Sprott Inc

TSX:SII

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Sprott Inc's. 2018 Third Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, November 12, 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 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 would now like to introduce to your host for today's conference, Peter Grosskopf, CEO of Sprott. You may begin.

[Peter F. Grosskopf, CEO & Director]

Good morning, everyone, and thanks for joining us today. On the call with me today is our CFO, Kevin Hibbert; and John Ciampaglia, CEO of Sprott Asset Management; as well as Glen Williams, our Head of Investor Relations.Our 2018 third quarter results were released this morning and are available on our website. You can also find our financial statements and MD&A.I'll start on Slide 4 with a quick look at our results for the quarter. Our business model was proven resilient this quarter as we delivered steady financial results despite the pullback in precious metals. Our adjusted base EBITDA for the period was a $9.7 million, up more than 20% on an adjusted basis from the same quarter last year. This is in line with the approximately $10 million per quarter we've generated through the first 9 months of 2018. Our AUM fell to $10.1 billion due largely to the weakness in gold and silver prices as well as redemptions from our physical trusts. These redemptions were expected following the acquisition of CFCL and are still tracking well within our estimates. On a year-to-date basis, our AUM is up by $2.7 billion post-CFCL transaction.Turning now to Slide 5. Q3 was a very tough quarter for junior miners, and gold equities are now down approximately 20% on the year. This sector weakness has been exacerbated by 2 factors: the temporary selling pressure from some large funds that were either repositioned or exited the sector entirely and the ongoing overall lack of generalist interest in the space. It's not all doom and gloom though because as competitors have left the playing field, it has created, first, exceptional divergence from value and great buying opportunities for Sprott; and second, left us as one of the last sector specialists focused on buying opportunities in the miners. We view this as a chance to increase our market share and grow our client base through making all efforts to attract new client capital and be positioned for a return to favor of the sector. Our strong balance sheet and financial strength will also allow us to explore tuck-in acquisitions to add scale in some of our key business lines.I'll now turn it over to Kevin for a closer look at our financial results.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Thanks, Peter, and good morning, everyone. I'll start on Slide 6 with a look at our earnings summary. Similar to last quarter, given that 2017 was a year of significant transition and change for our company, I will be separately highlighting the results of our core go-forward businesses to ensure you have a more meaningful analysis of our year-over-year comparative results.Adjusted base EBITDA, despite a very challenging third quarter, came in at $9.7 million, up $1.7 million or 21% from the prior period. On a normalized basis, that is excluding earnings generated from our noncore assets that were sold last year, adjusted base EBITDA was up $3.7 million or 61%. The increase in the quarter was primarily due to increased fee generation on the CFCL assets acquired earlier this year, increased management fees and co-investment income from our lending LPs as we grow AUM in that area through ongoing capital calls from our institutional investor base in these funds, and acceleration of deferred interest income on the early settlement of a loan in the quarter. EBITDA was also positively impacted by lower SG&A as a result of last year's sale transaction as well as ongoing cost containment initiatives this year. These increased revenues and lower SG&A expenses more than offset higher compensation that was entirely the result of last year's reversal of $1.1 million of cash compensation and $2.2 million of equity grant forfeitures pertaining to employees impacted by the sales transaction last year. For more information on our earnings, you can refer to Slides 15 and 16 of this presentation or our MD&A filed earlier this morning.Moving on to Slide 7. You'll see a summary of our AUM. And for greater detail into our individual AUM components, you can refer to Slide 14 of this presentation or our MD&A, again, filed earlier this morning. As at September 30, AUM was $10.1 billion, down 10% from Q2 of this year. The decrease was primarily due to lower precious metal prices in our physical trusts as well as redemptions in our recently acquired CFCL assets. As at September 30, 11% of our acquired CFCL assets have redeemed. However, that is a well below our estimated redemption experience when we first began our review of this acquisition target. We were also negatively impacted by poor market performance and ongoing redemptions of our sub-advised fund products. This more than offset the increased AUM from higher capital call activity in our lending LPs.Finally, a look at Slide 8 for our investable capital. We continue to put our capital to EBITDA accretive use, most notably with the acquisition of CFCL earlier this year. However, going forward, our capital will be used increasingly to invest alongside our institutional lending fund clients given the anticipated growth in capital calls beginning in the fourth quarter of this year and into the first half of 2019.That said, I'll pass it back to Peter for some final thoughts.

