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MOLYCORP, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) In this Quarterly Report on Form 10-Q, unless the context requires otherwise, references to "Molycorp," "we," "our" or "us" refer to Molycorp, Inc. and its consolidated subsidiaries. As used herein, a ton is equal to 2,000 pounds, the term "mt" means a metric tonne (equal to 2,205 pounds), and the term "Rest of World" means the entire world except China. For definitions of certain rare earth-related and mining terms, see "Glossary of Selected Mining Terms." This Quarterly Report on Form 10-Q contains forward-looking statements that represent our beliefs, projections and predictions about future events or our future performance. You can identify forward-looking statements by terminology such as "may," "will," "would," "could," "should," "expect," "intend," "plan," "anticipate," "believe," "estimate," "predict," "potential," "continue" or the negative of these terms or other similar expressions or phrases. These forward-looking statements are necessarily subjective and involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements or industry results to differ materially from any future results, performance or achievement described in or implied by such statements. Risk factors and uncertainties that may cause actual results to differ materially from expected results include, among others: the need to secure additional capital to implement our business plans, and our ability to successfully secure any such capital; our ability to complete our planned capital projects, such as our modernization and expansion efforts, including achieving an annual production capacity of 19,050 mt at our Mountain Pass, California rare earth mine and processing facility, or the Molycorp Mountain Pass facility, which we refer to as Project Phoenix Phase 1, and our second phase capacity expansion plan, which we refer to as Project Phoenix Phase 2, and reach full planned production rates for rare earth oxides, or REO, and other planned downstream products, in each case within the projected time frame; the success of our cost mitigation efforts in connection with Project Phoenix, which if unsuccessful, might cause our costs to exceed budget; the final costs of our planned capital projects, such as Project Phoenix Phase 1, including the accelerated start-up of the Molycorp Mountain Pass facility, and Project Phoenix Phase 2, which may differ from estimated costs; our ability to successfully integrate Neo Material Technologies, Inc. (now Molycorp Minerals Canada ULC, or Molycorp Canada), with our operations; our ability to achieve fully the strategic and financial objectives related to the acquisition of Molycorp Canada, including the acquisition's impact on our financial condition and results of operations; and unexpected costs or liabilities that may arise from the acquisition, ownership or operation of Molycorp Canada. Also as a result of the Molycorp Canada acquisition, our business performance may be materially affected by a number of other factors and uncertainties including, but not limited to: the rate of exchange of the U.S. dollar to the Canadian dollar, the Japanese yen, and the Chinese Renminbi; new products pricing; the competitive environment for these new products; unexpected actions of domestic and foreign governments; and various events which could disrupt operations, including natural events and other risks. Other risk factors and uncertainties that may cause actual results to differ materially from expected results include: uncertainties associated with our reserve estimates and non-reserve deposit information, including estimated mine life and annual production; uncertainties related to feasibility studies that provide estimates of expected or anticipated costs, expenditures and economic returns, REO prices, production costs and other expenses for operations, which are subject to fluctuation; uncertainties regarding global supply and demand for rare earths materials; uncertainties regarding the results of our exploratory drilling programs; our ability to enter into additional definitive agreements with our customers and our ability to maintain customer relationships; our sintered neodymium-iron-boron, or NdFeB, rare earth magnet joint venture's ability to successfully manufacture magnets within its expected timeframe; our ability to successfully integrate other acquired businesses; our ability to maintain appropriate relations with unions and employees; our ability to successfully implement our "mine-to-magnets" strategy; environmental laws, regulations and permits affecting our business, directly and indirectly, including, among others, those relating to mine reclamation and restoration, climate change, emissions to the air and water and human exposure to hazardous substances used, released or disposed of by us; uncertainties associated with unanticipated geological conditions related to mining; and those risks discussed and referenced in the section entitled "Risk Factors" described in our Annual Report on Form 10-K for the year ended December 31, 2011. Any forward-looking statement you read in this Quarterly Report on Form 10-Q reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, operating results, growth strategy and liquidity. You should not place undue reliance on these forward-looking statements because such statements speak only as to the date when made. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future, except as otherwise required by applicable law. The following discussion and analysis should be read in conjunction with our September 30, 2012 unaudited condensed consolidated financial statements and related notes included herein. This Quarterly Report on Form 10-Q also contains statistical data and estimates we obtained from industry publications and reports generated by third parties. Although 35-------------------------------------------------------------------------------- Table of Contents we believe that the publications and reports are reliable, we have not independently verified their data. Overview We are one of the world's leading rare earth products and rare metals companies that combine a world-class rare earth resource at Mountain Pass, California, with world-leading ultra-high-purity rare earth and rare metal materials processing capabilities. We are vertically integrated across the global rare earth mine-to-magnetics supply chain and we produce custom engineered materials from 13 different rare earths, plus yttrium, with purity levels of up to 6N (99.9999%), and from five other metals (niobium, tantalum, gallium, indium and rhenium) at purity levels of up to 8N (99.999999%). 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 mobile devices, fiber optics, lasers and hard disk drives; critical 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 by industry analysts 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. The foundation for our "mine-to-magnets" strategy is our Molycorp Mountain Pass facility. Our Molycorp Mountain Pass facility is the largest, most fully developed rare earth mine outside of China and has been producing rare earth products for approximately 60 years. Upon completion of Project Phoenix Phase 1, which we anticipate to occur in the fourth quarter of 2012, we expect our Molycorp Mountain Pass 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. We are targeting a full planned production rate of approximately 19,050 mt of REO per year in the fourth quarter of 2012, an annual production capacity of 40,000 mt of REO by the end of 2012 and, if customer demand and end-market conditions warrant, a full planned production rate of 40,000 mt of REO per year as early as mid-2013. We also own several of the leading rare earth processing facilities in the world. Our Molycorp Silmet facility, located in Sillamäe, Estonia, is one of the largest REO and rare metals producers in Europe. Our Molycorp Metals & Alloys, or MMA, facility, located in Tolleson, Arizona, is the only producer of neodymium and samarium magnet alloy and other specialty alloy products in the United States. We also have created a joint venture with Daido Steel Co., Ltd., or Daido, and Mitsubishi Corporation, or Mitsubishi, in the form of a private company, Intermetallics Japan, or IMJ, to manufacture sintered NdFeB permanent rare earth magnets. The sintered NdFeB magnet manufacturing facility we are constructing in Japan through IMJ remains on schedule for production in early 2013. The next-generation magnets the joint venture will manufacture do not depend on the use of patents held by other magnet companies and will deliver greater performance with less reliance on dysprosium, a relatively scarce rare earth. The joint venture has been provisionally awarded a supply agreement for a next-generation electric vehicle with a major automotive manufacturer. As demand for sintered NdFeB magnets continues to rise in the advanced automotive, wind energy, home appliance, industrial motors and other markets, all of the joint venture partners are prepared to invest in additional facilities as needed. As a result of the Molycorp Canada acquisition in June 2012, we became a leading global producer, processor and developer of NdFeB magnetic powders, or Neo Powders, rare earths and zirconium based engineered materials and applications and other rare metals and their compounds. These innovative products are essential in many of today's high-technology products. Neo Powders are used in the production of high performance, bonded NdFeB permanent magnets, which are found in micro motors, precision motors, sensors and other applications requiring high levels of magnetic strength, flexibility, small size and reduced weight. This acquisition allows us to manufacture also a line of mixed rare earth/zirconium oxides and to reclaim, refine and market high value niche metals and their compounds including gallium, indium and rhenium used in wireless, light emitting diode, or LED, flat panel display, turbine, solar and catalyst applications. Through the Molycorp Canada acquisition we have expanded our operations to include joint ventures and majority owned manufacturing facilities in Jiangyin, Jiangsu Province, China; Zibo, Shandong Province, China; Tianjin, China; Hyeongok Industrial Zone in South Korea; Korat, Thailand; Stade, Germany; Sagard, Germany; Peterborough, Ontario; Napanee, Ontario; Blanding, Utah; and Quapaw, Oklahoma. Additionally, we now conduct research and product development through laboratories in Singapore and Abingdon, United Kingdom. Our combined workforce of approximately 2,677 employees includes scientists, engineers, chemists, technologists and highly skilled workers in 27 locations across 11 countries. 36-------------------------------------------------------------------------------- Table of Contents Material Changes in Results of Operations The comparability of our operating results during 2012 and 2011 is significantly affected by the Molycorp Canada acquisition on June 11, 2012. This Quarterly Report on Form 10-Q includes the results of Molycorp Canada for the third quarter of 2012 and for the period from June 12, 2012 to September 30, 2012. Recent Developments Issuance of 6.00% Convertible Senior Notes due 2017 and Concurrent Offering of Shares of Common Stock On August 22, 2012, in separate underwritten public offerings, we issued $360 million aggregate principal amount of our 6.00% Convertible Senior Notes due 2017, which we refer to as the 6.00% Convertible Notes, and 12,000,000 shares of our common stock, which we refer to as the Primary Shares, at a price to the public of $10.00 per share. Certain of our officers, directors and other related parties participated in both offerings, but no underwriting fees were paid with respect to the purchases by the insiders. On August 28, 2012, the underwriters of the 6.00% Convertible Notes exercised their option to purchase an additional $54 million aggregate principal amount of the Notes. On August 31, 2012, the underwriters of the Primary Shares exercised their option to purchase an additional 1,800,000 Primary Shares. Concurrently with the offering of the 6.00% Convertible Notes and the Primary Shares, we entered into a share lending agreement with Morgan Stanley Capital Services LLC, or MSCS, an affiliate of Morgan Stanley & Co. LLC, under which we agreed to loan to MSCS up to 13,800,000 shares of our common stock. We entered into the share lending agreement to facilitate the 6.00% Convertible Notes offering. Acquisition of Neo Material Technologies Inc. (now known as Molycorp Canada) On June 11, 2012, we completed the acquisition of all of the outstanding equity of Molycorp Canada's predecessor company pursuant to the terms of an arrangement agreement, which we refer to as the Arrangement Agreement, for an aggregate purchase price of approximately $1,192.3 million. Pursuant to the Arrangement Agreement, Molycorp Canada's former shareholders elected to receive: a) cash consideration equal to Cdn $11.30 per share of the predecessor company's common stock; b) share consideration of 0.4242 shares of Molycorp common stock or 0.4242 shares, which we refer to as the Exchangeable Shares, issued by MCP Exchangeco Inc., our wholly-owned Canadian subsidiary, which are exchangeable for shares of our common stock on a one for one basis, per each share of the predecessor company's common stock; or c) a combination of cash and shares of Molycorp common stock or Exchangeable Shares, all subject to the proration mechanics set forth in the Arrangement Agreement. The consideration paid to Molycorp Canada's former shareholders was comprised of approximately $908.2 million in cash, exclusive of realized losses on the contingent forward contract to purchase Canadian dollars, accounted for a separate transaction apart from the business combination. Additionally, approximately 13,545,426 shares of Molycorp common stock and 507,203 Exchangeable Shares were issued and collectively valued at $284.1 million based on the closing price of the Company's common stock on the acquisition date in accordance with the relevant accounting guidance. Substantial Repayment of 5.00% Subordinated Unsecured Convertible Debentures As a result of the Molycorp Canada acquisition, we assumed $230.0 million principal amount of subordinated unsecured convertible debentures due December 31, 2017 (the "Debentures") that bear interest at an annual rate of 5.00%, as further discussed in Note 14 of the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. In August 2012, holders of $9.4 million aggregate principal amount of Debentures elected to convert, while holders of $217.9 million aggregate principal amount of Debentures elected to have their Debentures repurchased for cash plus accrued interest. As a result of the conversion, a total of $8.0 million, including accrued interest, was paid in cash with the remainder converted into 99,723 shares of our common stock. As of September 30, 2012, $2.7 million principal amount of the Debentures was outstanding. Modernization and Expansion of our Molycorp Mountain Pass Facility Project Phoenix remains on track to begin producing at our Phase 1 annual rate of 19,050 mt of REO in the fourth quarter of 2012. Additionally, we are on track to achieve an annual production capacity of 40,000 mt of REO by the end of 2012 and, if customer demand and end-market conditions warrant, a full planned production rate of 40,000 mt of REO per year as early as mid-2013. Project Phoenix construction advanced to the point where the concentrate production circuit became operational. This means that we are now producing rare earth concentrate at our Molycorp Mountain Pass facility with new processes and in new 37-------------------------------------------------------------------------------- Table of Contents facilities as part of Project Phoenix, including the following: • Mining of approximately 2,500 metric tons of fresh ore and/or overburden per day, 4 days/week • Combined Heat & Power, or CHP, Unit • Crushing / Blending • First Stage Crack Facility • Mill & Flotation Circuit • Cerium Production Unit • Paste Tailings Facility • Paste Tailings Permanent Disposal Facility • Natural Gas Pipeline Lateral The concentrate being produced with fresh ore at the Molycorp Mountain Pass facility is being processed into separated REOs by our existing separations facility. In addition, concentrates are being shipped to our existing separations facilities at the Molycorp Silmet, and is being stockpiled for eventual processing in our new separations facilities under construction at the Molycorp Mountain Pass facility as part of Project Phoenix. 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 in early September 2012. Installing CHP technologies at the Molycorp Mountain Pass facility contributes to several major goals in our business plan: • Reducing our Cost of Production - We expect that producing our own electricity, heat, and steam will reduce our cost of power from what we traditionally paid at the Molycorp Mountain Pass facility, of $0.16 cents per kilowatt-hour for non-interruptible service, to less than $0.03 per kilowatt-hour. This will help us in achieving the lowest cost of production in the industry. • Maintaining Environmental Superiority - We designed our CHP plant to be extraordinarily energy efficient. In fact, when fully operational, it is expected to operate above 80% efficiency, with a peak efficiency as much as 85% (Lower Heating Value). That approaches the maximum practical efficiency for a thermal power generation plant, which we expect will result in less emissions and reduced energy consumption for the same output. In mid-September 2012, we achieved two other milestones in the modernization and expansion of our Molycorp Mountain Pass facility: start-up and commissioning operations of our new water treatment plant and our neodymium/praseodymium, or NdPr, separation facility. When fully operational, the Project Phoenix water treatment facility will help us recycle process water that historically was treated as wastewater. This technology puts us on track to achieving our goals of operating as a near-zero wastewater discharge facility and maintaining environmental superiority in rare earth production at the Molycorp Mountain Pass facility. This technology also helps drive down our production costs. The start-up and commissioning of our NdPr separation facility is also a very significant milestone to achieving Phase 1 production in the fourth quarter of 2012, and ultimately effectuating Molycorp's vertical integration business model. Being able to feed NdPr oxide from our high efficiency operations at Mountain Pass to our NdFeB magnet powder and sintered NdFeB magnet manufacturing supply chains is core to our entire mine-to-magnets business strategy. During the third quarter of 2012, we also started up our new Project Phoenix heavy rare earth concentrate facility at Mountain Pass. This facility will produce heavy rare earth concentrate from freshly mined Mountain Pass ore containing the full range of heavy rare earth elements, such as samarium, europium, gadolinium, terbium, dysprosium, and others. Because of our acquisition of Molycorp Canada, we have the ability to proceed directly to separation and purification of that concentrate into many high-purity, custom engineered heavy rare earth products. As our global business expands, we plan to incorporate the high-purity separations technologies now operating in our Jiangyin facility in China to other Molycorp locations, such as Mountain Pass, California; Tolleson, Arizona; and/or Sillamäe, Estonia. 38-------------------------------------------------------------------------------- Table of Contents 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 companies 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. We expect our labor and benefits costs to increase through at least the remainder of 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. 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 "mine-to-magnets" 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. Interest Expenses We are incurring significantly higher interest costs as a result of issuing additional indebtedness in 2012 to partially finance the Molycorp Canada acquisition, including the repayment of Molycorp Canada's indebtedness, and to fund the remaining capital expenditures under Project Phoenix Phase 1 and Phase 2. The substantial majority of our interest costs is currently capitalized. 39-------------------------------------------------------------------------------- Table of Contents Income Taxes We are a Subchapter C corporation and, therefore, are subject to federal and state income taxes on our taxable income. 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 no valuation allowance was required as of September 30, 2012, and a $2.2 million valuation allowance was required as of September 30, 2011. 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 do 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 gases, 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 retain, both within Molycorp and outside Molycorp, the services of reclamation and environmental, health and safety, or EHS, professionals to review our operations and assist with environmental compliance, including with respect to product management, solid and hazardous waste management and disposal, water and air quality, asbestos abatement, drinking water quality, reclamation requirements, radiation control and other EHS issues. We have spent, and anticipate that we will continue to spend, financial and managerial resources to comply with environmental requirements. For example, we have acquired enough air emission offset credits for both Project Phoenix Phase 1 and Project Phoenix Phase 2. In addition, at our Molycorp Mountain Pass facility during the third quarter of 2012 and 2011, we incurred operating expenses of approximately $1.9 million and $2.5 million, respectively, associated with environmental compliance requirements. The costs we anticipate to incur as part of our on-going mine reclamation activities at the 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 of the Condensed Consolidated Financial Statements, included elsewhere in this Quarterly Report on Form 10-Q. As part of our continuous efforts to comply with environmental laws and regulations, in 2011 we identified liner defects in three of the onsite evaporation ponds at the Molycorp Mountain Pass facility. This led to minor groundwater contamination issues that are limited to a small area directly underneath the evaporation ponds. In order to remediate this issue, we will replace the primary lining system in two of our evaporation ponds. We estimate the cost of these items to range between $2.4 million and $4.6 million, which will be treated as capital expenditures in 2012. 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, and the related costs were recorded as of December 31, 2011. We also estimated that we will incur approximately $17.0 million for wastewater transportation and disposal costs in 2012, primarily for the removal and disposal of any wastewater generated in excess of the existing evaporation capability of all ponds at the Mountain Pass facility, until all facilities currently under construction as part of Project Phoenix Phase 1 and Phase 2 are operational and properly coordinated. We have already incurred $13.0 million of these costs through September 30, 2012. We cannot predict the impact of new or changed laws, regulations or permit requirements, including the matters discussed below, or changes in the way such laws, regulations or permit requirements are enforced, interpreted or administered. Environmental laws and regulations are complex, change frequently and have tended to become more stringent over time. It is 40-------------------------------------------------------------------------------- Table of Contents possible that greater than anticipated environmental expenditures will be required in 2012 or in the future, including expenditures as a result of our acquisitions of MMA, Molycorp Silmet and Molycorp Canada. We expect continued government and public emphasis on environmental issues will result in increased future investment for environmental controls at our operations. Additionally, with increased attention paid to emissions of GHGs, including carbon dioxide, current and future regulations are expected to affect our operations. We will continue to monitor developments in these various programs and assess their potential impacts on our operations. Violations of environmental laws, regulations and permits can result in substantial penalties, court orders to install pollution control equipment, civil and criminal sanctions, permit revocations, facility shutdowns and other sanctions. In addition, environmental laws and regulations may impose joint and several liabilities, without regard to fault, for costs relating to environmental contamination at our facilities or from wastes disposed of at third-party waste facilities. The proposed expansion of our operations is also conditioned upon securing the necessary environmental and other permits and approvals. In certain cases, as a condition to procuring such permits and approvals, we are required to comply with financial assurance requirements. The purpose of these requirements is to assure the government that sufficient company funds will be available for the ultimate closure, post-closure care and/or reclamation at our facilities. We typically obtain bonds as financial assurance for these obligations and, as of September 30, 2012, we had placed a total of $28.8 million of surety bonds with California state and regional agencies. These bonds require annual payment and renewal. In the second quarter of each year, we are required to provide the State of California with an updated estimate of the costs associated with the mine reclamation. This estimate is reviewed and approved by the State of California, after which we are responsible for making any necessary changes to surety bonds placed with the State of California. As a result of new construction activity at the Molycorp Mountain Pass facility associated with our modernization and expansion project, 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 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. Our Molycorp Sillamäe facility has an Integrated Environmental Permit, which controls its operations in general, and Radiation Practice Licenses for the management of radioactive materials. The Integrated Environmental Permit must be renewed when and if we expand our operations in that facility. The Radiation Practice Licenses are renewed approximately every five years. Some of Radiation Practice Licenses are due for renewal in 2013 and some in 2015. We are also subject both to Chinese national and local environmental protection regulations, which currently impose a graduated schedule of fees for the discharge of waste substances, require the payment of fines for discharges exceeding the standards, and provide for the closure of any facility that fails to comply with orders requiring it to cease or remedy certain activities causing environmental damage. Our Chinese joint ventures, Jiangyin Jia Hua Advanced Material Resources Co., Ltd., or Jiangyin, and Zibo Jia Hua Advanced Material Resources Co., Ltd., or Zibo, produce waste water from their solvent extraction processes. In the case of Jiangyin, its expansion in 1995 included an upgrading of its waste water processing and treatment procedures, as a result of which its waste water passes all environmental requirements. Jiangyin pays an agreed fee once a year for the discharge of waste waters. In the case of Zibo, the plant was designed to make use of waste water discharge facilities of an adjacent petrochemical complex, which has a variable monthly charge based on usage. Zibo is also obliged to pay a monthly environmental administration fee to the municipal government of Linzi. Waste water has met the requirements set by local authorities for all environmental standards. Both Jiangyin and Zibo were inspected in 2012 as part of an environmental audit and have received the Chinese Ministry of Environmental Protection's approval for compliance with applicable environmental laws. However, there is no assurance that Chinese national or local authorities will not impose additional regulations which would require additional expenditures that may have a material adverse effect on the profitability of the joint ventures. 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 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. 41-------------------------------------------------------------------------------- Table of Contents Discussion and Analysis of our Reportable Segments In the third quarter of 2012, we reorganized our operations into four new reportable segments to better reflect our primary activities as a global rare earths and magnetics producer: Resources; Chemicals and Oxides; Magnetic Materials and Alloys; and Rare Metals. The new composition of our reportable segments is based on a combination of product lines and technologies that align with our mine-to-magnet strategy. See Note 3 of the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for further details. 