Sculptor Capital Management Inc (SCU) 2016 Q4 法說會逐字稿

Good morning everyone, and welcome to Och-Ziff Capital Management Group's 2016 fourth-quarter and full-year earnings conference call. My name is Sally and I'll be your operator today.

(Operator Instructions)

I would now like to turn the call over to Tina Madon, Head of Investor Relations at Och-Ziff. Please proceed.

Thanks, Sally. Good morning everyone, and welcome to our call. Joining me are Dan Och, our Chairman and Chief Executive Officer, and Alesia Haas, our Chief Financial Officer. As a reminder, today's call may include forward-looking statements, many of which are inherently uncertain and outside of our control.

Before we get started, I need to remind you that Och-Ziff's actual results may differ, possibly materially, from those indicated in these forward-looking statements. Please refer to our most recent SEC filings for a description of the risk factors that could affect our financial results, our business and other matters related to these statements. The Company does not undertake to any obligation to publicly update any forward-looking statements.

During today's call we will be referring to economic income, distributable earnings, and other financial measures that are not prepared in accordance with US GAAP. Information about and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available in our earnings release, which is posted on our website. No statements made during this call should be construed as an offer to purchase shares of the Company or an interest in any Och-Ziff fund or any other entity.

Earlier this morning we reported fourth-quarter 2016 GAAP income of $2.9 million, or $0.02 per basic and diluted Class A share. The full-year GAAP loss was $130.8 million, or $0.72 loss per basic and $0.73 per diluted Class A share. As always, you can find a full review of our GAAP results in our press release which is available on our website.

On an economic income basis we reported 2016 fourth-quarter distributable earnings of $7.5 million, or $0.01 per adjusted Class A share. For the full year, distributable earnings were $191 million, or $0.37 per adjusted Class A share. This excludes the $412 million FCPA settlement and the adjusted income tax reversal taken in the third quarter related to TRA payments waived by our partners. Including the settlement and the TRA reversal, full-year distributable earnings were a loss of $121 million, or $0.23 per adjusted per Class A share. We declared a $0.01 dividend for the fourth quarter.

If you have any questions about the information provided in our press release or on our call the morning, please feel free to follow up with me. With that, let me now turn the call over to Dan.

Thanks Tina, and good morning everyone. We appreciate you joining us. Before we get started, I would like to take a moment to welcome our new CFO and partner Alesia Haas. We're very pleased to have her here at the Firm and on our call today. We have come through a challenging year. However I am pleased to say that we are performing well, we are all energized by our prospects, and we are investing in the Firm for long-term success.

Performance in the fourth quarter was broad-based, generating strong absolute returns across our major funds and strategies. In multi-strategy, the OZ Master Fund, our largest multi-strategy fund was up 2.7% net. In opportunistic credit, OZ CO, our largest credit fund was up 5.9% net, and our 2016 our real estate funds realized six investments for a gross IRR of 23.6%.

The performance in the OZ Master Fund in the quarter was strong and balanced across the board. Equities, credit and convertible and derivative arbitrage each contributed meaningfully to the performance of the Fund.

The US election in November was the seminal event of the fourth quarter. Coming into the election we had constantly attempted to minimize the portfolio's exposure to any outcome. Immediately following the election it was there to us that there was opportunity. We adjusted our sector position in equities, specifically in the US, by increasing our net long exposure in financials and energy and increasing our short bias in consumer staples and utilities. These top-down changes were primarily implemented by adjusting the size of existing high conviction positions. These changes, along with other position-specific catalysts and realizations across credit and convertible and derivative arbitrage, contributed to strong performance during the quarter.

Our success in credit continued across our corporate and structured credit strategies. As I just mentioned, OZ CO had a strong fourth quarter, ending the year with and 18% net return. Value creation was driven in part by realizations in structured credit and successful resolutions in various distressed situations in corporate credit. Since its inception five years ago OZ CO is up 89% net, annualizing at a 13.1% net rate of return.

