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MCP > SEC Filings for MCP > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for MOLYCORP, INC.


18-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis contains forward-looking statements that reflect our plans, estimates and beliefs and involves risks and uncertainties. Our actual results could differ materially from those discussed in these forward-looking statements as a result of various factors, including those discussed below, under the headings "Risk Factors" and "Special Note Regarding Forward-Looking Statements" and in other parts of this Annual Report on Form 10-K. In this Annual Report on Form 10-K, unless the context requires otherwise, references to "Molycorp," "we," "our" or "us" refer to Molycorp, LLC and its consolidated subsidiaries prior to the Corporate Reorganization (as described below) and Molycorp, Inc. and its consolidated subsidiaries after the Corporate Reorganization. Overview
We are one of the world's leading global rare earth companies, and the only one that operates a vertically integrated, global supply chain that combines a world-class rare earth resource with manufacturing facilities on three continents that can produce a wide variety of custom engineered, advanced rare earth materials from all of the lanthanide elements, plus yttrium.

Our vertically integrated, global manufacturing supply chain is comprised of a workforce of approximately 2,700 scientists, engineers, chemists, technologists, and highly skilled workers in 27 locations across 11 countries. Our vertical integration allows us to operate multiple product supply chains, serve as a highly reliable supplier of advanced rare earth and rare metal materials, and provide price visibility to customers worldwide.

Our business is organized into four reportable segments: (1) Resources; (2) Chemicals and Oxides; (3) Magnetic Materials and Alloys; and (4) Rare Metals. See Note 4 in Item 8 of this Annual Report on Form 10-K for financial information regarding our reportable segments.
The Resources segment includes our operations at the Molycorp Mountain Pass Rare Earth Facility, which we refer to as the Molycorp Mountain Pass facility, home to one of the world's largest and richest deposits of rare earths (including light, mid, and heavy rare earths). At the Molycorp Mountain Pass facility, we conduct rare earth minerals extraction to produce: rare earth concentrates; REO, including lanthanum, cerium, neodymium, praseodymium, and yttrium; heavy rare earth concentrates, which include samarium, europium, gadolinium, terbium, dysprosium, and others; and SorbXTM, a line of proprietary rare earth-based water treatment products.
The Chemicals and Oxides segment includes: production of REO at our operations at Molycorp Silmet; separated heavy rare earth oxides and other custom engineered materials from our facilities in Jiangyin, Jiangsu Province, China; and production of REO, salts of rare earth elements, or REEs, zirconium-based engineered materials and mixed rare earth/zirconium oxides from our facilities in Zibo, Shandong Province, China. Rare earth and zirconium applications from products made in this segment include catalytic converters, computers, television display panels, optical lenses, mobile phones, electronic chips, and many others.
The Magnetic Materials and Alloys segment includes: the production of Neo Powders™ through our wholly-owned manufacturing facilities in Tianjin, China, and Korat, Thailand, under the Molycorp Magnequench brand. This operating segment also includes manufacturing of neodymium and samarium magnet alloys, other specialty alloy products and rare earth metals at our MMA facility, located in Tolleson, Arizona. Neo Powders™ are used in micro motors, precision motors, sensors, and other applications requiring high levels of magnetic strength, flexibility, small size, and reduced weight.
The Rare Metals segment produces, reclaims, refines and markets high value niche metals and their compounds that include gallium, indium, rhenium, tantalum, and niobium. Operations in this segment include the following: Quapaw, Oklahoma; Blanding, Utah; Peterborough, Ontario; Napanee, Ontario; Sagard, Germany; Hyeongok Industrial Zone in South Korea; and Sillamäe, Estonia. Applications from products made in this segment include wireless technologies, LED, flat panel display, turbine, solar, catalyst, steel additive, electronics applications, and others.
Our Mountain Pass Rare Earth facility has been producing rare earth products for approximately 60 years. Upon reaching a planned annual run rate of 19,050 mt of REO by mid-2013, and upon completion of the chloralkali plant (expected later in 2013), we expect our Molycorp Mountain Pass Rare Earth facility to have production cash costs lower than those publicly reported for China by government officials and those reported for other non-Chinese rare earth projects. Although the modernization and expansion of our Molycorp Mountain Pass facility was planned to allow an expanded run rate of up to


