other rare earth projects do not commence production when anticipated, we expect there will continue to be a gap between current and forecasted demand and supply.
As a result of the global economic crisis, rare earth product prices declined by approximately 50% during between 2008 and through the end of the third quarter of 2009. According to Metal-Pages, from the beginning of the fourth quarter of 2009 through the end of 2011, average prices for rare earths have risen by approximately 1,100%. Furthermore, over the same period, average prices for some of the most common rare earths (cerium oxide, lanthanum oxide, neodymium oxide, and praseodymium oxide) have risen by more than 1,000%. Average prices for lanthanum oxide and cerium oxide have decreased by approximately 50% during the second half of 2011 as compared to the average in the first half of 2011 due, in part, to a reduction in reported speculative buying of rare earth materials in China.
Factors Affecting Our Results
Modernization and Expansion of Molycorp Mountain Pass Facility
We anticipate a dramatic change in our business and results of operations upon the completion of Project Phoenix Phase 1 and Project Phoenix Phase 2 and the full execution of our "mine-to-magnets" strategy through which we expect to produce rare earth metals, alloys, and magnets in 2012. For example, we expect to increase our capacity and ability to produce and sell a significantly expanded slate of products, including specialty cerium products for water treatment, neodymium and praseodymium metal, NdFeB and SmCo alloys for magnets, europium, gadolinium, and terbium oxides for phosphors, and dysprosium and terbium for magnets.
We are utilizing the assets we acquired from Chevron Mining Inc. as a foundation to build an integrated rare earth products and technology company, which requires considerable additional capital investment. We believe the application of improved technologies, along with the capital investment, will allow us to create a sustainable business by cost effectively producing high purity rare earth products. Prior to the completion of Project Phoenix Phase 1, start-up of the new processing facility, we anticipate further diversifying our product line through the production of samarium/europium/gadolin ium concentrate from bastnasite concentrate stockpiles. Upon completion of Project Phoenix Phase 1 and Project Phoenix Phase 2, we expect to produce lanthanum, cerium, praseodymium, neodymium, samarium, europium, gadolinium, terbium, dysprosium and yttrium in various chemical compounds and/or metal forms, including alloys.
Cost of Goods Sold
Our cost of goods sold reflects the cost allocated to the inventory we acquired as part of our purchase of the Molycorp Mountain Pass facility and, beginning in the second quarter of 2011, the cost allocated to the inventory we acquired as part of our purchase of the Molycorp Sillamäe and Molycorp Tolleson facilities. In addition, our cost of goods sold includes the processing costs and the cost of certain raw materials we purchased from outside vendors, which we allocated to the products we sold at our three operating facilities. Because many of our costs are fixed, as our production increases or decreases, our average cost per metric ton decreases or increases, respectively. Primary production costs include direct labor and benefits, maintenance, natural gas, electricity, operating supplies, chemicals, depreciation and amortization and other plant overhead expenses. Our cost of goods sold also reflects write-down of inventory, which could materially affect our consolidated net results of operations.
Our most significant variable costs are chemicals, raw materials for alloy production and electricity. In the future, we intend to produce more of our chemicals for our Molycorp Mountain Pass facility at a plant on-site, which we expect will reduce our variable chemical costs. We are building a co-generation facility to provide power to our Molycorp Mountain Pass facility. Following the start-up of the co-generation facility, which we expect to occur in the second quarter of 2012, natural gas will substantially replace third-party electricity costs and become one of the most significant variable costs at our Molycorp Mountain Pass facility.
We expect our labor and benefits costs to increase through at least 2012 due to the addition of personnel and contractors required to implement Project Phoenix Phase 1 and Project Phoenix Phase 2. In addition to volume fluctuations, our variable costs, such as electricity, operating supplies and chemicals, are influenced by general economic conditions that are beyond our control. Other events outside our control, such as power outages, have in the past interrupted our operations and increased our total production costs, and we may experience similar events in the future.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of personnel and related costs, including stock-based compensation; legal, accounting and other professional fees; occupancy costs; and information technology costs. We continue to experience increased selling, general and administrative expenses as we expand our business and operate as a publicly traded company. These expenses include additional personnel costs as we construct our new facilities and pursue other business development activities to execute our "mine-to-magnets" business plan. We have also experienced additional legal, compliance and corporate governance expenses, as well as additional accounting and audit expenses, stock exchange listing fees, transfer agent and other stockholder-related fees and increased premiums for certain insurance policies, among other expenses. Additionally, we incurred significant professional fees and other expenses in connection with the business acquisitions that we completed in April 2011, and our future selling, general and administrative expenses will be higher as a result of those acquisitions. We also invest significant resources to improve the efficiency of our REO processing operations and the development of new applications for individual REEs. For the period ending December 31, 2011, 2010 and 2009, we spent $8.3 million, $2.4 million and $1.5 million, respectively, in research and development. These costs consist primarily of salaries, outside labor, material and equipment.
Income Taxes
We account for income taxes in accordance with Accounting Standard Codification 740, Income Taxes . This guidance requires that deferred tax assets and liabilities be recognized for the tax effect of temporary differences between the financial statement and tax basis of recorded assets and liabilities at enacted statutory tax rates. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The recoverability of deferred tax assets is based on both our historical and anticipated earnings levels and is reviewed each reporting period to determine if any additional valuation allowance is necessary when it is more likely than not that amounts will not be recovered. We have concluded that no valuation allowance is required as of December 31, 2011 and a 100% valuation allowance was required as of December 31, 2010.