[Peter F. Grosskopf, CEO & Director]

Thanks, Kevin. As we all know, scale is important in the asset management business, and we believe our physical trust business unit is at scale and has the potential for further growth in the right market conditions. Our private lending LPs are delivering good results, and we expect this business to grow significantly over the next year. Ultimately, we think that our lending and related resource debt business has the capacity for about $2 billion to $2.5 billion in AUM. Some of the other growth areas that we are looking at include complementary credit strategies where we have specific expertise as well as new PE-style LPs for which we've received investor interest. Our flow-through business also has been steadily growing, and we recently added some new talent to help Jason Mayer in attracting assets to those strategies.On Slide 10, we are believers that digitization will become the next major innovation in the gold markets, and we are committed to being at the forefront of this area. Over the past couple of years, we've invested in 2 fintech ventures at the forefront of making digital gold a reality. Today, we announced the third initiative in the area with the launch of OneGold. OneGold is the first of its kind digital precious metals marketplace that Sprott has launched with APMEX, North America's largest online coin and bullion dealer. The first products offered by OneGold are VaultChain Gold and VaultChain Silver, both of which are powered by Tradewind's blockchain technology.Flipping to Slide 11. The goal of OneGold is to combine the key benefits of precious metals with those of blockchain-based digital assets. Digital gold provides the same benefits that physical gold offers, but it also offers the security, ease and efficiency of transacting that comes with blockchain technology. Unlike bitcoin and other cryptocurrencies, all OneGold products are backed by physical metal. We are enthusiastic about the OneGold platform and encourage you all to visit it at the URL which is posted on our press release.That concludes our formal remarks for today's call. We'll now open the call to field some questions. Operator?

[Operator]

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

[Gary Ho, Analyst]

Just a first question just on your comments in your MD&A that capital deployment should accelerate in Q4 and early 2019 with respect to the lending fund. Should we expect the remaining undeployed amount substantially deployed by the end of Q1? Is that how we should read into that? And perhaps what have you seen so far in Q4?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

So -- Gary, it's Kevin here. So I would say, no, you wouldn't want to expect the entire $340 million -- the $340 million, you're referring to, right?

[Gary Ho, Analyst]

Yes.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Yes. So I wouldn't expect all of that to be deployed this year or even into next year. There's -- obviously, with these types of PE-style funds, there's always a portion that we will hold back to support loans as needed. So I would say, if anything, expect a substantial amount of that going into probably by the second quarter of next year. So at least half is probably a fair estimate for you.

[Gary Ho, Analyst]

Yes, and any updates for -- so far in Q4, Kevin?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Nothing to really report at this time. I think we're progressing as planned. So we are pretty confident that in the fourth quarter, we'll see some good deployments and again going into the first half of next year but nothing specific that I can give you at this time, Gary.

[Gary Ho, Analyst]

Yes. And then maybe related to that, Fund II, have you guys started talking to clients about that or started marketing that yet?

[Peter F. Grosskopf, CEO & Director]

Yes. The process for Fund II is well underway. We've received indications that we will be fully subscribed, and we've planned a closing schedule over the next quarter or 2. So I anticipate that by the end of the first quarter, we'll be fully raised and kind of continuing to build the overall business as expected.

[Gary Ho, Analyst]

And that should be larger than Fund I, right, in terms of size?

[Peter F. Grosskopf, CEO & Director]

Correct.

[Gary Ho, Analyst]

Okay. And then just as my last question, on the CFCL redemptions, I think you've highlighted in the past that we should see some elevated redemptions in the kind of near term. So are we behind that now? And should we see anymore kind of big redemptions out of that fund?

[John Ciampaglia, Senior Managing Director]

Gary, it's John here. No, we don't believe so. We did have a big redemption in the month of September. We think that flushed a lot of the shares out from the original transaction. In October -- the month of October, we had aggregate redemptions of about $7 million. So we view that as a positive sign in terms of working some of that overhang through the system. Generally, the precious metals ETFs around the world were under redemption pressure in the third quarter. Obviously, they traded very much off price action and sentiment in the sector. We think generally that in those down periods, we tend to gain market share because we don't lose as many assets from redemptions as some of the big funds like GLD, which are the primary providers of liquidity in those down markets. We generally gain market share. So that's one of the silver linings in those periods. And so we would expect a lot of these redemptions to be behind us.

