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Edited Transcript of SCP.TO earnings conference call or presentation 12-May-15 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2015 Sprott Resource Corp Earnings Call

TORONTO Dec 7, 2017 (Thomson StreetEvents) -- Edited Transcript of Sprott Resource Corp earnings conference call or presentation Tuesday, May 12, 2015 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Steve Yuzpe

Sprott Resource Corp. - CEO

* Michael Staresinic

Sprott Resource Corp. - CFO

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Conference Call Participants

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* Anoop Prihar

GMP Securities - Analyst

* Carey MacRury

TD Securities - Analyst

* Arlindo Adawa

RBC Capital Markets - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Sprott Resource Corp's 2015 First Quarter Results Conference Call.

At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for your question.

(Operator Instructions)

As a reminder, this conference is being recorded today, Tuesday, May 12, 2015.

On behalf of the speakers that follow, listeners are cautioned that today's presentation and the responses to questions may contain forward-looking statement within the meaning of the Safe Harbor provision of the Canadian Provincial Securities Laws. Forward-looking statements involve risk 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 the 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 period in Sprott Resource Corp's annual information form and other filings with the Canadian Securities Regulations.

I'll now turn the conference over to Mr. Steve Yuzpe. Please go ahead.

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Steve Yuzpe, Sprott Resource Corp. - CEO [2]

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Thank you, Nicole. Good morning everyone and thank you for joining us today. With me is our CFO Michael Staresinic. Our 2015 Q1 results have been released and are available on CEDAR and on our website.

We're going to do things a little bit differently this quarter. I'll start on slide 4 with a quick introduction to the earnings call, and then I'll turn it over to Michael to walk you through our financial results. After that, we are going to spend some time addressing the key questions that have come up in our recent conversations with shareholders. We hope this will provide everyone with additional visibility into our process, strategy, and the objectives we need to achieve to create value for our shareholders.

But first, a look at the quarter. The sell-off in the energy sector and continued weakness in metallurgical and thermal coal prices weighed on both our net asset value and share price during the first quarter. Prices began to recover in the latter part of Q1 and into Q2 as sentiment towards the energy sector improved and key indicators, such as inventories, have begun to stabilize. This has started to have a positive impact on our net asset value and stock price.

We remain constructive on energy, and believe the long-term supply and demand fundamentals point to normalizing prices. However, we expect that any recovery in the energy sector is going to be gradual. Our current focus is on helping our current energy holdings to position themselves for the next steps [going] in the commodity cycle.

Our agriculture businesses continue to perform well. One Earth Farms, in particular, has made tremendous strides over the past year, and is now one of Canada's leading natural and organic meat producers with a growing shelf of high-quality brand of products.

We will talk more about the portfolio later in the call. But first, I will pass it over to Michael.

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Michael Staresinic, Sprott Resource Corp. - CFO [3]

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Thanks Steve.

I'll start on slide number 5 with a look at our net asset value. At March 31, 2015, we had total assets of $217 million compared with total assets of $242 million at the end of 2014. Total liabilities were $15 million including $12 million drawn on our credit facility with Sprott Inc.

Our net asset value as of March 31, 2015 was $202 million or $2.06 per share, down from $228 million or $2.33 per share at the end of last quarter. As Steve mentioned earlier, the majority of the decline was attributable to the sell-off in energy and continued weakness in metallurgical and thermal coal prices.

Turning now to slide 6 for a look at the income statement. For the quarter ended March 31, 2015, we recorded a loss of $25.9 million or $0.27 per share. This compares to a loss of $137.9 million or $1.41 per share in the quarter ended December 31, 2014. I should note that once again, in this quarter, a sizeable portion of the loss was attributable to unrealized losses in our energy-related investments, together with the weakness from our coal exposure through Corsa Coal.

We recorded expenses totaling $1.9 million during the quarter compared to $3.2 million for the quarter ended December 31, 2014. In the last quarter of 2014, we also recorded a deferred income tax expense of $4.6 million.

Turning now to slide 7. We have a strong liquidity profile with access to capital through our credit facility and/or through the monetization of liquid investments. At quarter end, our current cash balance was approximately $2 million, and we had drawn down on $12 million of our $20 million credit facility with Sprott Inc.

We currently have $1.7 million of unfunded commitments that will only be funded subject to milestones. At current asset levels, our expected burn rate is approximately $7 million to $8 million annually, with $1 million of annual offset in cash inflows from our royalty investments.