We are a Subchapter C corporation and, therefore, are subject to federal and state income taxes on our taxable income, whereas prior to our Corporate Reorganization, we operated entirely within limited liability companies, which were not directly liable for the payment of federal or state income taxes and our taxable income or loss was included in the state and federal tax returns of Molycorp, LLC's members. For the years ended December 31, 2011 and 2010, our effective income tax rate was 19.5% and 0%, respectively. Our effective income tax rate is impacted primarily by the 100% valuation allowance reversal on our deferred tax assets, permanent differences between book and tax income, including the benefit associated with the estimated effect of the domestic production activities deduction and federal tax credits.
The tax basis of the assets and liabilities transferred to us pursuant to the Contribution Agreement was, in the aggregate, equal to Molycorp, LLC's adjusted tax basis in the assets as of the date of the contribution. Therefore, the tax basis in the assets transferred to us is significantly higher than the book basis in the same assets, which resulted in a deferred tax asset. The majority of our deferred tax asset has been assigned to mineral resources, and the anticipated use of percentage depletion to reduce our taxable income, relative to book income, is expected to provide full realization of this asset over time.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Presentation
Molycorp, Inc. was formed on March 4, 2010 for the purpose of continuing the business of Molycorp, LLC in corporate form. On April 15, 2010, pursuant to the Contribution Agreement, the members of Molycorp, LLC contributed either (a) all of their member interests in Molycorp, LLC or (b) all of their equity interest in entities that held member interests in Molycorp, LLC (and no other assets or liabilities) to Molycorp, Inc. in exchange for Molycorp, Inc. Class A common stock. Accordingly, Molycorp, LLC and its wholly owned subsidiary, Molycorp Minerals, LLC, or Molycorp Minerals, became subsidiaries of Molycorp, Inc., which we refer to as the Corporate Reorganization. On June 15, 2010, Molycorp LLC was merged with and into Molycorp Minerals.
We have three operating segments: Molycorp Mountain Pass, Molycorp Metals and Alloys ("MMA") and Molycorp Silmet. Each of the segments has only one production and shipping location. Sales to external customers by geographic area are based on the location in which the sale originated.
Recent Developments
Planned acquisition of Neo Material Technologies Inc.
On March 8, 2012, we and Neo executed a definitive agreement, or Arrangement Agreement, under which we will acquire Neo for approximately Cdn $1.3 billion. The proposed Neo acquisition is expected to create one of the most technologically advanced, vertically integrated rare earth companies in the world. Under the Arrangement Agreement, which was unanimously approved by Neo's and our Board of Directors, Neo shareholders may elect to receive either (i) cash consideration equal to Cdn $11.30 per share, (ii) share consideration of either 0.4242 shares of our common stock or 0.4242 shares issued by MCP Exchangeco Inc., our wholly owned Canadian subsidiary, which we refer to as the Exchangeable Shares (which are exchangeable for shares of our common stock), per share or (iii) a combination of cash and Exchangeable Shares and/or shares of our common stock, provided that the aggregate consideration received by Neo shareholders will be pro-rated to approximately 71.2% in cash ($926 million) (Cdn $926 million)) and approximately 28.8% in Exchangeable Shares and/or shares of our common stock.
In addition, Neo currently has $230.0 million in aggregate principal amount of convertible debentures outstanding, which we refer to as the Neo debentures. Pursuant to the indenture governing the Neo debentures, holders of the Neo debentures will have the opportunity to convert their Neo debentures into shares of Neo common stock as a result of the proposed Neo acquisition. That conversion takes place at a ratio of 72.4637 shares of Neo common stock per $1,000 principal amount of Neo debentures. In addition, if holders convert their Neo debentures into shares of Neo common stock pursuant to certain prescribed procedures in the indenture, then they will be entitled to a number of additional "make-whole" shares of Neo common stock calculated pursuant to a matrix set forth in the indenture. Given the variables in the indenture, we will not be able to calculate the number of "make-whole" shares issuable upon conversion of Neo debentures until after the closing of the proposed Neo acquisition; however, we anticipate that between 18 and 20 "make-whole" shares will be issued for each $1,000 in principal amount of Neo debentures converted. In total, we anticipate that holders of Neo debentures will convert their Neo debentures into between 20 million and 23 million shares of Neo common stock. As a result of the proposed Neo acquisition, holders of Neo debentures that elect to convert their Neo debentures into shares of Neo common stock will, instead of receiving shares of Neo common stock, receive the consideration mix received by Neo's common shareholders in the proposed Neo acquisition contemplated by the Arrangement Agreement.
The Cdn $11.30 per share represents a premium of approximately 42% to Neo's closing share price of Cdn $7.97 on March 8, 2012. The proposed combination of Molycorp and Neo will expand Molycorp's geographic footprint across 11 countries and provide leading product development, research, and sales capabilities. Additionally, we will gain cutting-edge technologies and will leverage Neo's years of processing experience and knowledge, to better service our customer base as well as new customer segments. The proposed acquisition will bring to us direct operating and sales channels in China, the world's largest and fastest growing rare earth consuming nation. In 2010 and 2011, Neo's sales to China and Japan, collectively, accounted for approximately 68% and 64% of its total sales, respectively.