[Operator]

Our next question is from Geoff Kwan from RBC Capital Markets.

[Geoffrey Kwan, Analyst]

Just a question thinking about performance fees. When I take a look at your AUM, what would be the areas where you see that there's reasonable, at least as it stands today, visibility on the performance fees, for example the fixed-term limited partnerships that you have on the global side? But then also, two, is the lending business, it sounds like you probably have a pretty good shot as the fund matures to get the performance fees there but also, again, comment on stuff like the managed companies and the SMAs and things like that.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Sure. Let me tackle that first, Geoff, and then I'll hand it over to Peter to add some additional color. So as far as visibility around performance and carry, I would say overall, the most likely P&L you should expect to see would be the carried interest. And the carried interest is going to come significantly going forward from the lending LPs, to your point, which is about $0.5 billion of our total AUM. I can say right now it's the first lending fund that has about a time horizon of around 7 years or so. And so over time, just looking at where our numbers are right now, things are looking very, very positive from a carried interest perspective. Forgive me that I have to be a little cryptic on that front, but the numbers are looking very, very good at this time. When it comes to the fixed-term LPs, that's where we used to have the carry several years ago. I think right now, just given the vintage of these funds and the -- relative to their hurdles and where the markets have been over the past few years, I would not expect anything significant at all coming from the exploration LP. So again, primarily, the lending funds is where the carry will come. And if there is any performance fees elsewhere, you could expect to see those in the flow-through space but nowhere near the size of what we'd see in the lending funds. I don't know, Peter, if you have anything to add to that or...

[Peter F. Grosskopf, CEO & Director]

Well, a lot of the high watermarks for the PE funds are a ways off. So we'll see that coming more so when we initiate new funds, new vintages, which we do plan on doing. The flow-through funds as well can kick in and, just depending on the year, are usually quite close to their high watermarks. So that's a business that I would expect can generate some reasonable numbers on performance fees going forward.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

And one last thing I'll throw at you, Geoff, if it helps is although there's no performance in the exchange-listed products, obviously, they're very, very tightly correlated to the price of gold. So as gold prices recover or even get a bit of a tailwind behind them, you could see a fairly substantial increase in our EBITDA just given how high the earnings margins are in that business, which are well north of 70-plus percent.

[Geoffrey Kwan, Analyst]

Got it. That's helpful. And can you just remind me on the lending fund? The carried interest, would you receive that link kind of right at the end? Or if you kind of have closer to that date where it becomes quite clear you're going to make it and there's the low risk of some sort of clawback, are you able to recognize that earlier? Or would you just wait until the end?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Right, great question. So under the current accounting rules, we would have to wait until the expiry of the clawback period, which would be at the end of life of the fund. However, also to your point, Geoff, as we get more visibility into the numbers and as we get a little bit closer to those funds winding down, at that stage, we'd be in a situation where we'd be permitted to at least provide some disclosure around what the number looks like, but it would take different forms. It'd be on sort of some terminal basis where we're estimating how much we would generate in theory if the entire fund were to have collapsed and paid out at that point in time, which would be a number that would be materially below what we know we would actually generate due to the end of the life of the fund. So some technical accounting stuff there but suffice it to say that as we progress, to your point, we will be able to provide at least some color on some basis that the accounting rules and the regulators would be comfortable with, but again, the actual monetization of the carry would come at the end of the life of the fund once the clawback fully expires.

[Geoffrey Kwan, Analyst]

Got it. That's helpful. Just the other question I had was on the interest income. I think you mentioned there was an amount that was recognized that was accelerated in Q3. What do -- what was the amount on that?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Yes. So I can't recall the exact number. I'll take a look and I'll circle back to you after the call. But the one thing I would just note there is the repayments on loans are obviously a natural and expected part of our business. And so in the lending space, we've always had loans repaying by extension. We'd have the acceleration of the interest income. So we've had that pretty much in most quarters. I think we also had it last quarter, too. So I'll get that for you and I'll slip it to you when the call's done.

[Geoffrey Kwan, Analyst]

Okay, sure, yes. And I mean, I recognize that always happens. I just -- it kind of sounded like maybe it was a little bit more meaningful this quarter than prior quarters.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

No, it wasn't.

[Operator]

Our next question is from Graham Ryding from Sprott (sic) [ TD Securities ].

[Graham Ryding, Research Analyst of Financial Services]

Just the commissions were down a little bit versus last couple of quarters. Is that just merchant banking activity was softer this quarter?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Graham, Kevin here. Welcome to Sprott. So yes, you're right. It was a very, very tough quarter not only for precious metals prices but also just around mining finance in general. So you have that side of material impact on our placement activities and other equity origination activity both in our merchant bank in Canada as well as our broker-dealer down in the U.S.

[Graham Ryding, Research Analyst of Financial Services]

Okay, got it. And then I noticed compensation in SG&A, those were down a fair bit and really helped your EBITDA result this quarter. Any color on why the big drop relative to Q1 and Q2? And what's the sort of run rate expectation here?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Sure. So on the SG&A side, part of the drop is just the fact that in the third quarter last year, we had about a little over a month since the first part of the sale transaction closed in August. We had a little bit of -- about a month with expenses coming from that business, whereas now we don't have that. And we just continue to be very diligent overall with our cost containment program, which, I think, we launched back in -- maybe it was late 2015 or early 2016, Graham. I can't recall. But we continue to work hard there in that area. On the compensation expense side, I would say the drop is primarily due to the fact that we're down almost 100 people year-over-year. But on a go-forward basis, I would expect that the compensation expense should continue to decline especially if we move into next year, where, if you recall on the previous calls, I had mentioned that the stock-based compensation expense, a large chunk of it under the accounting rules of IFRS 2, hit our numbers in the first 2 years of the term, which is a 5-year term for the vesting of the stock. And so the final 3 years is going to be a much lower number than the first 2 years. So I'd say you're probably looking at a number that will be likely a little bit smaller than what you're seeing now but I'm not sure if it would necessarily be a run rate, but I would expect something around what you're seeing today and even potentially a little bit smaller.

[Graham Ryding, Research Analyst of Financial Services]

Right, okay, yes. I was more referring to like Q1 and Q2 this year, where the business is more similar to where it is now, and it was still pretty material.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Oh, okay, okay, I agree, yes. On the SG&A side, I would say we're probably a little lower than run rate. I think if you think about maybe $5 a quarter on the SG&A side, that would probably be more of a realistic go-forward number for your model.

[Graham Ryding, Research Analyst of Financial Services]

Yes, okay. That's helpful. And then just on the lending LPs and the funds, just to make sure I'm understanding things correctly. So you're looking at a second fund here. Is this -- is it a similar type of fund as your first one? It's just you're looking to sort of scale that original product. And then maybe can you kind of clarify what you're looking at when you talk about complementary credit or even these PE-style funds.

[Peter F. Grosskopf, CEO & Director]

Sure. The lending Fund II is a simple rollover, so no change in the strategy. And we've got a couple of different feeders coming into it, but really, it's just the bigger LP altogether. And then related to that business, we see the potential to add some different types of debt, for instance, some slightly more senior credit and some debt that actually participates along with the commodity price, so kind of different flavors of the same strategy.

[Graham Ryding, Research Analyst of Financial Services]

Okay, okay. That's helpful. But the first fund, the fund -- the Resource Lending LP that you've got now, that fund persists. You just -- the second fund is just sort of a second iteration of that strategy. Is that right?

[Peter F. Grosskopf, CEO & Director]

Yes, correct. The way the funds work is they have a certain investment period. And as that investment period draws to a close or you start hitting the capacity constraint of the strategy, you're into the raising of the next one. So there is some overlap of periods. And what you're trying to do is get a nice, smooth AUM build and book of business build over time irrespective of the total capacity in both funds.

[Graham Ryding, Research Analyst of Financial Services]

Got it. That's helpful. And then just my last question, just a follow-on on one of the previous questions. The carried interest from this first Resource Lending LP, when does that visibility start to come through? Like how many years out are we sort of thinking?

[Peter F. Grosskopf, CEO & Director]

Well, the visibility comes through now and starting to come through now. But Kevin, I'll pass it over to you for the actual accounting and the harvesting of the carried interest a bit later. You have to basically pay your cash back and recognize your cash gains as you're paying them to LPs before you actually take the fund -- the carry onto our books.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Yes.