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 for the nine months ended September 30, 2012 is actually for the period from June 12, 2012 (the beginning of the reporting period of Molycorp Canada) through September 30, 2012. 42-------------------------------------------------------------------------------- Table of Contents Three and Nine Months Ended September 30, 2012 and 2011 Three months ended Magnetic September 30, 2012 (In Chemicals and Materials and Corporate and Total thousands) Resources Oxides Alloys Rare Metals Eliminations(a) other(b) Molycorp, Inc. Sales: External $ 17,150 $ 87,820 $ 74,789 $ 25,845 $ - $ 205,604 Intersegment 3,745 11,559 - - (15,304 ) - Total sales $ 20,895 $ 99,379 $ 74,789 $ 25,845 $ (15,304 ) $ 205,604 Depreciation, amortization and accretion $ (4,035 ) $ (5,685 ) $ (8,857 ) $ (1,715 ) $ - $ (43 ) $ (20,335 ) Operating (loss) income $ (23,966 ) $ 2,149 $ 1,419 $ (3,774 ) $ 369 $ (16,526 ) $ (40,329 ) (Loss) income before income taxes and equity earnings $ (25,506 ) $ 1,201 $ 1,215 $ (3,812 ) $ 369 $ (17,212 ) $ (43,745 ) Total assets at September 30, 2012 (d) $ 1,686,524 $ 565,673 $ 536,299 $ 79,996 $ (161,201 ) $ 178,465 $ 2,885,756 Capital expenditures (c) $ 187,611 $ 2,597 $ 1,432 $ 2,837 $ - $ 1,387 $ 195,864 Magnetic Nine months ended September Chemicals and Materials and Corporate and Total 30, 2012 (In thousands) Resources Oxides Alloys Rare Metals Eliminations(a) other(b) Molycorp, Inc. Sales: External $ 78,162 $ 134,158 $ 125,277 $ 57,054 $ - $ 394,651 Intersegment 5,977 15,496 - - (21,473 ) - Total sales $ 84,139 $ 149,654 $ 125,277 $ 57,054 $ (21,473 ) $ 394,651 Depreciation, amortization and accretion $ (8,743 ) $ (7,419 ) $ (10,810 ) $ (4,358 ) $ - $ (96 ) $ (31,426 ) Operating (loss) income $ (23,594 ) $ (21,863 ) $ (1,544 ) $ (1,947 ) $ 24,480 $ (66,804 ) $ (91,272 ) (Loss) income before income taxes and equity earnings $ (25,044 ) $ (23,663 ) $ (2,381 ) $ (2,998 ) $ 24,480 $ (113,546 ) $ (143,152 ) Capital expenditures (c) $ 675,836 $ 6,615 $ 1,612 $ 6,955 $ - $ 1,733 $ 692,751 (a) The net elimination in operating results includes cost of sales elimination of $15,673 for three months ended September 30, 2012, and $45,952 for the nine months ended September 30, 2012. The cost of sales elimination consists of the intercompany gross profits as well as elimination of lower of cost or market adjustments related to intercompany inventory. The $161,201 of total assets elimination is comprised of $159,009 of intercompany investments and $2,192 of intercompany accounts receivable and profits in inventory. (b) Corporate loss before income taxes and equity earnings includes business development costs, personnel and related costs, including stock-based compensation expense, accounting and legal fees, occupancy expense, information technology costs and interest expense. Other consists of nominal expenses incurred by the sales office in Tokyo, Japan. Total corporate assets is comprised primarily of cash and cash equivalents. (c) On an accrual basis excluding capitalized interest. (d) Excludes goodwill of $501.6 million arising on the Molycorp Canada acquisition which has not been allocated to its operating segments. 43-------------------------------------------------------------------------------- Table of Contents In prior periods, 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 nine months ended September 30, 2011 is actually for the period from April 1, 2011 (the beginning of the reporting period of Molycorp Silmet) through September 30, 2011. Some of the information under Magnetic Materials and Alloys for the nine months ended September 30, 2011 is actually for the period from April 15, 2011(the beginning of the reporting period of MMA) through September 30, 2011. Three months ended Magnetic September 30, 2011 (In Chemicals and Materials and Corporate and Total thousands) Resources Oxides Alloys Rare Metals Eliminations(e) other(b) Molycorp, Inc. Sales: External $ 94,342 $ 15,927 $ 14,449 $ 13,332 $ - $ 138,050 Intersegment 30,535 6,652 - - (37,187 ) - Total sales $ 124,877 $ 22,579 $ 14,449 $ 13,332 $ (37,187 ) $ 138,050 Depreciation, amortization and accretion $ (2,715 ) $ (1,627 ) $ 128 $ (1,386 ) $ - $ - $ (5,600 ) Operating income (loss) $ 101,727 $ 2,682 $ 610 $ (3,148 ) $ (22,329 ) $ (12,597 ) $ 66,945 Income before income taxes $ 101,606 $ 1,559 $ 614 $ (4,121 ) $ (22,329 ) $ (13,172 ) $ 64,157 Total assets at September 30, 2011 $ 632,098 $ 52,955 $ 33,032 $ 69,361 $ (154,710 ) $ 552,706 $ 1,185,442 Capital expenditures (c) $ 106,162 $ 2,300 $ - $ - $ - $ - $ 108,462 (e) The total assets elimination of $154,710 is comprised of $102,357 of intercompany investments and $52,353 of intercompany accounts receivable and profits in inventory. Nine months ended Magnetic Total September 30, 2011 (In Chemicals and Materials and Corporate and Molycorp, thousands) Resources Oxides Alloys Rare Metals Eliminations other(b) Inc. Sales: External $ 180,951 $ 31,419 $ 24,699 $ 26,858 $ - $ 263,927 Intersegment 46,482 10,290 - - (56,772 ) - Total sales $ 227,433 $ 41,709 $ 24,699 $ 26,858 $ (56,772 ) $ 263,927 Depreciation, amortization and accretion $ (7,538 ) $ (1,707 ) $ (271 ) $ (1,456 ) $ - $ - $ (10,972 ) Operating income (loss) $ 163,392 $ 10,333 $ (586 ) $ (175 ) $ (31,514 ) $ (34,684 ) $ 106,766 Income before income taxes $ 163,234 $ 9,232 $ (580 ) $ (1,124 ) $ (31,514 ) $ (34,945 ) $ 104,303 Capital expenditures (c) $ 218,128 $ 4,672 $ - $ - $ - $ - $ 222,800 44-------------------------------------------------------------------------------- Table of Contents Resources Sales from our Resources segment were $20.9 million and $84.1 million for the three and nine months ended September 30, 2012, respectively, as compared to sales of $124.9 million and $227.4 million for the three and nine months ended September 30, 2011, respectively. In the third quarter of 2012, this segment sold 835 mt of products at an average sales price, or ASP, of $25.02 per kilogram (on a REO basis), as compared to 1,002 mt at an ASP of $124.65 per kilogram for the corresponding period in 2011. For the nine months ended September 30, 2012 and 2011, Resources sold 2,032 mt at an ASP of $41.41 per kilogram, and 2,685 mt of products at an ASP of $84.69 per kilogram, respectively. The decrease in volume shipped during the three and nine months ended September 30, 2012 as compared to the corresponding prior periods, was primarily attributable to limited Bastnasite feedstock due to the new mill coming online at the same time the last of the historical stockpiles were drawn down. Prices for the segment's primary products (cerium, lanthanum, neodymium and praseodymium) have also significantly decreased, as compared to the corresponding periods in 2011, due to premiums placed on Chinese export quotas in 2010 combined with the unwinding of speculative purchases that drove prices for virtually all rare earth elements to a historical peak in July 2011. Beginning in the second quarter of 2012, prices for most rare earth elements have stabilized or declined at a slower pace than earlier in the year. We believe this trend may continue for the remainder of 2012, although there can be no assurance. Aggregate production volume at our Resources segment was 565 mt and 1,851 mt for the three and nine months ended September 30, 2012, respectively, compared to 739 mt and 2,052 mt for the three and nine months ended September 30, 2011, respectively. We expensed $2.2 million and $7.5 million during the three and nine months ended September 30, 2012 of production-related costs that would have otherwise been charged to inventory if we maintained normal production levels during these periods. This compares to expensing of abnormal production-related costs of $0.8 million and $4.3 million during the three and nine months ended September 30, 2011. However, as we complete and begin to commercialize Project Phoenix Phase 1, we expect to attain increased production levels in future periods. We recognized a $11.3 million and $20.9 million of total inventory write-down to net realizable value for the three and nine months ended September 30, 2012 as compared to $0 and $0.6 million for the corresponding periods in 2011, respectively. Variable production costs in this segment were affected by rising prices of chemicals and other raw materials used in our REO production, primarily during the separation process. However, we intend to produce more of our chemicals for our Molycorp Mountain Pass facility at an on-site plant in the near future, which we expect to significantly reduce our variable chemical costs for the segment. Given the lower level of production attained in the current quarter-to-date and year-to-date periods, as compared to the corresponding prior periods, labor cost increases also had a slightly negative effect on the results of operations for this segment. As of September 30, 2012, we had a total of 365 employees at our Molycorp Mountain Pass facility, as compared to 171 employees as of September 30, 2011. Staffing increases are directly related to the ramp up in employees needed to run the larger production facilities, which are in the process of coming online. In addition, the annual wage increase required under our union contract took effect in January 2012 for approximately 60% of our employees at Mountain Pass. Chemicals and Oxides Comparative results