Our CLO business continues to post top quartile performance, with inception to date annualized cash-on-cash equity returns averaging in excess of 20%, all while are generating these returns with below average risk. Our performance has attracted significant interest from institutional investors, which in part enabled us to close four transactions during the fourth order. This included two new deals, one in the US and our inaugural European CLO, totaling $819 million of assets under management and two refinancings of existing deals.

Our third opportunistic real estate fund continues to put capital to work in attractive investment opportunities. We invested $158 million of capital during the fourth quarter, and have committed over half the fund at this point, leaving approximately $740 million to invest. We're focused on harvesting investments in Fund I and Fund II, and in 2016 we realized six investments at 2.2 times our cost and a gross IRR of 23.6%.

Now turning to our outlook for 2017. A number of factors make us optimistic about our ability to deliver strong absolute returns to our clients in 2017. The Master Fund was up an estimated 2.2% net in January, building on the momentum of the past two quarters. Similarly, OZ CO followed its strong year in 2016 with an estimated 1.5 net return in January. While it is early in the year, this performance means we are well-positioned to generate incentive income.

For the last two years, securities and other assets have marched in lock-step. We're now seeing greater uncertainty and volatility emerge in the market, and these market conditions are positive for fundamental investors like us across a variety of asset classes.

Many market participants have spoken about the positive impact that this environment should have on long/short equities, but the opportunities are broader. For example we believe our merger arbitrage business could also benefit. Tax reform, geopolitical uncertainty, antitrust rulings and changing regulations all create a ripe environment for our merger arbitrage business to find opportunities to generate value for our clients.

Additionally, the prospect of moving off of zero-bound interest rates and towards higher inflation should result in more differentiation in asset prices over time. We believe in the low rate and low inflation environment in recent years has led to less asset price and discrimination, which we expect to reverse as these conditions evolve. This change in the environment should enable us to find attractive absolute return opportunities, and is complementary of our capabilities in asset allocation across strategies and geographies.

Turning to flows. As expected, our January 1 net outflows were elevated, with redemptions primarily concentrated in our multi-strategy funds. The investigation and resulting settlement obviously had an impact on outflows, but we believe the worst quarter is behind us. That is not to say we won't experience additional outflows; however, the tone of investor conversations over the past few months has changed for the better. Investors are pleased with our recent performance and to have the investigation behind us.

Over the next few quarters we believe that multi-strategy flows will return to being primarily driven by our performance and the broader trends at work in the industry. We are optimistic that the strength of our performance across our credit and real estate businesses will allow us to grow our net assets to those platforms. More specifically, we believe the combination of these two core competencies creates opportunities for us to grow in the real estate credit marketplace. As we have mentioned before, we continue to see an opening in US real estate credit, and are now equally excited for real estate credit capital deployment in Europe.

We see increasingly favorable European conditions due to debt coming to maturity, increasing transaction volumes and supply constraints that have created significant market bifurcation. Lastly as I mentioned earlier, our CLO business continues to perform extremely well, and our pipeline is strong for launching new CLOs in both the US and Europe this year.

Now turning to our new incentive plan for partners. Aligning the long-term interests of our executive managing directors with our clients and shareholders has always been important to us. To that end we're pleased to announce that we have established a new long-term performance-based incentive plan tied to total shareholder return for our executive managing directors. These performance-based units will ensure the future continuity of our partnership while further strengthening alignment with our clients and shareholders. Alesia will provide details of the incentive plan and discuss the pro forma impact of our share activities in her remarks.

Next I would like to share with you an update on our investment team. David Windreich and Jimmy Levin serve as Co-Chairs of our Portfolio Committee. In this capacity they are and have been the Portfolio Managers of our global multi-strategy funds, with David overseeing our equities business and Jimmy overseeing our credit business. We have recently formalized their roles for naming them Co-Chief Investment Officers of the Firm. David, while now formally assuming the Co-CIO title, has been a senior leader of our team for the last two decades and has been effectively operating in this role for many years.

Joining David as Co-CIO will be Jimmy Levin. He is one of the architects of our global credit business, and he and his team have turned into one of the top-performing credit franchises in the industry with over $13 billion in AUM, spanning multiple products and geographies. I am very excited to formalize this partnership that has already been working well over the past several years.

