Sprott Inc. (SII) Q1 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sprott Inc. 2018 First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, May 11, 2018. 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 meaning of the safe harbor provisions of the Canadian provincial security 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 would now like to hand the conference over to Mr. Peter Grosskopf.

Good morning, everyone, and thanks for joining us today. We have a large cast with us this morning. On the call with me today is our CFO, Kevin Hibbert; John Ciampaglia, the CEO of Sprott Asset Management; and up from New York from – for our annual meeting is Whitney George, our Chief Investment Officer. Our 2018 first 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 4 with a recap of our progress so far in 2018. We completed the acquisition of the Central Fund at the beginning of Q1, and the impact of that acquisition began to be realized in our financial results for the quarter. As of March 31, 2018, our assets under management were $11.6 billion, which is the highest level ever. The platform we have built has been optimized for our new focus and is capable of supporting our goal of becoming the global leader in precious metal management and also a leader in related mining and natural resource strategies. Adjusted base EBITDA for the quarter was $10 million or $0.04 per share, reflecting an increase of 61% on a normalized basis from Q1 2017. We continue to deploy our balance sheet more fully through the acquisition and by allocating capital to seed new strategies and co-investments. More on that later. At the end of Q1, we had approximately $189 million in investable capital as well as a bank line with RBC that provides us with additional flexibility to make new investments. Turning now to Slide 5. We’re looking at some of the business unit highlights for the quarter. The integration of CFCL is going well, and redemptions related to that transaction are well within the line of our expectations. In the digital gold space, Tradewind recently launched VaultChain Gold, which is the first application of its technology platform designed to digitize and trade precious metals. In April, Tradewind also closed a $10.6 million financing that included investments from Agnico Eagle, IAMGOLD, Wheaton Precious Metals as well as Sprott and other financial investors. Our merchant banking business, Sprott Capital Partners, is continuing to grow and expanded its transactional team in order to cover the cannabis sector, which is an emerging sector in the Canadian market. On Slide 6, you can see the progress that we are making in deploying our Private Resource Lending LP. On a year-to-date basis, we’ve deployed $229 million, which now performs as fee-generating assets under management. In addition, we have signed commitments for another $161 million in loans that have not yet been funded. We are happy with our pipeline, and we expect this fund to be substantially deployed by year-end. Again, More on that later. With that, I’ll turn it over to Kevin for a closer look at our financial results. Kevin?

Thanks, Peter, and good morning, everyone. I’ll start on Slide 7 with a look at our earnings summary. As you know, 2017 was a year of significant transition and change for our company, which led to a fair bit of noise in our 2017 financial results. With this in mind, over the next four quarters, I will be separately highlighting the results of our core go-forward businesses to ensure you have a more meaningful analysis of our comparative results. Adjusted base EBITDA in the quarter was $10 million, as Peter mentioned earlier. That was down $5.9 million or 37% from the prior period. Excluding the impact of last year’s sale transaction, loan loss provision reversal and related catch-up interest, adjusted base EBITDA was actually up $3.8 million or 61%. The increase in earnings on a normalized basis from our core remaining businesses was due to higher net fees generated on the newly acquired CFCL assets. Looking at our revenue performance, details of which can be found on Slide 13, total net revenues for the quarter were $27.2 million, an increase of $300,000 or 1% from Q1 2017. Key revenue items worth noting include net fees, interest income and net commissions. Net fees for the quarter were $14.6 million, a decrease of $2.2 million or 13% from Q1 2017. Excluding net fees that were earned on the diversified assets sold as part of last year’s sale transaction, net fees generated by our remaining core businesses were actually up $4.8 million or 49% from this time last year. The increase on a normalized basis was due to management fee generation on the newly acquired CFCL assets. However, we also experienced increased fee generation from our lending LPs as we continue to deploy committed capital in this area. Interest income for the quarter was $2.7 million, a decrease of $3.1 million from Q1 2017. Excluding last year’s impact of catch-up interest recorded on a previously impaired loan, interest income was down only $500,000 as a result of the ongoing runoffs of our on-balance sheet loan book in substitution for fee-earning AUM in our lending LPs. Net commissions for the quarter were $5.2 million, up $200,000 or 4%, largely unchanged from the prior period. Total expenses, details of which can be found on Slide 14, were $16.4 million, a decrease of $500,000 or 3% from Q1 2017. Key expense items worth noting include compensation and SG&A. Compensation, excluding commissions and performance fee payouts, which are presented net of their related revenues in our MD&A and excluding severance accruals, which are nonrecurring, was $9.5 million, a decrease of $3 million or 24% from Q1 2017. The decrease was due to a combination of lower headcount and lower incentive accruals as a result of last year’s sale transaction. SG&A was $4.7 million, a decrease of $1.9 million or 29% from the prior period. This was largely due to lower marketing and sales, professional fees, technology and fund operating expenses, again, as a result of last year’s sale transaction. On Slide 8, you’ll see a summary of our AUM. And for a greater detail into our individual AUM components, you can refer to Slide 12. As of March 31, AUM was $11.6 billion, up $4.3 billion or 58% from December 31, 2017. The increase was due to the successful acquisition of CFCL, net of previously anticipated redemptions. We also benefited from improved precious metals prices in our Physical Trusts during the quarter. Finally, a look at Slide 9 for our investable capital. The CFCL transaction closed in January, and the $105 million of upfront cash required on closing was funded entirely through the balance sheet and has been immediately accretive to EBITDA since its on-boarding. Our remaining investable capital will continue to be deployed in a highly disciplined manner so as to ensure maximum shareholder benefit. I’ll now pass it back to Peter for some final thoughts.

Thanks, Kevin. During the past quarter, several of our direct competitors with a focus on precious metals either exited the business or adjusted their strategies to go more indexed. In contrast, we continue to believe that there’s never been a better time for precious metals investment, both due to bargains in the sector and due to the insurance value that our strategies have to the general markets. Thankfully, we’re seeing renewed interest from institutions and sophisticated investors who share our view and are actively seeking uncorrelated investments. Our assets under management continue to rise, and we’re building additional AUM through the ongoing deployment of our resource lending LPs. And we have the balance sheet strength to consider opportunistic acquisitions in areas where we can add complementary investment or distribution capability. We continue to believe that the digitization of gold will be the next significant event in the gold sector, and we’re pursuing additional investments in this area. In summary, we break these down into products where we believe three or four can be truly transformative and the distribution of digital metals, which will have more predictable profit margins, we intend to explore both. I’d now like to introduce our Chief Investment Officer, Whitney George, who many of you know and who is really the best person to outline our macro view and how we are positioned for it. I’d also note that Rick Rule just joined us in the room and is also available to answer questions after the call.

Thank you, Peter. I’m happy to be here. And I’m particularly happy, after being here three years, to see Sprott where it was that I dreamt it could be when I joined the firm, i.e., well-positioned to be absolutely the best-in-class resource company partner to invest in hard assets, especially on precious metals. In the first quarter, the pickup in market volatility, I think, has reawakened a lot of sophisticated investors to the need for diversity and alternative types of strategy. It’s – what we have discovered is this is really a three step process, particularly in the United States, which is potentially the largest market on the planet with the least amount of interest in this area and, therefore, the greatest opportunity. The step process is, first, education. I think with the help of Rick and Trey Reik and the addition of Heather Macleod from VanEck the last fall, we are producing some of the best content available so that investors at all levels can gain information to get them to the next step, which is physical ownership. And clearly, we have invested aggressively to enhance that franchise. And finally, the third step is an interest in equity participation. Along the way, we have built in growth with our lending franchise. And so I feel that we are very well-positioned. While we can’t control the markets, and gold continues to flip between $1,300 and $1,350, and the silver-gold ratio still hovers around $80, as high as it usually gets, what I do know is when it’s our time, we will be well-positioned to capitalize in a way that I don’t believe Sprott has ever been able to perform. The final two thoughts that I wanted to add are two initiatives, one is internal and one is external. You’ll see the bullets. There’s the One Sprott Initiative, which we began in earnest after the divestiture of Ninepoint last year, which is designed to collaborate across all of our different business units so that we can find synergies, not only in business opportunities, but also in intellectual capital, research and understanding of the field that we serve. And that’s already bearing fruits in terms of our internal improvement. And finally, the way we’d like people to think of us is as contrarian, certainly being committed to the precious metals space and doubling down on it when others are retreating, I think, is the first example of that; innovative, making sure that we understand where our investors and future investors are going to have interest in our domain; and finally, aligned. And sitting in the room with me are some – are the largest shareholder and a couple of the other top 10 shareholders, myself included. So I’m very excited about the way we’re positioned. And I know it’s a matter of when, not if, that we’re going to be rewarded for our patience. Thank you.