The proposed acquisition will expand our technology portfolio to include production of magnetic powders, zirconium based engineered materials, and rare metals including gallium, indium and rhenium, which will enable us to produce and market materials that are integral to a wide variety of strategic technologies, including advanced electronics, thin film photovoltaic, light-emitting diode, or LED, flat panel display, super alloys, catalytic converters, mobile and smart phones, magnets, batteries. The addition of Neo expertise will provide entry for us into customer segments requiring value-added rare earth and rare metal production capabilities—up to 99.99999% purity for some elements.
Investment by Molibdenos y Metales S.A.
On March 8, 2012, Molibdenos y Metales S.A., or Molymet, the world's largest processor of molybdenum and rhenium headquartered in Santiago, Chile, purchased 12.5 million shares of our common stock for $390.1 million, net of stock issuance costs of $0.1 million, at a purchase price of $31.218 per share, which price was determined based on the average daily volume weighted average price of our common stock on The New York Stock Exchange for the 20 consecutive trading days immediately preceding the date of the agreement, plus a 10% premium. Pursuant to this investment, Molymet acquired the right to nominate a member of our Board of Directors, for so long as Molymet owns a certain percentage of our common stock.
Intermetallics Japan Joint Venture
On November 28, 2011, Molycorp, Daido Steel Co., Ltd., or Daido, and Mitsubishi Corporation, or Mitsubishi, formed a joint venture, Intermetallics Japan, or IMJ, to manufacture and sell next-generation NdFeB permanent rare earth magnets. The joint venture will manufacture sintered NdFeB permanent rare earth magnets with technology licensed from Intermetallics, Inc., a partnership between Mitsubishi, Daido and Dr. Masato Sagawa, co-inventor of the NdFeB magnet. The new company will take full advantage of Daido's commercial scale magnet manufacturing technologies, Mitsubishi's domestic and international marketing and sales network and Molycorp's REOs, metals, and alloy manufacturing resources and capabilities. The capital contribution ratio of the newly formed company is 30.0% by Molycorp, 35.5% by Daido and 34.5% by Mitsubishi. We will contribute, upon achievement of certain milestones and subject to our Board of Directors' approval, Japanese Yen (JPY) 2.5 billion in cash (or approximately $30.4 million based on the JPY/ U.S. dollar exchange rate as of March 31, 2012), in exchange of ordinary shares of the joint venture over a period of twelve months. On March 12, 2012, we made our first contribution of $3.8 million to IMJ.
Additionally, IMJ will be partially financed by a government subsidy sponsored by Japan's Ministry of Economy, Trade, and Industry. IMJ plans to construct an initial 500 metric-ton-per-year magnet manufacturing facility in Nakatsugawa, Japan (Gifu Prefecture), with operations expected to commence by January 2013.
The joint venturers began working on the new facility in late December 2011 and expect to eventually expand operations in the United States and elsewhere. The technology to be used by IMJ is a new and novel approach that does not depend on the use of patents held by other magnet companies. This technology allows for the manufacture of permanent rare earth magnets that deliver greater performance with less reliance on dysprosium, a relatively scarce rare earth. The process also results in higher production yields. Target markets for IMJ are the automotive and home appliance markets. These markets, as well as other markets for environmentally friendly technologies, are forecast to be significant drivers of demand growth for permanent rare earth magnets. IMJ has been provisionally awarded a supply agreement for a next-generation electric vehicle with a major automotive manufacturer.
Concurrently with the formation of IMJ, we, Mitsubishi (acting as the procurement agent) and IMJ entered into a supply agreement pursuant to which we will sell to IMJ certain rare earth products under the conditions set forth in the supply agreement.
Our Business
We are the largest REOs producer in the Western hemisphere and own one of the world's largest rare earth projects outside of China. We also own one of the largest rare earth oxides and rare metals producers in Europe, and the only producer of rare earth alloys in the United States. Upon the full execution of our "mine-to-magnets" strategy and completion of Project Phoenix Phase 1and Project Phoenix Phase 2, we expect to be one of the world's most integrated producers of rare earth products, including oxides, metals, alloys and magnets.
Rare earth products are critical inputs in many existing and emerging applications including: clean energy technologies, such as hybrid and electric vehicles and wind power turbines; multiple high-tech uses, including fiber optics, lasers and hard disk drives; numerous defense applications, such as guidance and control systems and global positioning systems; and advanced water treatment technology for use in industrial, military and outdoor recreation applications. Global demand for rare earth elements, or REEs, is projected to steadily increase both due to continuing growth in existing applications and increased innovation and development of new end uses. We have made significant investments, and expect to continue to invest, in developing technologically advanced applications and proprietary applications for individual REEs. Our goals are:
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develop innovative rare earth technologies and products vital to green energy, high-tech, defense and industrial applications;
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be commercially sustainable, globally competitive, profitable and environmentally superior;
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act as a responsible steward of our rare earth resources; and
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use our technology to improve the daily lives of people throughout the world.
Our objective is to be the rare earth products and technology company recognized for its "ETHICS"—Excellence, Trust, Honesty, Integrity, Creativity and Safety. Since July 2005, the Molycorp Mountain Pass facility has not had a lost-time accident and has received from the Mine Safety and Health Administration, or MSHA, the coveted Sentinels of Safety Award (2008, 2006 and 2004); the National Safety Council Awards—Perfect Record (2008, 2007, 2006, 2004); and the National Safety Council Awards—Occupational Excellence achievement award (2009, 2007 and 2004). Additionally, the MMA facility has not had a lost-time accident for the past 15 years and the Molycorp Silmet facility has had one lost-time accident in 2011, and one during the 12 months prior to the acquisition by us. The Molycorp Silmet facility is now reporting lost-time accidents consistently with the U.S. standard followed by the Molycorp Mountain Pass and MMA facilities.