In addition, this morning we filed an 8-K detailing a new 10-year employment agreement with Mr. Levin. In connection with this agreement I will be giving up 30 million of my Class A units in order to reduce the resulting dilution to shareholders. I view this, like the $400 million preferred, as an investment in the Firm and a representation of my belief in the long-term value of Och-Ziff.

To close, I believe the market dynamics will be favorable to our investment capabilities, and we're entering 2017 well positioned to create value for our clients and public shareholders. I look forward to building on the momentum we have, and I am personally committed to the future success of our business, not just in 2017 but also in the years to come. With that, let me turn the call over to Alesia.

Thanks, Dan. Let me start with the report of our economic income results. For purposes of this discussion, full-year results exclude the effect of the FCPA settlement.

Our full-year revenues were $730 million, down 14% year over year due to a decline in management fees. Management fees were $495 million, 23% lower versus a year ago, primarily due to redemptions from our multi-strategy fund and the reduction in the multi-strategy management fee rate we shared with you last quarter.

Our incentive income was $233 million for the year, up 14% year over year. As of December 31, 2016, our gross accrued but unrecognized incentives generated from our extended fee-paying assets was $329 million. With the exception of our real estate and energy funds, in which investment professionals participate in the funds performance with carry points, the remainder of this balance has no associated compensation or carry payments upon recognition. We anticipate crystallizing the majority of this incentive over the next four to five years.

In 2017 approximately $20 million will contractually crystallize. In addition, approximately $70 million of accrued but unrecognized incentives in our opportunistic credit fund is deep in the money and is available for crystallization at the time we deem it in the best interest of clients to harvest these investments. Please keep in mind the overall accrued but unrecognized incentive balance may increase or decrease based upon future performance of our fund.

Now, turning to our operating expenses. Our full-year expenses totaled $530 million, up 5% year over year. For the year, compensation and benefits were $330 million, up 9% year over year, driven by an increase in the cash bonus expense offset by a small decline in salaries and benefits. Our cash bonus expense for the year was $219 million, up 16% year over year, driven by the performance of our funds. The resulting increase in incentive income was a key driver in our bonus amounts.

Salaries and benefits for the year totaled $111 million, down 2% from last year. For the fourth quarter salaries and benefits were $25 million, reflecting an 8% decline from the third quarter. The salaries and benefits decline reflected the full-quarter effects of attrition and headcount reduction completed in the third quarter. Our headcount declined by approximately 20% over the course of 2016, and we expect our headcount to remain stable throughout 2017.

Full-year non-compensation expenses were $200 million, down 1% year over year. For the fourth quarter, non-compensation expenses were $44 million, down 2% sequentially. The quarterly reduction was primarily due to a decline in professional services fees resulting from lower legal costs and the effects of additional cost saving initiatives we implemented throughout the last year. Our fourth-quarter taxes reflected the reversal of prior period tax accruals, resulting in a $2.4 million tax credit.

Now I would like to share with you our expectations for 2017. We estimate that our salaries and benefit expense will range between $100 million and $105 million for the full year 2017, which reflects a tightening of the range previously provided. The Firm has elected to change its methodology for discretionary cash bonuses, largely in recognition of the continued diversification of our business and the importance of retaining our employees across market cycles. As such, beginning in the first quarter of 2017 a minimum amount of the discretionary cash bonuses will be accrued and expensed on a quarterly basis.

To the extent our funds generate incentive income in the fourth quarter, we may elect to increase the amount of cash bonuses paid to employees over the amount already accrued, with any incremental amounts recognized as an expense in the fourth quarter. Our estimated accrual for 2017 will be between $18 million and $20 million per quarter.

We estimate that our non-compensation expense will range between $140 million and $155 million for the full year 2017. This is $10 million lower than our previous guidance of $150 million to $165 million, driven by our identification of further expense saving opportunities primarily in the categories of professional services, insurance and other expenses. These savings will be realized throughout 2017, with the majority of the savings being fully realized in the latter half of the year.

