Sprott Inc. (SII) Q3 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Sprott Inc.'s 2017 Third Quarter Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded today, November 9, 2017. On behalf of the speakers that follow, listeners are cautioned that today's presentation and the responses to questions may contain forward-looking statements within the meanings of the safe harbor provision of the Canadian provincial securities law. Forward-looking statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are implied in making forward-looking statements and actual results may differ materially from those expressed or implied in such statements. For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for the quarter and Sprott's other filings with the Canadian securities regulators. I'll now turn the call over to Mr. Peter Grosskopf. Please go ahead, Mr. Grosskopf.

Good morning, everyone, and thanks for joining us today. On the call with me today is our Chief Financial Officer, Kevin Hibbert; our Chief Executive Officer of Sprott Asset Management, John Ciampaglia; and our Head of Investor Relations, Glen Williams. Our 2017 third quarter results were released this morning and are available on our website, where you can also find the financial statements and MD&A. I'll start on Slide 3 with a brief recap of our progress so far in 2017. This has been a big transition year for the firm, as we reposition to focus on our core strengths in precious metals, mining and real assets. We believe Sprott has a proven ability to add investment value in these areas, and our goal is to run strategies with track records to attract both institutional and retail investors, and completely earn their trust and support. As part of the strategic review, we completed the sale of our Canadian retail mutual fund business and the accompanying sale of a majority of our nonresource private client accounts, which is expected to close later this month. Concurrent with the sale of these divested assets, we appointed a new leadership team. Each business head has been tasked with driving growth in their respective businesses, and ensuring that we maintain a best-in-class culture, products and service. Early in the year, we launched our new merchant bank, Sprott Capital Partners, with the objective of enhancing our origination capabilities and providing additional EBITDA growth potential. We believe we've now put in place the foundation for future growth with the acquisition of management of Central Fund of Canada, which John will talk about in a minute, as well as the successful raise of our first PE-style fund, the Sprott Private Resource Lending LP. Our financial performance, bottomed in 2015, is gradually improving. Our year-to-date adjusted EBITDA increased by a substantial amount. Our operational EBITDAs are increasing. And our SG&A expense ratios continue to decline. The addition of the CFCL is expected to further improve margins and increase the base profitability of our business. I'll now have John address the points on CFCL on Page 4.

Great. Thanks, Peter, and good morning, everybody. It's been about a month now since we announced the acquisition of CFCL, and I'm very pleased to report that the investor response has been excellent. We've created a lot of value creation for the shareholders since that time with the Central Fund of Canada trading at approximately a 2% discount to its net asset value. This compares to 7% preannouncement and about 9% discount to NAV when we initiated action earlier this year. So we've already created a lot of value for shareholders. They're responding in the right way, and we're very confident we're going to have this transaction closed in the early part of 2018. The circular was mailed this week to shareholders, and our vote is scheduled for November 30. The acquisition is a very sizable one for us, it will add CAD 4.3 billion AUM. And by the way, despite the precious metals markets being a bit soft in the last 30 days, the asset base has remained at this CAD 4.3 billion mark. So we're happy with that. That will grow our firm-wide AUM by both 60% to $11.5 billion. It doubles our exchange with the products business to $9 billion. That would make us the #3 in the precious metal space in North America, behind the large giants of State Street and iShares. And it's obviously very accretive, synergistic, and will drive our earnings growth going forward. The shareholder base of Central Fund is approximately 90,000 and it represents a very attractive cross-selling opportunity for us. Our plan is to be very active in engaging with them to try to sell other products and nurture a deeper relationship. I'll pass that over -- I'll pass it back to Kevin -- or Peter. Sorry.

Thanks, John. So just looking at Slide 5 on the Q3 financial review. Our AUM declined to $7.2 billion during Q3, largely due to the sale of our Canadian retail business. Our adjusted based EBITDA was $8 million or $0.03 per share. Investable capital was $307 million as at September 30, but that number will drop after the CFCL acquisition is completed. We recorded $85 million in net sales or capital deployed during the quarter, most of which came from new loans funded by our private lending LP. On Slide 6, you can see some of the recent highlights from our key business units. All of our divisions are profitable, most are currently growing, and all are raising pools of capital for new resource and real asset investments. Our lending LP now stands at USD 640 million, including co-investments. As of September 30, $150 million had been deployed in the new loans with an additional $115 million committed after the end of the quarter. As I noted, our merchant bank has been active, participating in more than $750 million in financings in this sector so far this year, generating both origination opportunities and EBIT for Sprott. In our Exchange Listed business, our junior gold equity ETF has outperformed the GDXJ since its rebalance. We hope to capitalize on this opportunity more in the future as ours is now the only true junior gold equity ETF in the market. And finally, we recently announced a joint venture with Ceres Partners in the U.S., and established farmland manager. The goal is to build an institution on high net worth client base in the farmland investment area by targeting yield and upside potential. This client base, which is generally responsive to tactical and uncorrelated real assets, fits quite well alongside our existing clients. I'll now pass it over to Kevin for a more detailed look at our results. Kevin?

Thanks, Peter, and good morning, everyone. I'll start on Slide 7 with a look at our AUM roll forward. AUM, as of September 30, 2017, was $7.2 billion, which was down $2.1 billion from Q2 of this year. The decrease was primarily due to the sale of our Canadian diversified funds business, which closed on August 1 of this year and, to a lesser extent, market value depreciation on lower gold prices in our exchange listed products, which more than offset the addition of new AUM in our Private Resource Lending fund. Moving on to Slide 8. You'll see a breakdown of our third quarter revenues. Net fees in the quarter were $13.4 million, down $4.9 million or 27% from the prior period. The decline in the quarter was mainly due to the sale of our Canadian diversified funds business. In addition to this fee reduction, we also experienced lower fee generation in our Exchange Listed Products business due to a combination of lower precious metals prices and a weaker U.S. dollar. The loss of fees on the sale of our Canadian diversified funds business and from our exchange listed products business more than offset the increase in fee income from our private resource investments business. Net commissions in the quarter were $3.2 million, down $1.2 million or 27% from the prior period. The decline in the quarter was due to lower margin private placement activity in our Canadian broker-dealer period-over-period, and lower transaction volumes in our U.S. broker-dealer. Interest income in the quarter was $2.4 million, up $100,000 or 3% from the prior period. The increase was largely due to the recognition of interest income on a previously impaired loan, which more than offset the effects of the loan book runoff. Other income in the quarter was $39.3 million, up $35.2 million from the prior period. That increase was largely due to the net proceeds received on the sale of our Canadian diversified funds business. Turning now to Slide 9 for a look at our expenses. Compensation expense, excluding commissions, in the quarter was $5.7 million, down $5.4 million or 49% from the prior period. The decrease was due to a combination of lower headcount and higher equity grant forfeitures related to the completion of our diversified funds business sale. SG&A was $5.2 million in the quarter, down $2.2 million or 29% from the prior period. This was due primarily to the positive effects of the sale of our Canadian diversified funds business and, to a lesser extent, our ongoing cost-containment efforts across the rest of the platform. In terms of SG&A expense ratio, it continues to trend downwards on a year-to-date basis, as Peter mentioned earlier. And quarter-over-quarter, our SG&A expense is down in absolute terms. Other expenses in the quarter were $8.1 million, up $7.6 million from the prior period. That increase was largely due to nonrecurring transaction expenses related to the sale of our Canadian diversified funds business. Turning now to Slide 10. Adjusted base EBITDA was $8 million for the quarter, reflecting a decrease of $400,000 from the prior period. Lower adjusted base EBITDA was due to lower net commissions on lower margin private placement activity, and lower client transaction volume in our Canadian and U.S. brokerage businesses, respectively, and lower earnings in our exchange listed products business due to a combination of lower precious metals pricing and a weaker U.S. dollar in the quarter. These decreases were only partially offset by lower compensation and SG&A expenses in our alternative asset management business due to the sale closure of our Canadian diversified funds business. Finally, Slide 11 provides a snapshot of our current capital position. We continue to enjoy a strong balance sheet. No debt, and $307 million of investable capital, a material portion of which will be deployed to partially fund the purchase of CFCL, as Peter noted earlier. I'll now turn it back to Peter.