We currently have additional liquidity available to us through our public company portfolio, some positions of which are more liquid than others. As of March 31st, approximately $60 million of our public company portfolio was readily liquid, with a further $35 million providing some liquidity. Since quarter end, we have received net proceeds of approximately $2 million from the disposition of certain small, passive investments and expect to monetize an additional $1 million in the second quarter.

With that, I'll pass it back to Steve to talk more about our key priorities for 2015.

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Steve Yuzpe, Sprott Resource Corp. - CEO [4]

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Thanks, Michael.

On slide 8, you can see a list of our priorities for 2015. They are as follows.

First, improve liquidity through appropriate monetizations. As Michael mentioned earlier, we have already realized on $2 million of small, passive investments with another $1 million expected in the second quarter. We also continue to explore our options to monetize other investments that are appropriate candidates for [access].

One of those, as we had mentioned in the past calls, is Union Agriculture. We hope to provide further details on our progress with this investment in the coming quarters.

Two, reduce our discount to net asset value. We are committed to using the tools at our disposal to reduce the discount to NAV at which we currently trade. We believe that by improving our liquidity, generating positive news flow, and buying back shares when we are not prohibited by regulatory blackouts, we will be able to meaningfully reduce the discount.

Three, reposition the portfolio companies for recovery in the resource sector. In our role as a private equity sponsor, it is important that we provide our portfolio companies with the support they need to be successful. This was particularly true during tough resource markets.

There are times when improvements can be made to put us in a good position for a favorable exit during the next upswing. However, we are committed to preserving the capital we have on-hand, and maximizing the return on any new dollar we invest. I will get into this in more detail on the next slide.

But in summary, this means that we will continue to be supportive of our investee companies. But we will also maintain our discipline, and we will not hesitate to make tough decisions to create value for our shareholders. We will only provide additional financing to existing portfolio companies where appropriate.

Finally, number four, secure new capital to deploy into out-of-favor commodity sectors. In order to grow the business and position ourselves for future success, it is essential that we secure new capital to deploy opportunistically.

There are currently a number of commodity sectors that offer very compelling valuations, and we are working diligently to secure new capital to take advantage of these opportunities. However, we are mindful of our cost of capital and the potential dilutive impact of issuing shares at the current price that that would have on our shareholders. Rest assured, we will be selective in determining our sources of additional capital.

Looking now at slide 9, we view all capital allocation decisions in the context of the best return we can achieve through buying back stock, supporting existing investments, or making new investments. That said, excluding operating expenses which we manage very prudently, our current intent is to allocate both current and new capital in the following order of priority.

First, when we are not prohibited by regulatory blackout, we will buy back shares for cancellation when they are trading at an appropriate discount. One of the continuing challenges we face is that we are frequently blacked out or prohibited from purchasing back Sprott Resource Corp. shares.

These blackouts can be the result of our regular quarterly reporting cycles, pending developments at SRC, or pending developments at one of our portfolio companies. We are often asked between our regular quarterly investor calls if we are in a blackout. Unfortunately, this is not something we are able to disclose, as the near indication that we are in a blackout is prohibited by securities law.

In 2014, due to our high level of transactional activity, we were unable to be as active with our share buyback as we would have liked, because we were blacked out for more than nine months of the year. In the first quarter of 2015, there were only 11 days at the beginning of the year in which we were not blacked out. That said, when a short buying window opened up after the quarter end, we repurchased the maximum number of shares permissible for that period.

Second, as we discussed on the previous slide, we will support existing investments as appropriate. And finally, once we have increased our liquidity, either through a significant monetization or by greatly reducing our cost of capital, we will look to pay back debt and redeploy capital into accretive new investment opportunities.

Turning now to slide 10, the question we are most frequently asked by investors is, what are you doing to reduce the discount to net asset value? As of March 31, 2015 the discount to NAV was approximately 55% compared to 19% at the end of 2014.

I've covered most of the points on this slide already, but we think it's important to lay them out in isolation so everyone has a clear understanding on how Resource Corp. management intends to tackle this issue. We haven't yet covered the final point on this slide regarding how we value our private company holdings. We believe this is very important for investors to understand, so Michael is going to address it in more detail now.

Michael?

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Michael Staresinic, Sprott Resource Corp. - CFO [5]

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Thanks Steve.

As you all know, the public market provides a general consensus to fair value. This isn't necessarily the case for private companies. With our private company holdings, we take great care in our process of providing a reasonable representation of fair value.

I used the word reasonable purposely. The reason for this is that the private companies trade very infrequently, if at all. And because of this, a fluid market does not exist to observe the dynamics in which prices are set. In the absence of this liquidity, and hence price discovery, the available information about the private company at any point in time requires thoughtful analysis, interpretation and judgment. This embedded uncertainty flows into the determination of fair value which results in a range of fair value.