We expect our full-year adjusted tax rate in 2017 to normalize to approximately 20% to 25%. As these are estimates, we intend to update these amounts quarterly as we move forward.

As Dan mentioned earlier, we have created a new performance-based incentive plan for our executive managing directors in the form of P Units. The February 28 issuance announced in our 8-K this morning will total 73 million P Units.

The P Units will vest when two conditions are satisfied. The first is a service condition that requires the recipient to be employed with the Firm for three years, and the second is the achievement of certain total shareholder return thresholds, measured over a three-year period following the service condition. More details on these Units and the total shareholder performance threshold are outlined in the 8-K.

The P Units will not be counted in our adjusted Class A shares in 2017. Again, in order for the P Units to vest, have value to the recipient, and to be included in our adjusted Class A shares, the recipient must be with the Firm until the first quarter of 2020 and the performance threshold must be met. In other words, our partners only win if our clients and our shareholders win.

Separately, we are issuing RFUs and Partner Units in connection with our year-end 2016 bonus payments and the new 10-year employment contract entered into Jimmy Levin that was announced in our 8-K this morning. This issuance will be partially offset by the relinquishment of units by Dan Och for a net issuance of $35 million adjusted Class A shares. We anticipate pro forma for this issuance having approximately 555 million adjusted Class A shares outstanding.

We declared a fourth-quarter dividend of $0.01 per Class A share. Going forward we intend to continue paying quarterly dividends. However, we will continue to withhold some amount of earnings for general corporate purposes, which may include the seeding of new investment opportunities or strengthening our balance sheet.

Finally, I would like to touch briefly on our balance sheet. We closed on the second tranche of the $150 million preferred funding on January 23, 2017, and intend to use a portion of that cash to fully repay the $120 million borrowed under our revolving credit facility later this quarter.

In closing, I would share that I am personally excited to have joined such a talented team. We are intensely focused on execution. As Dan mentioned, we believe we are well positioned from an investment performance standpoint, and I would add that we believe we are equally well positioned to deliver on the guidance we have outlined. I look forward to updating you on our progress as we move forward throughout the year. With that, we will open the line up for questions.

(Operator Instructions)

Robert Lee, KBW.

Great. Thanks for taking my questions. I guess maybe following up on the new partners plan, were there any other, because I haven't had a chance to go through the 8-K, were there any other substantive changes? I know that in the old plan, up to, I think it was up to about $30 million, $35 million or so, there was also some additional participation in incentives, up to some limit. Could you maybe go through any other changes that may have taken place besides just the share issuance?

We have not made any changes other than those that were outlined on the call and in the 8-K.

Okay, great. Then maybe, I know you touched on real estate, credit and whatnot. Could you maybe update us to some possible on what specific strategies you are actually going into the market with now?

I know that your credit performance has been very good, I think your last Credit Opportunities Fund was probably raised and invested a few years ago. Maybe just update us on more broadly on the new business initiatives?

Sure. We can't talk about specific funds on a call like this, but in terms of product areas, we have been very focused -- we have a very strong real estate team and a very strong structured credit team. In the US we've been very focused on single asset commercial real estate opportunities that having both resources enable us to do. We think that getting back to our secular focus on areas where banks aren't doing what they used to do, that's been a very robust area for us and it continues to be a focus.

Over the past several years we have also established a very strong real estate team in London to go along with our structured credit team, and we are seeing opportunities in Europe as well. So continuation of our plans in the US and an emergence of the opportunity and our capability in Europe is where we are in that area.

And maybe one last question, I appreciate your patience, on comp. If I look historically, full-year incentive comp has ranged between, call it, depending on the year 19%, 22% or so of total revenues, and certainly this year bumped up. Obviously a lot depends on incentive generation over the course of the year, but should we be thinking that the normalized range maybe has risen, given the reduced revenue capacity, at least on a management-fee basis currently?