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40,000 mt of REO per year, we will not expand production beyond the initial planned run rate unless market demand, product pricing, capital availability and financial returns justify such production. Material Changes in Results of Operations The comparability of our operating results during 2012, 2011 and 2010 is significantly affected by the Molycorp Canada acquisition on June 11, 2012, the Molycorp Silmet acquisition on April 1, 2011 and the MMA acquisition on April 15, 2011.
Recent Developments
Public Offerings
On January 30, 2013, we completed a public offering of $150.0 million aggregate principal amount of 5.50% convertible senior notes due 2018. We granted the underwriters the right to purchase, within a 30-day period from January 30, 2013, up to an additional $22.5 million aggregate principal amount of notes, solely to cover over-allotments, which right was exercised in full on March 1, 2013. Holders may convert their convertible senior notes at their option at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. The conversion rate is initially 138.8889 shares of common stock per $1,000 principal amount of convertible senior notes (equivalent to an initial conversion price of approximately $7.20 per share of common stock) and is subject to adjustment in some events.
In addition to the 5.50% convertible senior notes offering, we completed a public offering of 37,500,000 shares of common stock at a price of $6.00 per share on January 30, 2013. We also granted the underwriters the right to purchase, within a 30-day period from January 30, 2013, up to an additional 5,625,000 of shares of our common stock, which right was exercised in full on February 5, 2013. Also, to facilitate transactions by which investors in the 5.50% convertible senior notes may hedge their investments, we entered into a share lending agreement with an affiliate of the underwriter, under which the affiliate initially borrowed 6,666,666 shares of common stock.
We intend to use the net proceeds of $414.2 million from the convertible notes offering and the common stock offering to fund current capital needs for capital expenditures and other cash requirements for 2013, including, without limitation, capital expenditures at the Molycorp Mountain Pass facility. Impairment of Goodwill and Other Intangible Assets We tested the recoverability of our goodwill and other intangible assets at December 31, 2012 and recorded a total impairment charge of approximately $264.3 million in the fourth quarter of 2012. See Note 9 in Item 8 of this Annual Report on Form 10-K for further details. Circumstances that negatively affected our fair value estimate of the reporting units where goodwill was impaired included: longer-than-anticipated soft pricing environment for rare earths and certain rare metals; loss of some end markets due to 2011 rare earths high prices not returning to lower levels as quickly as anticipated; stalled growth for some new bonded magnet applications due to a peak in neodymium prices in 2011; and delays in ramping up our Molycorp Mountain Pass facility that deferred our ability to enter into longer-term contracts and generate the anticipated synergies expected from the Molycorp Canada acquisition. Circumstances leading to the impairment of other intangible assets included lower margins forecast due to certain patents expiration in 2014. The goodwill and other intangible assets impaired were substantially derived from the Molycorp Canada acquisition. Modernization and Expansion of our Molycorp Mountain Pass Facility All key production components of our Molycorp Mountain Pass facility are operational and now ramping up toward our initial planned annual run rate of 19,050 mt of REO by mid-year 2013. Our ability to expand production beyond the initial planned annual run rate will be influenced by customer demand and end-market conditions, among other factors.
We expect to complete construction of the chloralkali plant at our Molycorp Mountain Pass facility in 2013. Our chloralkali plant will help us recycle water used in separation processes, as well as regenerate chemical reagents needed for separations, which is expected to significantly reduce the amount of reagent supplies we must purchase. While the chloralkali plant is not required for rare earth production, it is expected to significantly drive down our unit production costs at our Molycorp Mountain Pass facility to a level below those reported by Chinese public officials once it comes online.
In addition to directly supplying customer demand, our Molycorp Mountain Pass facility is also expected to provide rare earth feedstock for our downstream processing plants in Sillamäe, Estonia; Zibo, China; Jiangyin, China; and Tolleson,