Thanks, Thanks, Whitney. So in summary, our goal for the year is to focus on execution and driving profitability in all of our business units. We continue to believe we’re on the right track. We look forward to keeping you updated on our progress. And with that, I’ll turn it back to the operator for questions. And really, you can ask any one of us. Thank you.

Thank you. [Operator Instructions] Our first question comes from the line of Graham Ryding of TD Securities. Your line is open.

Hi, good morning.

Hi, Graham.

Okay ,great. Maybe I could start with Tradewind. Can you just flesh out the business model here? Like, does the business earn money from trading digital gold on a blockchain platform? Is that – or is that just too simplistic?

The business model is to introduce assets in the form of physical gold to be digitized by their platform and then to earn dollars, both by – revenue streams both by the creation of that unit and by the trading of that unit. They also, I believe, earn very small fees for the exchange of that unit for other forms of gold. So it’s a very small fee coming in. It’s a very small trading fee, and it’s a very small fee going out.

Got it. Okay, that’s helpful. And what’s the competitive landscape like right now? It feels like it’s a very burgeoning space. Are there other digitally – digital gold platforms that Tradewind is going up against?

Well, it’s definitely a burgeoning area, and a lot of people have announced plans, including the LBMA and the Chicago Merc and other large organizations. So we do think it’s happening that the gold ledger, the vaults around the world will become digitized. Our opinion is that Tradewind is the most advanced through VaultChain. But obviously, you’re going to need to capitalize on that, and there are other high-quality efforts that will be hitting the market.

Okay. Jumping to the Resource Lending LP, $161 million of commitments. What would you expect as a reasonable cadence for that to fund over the next quarter and throughout the rest of the year?

Well, so I’ll go to the – the bigger number is $580million, which is the size of the fund. The way it will work is that you can only deploy a certain amount of that. By the time we get to 75% or 80%, we’re basically done, and we’re moving on to the next fund because there has to be some unutilized capacity for follow-ons. So we expect to be there by – at that 75% level by the third quarter and moving on to the next version of that fund.

Okay. So 75% of $500 million will be deployed by Q3 2015, and that’s relative to, I think, you’re at $250 million now, is that correct?

That’s right. And then we do expect that business to keep growing.

Just a minor update, Graham, so we’re at $220 million right now.

And that $580 million in the $number as well, correct?

Correct.

Okay, that’s helpful. And just the $30 million that was deployed this quarter was a little bit lower than what I thought based on the commentary last quarter. I was just trying to get a feel for that.

It’s a funny thing. Obviously, we have pipeline and then we have signed term sheets and then we actually have the drawdowns. So the drawdowns are a little bit harder to predict. We are focused on the signed term sheets and what we are committed to. In this particular quarter, there just happen to be fewer draws, and we can’t really control the pace of that. That depends on the actual building of the projects. So I think it works that – so that quarter looked a little smaller in terms of draw and then immediately afterwards, you get an avalanche of draws. So it’s a little bit less than steady.