Rob, this is Alesia. I think that is right. I think what you should think is that we have now provided you guidance on the amount of minimum bonus that we should expect to pay in the event that we do not generate incentive incremental funds. And to the extent that we generate incentive income in the fourth quarter, we will then expect additional bonuses. But as management fees have come down as you noted, that the historic range of 19% to 22% no longer is applicable on a prospective basis.

Okay. Thank you for taking my questions.

Patrick Davitt, Autonomous.

Good morning. Thank you for taking my question. From the payout ratio, just quickly, should we take your commentary to mean that you are essentially back to the same policy you had before the FCPA issue?

With regards to dividend, as we shared, dividends are incredibly important to us and we intend to continue paying quarterly dividends prospectively. In 2017 our capacity will be largely driven by the performance of our funds and the associated incentive income that we'll earn from that performance. Going forward, the growth of this amount will be driven by a combination of the performance of our funds and then growth in our assets under management.

And paying the dividend this quarter, even though the distributable earnings did not allow us to pay a substantial dividend, it was meant to make clear that in our view the period of not paying dividends is over and we are looking forward to distributions to our shareholders and unitholders.

Great. That is helpful, thanks. Then finally on the broad guidance you gave on the fundraising redemption tone with clients, could you give us some framework around, I guess from your historical experience, if you would've already had good visibility on the April 1 redemption picture? Or is it probably too early for that, from what you have seen historically?

We have not reached the dates where we disclose and discuss that quarter. Other than the comments we made on the call, we are not discussing any specific quarter.

Great. Thank you.

William Katz, Citigroup.

Jack [Hewlert] filling in for Bill this morning. Thanks for taking our question. First question around US corporate tax reform. I believe you mentioned, Alesia, in your prepared comments that your corporate tax would be 18% to 20% on a full-year basis.

It's a two-part question. First, if corporate tax reform does go through and the statutory rate moves lower in the US, what impact would that have on your tax rate today? Secondly, would that make you reconsider whether you'd think about converting to a C Corp in the future?

First I want to clarify, Jack. The guidance we provided was that we expect our tax rate to resume to the historical levels of 20% to 25%. With regards to tax reform, at this point it's too early to tell and make any definitive conclusions. We will update you at the appropriate time.

Obviously if there are substantial changes to corporate tax laws, we will sit down as a Company and [support] and make the right decisions. But we obviously don't know. It is too early what the different changes might be.

Understood, thanks. Then on the distribution as I think through the current compensation throughout the year as opposed to having it back-ended into 4Q, is it reasonable then to think that your distribution policy would be more skewed towards the fourth quarter? Or will you not consider the accrued incentive comp throughout the year as you think about your distribution on a quarterly basis?

You're correct. You should assume it'll be more skewed towards the fourth quarter.

Got it. Thanks for taking the question.

Ken Worthington, JPMorgan.

Hi, good morning. I apologize if I missed this, but in terms of share count, I think you said that the share count will increase by 35 million shares over time. Over how many years does the share count increase by that 35 million? I assume that is not all in 2017.

Let me clarify. The 35 million I referenced is in regards to the RFUs and the Partner Units we are issuing in connection with our 2016 year-end bonuses. So those units will be issued in the first quarter of 2017, which will bring us to 555 million shares outstanding by the end of the first-quarter 2017.

The P Units, as we shared, these are longer dated incentive units. The P Units will vest over the next three to six years, conditioned on us achieving certain performance thresholds that we've outlined in our 8-K. To provide more color, we plan to issue these at a price of $3.21 and that the total shareholder return of 125% would need to be achieved, which creates $4 of value total shareholder return in order for these to fully vest.

Okay. Am I right, this seems like this is like 7% dilution in one year? Is that about right?

35 million is just under 7%, that is correct.

Okay, okay. As a big CLO manager, how do you think about the competitive environment for CLOs if regulation on skin in the game is rolled back? Is this still a good business to be in, you think it is a good business for Och-Ziff?

We think it's an excellent business to be in, and we think it's an excellent business for Och-Ziff. I think we have shown an ability to adapt. These risk retention rules have been put into place, we have adapted accordingly.