for the Chemicals and Oxides segment were affected by the addition to our product mix of REO, salts of REEs, zirconium-based engineered materials and mixed rare earth/zirconium oxides from the Molycorp Canada acquisition on June 11, 2012, and REO production from our operations in Sillamäe, Estonia as a result of our acquisition of Molycorp Silmet on April 1, 2011. This segment did not have sales prior to April 1, 2011. Chemicals and Oxides' sales were $99.4 million on volume of 1,933 mt and $149.7 million on volume of 2,901 mt for the three and nine months ended September 30, 2012, respectively. This compares to sales for this segment of $22.6 million on volume of 384 mt and $41.7 million on volume of 888 mt for the three and nine months ended September 30, 2011, respectively. ASP was $51.41 per kilogram and $51.59 per kilogram for the three and nine months ended September 30, 2012, respectively, as compared to $58.79 per kilogram and $46.95 per kilogram for the corresponding periods in 2011, respectively. The segment's operating income for the third quarter of 2012 and year-to-date September 30, 2012 was negatively affected by the release of inventory that was stepped-up in value in conjunction with the Molycorp Canada acquisition, and by the write-down of inventory to net realizable value. These adjustments, in the aggregate, totaled to $15.9 million for the three and $23.7 million for the nine months ended September 30, 2012, respectively. This compares to an increase in cost of sales of $10.2 million for the corresponding periods in 2011 from the release of inventory that was stepped-up in value in conjunction the Molycorp Silmet acquisition in April 2011. 45-------------------------------------------------------------------------------- Table of Contents Main drivers of the period-over-period decrease in ASP was the change in product mix combined with the same REE market's factors that affected realized prices in our Resources segment. Given the current global economic environment, customers in all market segments we serve have been monitoring closely and, in some instances, reducing their inventory levels. However, during the third quarter of 2012 we have seen signs that our major customers are getting back to desired inventory levels, particularly in some markets. For example, demand for our mixed REO for automotive catalyst applications was positive during the third quarter of 2012. As a result, we plan to add capacity for the Chemicals and Oxide segment in 2013 in order to support anticipated growth in this area where we continue to qualify new products with all our major customers. Moreover, our recently acquired operations in Jiangyin, China and Zibo, China, which represent a significant portion of this segment's activity, remain focused on high purity and sophisticated downstream rare earth products. In the third quarter of 2012, Zibo passed the final phase of the Chinese environmental inspection process and we now have full access to our export quotas at both Zibo and Jiangyin for the remainder of 2012. Magnetic Materials and Alloys Comparative results for the Magnetic Materials and Alloys segment were affected by the inclusion of Neo Powders from the Molycorp Canada acquisition on June 11, 2012, and neodymium and samarium magnet alloy and other specialty alloy products from the MMA acquisition we completed on April 15, 2011. This segment did not have sales prior to April 15, 2011. Magnetic Materials and Alloys' sales were $74.8 million on volume of 1,527 mt and $125.3 million on volume of 1,959 mt for the three and nine months ended September 30, 2012, respectively. This compares to sales of $14.4 million on volume of 226 mt and $24.7 million on volume of 427 mt for the three and nine months ended September 30, 2011, respectively. ASP was $48.98 per kilogram and $63.95 per kilogram for the three and nine months ended September 30, 2012, respectively, as compared to $63.93 per kilogram and $57.84 per kilogram for the corresponding periods in 2011, respectively. The price for neodymium, the primary determinant of the price for Neo Powders, which currently account for a larger portion of the volume we sell in this segment, fell by approximately 11% during the third quarter of 2012. Therefore, based on our current pricing methodology, prices for Neo Powders were adjusted accordingly. The anticipation of falling Neo Powders price generally results in very conservative purchasing patterns by our customers. To the extent possible, purchases of Neo Powders are delayed until the month when the price is anticipated to be lower. This has caused inventory levels to fall to very low levels throughout the supply chain and has impacted volumes shipped. However, shipment for high performance Neo Powders improved, as new applications business - generally replacing standard sintered magnets - grew in the home appliance industry. During the third quarter of 2012, the operating income of the Magnetic Materials and Alloys segment was impacted by increased cost of sales related to purchase accounting adjustments to the inventory acquired as part of the Molycorp Canada acquisition, and by the write-down of inventory to net realizable value. These adjustments were nominal for the three and nine months ended September 30, 2012 and for the corresponding periods in 2011, respectively. Rare Metals Comparative results for the Rare Metals segment were affected by the addition to our product mix of gallium, indium and rhenium from the Molycorp Canada acquisition on June 11, 2012, and niobium and tantalum from our acquisition of Molycorp Silmet on April 1, 2011. This segment did not have sales prior to April 1, 2011. Sales from our Rare Metals segment were $25.8 million and $57.1 million for the three and nine months ended September 30, 2012, respectively, as compared to sales of $13.3 million and $26.9 million for the three and nine months ended September 30, 2011, respectively. In the third quarter of 2012, this segment sold 96 mt of products at an ASP of $269.22 per kilogram, as compared to 88 mt at an ASP of $151.50 per kilogram for the corresponding period in 2011. For the nine months ended September 30, 2012 and 2011, Rare Metals sold 265 mt and 167 mt of products, respectively, at an ASP of $215.30 per kilogram and $160.82 per kilogram, respectively. Similarly to the other segments, write-down of inventory to net realizable value had a negative impact to the operating income of the Rare Metals segment. These adjustments decreased operating income by $6.2 million and $6.3 million during the three and nine months ended September 30, 2012. There were no material adjustments to cost of sales for the corresponding prior year periods in this segment. 46-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Our consolidated selling, general and administrative expenses, including stock-based compensation, were $31.5 million and $78.7 million for the three and nine months ended September 30, 2012, respectively, as compared to $12.2 million and $31.5 million for the three and nine months ended September 30, 2011, respectively. A large portion of the quarter-over-quarter increase was attributable to higher personnel and related costs stemming from our recent acquisition of Molycorp Canada, higher information technology costs associated with on-going improvements and expansion of our Enterprise Resource Planning system, and larger start-up costs related to the construction of our Molycorp Mountain Pass facility. The increase from the nine months ended September 30, 2011 to the same period in 2012 was substantially driven by the same factors describe above for the quarter-over-quarter change. Corporate Development Corporate development expenses were $1.1 million and $19.4 million for the three and nine months ended September 30, 2012, respectively, as compared to $0.6 million and $3.9 million for the three and nine months ended September 30, 2011, respectively. This significant increase during the nine months ended September 30, 2012 over the corresponding period in 2011 was primarily related to the costs we incurred in connection with the Molycorp Canada acquisition in June 2012. The quarter-over-quarter increase was due to other business development activities. Depreciation, Amortization and Accretion Consolidated depreciation and amortization expenses related to production were $10.6 million and $19.1 million for the three and nine months ended September 30, 2012, respectively, as compared to $5.1 million and $9.6 million for the three and nine months ended September 30, 2011, respectively. The historical quarter-over-quarter and year-to-date change was primarily related to the addition of fixed assets in conjunction with the Molycorp Canada acquisition. Consolidated depreciation, amortization and accretion expenses unrelated to production were $9.7 million and $12.4 million for the three and nine months ended September 30, 2012, respectively, as compared to $0.5 million and $1.4 million for the three and nine months ended September 30, 2011, respectively. The increase in both comparative periods was mainly due to the addition of approximately $492.0 million in amortizable intangible assets acquired in connection with the Molycorp Canada acquisition. Research and Development Consolidated research and development expenses were $8.9 million and $18.6 million for the three and nine months ended September 30, 2012, respectively, as compared to $2.1 million and $5.2 million for the three and nine months ended September 30, 2011, respectively. The quarterly and year-to-date period over period increase was attributable primarily to our efforts to improve the efficiency of our REO processing