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Arizona. Those facilities produce advanced materials that are custom engineered for a variety of global rare earth markets. We expect that upon reaching our initial planned annual run rate of 19,050 mt of REO, our Molycorp Mountain Pass facility will have the capacity to produce rare earth feedstock in volumes greater than our initial planned run rates. We expect our Molycorp Mountain Pass facility to provide sufficient rare earth feedstock to meet the planned production of our Sillamäe and Zibo facilities in 2013.
Neodymium/praseodymium produced at our Molycorp Mountain Pass facility is expected to be sold directly to magnetic material customers, the IMJ joint venture, MMA and our downstream operations under the Molycorp Magnequench brand at our wholly-owned manufacturing facilities in Tianjin, China and Korat, Thailand.
Factors Affecting our Results of Operations Sales
The quantities we sell are affected by the production capabilities of our rare earth products and rare metals processing facilities, and by a combination of global and regional supply and demand factors, including the production level of certain industries relying on rare earth products, such as the automotive and electronics industries, China REEs export quotas and regulations, prices of REEs, and the demand and sophistication of downstream applications with rare earths content. Sales of our products are also subject to seasonal decreases in the first quarter of each year as customers react to the Chinese New Year holiday shutdown.
Cost of Sales
Our cost of sales includes the processing costs and the cost of certain raw materials we purchased from outside vendors, which we allocated to the products we produced at our operating facilities. In addition, our cost of sales reflects the cost allocated to the inventory we acquired as part of various business acquisitions. Because many of our costs are fixed, as our production increases or decreases, our average cost per metric ton produced decreases or increases, respectively. Primary production costs include direct labor and benefits, chemicals, natural gas, depreciation and amortization, electricity, maintenance, operating supplies and other plant overhead expenses. Our cost of sales may also reflect the write-down of inventory based on current prices for our products, which could materially affect our consolidated net results of operations. Our most significant variable costs are chemicals, raw materials and electricity. In early September 2012, our on-site CHP plant began feeding low-cost, high efficiency electrical power and steam to plants and buildings across the Molycorp Mountain Pass facility. As a result, natural gas costs will replace third-party electricity costs, which we expect will help us bring our power costs down significantly as further described in the Recent Developments section above. In the future, we also intend to produce more of our chemicals for the Molycorp Mountain Pass facility at an on-site plant, which we expect will reduce our variable chemical costs in that facility.
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.
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, including our recent acquisition of Molycorp Canada, operate as a publicly traded company and construct our new facilities at Mountain Pass.
Corporate Development
Our corporate development expenses consist of travel costs, legal and advisory fees that we incur in connection with business acquisitions and other business development activities we pursue as part of our vertical integration strategy. Research and Development
We incur expenses to improve the efficiency of our REO processing operations, develop new applications for individual REEs, research value added rare metals applications and perform exploratory drilling. These expenses, which we anticipate to continue to increase, consist primarily of salaries, outside labor, material and equipment. The acquisition of Molycorp Canada will further bolster our research and development, or R&D, activities with the addition of labs in Singapore and the United Kingdom and process development capabilities at most of the production facilities.