Europe has some different rules than the US. We launched our first European CLO. We think it is a business where scale is very important.

As in all businesses, it starts with performance. Being top quartile -- we weren't in this business five or six years ago. Being top quartile, being large, having scale, cash-on-cash returns on our equity being in excess of 20% enables us to grow. And the marginal profitability on each new CLO increases.

Okay, that is all for me. Thank you.

Jerry O'Hara, Jefferies.

Great. Thanks for taking my questions. Just a follow-up on the incentive pricing, or the incentive plan. Can you maybe just give a little color or context around how you came up with the $3.21 grant price, just for our help?

It is detailed in our 8-K, but it represents the average of the closing price for the trading days in January.

Just to be clear, when you use the term grant price, that is the reference price, meaning the total return to shareholders. You can see in the 8-K there are various thresholds as high as 125%. The total return to shareholders in order for these units to be granted are thresholds as high as 125% off of $3.21. It is really meant to be -- the holders of these and the EMDs only win if the shareholders win, and that is alignment.

Okay, fair enough. And then just one more, more broadly. Performance has been good, or perhaps remained strong since the announcement of the fee cuts. Can you talk a little bit about how demand has perhaps correlated with that decision?

First of all, that is by different product. You're right that performance has been good across products. We are focused on raising capital in all areas.

We have several things we are doing in the credit area, both real estate and others, that remain a focus. Obviously the CLO fundraising continues, as we saw.

Multi-strategy, as we said -- don't forget multi-strategy went through a number of different factors last year, including some industry factors that happened very quickly and were substantial. We are confident that over the next few quarters multi-strategy fund raising will return to the factors that have historically driven it, which are our performance and the trends in the industry.

Okay. Thank you.

Michael Carrier, Bank of America.

Hi, good morning. This is Mike Needham in for Mike Carrier. First one on the multi-strat, the fee rate cuts. Has this made your funds more attractive to new investors? How's your pipeline or the conversations you are having for growth flows today in the multi-strat funds compared to the past?

The fee cuts of last year were an adjustment to conditions in the industry. Look, our multi-strategy funds are going to be attractive to investors because of our returns, our risk management, the capabilities that they perceive.

We did think, as did many others in the industry, that an adjustment in management fees was appropriate. So that is why we made the change. But our funds are going to be attractive because of the factors I mentioned that we provide, the team, the infrastructure, the organization, everything that has made it attractive for 22 years.

Okay, thanks. Then just on pipeline, if you have any color on pipeline or conversations for new commitments.

On multi-strategy specifically, as we said, we believe that the worst quarter is behind us. We thought three factors had to change for us to turn multi-strategy flows in a positive direction.

Number one, we had to put the settlement behind us, and that is done. Number two, we had to get performance back to where Och-Ziff performance has always been historically, and that is we are doing it now and we are optimistic about the environment and intensely driven to do that.

Number three, we need the industry conditions, which clearly in the second half of 2016 were not positive, to at least neutralize and turn positive. And we believe that is happening as well.

Okay, thanks. Last on the incentive plan, I just want to confirm the 35 million P Units, is that the total amount of P Units that will be issued, or over time could more be issued? Thanks.

Again, I just want to clarify. 35 million pertains to RFUs and Partner Units issued in connection with compensation and the new employment agreement with Jimmy Levine. Separately we issued a P Unit incentive plan in which it detailed in our 8-K there's going to be an issuance as of February 28 which would be 73 million P Units.

Did that clarify it? I know there's a lot of numbers, so if that did not clarify it, please ask again because we want everyone to understand exactly what we are doing.

Yes, I've got it. Thank you.

Thank you.

Thank you. That concludes the question-and-answer session today. I will now turn the call over to Ms. Madon.

Thanks, Sally. Thank you, everyone, for joining us today and for your interest in Och-Ziff. If you have any questions, please don't hesitate to give me a call at 212-719-7381. Media inquiries should be directed to Joe Snodgrass at 212-887-4821.

Thank you, ladies and gentlemen. That concludes your conference call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.