[Graham Ryding, Research Analyst of Financial Services]

But will there be a point where you'll be able to actually quantify where your -- or an estimate of where you think this carried interest is sitting on?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Right. So everything Peter said is 100% correct. The visibility really starts as you begin to return the capital back to the institutional clients that are in the funds. And it's very difficult to get to the -- to a degree of visibility today in that respect because of a lot of that is -- if a loan is not repaid until the end of the life of the fund, it's very difficult to tell when it is that a loan may early repay such that you've essentially crystallized your carry. So what I can tell you is we have a good sense of where we think the carry is. It's a good number. But for reporting purposes, I just can't provide much right now because again, to Peter's point, the trigger for that visibility is once you start seeing these things repaying. The fund is obviously just started last year. We've got several years to go.

[Operator]

Our next question is a follow-up from Geoff Kwan from RBC Capital Markets.

[Geoffrey Kwan, Analyst]

You mentioned, I guess, the net redemptions in October on the CFCL assets, and you've talked about some increased interest although it may not have translated yet. Wondering if there's anything that you have in terms of commentary on AUM. Has it been up then this quarter given precious metal prices on AUM? And anything on net sales, performance ex CFCL assets?

[John Ciampaglia, Senior Managing Director]

Sure. It's John here again, Geoff. We definitely picked up some AUM from market appreciation in the month of October. As the U.S. equity markets have their little correction there, we definitely saw gold being a big beneficiary of that. It was up around 4%, I believe, in the months when most equity indices were down around 8% to 10%. So that definitely helped. Now surprisingly with -- the equity markets have been quite resilient the last 2 weeks and have clawed back a lot of those losses from October, and metals prices have done bit of a reversal. So we're generally flat from September 30 AUM levels. We don't have any sales. We don't have any redemptions that we know of for the month yet. And so we're kind of flat.

[Geoffrey Kwan, Analyst]

Okay, that's helpful. And just an additional question that I had on the lending fund. Are those loans that you're making, are you just kind of the sole lender to those companies? Or is it a part of a syndicate? And then also, are the loans the type where you would either solely or be a part of a syndicate that's -- maybe as part of a refinancing taken or prior financing or these, say, financing new projects with these companies?

[Peter F. Grosskopf, CEO & Director]

Well, we are almost always initiating and leading the credit facility or the loan. We do have syndicate partners. And we're not always on our own. Especially for the larger transactions, we would have syndicate partners. I'm not sure of the second part of your question. Just, I guess, it had to do with the type of loan whether it's refinancing or not. Usually, these are new loans that are being extended to companies that are either adding a second asset or bringing a resource asset into production. And it's late-stage money, and it's meant to be basically supporting companies as they transition into becoming a bigger producer.

[Operator]

And our next question is a follow-up from Nik Priebe from BMO Capital Markets.

[Nikolaus Priebe, Analyst]

I think most of my questions have been answered. I just had one on the next generation of the private lending LP. So as that continues to scale and you prepare for fundraising efforts for the next successor fund, have you given thought to what your ultimate co-invested capital piece could grow to? And maybe it's a bit premature to ask. I'm just trying to get a sense of how the balance sheet will evolve going forward.

[Peter F. Grosskopf, CEO & Director]

Yes -- and so we don't plan on changing our co-investment support for that fund. We were already very substantial seed investor and really like the risk/reward. And the fact that the loans pay enough yield to support our dividend and cash flow here at Sprott, I believe the total amounts committed to those funds are in the range of USD 70 million to USD 80 million, and we were not going to increase that. We've been pretty consistent about that actually for the last 4 years that we would be growing co-investment capital as opposed to our own. We would love to have a bigger balance sheet or the luxury of a bigger balance sheet, but we're really an asset manager at heart, not a private equity shop. So this is a good commitment, and it's an appropriate commitment and it will support a much larger fund in total.

[Operator]

At this time, I'm showing no further questions. I would like to turn the call back over to Peter Grosskopf, CEO of Sprott, for closing remarks.

[Peter F. Grosskopf, CEO & Director]

Okay. Well, thanks, everyone, for your continued interest and support. And we look forward to talking to you again at the next quarter. Thank you.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.