The process, in which we in management determine the range of fair value for our private company holdings, mimics to a large degree to the process and methodologies undertaken by the independent third-party valuators we engage from time to time. We engage independent third-party valuators to perform a fair value assessment of our private company holdings on at least an annual basis.

We select brand name valuation firms, like Deloitte, KPMG and Duff & Phelps, with their relevant industry expertise, and marry them up directly with the management teams of our investee companies. This unimpeded access provides for a pure exchange of information leading to an unbiased opinion of fair value.

At the conclusion of this process, our incumbent auditor, PwC, and their valuation group, reviews the conclusion of fair value reached by the independent third-party valuator. It is only after this step that we peg the fair value that is disclosed in the financial statements.

From the fair value range that is determined by the valuator, we select the mid-point of the fair value range concluded upon. If there is a major dislocation in a certain sector, such as the one we recently experienced in the energy markets, we would do an additional third-party review even if one had recently been completed.

Each quarter, we also undertake a determination of fair value for those private company holdings that are not reviewed by an independent third party firm. As I indicated earlier, our process of determining fair value mimics, to a large degree, the process and methodologies undertaken by the independent third-party valuators we engage from time to time.

Our analysts and associates work closely with our finance team to build financial models, supplemented by qualitative information, public market peer pricing, macroeconomic events, and various other inputs to derive a reasonable representation of fair value. The analysis is then reviewed by various members of management, including Steve and myself, before determining the fair value figure.

At the conclusion of this process, our incumbent auditor, PwC, and their valuation group, reviews the conclusion of fair value reached by management. It is only after this step that we peg the fair value that is disclosed in the financial statements.

I realized this was a lengthy monologue to absorb. But the takeaway from this should be that we take great care in the process for determining fair value of each of our private investments.

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Steve Yuzpe, Sprott Resource Corp. - CEO [6]

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Turning now to slide 12, I'd like to call your attention to the first pie chart. As you can see, 92% or $95 million of our market cap is in public companies. However, $110 million of our net asset value is in private companies. What this means is that at today's share price, the market is only assigning $8 million in value to our private holdings. On that basis, we believe there's a huge optionality in our share price as the market begins to better understand the value of businesses like InPlay Oil, Union Agriculture, and One Earth Farms. Also on the slide, you can see the breakdown of our portfolio by sector and listed versus unlisted holdings.

Another question that we are often asked is about Sprott Resource Corps' relationship with Sprott Inc. This is a natural question because Sprott Resource Corp. is a complicated structure, and this includes our relationship with Sprott Inc. Now, this relationship provides us with a unique number of benefits including deal flow, access to capital, access to technical expertise, and significant cost savings through shared services such as legal and marketing.

We understand that this relationship causes some to wonder about the potential for conflict. However, let me assure you management and the board of Sprott Resource Corp. are committed to the highest standards of transparency and ethical operation.

Sprott Resource Corp. has an independent board of directors with a dedicated Conflict Resolution Committee composed solely of independent directors with a mandate to review situations where the potential for conflict, real or perceived, may arise.

As an example, Sprott Resource Corp's line of credit with Sprott Inc. was entered into only after reviewing a broad range of market alternatives and with oversight provided by the Conflict Resolution Committee.

Yesterday, at our first quarter board meeting, our Conflict Resolution Committee finalized a new management services agreement between Sprott Resource Corp. and Sprott Inc. And a summary of the changes adopted are included in our Q1 MD&A. You can also find the full management services agreement posted on SEDAR this morning.

One point from the MSA that I would like to highlight is that we will now, retroactive to January 1st, 2015, be pushing a (inaudible) expenses up to Sprott Inc. Absorbing these expenses is consistent with the role of our private equity sponsor, and we're glad that Sprott has agreed to this new arrangement which is expected to save Sprott Resource Corp. approximately $500,000 in 2015.

Turning now to slide 14 which provides an overview of our investment portfolio. As you can see, the portfolio is made up of companies in various stages of development ranging from early stage to mature. As we have stated previously, we are now actively pursuing opportunities to monetize some of our more mature investments while working with the earlier stage companies and position them for future growth.

InPlay Oil, Delphi, and Corsa Coal are investments that we made last year and I'm very optimistic about each of these. We believe we have the right team in place to create value for the portfolio. This will involve harvesting gains in some cases while also having the discipline to cut our losses and walk away from an investment if circumstances were to warrant.

We are also confident that we have an investment process in place that positions us well to create further value through new investment opportunities.