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Interest Expenses
We are incurring significantly higher interest costs as a result of issuing additional indebtedness to partially finance the Molycorp Canada acquisition, including the repayment of Molycorp Canada's indebtedness, and to fund the remaining capital expenditures at our Molycorp Mountain Pass facility. The substantial majority of our interest costs is currently capitalized. Income Taxes
We account for income taxes in accordance with Accounting Standard Codification 740, Income Taxes. This guidance requires the recognition of deferred tax assets and liabilities 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 a valuation allowance of $20.6 million is required as of December 31, 2012 and no valuation allowance was required as of December 31, 2011.
We are a Subchapter C corporation and, therefore, are subject to federal and state income taxes on our taxable income. For the years ended December 31, 2012, 2011, and 2010 our effective income tax rate was 10.9%, 19.5% and 0%, respectively. Our December 31, 2012 effective income tax rate was impacted primarily by permanent differences between book and tax income including the impairment of goodwill, settlements related to uncertain tax positions, and the difference in income tax rates between the U.S. and foreign jurisdictions adjusted for the U.S. taxation of foreign profits.
We review our deferred tax assets and liabilities each reporting period using the enacted tax rate expected to apply to taxable income for the period in which the deferred tax asset or liability is expected to be realized. The statutory income tax rates that are applied to our current and deferred income tax calculations are significantly impacted by the jurisdictions in which we conduct business. Changes in jurisdiction income tax rates and apportionment laws will result in changes in the calculation of our current and deferred income taxes. The effects of any changes are recorded in the period of enactment and can increase or decrease the net deferred tax assets and liabilities on the balance sheet.
Environmental
Our operations are subject to numerous and detailed environmental laws, regulations and permits, including those pertaining to employee health and safety, environmental permitting and licensing, air quality standards, greenhouse gas, or GHG, emissions, water usage and pollution, waste management, plant and wildlife protection, handling and disposal of radioactive substances, remediation of soil and groundwater contamination, land use, reclamation and restoration of properties, the discharge of materials into the environment and groundwater quality and availability.
We have spent, and anticipate that we will continue to spend, financial and managerial resources to comply with environmental requirements. For example, we incurred approximately $4.7 million and $6.1 million in 2012 and 2011, respectively, and expect to incur approximately $4.0 million in 2013, for ongoing operating environmental expenditures, including salaries, monitoring, compliance, reporting and permits. Included in the 2012 and 2011 amounts above are approximately $22.1 million and $4.9 million, respectively, for the removal and disposal of wastewater generated in excess of the existing evaporation capability of all ponds. The expenditures for removal and disposal of excess wastewater were incurred to allow the facilities under construction at Molycorp Mountain Pass to become fully operational. We estimate that we will incur approximately $6.0 million for wastewater transportation and disposal costs in 2013.
In addition, as part of our continuing efforts to comply with environmental laws and regulations, in 2011 we identified potential liner defects in three of the onsite evaporation ponds at our Molycorp Mountain Pass facility. This led to minor groundwater contamination issues that were limited to a small area directly underneath the evaporation ponds. The evaporation ponds in which the lining tears have been detected were substantially drained in 2011 to allow for a detailed inspection of the lining system. In 2012, we replaced the primary lining system in two of our evaporation ponds and the total cost of approximately $2.4 million was treated as capital expenditures. Further investigation of the lining system in the third pond did not reveal any lining system defects.
As a result of new construction activity at the Molycorp Mountain Pass facility associated with our modernization and expansion efforts, additional lands have been disturbed since the last mine reclamation cost estimate in 2010, resulting in an increase in the mine reclamation obligation from $3.3 million to $4.1 million. The additional $0.8 million surety amount was


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placed with the County of San Bernardino and the State of California earlier in 2012. The EPA has announced its intention to establish a new financial assurance program for hardrock mining, extraction and processing facilities under the Federal Comprehensive Environmental Response Compensation and Liability Act or the "Superfund" law, which may require us to establish additional bonds or other sureties. We cannot predict the effect of any such requirements on our operations at this time.
The costs we anticipate to incur as part of our on-going mine reclamation activities at our Molycorp Mountain Pass facility, which we expect to continue throughout closure and post-closure periods of our mining operations, are included in asset retirement obligation disclosure in Note 13 in Item 8 of this Annual Report on Form 10-K.
We incurred approximately $0.3 million and $0.4 million in 2012 and for the period from April 1, 2011 to December 31, 2011, respectively, at our Molycorp Silmet facility, and we expect to spend approximately $0.4 million in 2013, for ongoing operating environmental expenditures to comply with the European Union directives and with the Estonian regulatory act governing environmental permitting and licensing. In addition to routine environmental compliance costs, we incurred approximately $0.5 million in 2012, and expect to spend approximately $0.8 million in 2013, to comply with the European Union's REACH program at Molycorp Silmet. We may have to incur environmental capital and operating costs associated with future possible modernization plans at our Molycorp Silmet facility.
As part of the recycling of gallium, indium, and rhenium scrap into saleable metal, a significant degree of waste material is generated during the leaching and ion-exchange-barren process. We have adequate procedures in place to ensure that waste generated from these processes are appropriately contained and disposed of in a safe and responsible manner. Our Rare Metals operations in Ontario, Canada are subject to provincial regulation under the Ontario Ministry of Environment and must periodically submit documentation to validate the waste disposal process throughout the year. For the period from June 12, 2012 to December 31, 2012, waste disposal costs related to our operations in Ontario, Canada totaled $0.8 million.
Although we have not incurred any significant environmental expenditures at our MMA facility and our other Molycorp Canada's facilities in 2012, we may have to incur environmental capital and operating costs associated with future possible modernization and expansion plans related to those operations. Impact of Inflation
The cost estimates associated with the modernization and expansion of the Molycorp Mountain Pass facility described under the heading "Capital Investments" have not been adjusted for inflation. In the event of significant inflation, the funds required to execute our business plan over the next few years could increase proportionately. This could delay or preclude our business expansion efforts, or require us to raise additional capital. In addition, historical inflation rates have been used to estimate the future liability associated with our future remediation and reclamation obligations as reflected in the asset retirement obligations in our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. If inflation rates significantly exceed the historical inflation rates, our future obligations could significantly increase.
Foreign Currency Fluctuations
See "Interest Rate Risk" under Item 7A of this Annual Report on Form 10-K. Discussion and Analysis of our Reportable Segments The following analysis presents operating results on a gross basis (i.e., before intercompany eliminations). We believe this presentation provides a better understanding of the performance of each reportable segment in terms of contribution to our vertically integrated operations.