Yes, basically, like a lag effect, Graham. If you look at the – what’s ultimately deployed that we would consider to be AUM, the next and most immediate dry powder that would be imminently deployed would be that committed but undeployed number that you see in Slide 6 of the deck. So that’s that extra $161 million that you see that Peter is referring to, that could be fully deployed by third quarter.

Got it. Okay, that makes sense. The average management fee rate based on your expectations for the different buckets in your portfolio, how are you expecting that to trend this year?

Graham, it’s John here. Well, with Central Fund coming on January 16, obviously, that’s going to have a huge impact on the weighted average fee of the overall assets under management. But I think what’s more important is the margin off of that business. While the fee may look low, in absolute terms, the margin on it is very, very high and sticky. So that’s the number we’re more anchored on, and we think it provides more value than the absolute fee.

Okay, that makes sense. My last question, if I could. The redemptions within your Physical Trusts this quarter, I think it was $122 million. Was that related to the CFCL fund and closing the deal? Or what was behind that $122 million number?

Sure. It’s John again, Graham. Yes, that was primarily closing the Central Fund acquisition. Obviously, a number of arbs play these kinds of transactions, and they had a few months to acquire shares. We did have the first redemption come in the month of February. We did have some other redemptions in the pipeline. But overall, I think the main message is that the discounts have tightened quite a bit on our funds. The redemptions are well within what we were anticipating. And we’ve also been able to offset some of those redemptions through our at-the-market issuance that we’ve been able to do periodically in the quarter. So all of those things are working to overall support the franchise. I think most importantly, the discounts we’ve seen tightened up quite a bit across all the funds that are reflecting higher interest in the category, and I think that’s one of the key barometers we look at.

And how are the gross sales in the quarter and net creations of those units in the quarter, I guess, maybe relative year-over-year, just given the market volatility? Any color there, please?

Sure. Let me just grab those numbers. Well, the net outflow was minus $122 million. Most of that was Central Fund. So I’ll come back to you with the exact numbers on what we’re able to do for the at-the-market. I have a year-to- date number, which creeps over the quarter. That was CAD 92 million for the Gold Trust and $17 million for the Silver Trust. So part of that was in April as well. But that’s all public information. We mark the sales each day as they came in. And for context, at the same point – sorry, in all of 2017, our Gold Trust only had $10 million of at- the-market sales, and we’re at $92 million so far this year. So I think that’s a really good barometer of the uptick we’re seeing in the category. On the silver side, we did $24 million in at-the-market sales in 2017, and we’re already at 17 – or sorry, excuse me, $24 million in 2017 and we’re at $2017 million year-to-date. So both of them are tracking well ahead of last year’s pace.

And you’ll see most of that happening in our Q2 results, as John points.

It’s quite important to note that our trusts offer a benefit to taxable investors in the U.S. and that they’re held as capital property if filed properly. As Whitney indicated, the process of education and connecting with those investors is under way. It’s – because we’re not as big as the GLD, we have a less retail-oriented – sorry, a less institutional-oriented customer base. We have a lot of retail investors. I think it’s, like, over 100,000. Retail has not really moved back into the gold trade yet. When it does, we expect that those trusts will have tremendous expansion opportunity because they have that taxable benefit, and they offer less counter-party risk through our storage arrangement with the Mint. So I think it’s going to be a very popular equation again. It’s just hard to see the flows when retail hasn’t really come back to the gold space yet.

Great, thank you for that.

And our next question comes from the line of Gary Ho of Desjardins Capital Markets. Your line is open.

Thanks. First question, Peter, you talked about complementary acquisitions and strategic partnerships in the press release. Can you remind me what those may look like and timing perhaps in terms of deploying some of your excess capital?

Well, as I mentioned, a bunch of our competitors have, in one way or another, left the active management business in our sector. I think the most important comment is, we are seeing a lot of top-quality professionals applying to Sprott to open new areas or complementary areas. That’s probably the biggest natural area of growth is just meeting these people and understanding whether they could be great partners of ours. The sector is getting fairly hollowed out. There are a number of profitable private equity-style firms, and there are a number of remaining boutiques in the sector that still service interesting client bases. So of course, we have to be looking at them. And sometimes, that represents a geography; sometimes, it represents a distribution network; sometimes, it represents a portfolio team. Interestingly, it’s not at all in Canada. And lastly, we would benefit from a relationship with a large distributor, so we always have to be on the lookout for those.