operations, to 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 in the foreseeable future, consist primarily of salaries, outside labor, material and equipment. Interest Expense Interest expense related to all our long-term indebtedness was substantially capitalized through the third quarter of 2012. The larger interest expense we incurred for the three and nine months ended September 30, 2012, as compared to the corresponding periods in 2011, related primarily to the payment of a commitment fee of approximately $7.9 million for a bridge loan we secured with a financial institution prior to the issuance in May 2012 of $650.0 million aggregate principal amount of 10% senior secured notes due 2020, which we refer to as our Senior Notes, and $1.7 million of interest accrued that we paid upon the repurchase of the majority of the $230.0 million aggregate principal amount of Debentures in August 2012. See Note 14 to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for further detail on our indebtedness. Non-capitalized interest expense was nominal in 2011. Foreign exchange (losses) gains Net foreign currency transaction gains were $1.9 million and $0.7 million during the three and nine months ended September 30, 2012, respectively. This compares to foreign currency transaction losses of $2.0 million and $1.8 million during the three and nine months ended September 30, 2011, respectively. These gains and losses relate primarily to the revaluation in Euro of U.S. dollar monetary balances owed by Molycorp Silmet. 47-------------------------------------------------------------------------------- Table of Contents Other Expense Other expense increased by approximately $37.5 million in the nine months ended September 30, 2012 from the corresponding period in 2011, primarily as a result of a loss recognized upon settlement of the contingent forward contract we entered into to purchase Canadian dollars with a notional amount of Cdn $870.0 million to manage the foreign currency exposure with respect to our acquisition of Molycorp Canada. Capital Expenditures Our consolidated capital expenditures, on an accrual basis and excluding capitalized interest, totaled $195.9 million and $692.8 million for the three and nine months ended September 30, 2012, as compared to $105.4 million and $219.0 million for the three and nine months ended September 30, 2011, respectively. The majority of these capitalized costs relate to Project Phoenix Phase 1 and Project Phoenix Phase 2 at our Molycorp Mountain Pass facility. Related Party Transactions We had no payments in 2012 and made principal payments of $0.6 million and $2.3 million for the three and nine month period ended September 30, 2011, respectively, under the inventory financing arrangement with Traxys North America LLC, which we refer to collectively with its affiliates, as Traxys and affiliates, a subsidiary of one of our stockholders, Traxys S.a.r.l. We and Traxys and affiliates jointly market and sell certain lanthanum oxide, cerium oxide, misch metal and erbium oxide products. Pursuant to the terms of this other arrangement, we and Traxys and affiliates split gross margin equally once all costs associated with the sale are recovered by both parties. In addition, we purchased $6.2 million of lanthanum oxide from Traxys and affiliates during the nine months ended September 30, 2011. We did not have any material purchases from Traxys and affiliates in 2012. During the period from January 1, 2012 to June 11, 2012, we sold neodymium/ praseodymium oxides for $4.3 million and heavy rare earths for $1.6 million to Neo Material Technologies, Inc. For the quarter ended September 30, 2012 and for the period from June 12, 2012 to September 30, 2012, we purchased $1.4 million and $1.9 million, respectively, of compounds from Toda Magnequench Magnetic Materials Co. Ltd., or TMT (an equity method investee acquired as part of Molycorp Canada), and we sold $1.3 million and $1.4 million of Neo Powders to TMT, respectively. During the same periods, we purchased metals and received services from Ganzhou Keli Rare Earth New Material Co., Ltd., or Keli (an equity method investee acquired as part of Molycorp Canada), amounting to $16.1 million and $21.4 million, respectively. For the quarter ended September 30, 2012 and for the period from June 12, 2012 to September 30, 2012, we purchased $1.3 million and $1.7 million of gallium metal, respectively, from Ingal Stade (an equity method investee acquired as part of Molycorp Canada). Outlook for the Remainder of 2012 We anticipate China-based producers and suppliers will continue to limit the quantity of REO available outside of China for the remainder of 2012. On several occasions, the Chinese government has called for greater use of rare earths for China's own domestic manufacturing as it aims to boost the use of rare earths in high-end manufacturing. Recently, the Chinese government announced a significant reduction of mining permits in an effort to further consolidate the rare earth industry to achieve efficiencies in the industry and curb illegal exports of REE from China. Independent industry sources have also indicated that China is importing rare earth materials while investing in downstream operations, thus increasing the likelihood that China will make greater use of Western rare earth material in addition to its own. We will continue to progressively expand our products and markets through the remainder of 2012, including market penetrations of our SorbXTM (formerly XSORBX) technology into the water treatment industry. Additionally, we will continue to supply Molycorp Silmet and MMA with rare earth feedstocks, and our Molycorp Mountain Pass facility will increase shipments of certain REO to our facilities in Asia for use in value-added and downstream rare earth applications. However, the volume of rare earth products we are able to produce at our Mountain Pass facility will remain limited by the capability of our existing production facilities while ramping up to Project Phoenix Phase 1 production capacity. We expect our REO production in 2012 to be between 8,000 mt and 10,000 mt 48-------------------------------------------------------------------------------- Table of Contents across our facilities at Mountain Pass, Molycorp Silmet and MMA. We believe that our consolidated sales in 2012 will be sufficient to fund our normal operating activities throughout the year, including consolidated selling, general and administrative expenses. Based on our ongoing monitoring of the rare earth industry and our business, we expect that our cash flow from operations for the remainder of 2012 will likely be less than we originally expected. Capital Investments We are incurring significant capital expenditures under our plans to modernize and expand our Molycorp Mountain Pass facility, as well as consistent expenditures to replace assets necessary to sustain safe and reliable production. Most of the facilities and equipment acquired in connection with the acquisition of the Molycorp Mountain Pass facility are at least 20 years old. We are executing an accelerated modernization plan that includes the refurbishment of the Molycorp Mountain Pass mine and related processing facilities through 2012 in order to increase our REO production. We implemented a plan to accelerate Project Phoenix Phase 1 start-up to take advantage of favorable project economics at a time when the REO markets were robust. This acceleration, if successful, will help to improve the diversity of global supply, which continues to be an urgent matter for rare earth consumers. By accelerating Project Phoenix Phase 1 start-up, we also expect to reduce the overall project risk by allowing for a more orderly and sequential startup of the various circuits and facilities of this complex project. Cash expenditures for Project Phoenix Phase 1, Project Phoenix Phase 2 and other remaining 2012 capital projects related to operations at the Molycorp Mountain Pass facility are expected to total approximately $170.0 million for the fourth quarter of 2012, and approximately $305.0 million in the first half of 2013, respectively. These estimated cash expenditures described above represent the estimated remaining expenditures for Project Phoenix Phase 1, Project Phoenix Phase 2 and our other remaining 2012 capital projects related to operations at the Molycorp Mountain Pass facility. Including the applicable remaining expenditures, the aggregate cost of Project Phoenix Phase 1 and Project Phoenix Phase 2 is estimated to be approximately $1.25 billion for engineering, procurement and construction, or EPC, preliminary engineering, insurance, permitting, legal, start-up, commissioning and other costs. All amounts for future capital spending are estimates that include certain discretionary amounts and are subject to change as the projects are further developed. These estimates do not include capitalized interest. The estimated total costs for Project Phoenix Phase 1 and Project Phoenix Phase 2 include estimated additional EPC expenditures totaling up to $150.0 million for corrections resulting from certain defective engineering work, other engineering, design and scope changes and other cost increases. We are pursuing actions to recoup certain costs arising from defective engineering work, including making claims against applicable insurance policies, although there can be no assurance that we will be able to recoup all or any portion of such costs. We regularly monitor our capital projects to identify opportunities to reduce their total costs. We expect to incur capital expenditures of approximately $10.0 million during the fourth quarter of 2012 at all our