Our Mine Process and Development Plans
Processing at our Molycorp Mountain Pass facility entails mining the bastnasite ore followed by crushing and milling it to a fine powder. Milled bastnasite ore is then processed by flotation whereby the bastnasite, which is a mineral containing light and heavy rare earth elements, floats to the surface and is separated from the waste material, which sinks in a series of flotation cells. The resultant bastnasite concentrate is then processed by leaching (cracking) with acid solutions followed by a series of solvent-extraction separation steps that produce various individual REOs, generally in a high purity oxide form.
In December 2011, the U.S. Department of Interior Bureau of Land Management granted us authorization to commence exploratory drilling at an occurrence of heavy rare earths located near our Molycorp Mountain Pass facility. Preliminary exploration at the site has shown rare earth mineralization with an average ore grade of approximately four percent and a relatively high percentage of heavy REEs, such as terbium, dysprosium, europium and samarium, as well as relatively high percentages of yttrium, neodymium, and praseodymium. This prospect is still at an early stage of exploration and the commercial feasibility of what has been found to date cannot be known at this time.
Upon the completion of the construction of Project Phoenix Phase 1, we expect to have the capacity to produce approximately 19,050 mt of REOs per year at our Molycorp Mountain Pass facility by the beginning of the fourth quarter of 2012. Following the completion of Project Phoenix Phase 2 construction, which we expect to be by the end of the fourth quarter of 2012, we expect to have the ability to produce, if customer demand warrants, approximately 40,000 mt of REOs per year by mid-2013 at our Molycorp Mountain Pass facility, or approximately double the amount we expect to be able to produce upon completion of Project Phoenix Phase 1. Based on our estimated reserves and an expected annual production rate of approximately 19,050 mt of REOs under Project Phoenix Phase 1, the expected mine life of our Molycorp Mountain Pass mine is in excess of 30 years (SRK Consulting (U.S.), Inc., or SRK, has preliminarily indicated, however, that doubling the amount of production pursuant to Project Phoenix Phase 2 would reduce the current mine life to 22 years, assuming no additional exploration, conversion of known mineralized material to reserves, no realization of anticipated improvements in recoveries, and all other factors, such as cut-off grade, remain constant.)
We expect the consummation of the IMJ joint venture described above, in conjunction with our modernization plans at our Molycorp Mountain Pass facility, the strategic acquisitions of Molycorp Silmet and MMA and the planned acquisition of Neo, to provide us with the capability to mine, process, separate and alloy individual REEs and manufacture them into NdFeB magnets. This downstream integration, which we refer to as our "mine-to-magnets" strategy, would make us the only fully integrated producer of NdFeB magnets outside of China, helping to secure a rare earth supply chain for the Rest of World. In addition to the foregoing, we continue to explore additional joint ventures or other arrangements with third parties for the production of NdFeB alloys and/or magnets.
Our Products and Markets
Since our acquisition of the Molycorp Mountain Pass facility, we have been producing and selling REOs from stockpiled feedstocks to significantly improve our solvent extraction technologies and capabilities and commercially demonstrate several other new processing technologies. As of March 31, 2012, we had achieved greater than 98% recovery in our solvent extraction units at commercial scale for cerium, lanthanum, and didymium, which we believe is one of the highest recovery rates in the world. We have also developed the expertise to produce the following REEs in many usable forms: bastnasite concentrate; cerium; lanthanum; neodymium; praseodymium; europium; samarium; gadolinium; dysprosium; and terbium. When used to describe the current recovery rate for our solvent extraction units, the term "commercial scale" means that the solvent extraction units are operating at such a production rate that the scale-up factor required to achieve the desired production rate is less than ten times the current production rate.
We sell and transport a portion of the REOs we produce at our Molycorp Mountain Pass and Molycorp Silmet facilities to customers for use in their particular applications. The remainder of the REOs are processed into rare earth metals and rare earth alloys. We produce rare earth metals outside of the United States at our Molycorp Silmet facility and via toll manufacturing through third-party tolling arrangements. A portion of these metals is sold to end-users, and we process the rest into rare earth alloys at our MMA facility in Arizona. With the Molycorp Silmet acquisition in 2011, we added two rare metals, tantalum and niobium, to our product mix.
As of March 31, 2012, we have allocated 20% of Project Phoenix Phase 1 output to production of XSORBX®, our proprietary water treatment technology. In addition, we are in discussions with multiple large companies regarding the sale of XSORBX®, which could significantly expand demand for cerium-rich materials. We have begun to sell XSORBX® for commercial use in the wastewater, recreation, pool and spa, industrial process and other water treatment markets.
Key Industry Factors
Demand for Rare Earth Products
Global consumption of REEs is projected to steadily increase due to continuing growth in existing applications and increased innovation and development of new end uses. For example, the integration of rare earth permanent magnet drives into wind power turbines has reduced the need for gearboxes, which increases overall efficiency and reliability. We believe that this anticipated market dynamic will underpin growing demand for REEs. If Molycorp Mountain Pass and other rare earth projects do not commence production when anticipated, we expect there will continue to be a gap between current and forecasted demand and supply.