Some of the information under Chemicals and Oxides, Magnetic Materials and Alloys and Rare Metals for the year ended December 31, 2012 is actually for the period from June 12, 2012 (the beginning of the reporting period of Molycorp Canada) through December 31, 2012.

Prior to the third quarter of 2012, our basis of segment reporting was the location of our operations. As a result of the changes in the composition of our reportable segments discussed above, the prior period operating segments presentation has been revised for comparative purposes. Some of the information under Chemicals and Oxides and Rare Metals for the year ended December 31, 2011 is actually for the period from April 1, 2011 (the beginning of the reporting period of Molycorp Silmet) through December 31, 2011. The information under Magnetic Materials and Alloys for the year ended December 31,


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2011 is actually for the period from April 15, 2011(the beginning of the reporting period of MMA) through December 31, 2011. The Rare Metal segment in 2011 includes only rare metals production from Molycorp Silmet.

Prior to 2011, there was only one segment consisting of our operations at the Molycorp Mountain Pass facility.


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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

                                                                    Magnetic
                                               Chemicals and     Materials and                                          Corporate and        Total
Year ended December 31, 2012     Resources         Oxides            Alloys         Rare Metals      Eliminations(a)       other(b)      Molycorp, Inc.
Revenues:                                                                           (In thousands)
External                       $    88,870     $   181,849      $    179,335       $     78,856     $             -                      $    528,910
Intersegment                         7,256          25,717                 -                  -             (32,973 )                               -
Total revenues                 $    96,126     $   207,566      $    179,335       $     78,856     $       (32,973 )                    $    528,910

Depreciation, amortization
and accretion                  $   (13,991 )   $   (13,110 )    $    (19,737 )     $     (6,154 )   $             -     $       (133 )   $    (53,125 )

Operating (loss) income        $   (70,220 )   $  (174,927 )    $   (108,827 )     $    (21,641 )   $        24,803     $    (85,459 )   $   (436,271 )

(Loss) income before income
taxes and equity earnings      $   (70,469 )   $  (173,962 )    $   (110,265 )     $    (21,151 )   $        24,803     $   (143,269 )   $   (494,313 )

Total assets at December 31,
2012                           $ 1,802,842     $   646,316      $    591,052       $    116,300     $      (187,908 )   $     26,106     $  2,994,708

Capital expenditures (c)       $   814,054     $    10,910      $      5,614       $     10,750     $             -     $      1,733     $    843,061



                                                                 Magnetic
Year ended December 31,                     Chemicals and     Materials and                                          Corporate and       Total
2011                           Resources        Oxides            Alloys         Rare Metals      Eliminations(a)      other(b)      Molycorp, Inc.
Revenues:                                                                        (In thousands)
. . .
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