And when you guys look at M&A, is there a primary financial metric that you guys – or hurdle that you guys look at?

It’s not one metric alone. I mean, obviously, we have to look at how it fits with our company strategically and look at synergies. The way we base our own business is off of EBIT, so contribution to shareholders. And the way we would look at any deal is, from an accretion dilution perspective, is the amount of EBIT per share adjusted for leverage or risk that we’re taking on. So we’re looking at everything on the basis of delivering higher return to our shareholders.

Got it. That’s helpful. And then my – just my last question. John, just going back to the CFCL, any redemption potential that we should be aware of over the next couple of months?

It’s hard to predict because, as you know, individuals will make those decisions really at the last minute before the deadline for a monthly redemption notice has been put in. And so they will look for activities. Let me just be clear, each redeemer would absolutely prefer to sell their shares in the open market. Nobody really wants to do a physical redemption. There are costs associated with it. There is administration associated with it. And movement of precious metals is not always inexpensive, depending on the volume and where they’re stored. So what we find in talking to certain parties is they absolutely look for every opportunity to sell in the open market. And with the discounts tightening, we think the probability of them doing that improves. So I don’t have any concrete visibility of anything in the pipeline. It really comes down to how the funds are trading. Right now with our Gold Trust, for example, it’s trading just about at par at NAV. So there’s very little incentive to do a physical redemption. Our Silver Fund is trading at a very reasonable discount where it’s not advantageous for someone to take a physical redemption there. And Central Fund has tightened up from a low of a 4.5% discount. A few weeks after the transaction occurred, it’s tightened up to 2%. So everything’s moving in the right direction.

Got it, that’s all from me. Thank you.

Thank you. Our next question is from the line of Geoff Kwan of RBC Capital Markets. Your line is open.

Hi, good morning. Just wanted to follow up on the question on the private lending fund. So you had talked about the timing for Q3. Was that the end of Q3 or by the start of Q3, or is it somewhere in between?

I was quoting as somewhere in between, somewhat during the quarter.

Okay. And then when you talk about the 75% threshold that you look to go do another fund, I’m assuming that was based on the signed term sheet as opposed to the drawn amount/AUM.

Yes, that’s based on commitments.

Okay. And just the last question I had was, I know there was a little bit of a question on it before, but just, is there anything that you have that you can talk about in terms of any sort of new strategies or products, whether or not it may be something that be more broad-based distribution in terms of potential buyer or something you might be partnering with in an individual client or investor?

As the generalist here, Whitney George, the – I can say I have a keen interest in broadening our offerings, but it’s important to nail down what your core competency is first. You do a good job for your customers and it then opens up all sorts of opportunities. We have, and I have been working for three years actually seeding some absolute value investors myself, there are lots of other strategies that will become very interesting when the precious metal freight starts to work. And so we do have – I do have ambitions to continue to grow our business and attract talented people. But getting our own house in focus and order was the first order of business because if we ever were to diversify, it would not be far from hard assets or certainly absolute values, and it would be from a position of strength rather than running away from what we’re really good at.

And I would say that, with John and Rick Rule in the room, that we’re never short of ideas for new mining or precious metal or natural resource funds or strategies. It’s really easy to get a strategy to $25 million or $50 million. It’s quite a bit more difficult to get it to a scalable size where it matters to our firm. So we’re very, I guess, focused on sticking to projects that can be meaningful.

Okay, great. Thank you.

Thank you. And at this time, there are no further questions. I’d like to turn the conference back over to Mr. Peter Grosskopf for the closing remarks.

Okay. Well, thank you, everyone, for participating on this call. We appreciate your interest in Sprott. We look forward to speaking to you again after our Q2 results. Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everyone, have a great day.