Thanks, Kevin. With the Central Fund acquisition, we have significantly increased our leverage to precious metals, and over 85% of our total AUM is now leveraged to that sector. We've also established a global fully costed platform to manage resource investments. We believe we can use this platform to launch new resource investment products both institutional and ETF in global markets. One of our priorities is rebuilding our performance fee opportunities. As the capital and lending LP is deployed, it will convert into more than $650 million in performance fee eligible AUM. In raising that first PE-style fund, we established some very important relationships with globally recognizable institutions and endowments. And we intend to build on those through new PE and yield-style funds that are currently in our pipeline. Crypto currencies have been the story or one of the stories of the year in 2017. While we've been vocal that we are skeptical about bitcoin's long-term investment value, particularly as it compares to gold, we are bullish on the potential for block chain technology as it relates to gold. The digitization of gold is on the horizon, and we're seeking to capitalize on it through our investment in Trades markets. That company is advancing its business plan and expects to launch its digital gold token through third-party dealers and banks and/or an ICO initial coin offering in the near future. We're committed to using our brand recognition to increase the scope of our business and working to establish new global distribution arrangements for our products. These will be both internal and external. And that completes our remarks for today's call. We'll now open the line for questions. Operator?

[Operator Instructions]. And our first question comes from Gary Ho of Desjardins Capital.

Just first question. Can you give us an update on the progress on capital deployment for your Private Resource Lending LP? And how quickly can you deploy that over the next 6 to 12 months? And then is there demand for a fund 2 further down the road in kind of a year or 2's time?

Okay. Well, the deployment and the deal flow in the Lending LP has gone better than we've expected it to. Part of the -- I think, the difference is that we had been so busy on capital raising last year that our professionals were time consumed in that activity. So when we first started the process, we thought we could deploy about $100 million per quarter, and the deal flow that we're seeing is roughly double that. We've given specific numbers there, but I anticipate that the fund will be deployed quicker than we thought, sometime next year. And yes, we've got to start thinking, if we keep seeing the same amount of deal flow, about what we do as a follow on.

And is there any requirement? Do you guys need to be like 75% deployed to start fund 2 or something like that?

That's right. But there's also other related strategies that are different than pure lending that we're exploring.

Okay. That's helpful. And then just on -- you mentioned the crypto currency and the Tradewind markets participation. Can you elaborate further and also remind us how much you own in that investment?

Okay. Well, there are a number of products that have been talked about in the gold area that are starting to put physical gold onto a block chain ledger. And I won't list them by name, but there are other very credible groups that are advancing with that type of product. We, in particular, think that we have the most robust highest value added, the most technologically advanced product that's ready for the market. We're in partnership and really the lead on -- the project is IEX exchange with their world-leading exchange technology. So this is not just a block chain token but it is a token that can be traded on, and will be traded, on exchange. So full transparency. We think it's quite a bit more secure than bitcoin for several reasons, both because of the network and the way our particular network works, and because the fact that it's fully translatable to physical gold. So inside or outside of the financial system as opposed to a market that is a year or 2 old that has a $150 billion outstanding. It's a market that's 2,000-year old and that has $6 trillion outstanding and that trade $70 billion a day. So I like the chances of Tradewinds. And in terms of timing, they're completing initial agreements now with the providers that will offer the coins. Our stake as a Sprott Group is in the range of 20%, and that may change going forward because Tradewinds itself is being approached by strategic investors and we're looking to make the launch as big and as profitable as we can.

And do you guys have any ability to increase that stake?

Well, that's up to Tradewinds and the Tradewinds board, so it depends on a number of things.

Okay. And then just very lastly, on the NCIB, just curious to hear how aggressive you will be with the buybacks.