other operating facilities. Liquidity and Capital Resources We expect to fund the remaining capital expenditures under Project Phoenix Phase 1, Project Phoenix Phase 2 and other capital expenditures related to operations at Molycorp Mountain Pass and all other operating facilities, as well as working capital and other cash requirements, with our available cash balances of $436.0 million at September 30, 2012, anticipated future cash flow from operations and potential proceeds from revolving credit facilities or certain equipment financing that we are currently pursuing in our normal process of properly managing our cash and working capital requirements. There can be no assurance that we will be successful in securing access to additional cash proceeds through the revolving credit facilities and lease or loan financing for certain equipment that we are currently pursuing, or other forms of financing on commercially acceptable terms, or at all. Accordingly, if necessary, we believe we have the ability to curtail capital expenditures and revise our current business plan to the extent necessary to preserve adequate liquidity sufficient to sustain operations. Other cash requirements are expected to include an additional contribution of approximately $3.8 million to IMJ in September 2013. The actual remittance amounts to IMJ will vary depending on the future exchange rate between the U.S. dollar and the Japanese Yen and the achievement of certain milestones by the joint venture. We also anticipate making cash investments in other current and new ventures consistent with our mine-to-magnets strategy totaling approximately $8.0 million in the fourth quarter of 2012 and approximately $20.0 million in 2013. 49-------------------------------------------------------------------------------- Table of Contents Cash Used in Operating Activities Net cash used in operating activities was $47.2 million during the nine months ended September 30, 2012, as compared to a positive cash flow from operations of $28.7 million for the same period in 2011. This change was primarily driven by lower sales prices combined with a significant increase in operating expenses, including corporate development costs associated with the Molycorp Canada acquisition and the loss of $37.5 million recognized upon settlement of the contingent forward contract described above. Investing Activities Net cash used in investing activities increased to $1.3 billion during the nine months ended September 30, 2012 as compared to $198.0 million for the same period in 2011. This increase was due primarily to our acquisition of Molycorp Canada, higher capital expenditures as part our modernization and expansion plan at Molycorp Mountain Pass and our contributions to IMJ. Financing Activities Net cash provided from financing activities increased from $415.1 million during the nine months ended September 30, 2011 to $1.3 billion during the same period in 2012, due to the issuance of $650.0 million aggregate principal amount of our Senior Notes, Molymet's $390.2 million investment in our common stock, the issuance of $414.0 million aggregate principal amount of our 6.00% Convertible Notes, the issuance of 13,800,000 Primary Shares, and bank advances of $9.5 million. These cash inflows were partially offset by the repayment of $227.5 million aggregate principal amount of the Debentures acquired as part of the Molycorp Canada acquisition, including interest, the $8.5 million preferred stock dividend that we paid through September 1, 2012, and $0.9 million of other short-term debt repayments. Liquidity of Subsidiaries Our total $436.0 million of cash and cash equivalents at September 30, 2012 is comprised of: 1) $175.4 million held by Molycorp Minerals, LLC; 2) $0.7 million held by Molycorp Silmet; 3) $3.8 million held by MMA; 4) $256.0 million held by Molycorp Canada; and 5) $0.1 million held by our sales office in Tokyo, Japan. At September 30, 2012, our foreign operating subsidiaries held cash and cash equivalents in foreign countries as follows (in thousands): China (including Hong Kong) $ 144,398 Barbados 22,315 Canada 25,426 Japan 12,338 Germany 5,504 United Kingdom 2,070 Thailand 1,197 Korea 451 Singapore 563 Estonia 725Total cash and cash equivalents in foreign countries 214,987 United States 221,038 Total cash and cash equivalents $ 436,025 Approximately 17% of the total cash and cash equivalents held by our foreign operating subsidiaries relate to undistributed earnings that are considered indefinitely reinvested in these foreign subsidiaries. If such earnings were repatriated, additional tax expense may result, although the calculation of such additional taxes is not practicable. In addition to cash and cash equivalents, the primary sources of liquidity of our operating subsidiaries are cash provided by operations and, in the case of our operations in China, Japan and Estonia, borrowing under certain bank loans. From time to time, the sources of liquidity for our operating subsidiaries may be supplemented by short-term loans from Molycorp Minerals, LLC. At September 30, 2012, Molycorp Minerals, LLC advanced funds, in the form of interest bearing 50-------------------------------------------------------------------------------- Table of Contents unsecured promissory notes, to Molycorp Silmet for $17.2 million, and to MMA for $3.0 million, including accrued interest. Our operating subsidiaries' liquidity generally is used to fund their working capital requirements, capital expenditures and third-party debt service requirements. Contractual Obligations At September 30, 2012, we had the following contractual obligations, in thousands: Payments Due by Period Less Than More ThanContractual Obligations Total 1 Year 1 - 3 Years 4 - 5 Years 5 Years (In thousands) Operating lease obligations(1) $ 9,826 $ 1,417 $ 5,929 $ 1,110 $ 1,370Purchase obligations and other commitments(2) 287,819 284,534 1,798 538 949 Employee obligations(3) 1,952 1,952 - - - Asset retirement obligations(4) 36,721 1,955 9,402 568 24,796 Debt and capital lease obligations, including fixed interest payments 2,060,871 140,745 540,858 582,174 797,094 Total $ 2,397,189 $ 430,603 $ 557,987 $ 584,390 $ 824,209 (1) Represents all operating lease payments for office space, land and office equipment. (2) Represents contractual commitments for the purchase of materials and services from vendors. Amount includes $2.4 million of potential environmental obligations related to defects in pond liners, and $8.0 million in acquisition related commitments. (3) Represents primarily payments due to employees for awards under our annual incentive plan. (4) Under applicable environmental laws and regulations, we are subject to reclamation and remediation obligations resulting from our operations. The amounts presented above represent our estimated future undiscounted cash flows required to satisfy the obligations currently known to us. Off-Balance Sheet Arrangements As of September 30, 2012, our only off-balance sheet arrangements are the operating leases and purchase obligations included in the contractual obligations table above. Recent Accounting Pronouncements In December 2011, the Financial Accounting Standard Board, or FASB, issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05. ASU 2011-12 defers the requirement that companies present reclassification adjustments for each component of Accumulated Other Comprehensive Income, or AOCI, in both net income and other comprehensive income on the face of the financial statements. Companies will continue to be required to present amounts reclassified out of AOCI on the face of the financial statements or disclose those amounts in the notes to the financial statements. During the deferral period, there is no requirement to separately present or disclose the reclassification adjustments into net income. For the three and nine month periods ended September 30, 2012, we did not have any reclassification adjustments for components of AOCI. In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. Under this updated guidance, an entity will have the option to first assess qualitatively whether it is necessary to perform the current two-step goodwill impairment test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is necessary. The update does not change how an entity performs the two-step impairment test under the current guidance. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We do not expect the adoption of this updated guidance to have a significant impact on our 51-------------------------------------------------------------------------------- Table of Contents financial statements. GLOSSARY OF SELECTED REEs, RARE METALS AND MINING TERMS The following is a glossary of selected REEs, rare metals and mining terms used in this quarterly report on Form 10-Q that may be technical in nature: Assay The analysis of the proportions of metals in ore, or the testing of an ore or mineral for composition, purity, weight, or other properties of commercial interest. Bastnasite Bastnasite is a mixed-lanthanide fluoro-carbonate mineral (Ln F CO3) that currently provides the bulk of the world's supply of the light REEs. Bastnasite and monazite are the two most common sources of cerium and other REEs. Bastnasite is found in carbonatites, igneous carbonate rocks that melt at unusually low temperatures. Bonded magnet Bonded neodymium-magnets are prepared by melt spinning a thin ribbon of the Nd-Fe-B alloy. The ribbon contains randomly oriented Nd2Fe14B nano-scale grains. This ribbon is then pulverized into particles, mixed with a polymer and either compression or injection molded into bonded magnets. Bonded magnets offer less flux than sintered magnets, but can be net-shape formed into intricately shaped parts and do not suffer significant eddy current losses. Cerium Cerium (Ce) is a soft, silvery, ductile metal which easily oxidizes in air. Cerium is the most abundant of the REEs, and is found in a number of minerals, including monazite and bastnasite. Cerium has two relatively stable oxidation states, enabling both the storage of oxygen and its widespread use in catalytic converters. Cerium is also widely used in glass polish. Concentrate A mineral processing product that generally describes the material that is produced after crushing and grinding ore, effecting significant separation of gangue (waste) minerals from the desired metal and/or metal minerals, and discarding the wasteminerals. The resulting "concentrate" of minerals typically has an order of magnitude higher content of minerals than the beginning ore material. Cut-off grade The lowest grade of mineralized material that qualifies as ore in a given deposit. The grade above which minerals are considered economically mineable considering the following parameters: estimates over the relevant period of mining costs, ore treatment costs, general and administrative costs, refining costs, royalty expenses, by-product credits, process and refining recovery rates and price.Didymium Didymium is a natural and unseparated combination of neodymium and praseodymium, which is approximately 75% neodymium and 25% praseodymium, depending on the ore. Dysprosium A few percent of Dysprosium (Dy) is often added to high power neodymium iron boron magnets to increase their resistance to demagnetization. A minor use of dysprosium is in the magnetostrictive alloy, based on DyTbFe called terfenol-D.Europium Europium (Eu) is desirable due to its photon emission. Excitation of the europium atom, by absorption of electrons or by UV radiation, results in changes in energy levels that create a visible emission. Almost all practical uses of europium utilize this luminescent behavior. Gadolinium Gadolinium (Gd) absorbs neutrons and therefore is used for shielding and controlling neutron radiography and in nuclear reactors. Because of its paramagnetic properties, solutions of organic gadolinium complexes and gadolinium compounds are popular intravenous contrast enhancing agents for medical Magnetic Resonance Imaging contrast agents in (MRI). Gadolinium is sometimes added to samarium cobalt magnets to make their magnetic properties less temperature dependent. Gallium Elemental gallium is not found in nature, but it is easily obtained by smelting. Very pure gallium metal has a brilliant silvery color and its solid metal fractures conchoidally like glass. Almost all gallium is used for microelectronics. Grade The average REE content, as determined by assay of a metric ton of ore.Indium A rare, very soft, malleable and easily fusible post-transition metal that is chemically similar to gallium and thallium, and shows intermediate properties between these two. Indium's current primary application is to form transparent electrodes from indium tin oxide (ITO) in liquid crystal displays and touchscreens, and this use largely determines its global mining production. It is widely used in thin-films to form lubricated layers. It is also used for making particularly low melting point alloys, and is a component in some lead-free solders. Lanthanum Lanthanum (La) is the first member of the Lanthanide series. Lanthanum is a strategically important rare earth element due to its use in fluid bed cracking catalysts, FCCs, which are used in the production of transportation and aircraft fuel. Lanthanum is also used in fuel cells and batteries. Mill A processing plant that produces a concentrate of the valuable minerals contained in an ore. 52-------------------------------------------------------------------------------- Table of Contents Mineralization The process or processes by which a mineral or minerals are introduced into a rock, resulting in a valuable or potentially valuable deposit. Monazite Monazite is a reddish-brown phosphate mineral. Monazite minerals are typically accompanied by concentrations of uranium and thorium. This has historically limited the processing of monazite, however this mineral is becoming more attractive because it typically has elevated concentrations of mid-to heavy rare earths. Niobium Niobium is a rare, soft, grey, ductile transition metal found in the minerals pyrochlore, the main commercial source for niobium, and columbite. Niobium is used mostly in alloys, the largest part in special steel such as that used in gas pipelines. Although alloys contain only a maximum of 0.1%, that small percentage of niobium improves the strength of the steel. The temperature stability of niobium-containing superalloys is important for its use in jet and rocket engines. Niobium is used in varioussuperconducting materials. Neodymium Neodymium (Nd) has two major uses. It is key constituent of NdFeB permanent magnets and it is an additive to capacitor dielectrics. NdFeB magnets maximize the power/weight ratio, and are found in a large variety of motors, generators, sensors and hard disk drives. Capacitors containing neodymium are found in cellular telephones, computers and nearly all other electronic devices. A minor application of neodymium is in lasers. Ore That part of a mineral deposit which could beeconomically and legally extracted or produced at the time of reserve determination. Overburden In surface mining, overburden is the material that overlays an ore deposit. Overburden is removed prior to mining. Praseodymium Praseodymium (Pr) comprises about 4% of the lanthanide content of bastnasite and has a few specific applications, based mainly on its optical properties. It is a common coloring pigment, and is used in photographic filters, airport signal lenses, and welder's glasses. Because it chemically and magnetically is so similar to its neighbors neodymium and lanthanum, it is typically found in small amounts in applications where neodymium and lanthanum are popular, such as NdFeB magnets and catalysts. These latterapplications are actually the largest uses for praseodymium because the magnet and catalyst markets are so large. Thus praseodymium plays an important role, in extending the availability of the more popular neodymium and lanthanum.Probable reserves Reserves for which quantity and grade and/or quality are computed from information similar to that used for proven reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation.Proven reserves Reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling; and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well established. Recovery The percentage of contained metal actually extracted from ore in the course of processing such ore.Reserves That part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination. Same definition as 'ore' Rhenium It is a silvery-white, heavy, third-row transition metal. With an estimated average concentration of 1 part per billion (ppb), rhenium is one of the rarest elements in the Earth's crust. The free element has the third-highest melting point and highest boiling point of any element. Rhenium resembles manganese chemically and is obtained as a by-product of molybdenum and copper ore's extraction and refinement. Nickel-based superalloys of rhenium are used in the combustion chambers, turbine blades, and exhaust nozzles of jet engines. These alloys contain up to 6% rhenium, making jet engineconstruction the largest single use for the element, with the chemical industry's catalytic uses being next-most important. Samarium Samarium (Sm) is predominantly used to produce samarium cobalt magnets. Although these magnets are slightly lesspowerful than NdFeB magnets at room temperature, samarium cobalt magnets can be used over a wider range of temperatures and are less susceptible to corrosion. Sintered magnet Sintered neodymium-magnets are prepared by the raw materials being melted in a furnace, cast into a mold and cooled to form ingots. The ingots are pulverized and milled to tiny particles. This undergoes a process of liquid-phase sintering whereby the powder is magnetically aligned into dense blocks which are then heat-treated, cut to shape, surface treated and magnetized. Tantalum Tantalum is a rare, hard, blue-gray, lustrous transition metal that is highly corrosion resistant. It is part of therefractory metals group, which are widely used as minor component in alloys. The chemical inertness of tantalum makes it a valuable substance for laboratory equipment and a substitute for platinum, but its main use today is in tantalum capacitors in electronic equipment such as mobile phones, DVD players, video game systems and computers. 53-------------------------------------------------------------------------------- Table of Contents Terbium Terbium (Tb) is used primarily as a phosphor, either in fluorescent lamps or x-ray screens. It can replace dysprosium in NdFeB magnets but usually does not because of its cost. A minor use of terbium is in the magnetostrictive alloy, based on DyTbFe called terfenol-D. Yttrium Yttrium (Y), although not a lanthanide series element, is often considered to be a rare earth element and its behavior is similar to heavy rare earth elements. It is predominantly utilized in lighting applications and ceramics. Other uses include resonators, lasers, microwave communication devices and other electronic devices. Zirconium oxide A white amorphous powder that is insoluble in water and highly refractory, used as a pigment for paints, a catalyst, and an abrasive. 54-------------------------------------------------------------------------------- Table of Contents |