Supply of Rare Earth Products
China has dominated the global supply of REOs for the last fifteen years, and accounted for approximately 94% of global REOs production in 2011. Even with our planned production, global supply is expected to remain tight due to the combined effects of growing demand and actions taken by the Chinese government to restrict exports. As a result of the internal industrial development, as well as economic, environmental and regulatory factors in China, there is uncertainty with respect to the total planned production and availability of rare earth products from China. Export quotas imposed by the Chinese government have substantially decreased from 2008 to 2010, and remained virtually unchanged in 2011, thus reducing the amount of rare earth materials that China may export to the Rest of World. Despite the challenge to the Chinese export policy by some of the members of the World Trade Organization in early 2012, we believe the growing demand for REOs will continue to outstrip global supply in the future.
Factors Affecting Our Results
Modernization and Expansion of the Molycorp Mountain Pass Facility
We anticipate a dramatic change in our business and results of operations upon the completion of Project Phoenix Phase 1 and Project Phoenix Phase 2 and the full execution of our "mine-to-magnets" strategy, through which we expect to produce rare earth magnets later in 2012 in addition to our current production of REOs, rare earth metals and rare earth alloys. We expect to increase our capacity and ability to produce and sell a significantly expanded slate of products, including specialty cerium products for water treatment; neodymium, praseodymium and dysprosium metals for NdFeB magnets; samarium cobalt alloys for magnets; and europium, gadolinium, and terbium oxides for phosphors.
We are utilizing the assets we acquired from Chevron Mining Inc. as a foundation to build an integrated rare earth products and technology company, which requires considerable additional capital investment. We believe the application of improved technologies, along with the capital investment, will allow us to create a sustainable business by cost effectively producing high purity rare earth products. Prior to the completion of Project Phoenix Phase 1, we anticipate further diversifying our product line through the production of samarium/europium/gadolin ium concentrate from bastnasite concentrate stockpiles. Upon completion of Project Phoenix Phase 1 and Project Phoenix Phase 2, we expect to produce lanthanum, cerium, praseodymium, neodymium, samarium, europium, gadolinium, terbium, dysprosium and yttrium in various chemical compounds and/or metal forms, including alloys.
CONF CALL
Brian Blackman
Thank you, and good day everyone. We just released our financial and operating results for the first quarter of 2012. If you have not yet seen the press release, you can find it posted on the Investor Relations section of our website, at www.molycorp.com.
This call is being webcast and replay will be archived on the company’s website. For those of you who have dialed into the call, a slide show that accompanies our prepared remarks is available on the Molycorp website, in the investor relations section. For those of you listening by webcast, the slides will be presented in the webcast player. Please note that you need to advance the slides on your own.
Slide two includes our Safe Harbor statements. As always, we need to advice you that some of the information discussed on this conference call will contain forward-looking statements that involve risks, uncertainties, and assumptions that are difficult to predict.
The company’s actual results could differ materially from those contained in such statements, because of a variety of factors including those described in detail and risk factor section of Molycorp’s annual report on Form 10-K for the year ended December 31, 2011.
We also want to caution you that today’s presentation includes discussions of adjusted or non-GAAP financial measurements, which reflect how the management and directors of Molycorp, analyze the business on a daily basis. The adjusted measurements segregate out certain non-cash items such as depreciation, amortization, stock based compensation and certain out of ordinary items.
Internally, Molycorp management analyzes our business from an operating income perspective and we want our shareholders to have access to the same information we use in understanding our business.
However, these non-cash and other out of ordinary items are important to understanding the company’s long-term performance. Therefore, listeners are highly encouraged to study the non-GAAP to GAAP reconciliation supplied at the end of the earnings release, which can also be found on our website.
On the call today is Molycorp’s President and Chief Executive Officer, Mark Smith and our Chief Financial Officer and Treasurer, Jim Allen.
I’d like to now turn the call over to Mark.
Mark A. Smith
Thanks, Brain and good day everyone. Slide four shows the agenda for today’s call. I’ll begin by touching on a few of the financial highlights for the first quarter. Then I’ll review the progress we’re making on our top three business priorities. Jim Allen, our CFO will then step in to provide additional detail on our financial performance, then I’ll make some closing comments before opening the call for questions.
Skipping to slide six, let me give a few financial highlights of the quarter. We reported $84.5 million in revenues during the quarter, and adjusted non-GAAP diluted EPS of $0.18.
Revenues increased substantially year-over-year due to strong didymium and lanthanum sales, which helped offset lower cerium volumes. Adjusted gross margin of 44.6% was inline with internal expectations. We continue to believe that the economic scale of our business will begin to materialize as we complete and ramp up Project Phoenix production.
Lastly, I would note that the economics of our business came up confidently through Q1, which is always seasonally a slower quarter in the rare industry, largely due to the extended Chinese New Year holiday. Our mine to magnets vertical integration strategy has provided a sound diversified operating platform with growing cash from operations as we move beyond the first quarter.
This strong operational performance has allowed us to continue to make excellent progress in executing on other aspects of our business plan as well. In particular, we’re on track with our top three current priorities. Our number one priority, Project Phoenix, where we continue to meet our accelerated schedule.
Our number two priority, XSORBX, that’s our proprietary water purification technology where we are seeing increased demand in commercial traction for this innovative product.
And finally, our third top priority, our proposed acquisition of Neo Materials, which will help fuel very significantly, short and long-term growth for the company.
Now, I’d like to cover more detail for each of these three priorities. Starting on slide 7, with regard to Project Phoenix, many of you may recall that we announced on last quarter’s call, the successful sequential startup of several parts of our Project Phoenix facility. I’m proud to announce a major milestone to add to that list. As of today, we are starting up our new mill, flotation circuit and paste tailings plant including the associated permanent tailings disposal facility. This will effectively complete the rare earth concentrate production circuit portion of Project Phoenix.