So a lot of people talk to us about the buyback, and we have bought some shares back. And now, we're in a position to buy more. Things change quickly. Six months ago, we had $300 million in cash and not a lot of uses for that cash that we found attractive. Since then, we've committed to CFCL and to Ceres. And we've had a lot of institutional inquiries in terms of opening new accounts, and they usually like to see alignment capital. So we compare everything against the weighted average cost to capital, and we deploy our capital to the highest and best uses of that capital. We think our shares are cheap on an earnings multiple, EBITDA multiple basis. We were kind of trading at knockdown levels from where we think we could be if the resource market starts to improve. However, a lot of the projects that we see are equally lucrative in terms of earning a great return for our shareholders. So we just have to balance it. What trading price are the shares trading at, what's the project need, and we'll do that to optimize the return experience of the shareholders. So no commitments. We'll react to the market as we see the capital getting deployed. I would note that we anticipate having better and bigger access and -- on a very efficient basis to bank capital, if we need it. And we may also put that in as part of a mix.

And our next question comes from Geoff Kwan of RBC Capital Markets.

My first question was -- in your presentation, you talked about some new PE-style fund as well as striking new global marketing distribution agreements. Is it too early to kind of talk about what sorts of thing would be of interest to you? Is it certain geographies, is it certain products? Just any color would be helpful.

Sure. So just a couple of general comments. Again, don't take these as guidance or promises in terms of what we're doing, but we've been working for a long time in the Asian market. We've been doing more work recently in the European market, and we're looking at UCITS, we're looking at the demand that sits with U.K. and European institutions for some of the private resource strategies that we run. And of course, we're looking at the U.S. Most of our business is in the U.S. now. We are, in fact, more a U.S. company than we are a Canadian from the perspective of revenue, with respective of clients and, quite frankly, from the perspective of brand and positioning. So I think that where we've made some headway with U.S. distribution with our relationship with ALPS, and with the distribution of those first 2 ETFs, we think we can do better. And John and his team are looking at various different strategies to straight relationships to make it easier for us to access market. And then finally, and not to be left behind, we had a very good experience hiring top-notch professional internal salespeople. We've got one person in New York. We've got now a new marketing manager in New York. We've got one person in London. And we're about to hire again in the U.S., and find that one solid sales person with a lot of institutional leads can bring literally hundreds of millions of business. So we're going to keep doing that because that's been very successful for us.

And that leads actually into my second question on the sales force side. Are the types of people that you're looking for -- I mean, it's presumably a very specialized kind of skill set, how easy it is to find these types of people. And then, again, are there certain geographies, products that you're looking for, and can these people leverage kind of the suite of products? Or do you have to kind of hire more by kind of by product line?

Well, they break down into two categories, one, I call the more cap intro institutional people that are focused on raising money for private dedicated funds; and then there's the institutional people that are more focused on liquid products that go through the distribution networks. The skill sets tend to be broken down between those 2 areas. And I would say, it's a very sophisticated business and it's -- there's hundreds of billions of dollars that get raised through both channels. So I don't think there's any issue having expertise or access to relationships in -- or global geographies. You can hire what you need as you go along.

And our next question comes from Graham Ryding of TD Securities.

Can I just get a little bit of color on the Merchant Bank activity in the quarter?

Okay. Maybe I'll turn it over to Kevin, just in terms of what information we can release in terms of the numbers.

Sure, I'll talk to the numbers, to Peter's point. And then if there's anything beyond that, we'll see what we can provide for you. But basically, on the merchant banking side, the growth commission activity was up slightly year-over-year, as you may have seen in our segment results. But on a net basis, it was actually down. And that was mainly because the volumes of, I guess, the higher margin activity that we saw this time last year pulled back as we look to exit the SPW, AUA business, our assets undermine business. There were some private placement activity that we were doing in the past in that type of business where we didn't have the same investment banking specialty, suite of individuals driving that revenue. And so the margins were, quite frankly, higher. This quarter, the majority of those gross commissions came from the new capital partners, individuals that are now with us. They will have obviously a claim on those gross commissions, which will be higher than what we would have seen in the past when we didn't have a sophisticated a business. So the activity was actually lower than what we saw in the first half of the year from the capital markets -- capital partners team. And so because it was lower, it's a little bit more visible, the tighter margin, that is -- are a little more visible now relative to what we saw last year. But I think this was a softer quarter. And I think that going into Q4, you're going to see a little bit more of a results stream, so to speak, that's more consistent with what we saw in this first half of the year.

Maybe I'll break it down for you on the basis of what they're actually doing. So they originate small mission specific private placement opportunities for our funds and for other clients that they have that are dedicated to that area. So they originate a lot of those. They also occasionally serve as an adviser to companies that are trading assets in those areas. And occasionally, they participate in syndicates where larger financings are taking place. As Kevin said, it's going to ebb and flow. And there's a transition of the business from the old SPW, which was more diversified into this more resource-focused team, quite frankly, immediately after the end of the quarter that the business kind of skyrocketed. So it's just impossible to talk about the timing because it just ebbs and flows from quarter to quarter.

Yes. And if anything, Graham, I'd say to that end, if anything, this quarter's numbers in the merchandising business are more the anomaly. I think what you saw in the first half of the year is more likely what you'll see in the fourth quarter, to Peter's point.

Okay, great. Jumping to the physical-backed gold token that you talked about. Do you see that as an advantage being able to access physical gold via this token as opposed to your ETF products, or is it just another distribution stream?

It's a completely different product. Our physical trusts, our capital property, the gold token is a physical commodity product. It's almost like a warehouse receipt. It's going to be issued in a very different way. It's going to be issued through all manner of distribution networks, ranging from Internet distribution shops to coin dealers, to banks, to investment dealers. So it's a very different product and the margins on that product will depend, both on an exchange training and on the premiums to NAV that are achieved as it's issued, not from storage or management fees. So it's a completely different ecosystem.

Okay, got it. And then just, Kevin, this quarter's compensation in SG&A, can we sort of use that as an indication of what a run rate might look like now that you've divested the mutual fund platform? And then I'm conscious that there are some ebbs and flows around merchant banking activity. But am I thinking about your expense base properly now with this quarter's results?

I think they's still going to be a little bit of noise there. We closed in, I think, August 1, we closed the transaction, so there's still about a month's worth of com sets in there. So I think there's a little bit more room on the compensation side to see some more savings. But there could be some offsets, as we alluded to earlier, with some of the new hires coming on board to help grow our asset base. And then on the SG&A side, I think there's going to be ebbs and flows. But generally speaking, I think that if you're looking at our numbers in the above 5 a quarter, going forward, I think that's a realistic number to have in your model.

And our next question comes from Nik Priebe of BMO Capital Markets.

Looks like there was a -- it was a bit of a solid quarter for deployment of committed capital in the lending LP. Just wondering what the weighted average interest rate that you're seeing on the deployed capital looks like. Is that yielding something in the range of 10% or so that you've seen historically on the proprietary lending book?

Yes. So all of the deals are publicly disclosed by the companies. The borrowers are public in almost every case. They disclose it a little bit differently because they don't include all the fees and set up fees all the time. But historically, we averaged about 17% to 20%, when it was all said and done. And that's broken down between cash yields and upsides participation through warrants or streams. The market in that sector has come down a little bit, I would expect, because we also have some bigger and better loans now that the average would be closer to 15% to 17%. So it's nowhere near 10%.

Okay, got it. So that's with the upside of the warrants and everything inclusive?

Yes, that's right.

Okay. And then on the balance sheet, I know there's about $15 million of lending assets, and I was wondering how much of that would represent the -- I guess, the legacy assets, the proprietary lending book versus some of the co-commitments that you made to the new private lending LP.

It was 100%. Right Kev?

Yes, would be 100%. If we are co-investing in a fund, the co-investment would not show up on the loan line because it wouldn't be considered a loan asset, it would be considered a proprietary item. So if you look -- what might help you, Nick, is if you look at note 3 of the financial statements, you'll see a line that say, mutual funds an alternative investment strategies. So that's where would will hold any co-investment in the lending funds would be on that line.

As we've been mentioning for about the last year, as the direct loan book falls, the increase to those prop investments through the commitment to the lending fund will go up by approximately the same amount of money. But it's not a perfect fit. We now have 2 remaining loans on our direct investment line, and both of -- well, one of -- both of them are slated for repayment sooner than later. And so that's going to fall off by next year sometime.

And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Mr. Grosskopf for any closing remarks.

Okay. Well, thank you, everybody, for joining us. And we remain available to answer any questions that you have directly. Have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.