In closing, while we expect the energy markets to be very volatile in the coming quarters, we believe the worst effects of the sell-off in the energy space have passed, and we're seeing the beginnings of a recovery in this sector. Our agricultural businesses continue to perform well.

We are focused on working with our portfolio companies to position them for the next upswing in the commodities cycle. And because this is important to stress once again, let me say that management is committed to improving liquidity, pursuing monetizations where appropriate, and reducing the discounts to NAV.

Finally, we are pleased that we are continuing to see strong deal flow with top tier management and projects. We realize that we need a significant monetization for our cost of capital to come down before pursuing new investments. However, we are encouraged by the quality of the opportunities being presented to us.

We will now turn the call back to Nicole and open it up for questions.

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions). One moment for our questions. Our first question comes from the line of Anoop Prihar of GMP Securities. Your line is now open.

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Anoop Prihar, GMP Securities - Analyst [2]

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Steve, can you just give a bit more detail about that $0.5 million expenses that [got] pushed up?

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Michael Staresinic, Sprott Resource Corp. - CFO [3]

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Hey, Anoop. It's Michael. Thanks for the question. That $0.5 million, some of it relates to -- and I'll give a big chunk of it, for example, is rent. There's a sizable portion there that Sprott Inc. is going to take on as the sponsor for the fund. And there's various other office type of expenses that was negotiated by the Conflict Resolution Committee with Sprott Inc. as to what they believe should be a sponsor expense.

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Anoop Prihar, GMP Securities - Analyst [4]

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Thank you.

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Operator [5]

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Thank you. (Operator Instructions). Our next question comes from the line of Carey MacRury of TD Securities. Your line is now open.

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Carey MacRury, TD Securities - Analyst [6]

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Hi. Good morning, guys.

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Steve Yuzpe, Sprott Resource Corp. - CEO [7]

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Good morning, Carey.

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Carey MacRury, TD Securities - Analyst [8]

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You spoke about the disconnect between the market value and some of the private, or the valuations in your private investments. Just wondering could you not provide more visibility into those investments in terms of like operating metrics so we get a better sense of how things are progressing in each of those private entities?

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Michael Staresinic, Sprott Resource Corp. - CFO [9]

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Thanks, Carey. It's Michael. Are you looking for more color in the actual report or just on how it's --

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Carey MacRury, TD Securities - Analyst [10]

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Well, I mean an example, a few years back, you reported under a different structure. So for example, One Earth Farm, I mean we had a sense of what the financials look like or crop acreage and cattle [held]. We just have a valuation metric. We don't really see how these assets are actually performing over time.

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Michael Staresinic, Sprott Resource Corp. - CFO [11]

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Okay.

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Carey MacRury, TD Securities - Analyst [12]

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Like production rates and various operating metrics.

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Michael Staresinic, Sprott Resource Corp. - CFO [13]

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Right. We don't give that transparency, I guess, during the financials or the MD&A. But I will focus on One Earth Farm just as an example on what was undertaken by the third party valuation of which we also took consistency in our internal valuation.

Just to point out, historically, when we consolidated One Earth Farms under the old reporting standard, it was confusing, it wasn't at fair value. There was historical cost blended in with that. I found it a very confusing presentation.

Where the approach has taken now is they take -- given its limited history on cash flow or earnings in the past, the valuator never took a forward-looking earnings approach or a discounted cash flow approach. What was taken was looking at their balance sheet at a point in time and taking any assets that were not reflected at fair value and marking them the fair value.

And as you understand and we understand, that's how One Earth Farms has developed into more of a cattle and the crops division has been closed down. The biggest pricing of fair value is really on the herd itself. The cattle herd.

And so that's the biggest fair value adjustment that the valuators spent time on in understanding the dynamics of the cattle pricing in the market, and how does organic and antibiotic-free and grass-fed cattle that doesn't necessarily have a perfect match in typical cattle pricing how to provide a fair value specimen on those very unique assets.

So that's where we see the effort being involved in marking to market on One Earth Farms, as an example. I'm not sure if that provides the color that you're looking for. But if there's something else that you want to kind of tackle, I'm happy to take this on in a question if you're looking for more visibility on something that you're curious about.

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Carey MacRury, TD Securities - Analyst [14]

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I guess it's more just directionally quarter-to-quarter to see what sort of metrics, what sort of progresses you made in some of these entities because -- when we just get a valuation, it's hard to see has any changed, what's changed.

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Michael Staresinic, Sprott Resource Corp. - CFO [15]

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Okay. Interesting. We will look at those metrics on a go-forward basis and I'll try to certainly augment the disclosure for you.