As you can see, this circuit graphically is represented on slide eight. This means we are mining fresh ore, crushing and blending it, and starting to process milling and producing concentrate from our hot flotation process. We are also starting our paste tailings plant and the permanent disposal facility for our tailings.
I was just out at Mount Pass last week to be able to witness the final preparation of this operation firsthand was truly an amazing site, almost an emotional event. We plan to run the mill for a three week period, produce a large amount of concentrate for processing and then pause milling in order to further optimize that unit.
The entire concentrate circuit will run intermittently between now and continuous Phase 1 operations, which is slated for the beginning of the fourth quarter of this year. Achieving operation of a fresh ore concentrate production circuit is a significant milestone in our effort to increase the diversity of global rare earth production. This diversity benefits all rare earth customers and paves the way for an increased stability across our industry.
Slide nine, shows a photo representation of the major milestones that comprise Project Phoenix with those facilities that are either mechanically complete or operational in green and those facilities that are still under construction in the yellow.
Slide 10 shows the additional milestones that you will see us accomplish on our way to full Phase 1 production, which are moving from grid power to high efficiency, environmentally preferred power from our natural gas fueled combined heat and power plant, starting up our new full-size multi-stage cracking process, starting up the solvent exchange and heavy’s concentrate production, starting up the rare earth oxide facilities; and finally starting up the product finishing capabilities of the plant.
I cannot express how proud I am of the more than 1,850 employees and contractors working daily about that. Especially given that we recently logged more than 2.3 million hours of construction without a lost time incident. Indeed we have not had a recordable incident this year, which is truly a remarkable accomplishment in a project this large and complex.
We remain on track for Phase 1 operations by the beginning of the fourth quarter. Achieving our milestones on time and ahead of schedule where possible is important. But achieving these milestones while maintaining our ethics values and our safety culture is simply put, the way we do business.
Turning to slide 11, I’d like to move on to our second highest priority in the company, our patented water purification technology, we call XSORBX. Our XSORBX business is in its early commercialization stage, that over the past several months it has become an increasingly tangible part of our long term strategy.
The shift from product development to commercialization is a long and challenging process. For XSORBX, we are moving rapidly to commercialization and sales in one key market, recreational water purification. For example, we’ve recently signed a three year take or pay agreement with a domestic customer for 100 metric tons annually of XSORBX in the recreational pool and spa market. This new contract nearly doubles our 2011 sales volume. We’re producing a steady stream of XSORBX product out of our existing plant today. Our 2012 goal of selling approximately 1000 tons of XSORBX is on track.
Turning to slide 12, we also continue our XSORBX product development, the commercialization efforts in other water application markets including, pond remediation, municipal waste water, industrial waste water, municipal drinking water and point of use drinking water solutions.
As I’ve mentioned on prior calls, and in meetings with many of you, the potential for XSORBX in these additional markets is substantial, both in United States and around the world. To put this in the perspective, the United States market alone represents approximately, 163,000 metric tons annually of XSORBX product on the cerium oxide basis. Assuming only a 12.5% market penetration for XSORBX into these markets, we would consume all of the cerium that we would produce at full Phase 2 production.
Given the current favorable reception from our customers, we believe that achieving the internal target penetration rates are very realistic. The net result is that, XSORBX is materializing into an excellent growth platform for Molycorp.
Finally, on slide 13, I’d like to shift gears to our third near term priority, and update you on our pending acquisition of Neo Materials. We’ve been actively meeting with government officials, our customers and partners and of course with our investors on this deal. Things are progressing according to plan. We’ve already received clearance in the United States under the Hart-Scott-Rodino review process.
Our application for Investment Canada was filed on April 4, which started a 45 day clock that will expire next week on May 18. Neo Materials’ shareholder approval is also needed and the vote in scheduled to occur on May 30. We expect shareholder approval on that day.
Lastly, final court approval of the plan of arrangement is needed, which we anticipated occurring according to plan. Regarding Neo’s shareholder approval, their proxy circular was filed earlier this week and can be found on the SEDAR website or on Neo’s website in their Investor Relations section. The vote as I noted earlier is scheduled to take place on May 30. Based upon all information available, we remain confident that the deal should close sometime in the second or third quarter pending these approvals.
On to the slide 14, we reiterate some of the compelling industrials logic behind combining Molycorp and Neo Materials, and I’d like to make these points in that regard. First, this acquisition is truly a game changer for Molycorp. We will become virtually overnight, the most vertically integrated rare earth technology leader outside of China with a direct sales channel into Chinese markets. It is key to note that, while nearly 70% of rare earth sales take place within China, that’s largely a geographic distinction. In Neo’s case for example, most of its customers in China are actually Japanese, United States or European companies that move their manufacturing facilities into China, some time ago.
These companies tend to be large multi-national manufacturers that look for reliable rare earth material suppliers capable of producing for all of their facilities anywhere in the world. Neo’s base of operations strategically places us closer to these critical customers, and allows us to better meet their global needs.
Second, with Mountain Pass set to achieve Phase 1 production by the beginning of the fourth quarter, we’ll be in a strong position to leverage our low-cost production with Neo’s ultrahigh-purity rare earth processing and distribution strengths. And with Neo, we will be in a much better position to ramp up our Phase 2 production faster than originally anticipated.
Third, we will add to our portfolio, Neo’s patented magnet powder through its Magnequench subsidiary. This gives us a significant footprint in the bonded neodymium-iron-boron magnet market, and this strongly complements our plans to manufacture sintered neodymium-iron-boron magnets with our joint-venture partners Daido Steel and Mitsubishi Corporation. Given the independent forecast of annual growth rates for permanent rare earth magnets are between 8% to 12%, our expanded footprint in these markets positions us to tap into significant new revenue streams in 2013 and beyond.
And last, the Neo acquisition gives us expanded reach into the rare metal markets for high-purity gallium, indium and rhenium. The end-use application growth for these high-quality metals is substantial and provides additional exposure to the LED semiconductor and electronic component markets.
Immediately after closing, we intend to accelerate our development of ultrahigh-purity separations capabilities for heavy rare earth at both our Molycorp Mountain Pass and Molycorp Silmet facilities. This technology can be put to use very quickly, as we have been producing and stockpiling a heavy rare earth concentrate stream ever since we launched NFP separations at Mountain Pass in 2011.
We currently have tens of tons of this concentrate at Mountain Pass. With Neo, we will have the ability to again processing this concentrate almost immediately into ultrahigh-purity heavy rare earth products.
Simply put, we believe the combination of Molycorp and Neo Materials will create one of the industry's leading rare earth processing and high value added critical materials companies. I can’t wait to combine the immense human talent from both of these organizations to jointly tackle new opportunities, new technologies and new markets.
In addition to working hard on the top three priorities in the company, we have additional items that we have announced. Of note, following the end of the quarter, we announced that using SEC Industry Guide 7, our proven and probable reserves of contained rare earth oxide equivalent at Mountain Pass have increased by 36% as compared to 2010 levels.
Those reserves now stand at $18.4 million short tons of rare earth or at an average ore grade of 7.98% REO, and a cutoff grade of 5% REO. This equates to 2.94 billion pounds of contained REO equivalent in the ground or more than 1.3 million metric tons. We are also continuing our exploration efforts for new resources that are skewed towards higher concentrations of heavy rare earths. Exploratory drilling at a potential deposit near Mountain Pass has been completed, and analysis of those initial exploration course is ongoing. We are moving forward with development stage drilling, and we expect to have more updates on this project in the future.
Exploration of other deposits around the world also continues in earnest, and we will provide updates on this activity as the information is further developed. In short, we remain focused on execution, and on profitably growing our business. We’re investing in and assembling our world-class infrastructure now in order to support long term growth and increase shareholder value.
Now, let me turn the call over to Jim Allen for a detailed review of the quarter.
James S. Allen
Thanks, Mark, and good day everyone. For today’s discussion, I am going to first cover our quarterly financial performance on a consolidated basis, followed by segment detail, we’ll then review our cash position, tax rate, balance sheet and capital requirements.
I’ll start my discussion on slide 16. As Mark noted, we reported $84.5 million in sales during the first quarter as compared to $26.3 million during the first quarter of 2011. The increase is related to a stronger product mix due to increased didymium sales and a contributions from Silmet and Molycorp Metals & Alloys or MMA, which were both acquired during the second quarter of 2011.
On a consolidated basis, we sold 719 net metric tons of rare earth oxide equivalent products at an average sales price of $95.05 per kilogram. We also sold an additional 75 metric tons of rare metals at an average sales price of $182.88 per kilogram.
First quarter consolidated cost of goods sold was $53.4 million compared to $16.7 million in the first quarter of 2011. Consolidated gross margin percentage for the quarter was 36.7%. As indicated on our 2011 year-end call, we have recently incurred higher variable costs and additional non-capitalized cost related to Project Phoenix ramp up.
During the quarter, gross margin continued to experience pressure from higher variable costs such as labor and chemical, and increased regulatory inspections of construction and processing activities at Mountain Pass, which led to higher production cost per kilogram due to lower utilization of existing facilities and production.
Turning to slide 17, selling, general and administrative expenses excluding depreciation, amortization and accretion expenses for the quarter, were $31.2 million compared to $11.2 million first quarter of 2011. SG&A expenses increased compared to the prior year as a result of continued higher overhead related to Project Phoenix, exploratory drilling, M&A business development, research and development and other increased cost related to expanded business operations. These increases are in line with our expectations and in line with the statements made in our year-end call.
Note that this higher level of G&A cost will likely evade as move into the latter part of this year. Regarding taxes we experienced an income tax benefit of $2.2 million in the period ended March 31, 2012.
For the quarter we reported a GAAP net loss of $3.5 million. The more relevant measure is net income or loss attributable to common stockholders, which reflects dividends on our convertible preferred stock. Our net loss attributable to common stockholders is $6.3 million or a loss of $0.07 per diluted share. As a note, we no longer report net income attributable to non-controlling interest as we completed the 100% of acquisition of Silmet in October of 2011.
Removing certain non-cash out of ordinary and business expansion items, yields and adjusted net income attributable to common stockholders $15.5 million or an adjusted non-GAAP $0.18 per diluted share. Adjusted gross margin on non-GAAP basis was 44.6%.
Slide 18, provides details of our first quarter 2012 products and sales volumes.
Moving to slide 19, we have broken out performance by operating segment. As a reminder, consolidated financial and operational results presented on a net basis, which removes inter-company sales. Discussion of segment margins is performed on a gross basis.
Gross margin at Mountain Pass for the first quarter was 59.3%. This compares to a gross margin of 36.5% during the first quarter of 2011. The increase in gross margin is a result of shifting product mix and increased pricing for certain products.
During the quarter Mountain Pass produced 615 metric tons of REO equivalent product compared to 730 metric tons during the first quarter of 2011. We slowed production during the quarter to manage inventory levels both for finished product inventory and our rare earth concentrate stockpile.
As Mark mentioned earlier, the front-end concentrate circuit from mine to mill is in final preparation and will soon be operational to replenish our existing concentrate stockpile for feed into our NFB plant. Production at Silmet was 410 metric tons of REO equivalent during the quarter, as well as 170 metric tons of rare metals.
Cost of goods sold was negatively impacted by the lower constant market valuation adjustments totaling $15 million attributable to raw materials previously acquired at higher prices. While the majority of Silmet’s feedstock is being sourced from Mountain Pass, we will continue to source certain materials from third parties until we achieve Phase 1 production at Project Phoenix. The sourcing of feedstock from Mountain Pass on a more consistent basis will positively impact our margins.
Gross margin of Molycorp metals and alloys was 1.7% during the quarter. Total production during the period was 109 metric tons of rare earth alloys containing 44 metric tons of REO equivalents. In addition, the MMA facility produced 9 metric tons of other specialty alloys. As a reminder, the two year supply contract with Santoku Corporation display certain rare earth alloys of prices equal to feedstock cost plus the applicable product premium will come to term in April 2013.
Moving to the balance sheet, after closing the Molymet investment of $390 million will increase our cash and cash equivalents balance of $609.8 million as of March 31. Cash flow from operations during the quarter added $16 million to the business. Our consolidated capital expenditures totaled $206.5 million on a cash basis and we also invested $3.9 million in our magnet production joint-venture.
To date $628 million has been spent towards Project Phoenix. As indicated in the previous quarters financial results call, the company conducted and completed an extensive formal review of the Project Phoenix capital expenditure budget. The result of that analysis shows that the company anticipates no material change to its Project Phoenix EPC capital budget of $895 million, assuming that measures that we have implemented to mitigate certain adverse cost trends are successful.
Certain additional capital expenditures for capital projects related to operations at Mountain Pass are expected to total approximately $105 million. These operations relate to capital projects that cover in the company’s operating budget plans. We are continuing to closely monitor overall project expenses and we’ll revisit our forecast for all capital projects at the end of the second quarter.
Before I turn the call back to Mark for closing comments, I also want to address the proposed financing for Neo Materials. The structure outlined during the March conference call remains our intended financing structure. We anticipate that 29% of the acquisition consideration will be financed with Molycorp common stock. The remaining 71% will be cash secured to an expected debt offering, as well as proceeds from the Molymet investment and cash from the combined company balance sheets.
The debt to be issued from the expected offering will replace our current bridge financing commitment. The pending acquisition has been structured in Canadian dollars and at the end of March, we entered into a contingent forward contract to hedge the potential risk of foreign currency fluctuations between the U.S. dollar and the Canadian dollar.
As of March 31, marking this contract to market, we incurred an unrealized or non-cash loss of $6.7 million, which is recorded in the other expense line. This contract valuation partially reflects the premium related to the elimination of unwind risk should the acquisition not close.
I’ll now turn the call back over to Mark for closing comments on slide 20.
Mark A. Smith
Thank you, Jim. In my view the Molycorp value proposition has strengthened significantly since our year-end call in February.
we’re further ahead in reaching Phase 1 production at Mountain Pass. We’re seeing increased demand and commercial traction for XSORBX and our planned acquisition of Neo Materials, a game changer for our company is proceeding smoothly.
As those of you have been on past calls know, the first quarter of every year is seasonally the lowest for all rare earth companies largely as a result of the effects of the extended Chinese New Year holiday. While sales volumes were again impacted in the first quarter, the quarter also marked the end of the 2011 pricing roller coaster ride.
We’re starting to see more regular sustained business activity. Any potential demand destruction that begins to take hold during the summer of 2011 appears to have subsided. In mid-March, we observed a strengthening of internal China pricing, which is clearly reflective of revived demand. Early trends in April continue to build our confidence in a more stable market.
Of course, one month is not necessarily indicative of the entire quarter, but our day-to-day experience in these markets is demonstrating precisely what we have been predicting for many months. The long-term worldwide supply and demand fundamentals point to relatively tight markets that are leading to more stabilized pricing.
As Jim discussed, and as indicated on our year-end 2011 call, our margins are expected to face headwind this year, particularly in the first half of the year. In addition, spending associated with Project Phoenix will continue, but we expect these expenditures to scale down in the second half of this year, particularly towards the end of the fourth quarter.
Our goal remains to ensure Project Phoenix Phase 1 production rates to commence at the beginning of the fourth quarter this year. we are also reaffirming that we expect to reach our 2012 production guidance range of 8,000 to 10,000 metric tons of REO equivalent products across all of our operating segments this year.
With this increased production, we’ll be in a much better position to leverage our multi-facility approach especially with Neo Materials in the mix. It’s been a very busy two years. we know what we need to do, and we remain on track with our stated goals. I remain very optimistic about our future.
In closing, I want to say again that I could not be more proud of the work done by all of the members of the Molycorp family. I believe that in 2013, our customers, partners, and investors will see the benefits of our strategy and the impact that our global production strategy can and will have on our top and bottom line performance.
We’ll now open the call for questions. Operator?
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