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Carey MacRury, TD Securities - Analyst [16]

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Okay. Thank you.

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Michael Staresinic, Sprott Resource Corp. - CFO [17]

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No problem.

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Carey MacRury, TD Securities - Analyst [18]

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And the second question, if I can, you talked a lot about the share buyback and I know you spent a lot in the past on share buybacks. But is there some merit in maintaining a stronger balance sheet in order to take advantage of times like these?

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Steve Yuzpe, Sprott Resource Corp. - CEO [19]

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Carey, I think there's a balance. Right now, we're trading at such a large discount. It's appropriate for us to be using capital for buyback stock when we're not in a regulatory blackout.

So we look at our cost of capital, we look at the potential uses of capital being buyback stocks, support existing investments or making new investments. And we're making a call at what the best use of capital to create value for our shareholders is. And it's hard to argue against buying back stock when our discount's 50%, 55%.

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Carey MacRury, TD Securities - Analyst [20]

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Thank you.

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Operator [21]

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Thank you. (Operator Instructions). Our next question comes from the line of [Arlindo Adawa] of RBC Capital Markets. Your line is now open.

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Arlindo Adawa, RBC Capital Markets - Analyst [22]

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Good morning. Thanks. So my question is just on in terms of pipeline and deal flow. I think somewhere in the release you've mentioned you reviewed 45 transactions in Q1. Can you just give us some context in terms of the types of deals you're seeing public versus private, maybe by sector and just how quality compares year-over-year?

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Steve Yuzpe, Sprott Resource Corp. - CEO [23]

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Sure. Thank you. Good morning. Nice to speak with you. In terms of the split, so first of all, the 45 is the number of, I'll say, the qualified deals that we look at. There're certainly more deals than that that come in that get deleted right away because they clearly are not a fit with what we do. And that can be determined within 15 or 30 minutes.

But of the 45, more were private than public. They were predominantly earlier stage businesses. A few of them were management teams looking for backing. The sectors were predominantly energy and mining.

And I have to say that the quality of deals got better through the end of the quarter and actually into the second quarter. I can't tell you exactly why. I'm [sure] in the energy sectors that the weaker deals are clearly not going to get funded in a $40 to $50 price environment.

But the good deals can get funded in a $50 to $60 dollar oil price environment. So the quality of deals that have come to us is improving. And I'd say that they're relatively earlier stage.

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Arlindo Adawa, RBC Capital Markets - Analyst [24]

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Okay. Maybe just a follow-on, Steve, what do you think the sweet spot would be in terms of deploying capital as you go forward in your liquidity situation, changes potentially with UAG?

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Steve Yuzpe, Sprott Resource Corp. - CEO [25]

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Sure. Do you mean in terms of size of investment, or sector, or stage?

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Arlindo Adawa, RBC Capital Markets - Analyst [26]

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Probably more size for new investments. I understand the framework you've outlined in terms of NCIB supporting existing -- I'm sort of focused on the last category, right, in terms of new deployments. What would the ideal size be, I guess, for new investments?

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Steve Yuzpe, Sprott Resource Corp. - CEO [27]

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Sure. So it's certainly a function of the size of the monetization and the amount of liquidity we had. So we would want to keep capital on our balance sheet to participate in the buyback and sort of defend the stock that way. But I think we'd be looking at capital permitting something in the neighborhood of 10% of our NAV, which is today's value would be $20 million.

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Arlindo Adawa, RBC Capital Markets - Analyst [28]

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Okay. Okay. That's great. And then just a last question. On the NCIB, are there any restrictions or limitations on the use of the credit facility and funding buybacks? But, yes, I guess do you have to wait until you get proceeds from monetizations, or can you be a bit more creative and use a credit line as well?

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Steve Yuzpe, Sprott Resource Corp. - CEO [29]

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There are no restrictions on the use of the credit line at all.

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Arlindo Adawa, RBC Capital Markets - Analyst [30]

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Okay. Okay, that's it for me. Thanks.

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Steve Yuzpe, Sprott Resource Corp. - CEO [31]

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Thank you.

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Operator [32]

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Thank you. (Operator Instructions). One moment for questions.

And I'm showing no further questions at this time. I'd like to hand the call back over to Steve Yuzpe for any closing remarks.

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Steve Yuzpe, Sprott Resource Corp. - CEO [33]

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Thank you, everyone, for participating in this call today. We appreciate your interest in Sprott Resource Corp. and look forward to speaking with you again after our Q2 results. Thank you.

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Operator [34]

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Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone.