Sculptor Capital Management Inc (SCU) 2018 Q2 法說會逐字稿

Good morning, everyone, and welcome to Oz Management Second Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Adam Willkomm, Head of Business Development and Shareholder Services at Oz Management.

Thanks, Kim. Good morning, everyone, and welcome to our call. Joining me are Rob Shafir, our Chief Executive Officer; and Tom Sipp, our Chief Financial Officer.

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 Oz Management'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 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 U.S. 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 of our funds or any other entity.

Earlier this morning, we reported a second quarter 2018 GAAP net loss of $12 million or $0.06 per basic and 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 second quarter 2018 distributable earnings of $7 million or $0.01 per adjusted Class A share. Excluding the $13 million legal provision incurred in the quarter, second quarter 2018 distributable earnings were $18 million or $0.03 per adjusted Class A share. We declared a $0.02 dividend for the quarter. If you have any questions about the information provided in our press release or on our call this morning, please feel free to follow up with me.

With that, let me turn the call over to Rob.

Thanks, Adam. Good morning. We continue to be pleased with our fund performance thus far in 2018. The Oz Management fund returned 2.3% net for the quarter with positive performance each month and 4.4% for the first half of 2018.

Our disciplined and consistent approach continues to deliver. All of our major strategies within the Master Fund were positive for the quarter and the first half of the 2018. Specifically, this quarter's performance was bolstered by strong capital markets activity and the performance of many of our large technology positions. We also saw a few of our merger arbitrage positions reach positive outcomes, which lowered our total capital allocation and strategy. In fact, the only sub-strategy where we underperformed was in Asian equities. But even there, we outperformed the markets, thanks to our focus on local consumer exposure and lower overall exposure.

[Oz CO], our global opportunistic credit fund, was up 3.4% net in the second quarter and 6.2% net for the first half of 2018. Credit continues to be strong, with performance largely driven by process-driven trades as well as single-name catalyst in U.S. corporate credit.

In real estate, we continue to deploy capital in our opportunistic and credit real estate funds while also realizing investments. In the second quarter we invested over $37 million and had full or partial realizations of 2 investments, which grossed multiples of 2.1 and 2.2x. In total, we have committed approximately 65% of our most recent opportunistic real estate funds generating 23.5% net return for investors since inception. Our Real Estate Credit Fund is currently 20% deployed.

Our CLO franchise continues to perform, and we remain an active issuer. In the second quarter, we closed 2 new U.S. CLOs and added approximately $947 million in new assets under management. And we priced an approximately $480 million European CLO that closed yesterday.

I'd like to take a moment to highlight a new transaction that we think is the first of its kind and a new line of business for us. In June, we closed an approximately $700 million aircraft securitization in partnership with GE Capital Aviation Services, also known as GECAS, where Oz will serve as the asset manager. This is the first time an aircraft securitization has had an asset manager. We believe this structure will, over time, run the investor base in aircraft securitizations and bring increased institutional capital to the space, similar to other securitization markets, such as CLOs.

We are excited to team up with a great partner in GECAS and are hopeful that this transaction will be the first of many together. We continue to be active in aviation-related investments, and this platform creates unique investing opportunities for our LPs.

Turning to flows. On August 1, assets under management were $33.5 billion, an increase of $1.1 billion as compared to the end of 2017. We're pleased that our total assets under management are stable in 2018. We continue to see positive net flow contributions from our CLO platform; new initiatives, such as the GECAS transaction; and anticipate growing our real estate business. These inflows have been offset by the net outflows we are still experiencing in multi-strat. As I said in the last call, we believe that a multi-strat investment program is timely given the current market dynamics.

Our performance in the Master Fund is strong, and we believe that flows follow performance, but we have not seen the level of inflows that we would have expected to see at this point. We believe in multi-strat and remain optimistic that our product will resonate with clients and turn into flows over time.

Lastly, I am pleased to announce that our Board of Directors has elected Richard Ketchum to the board, effective July 31. Rick will be replacing Jerry Kenney, who is retiring from the board. We would like to thank Jerry for his service to Oz. Rick brings tremendous experience in the financial industry with time in senior roles with various regulatory agencies, most recently serving as the Chairman and Chief Executive of FINRA from 2009 through 2016. We are extremely pleased to add Rick to our board and look forward to working together.

Now let me turn the floor over to Tom to go through the financials.

Thanks, Rob, and I'm happy to be joining the call. As Adam mentioned at the beginning of the call, we reported second quarter 2018 distributable earnings of $18 million, excluding the legal provision incurred in the period.

Revenues for the quarter were $105 million, down 26% as compared to the second quarter 2017 and down 15% versus the prior quarter, driven primarily by lower incentive income. As a reminder, the bulk of our incentive income is recognized in the fourth quarter, and the timing of incentive recognition in the first 3 quarters of the year is not consistent from period to period.

Management fees were $66 million for the quarter 2018, 12% lower than a year ago and 2% lower than the prior quarter. The management fee decrease was driven primarily by a lower average management fee rate due to a shift in mix -- in our assets under management.

Incentive income was $35 million for the quarter, 48% lower than a year ago and 32% lower than the prior quarter. The decline in incentive income was due to a low level of incentive crystallizations from more extended fee-paying assets when compared to the prior periods. As I just mentioned, the timing of the recognition of incentive income related to extended fee-paying assets is not consistent from period to period and is driven by a number of variables, including realizations at the underlying fund level as well as the specific client terms.

As of the quarter end, our accrued but unrecognized incentive was $340 million, up 10.5% as compared to the prior quarter. The increase was primarily due to the performance in credit and real estate. As a reminder, with the exception of the balance associated with our real estate and energy funds, the remainder of this balance has no associated compensation expense as this was paid in earlier periods. We expect to realize a majority of this over the next 3 years. Other revenues were $4 million for the second quarter 2018, an increase of $3 million year-over-year, driven primarily by interest income on our CLO investments and 14% lower than the prior quarter as we began to sell certain of the risk retention investments in our U.S. CLOs, which I will elaborate on in a moment.

Now turning to our operating expenses. Our second quarter total expenses were $96 million. Excluding the $13 million legal provision that we will discuss shortly, second quarter expenses were $83 million, up 10% year-over-year and up 19% versus the first quarter of 2018. We accrued a $13 million provision related primarily to the outstanding shareholder class action suit previously described in our SEC filings. There was no previous expense recorded in relation to these matters in prior periods.

For the quarter, compensation and benefits were $48 million, up 10% year-over-year and 45% higher than the prior quarter, driven primarily by increased bonus expense, which was $25 million for the quarter. Similar to incentive income, the timing of certain bonus expenses are not consistent from period to period. Relative to a year ago, the bonus expense was higher, partially due to real estate incentive crystallizations in the period. Compared to last quarter, bonus expense was higher due to the deferred compensation forfeitures experienced in the first quarter. That said, we continue to expect that full year minimum annual bonus accrual will be between $80 million and $90 million.

Salaries and benefits were $23 million, down 5% from the second quarter of 2017 and 4% lower than the prior quarter due to lower headcount. We continue to expect full year 2018 salaries and benefits to be between $90 million and $95 million.

For the second quarter of 2018, noncompensation expenses, excluding interest expense and the previously mentioned legal provision, were $28 million, remaining relatively flat year-over-year and down 8% from the prior quarter. We continue to expect full year noncompensation expenses to be between $100 million and $110 million, excluding interest expense and the legal provision.

Our interest expense was $8 million in the second quarter, an increase of $2 million year-over-year. This increase was attributable to the overlapping interest on our term loan and our since retired senior bonds. We expect interest expense to step down below $5 million on a quarterly basis due to the smaller corporate debt load and a smaller balance of risk retention financing, which we will discuss in a moment.

In summary, while there are some expense variations quarter-to-quarter, we are confirming our previous guidance for all of our 3 major expense categories. Our guidance for the full year 2018 tax receivable agreement and other payables remains unchanged at 10% to 15%. As a reminder, tax estimates are subject to many variables that won't be finalized until the fourth quarter of the year and, therefore, could vary materially from the estimates provided.

Now an update on our balance sheet. Our cash, cash equivalents balance and longer-term U.S. government obligation investments as of June 30, 2018, were $435 million. As we mentioned last quarter, we redeemed the $400 million of senior notes through a combination of cash on hand and the issuance of a $250 million term loan. We subsequently voluntarily prepaid $50 million of the term loan. The combination of these actions reduced our corporate debt, excluding CLO risk retention financing, by 50%, consistent with our goal to strengthen our balance sheet.

As a result of a recent court decision that vacates application of U.S. risk retention rules in certain CLO transactions, Och-Ziff will no longer be required to hold risk retention for our U.S. CLOs going forward. Additionally, as a result of this decision, we sold a net of $135 million in U.S. CLO risk retention investments and paid down $118 million in related financing during the second quarter. These transactions netted approximately $17 million in cash and will also serve to further reduce both the other revenues and interest expense line items beginning in the third quarter. We will continue to hold risk retention on our European and our dual compliant CLOs.

With that, let me turn over to Rob for closing.

In summary, we are focused on delivering performance across all of our products and strategies for our clients. Performance in multi-strategy, credit, ICS and real estate were strong in the first half of the year. I believe the strength of the platform gives us a unique opportunity to source investment ideas across the globe as we create innovative new management opportunities, such as the GECAS transaction.

We continue to push forward on our plan to strengthen our balance sheet and prudently manage our expenses. I am pleased that we're on track to hit our expense guidance, and I believe that we're making progress in putting the legacy issues behind us. We are working diligently to turn around the flow picture around and continue to believe that our solid performance will resonate with clients and lead to flows.

With that, we will open the line up for questions.

(Operator Instructions) Your first question comes from the line of Gerald O'Hara from Jefferies.

Just maybe starting on the GECAS transaction. If perhaps you could provide a little bit more color on the size of the market opportunity there. And how we should maybe think about how that's going to work in terms of kind of a fee structure or a revenue opportunity, mix shift, similar to the CLOs? Or just kind of anything you can provide color-wise there would be helpful.

This is Rob. Thanks for the question. Look, we're pretty excited about the GECAS opportunity. As I mentioned it's the first situation where on one of these aviation financings, we are actually acting as an asset manager. I'd say it's early days, but it's obviously a very big market, the aircraft market. And what we're also very excited about is that GECAS, we believe, is the premier partner of what is a multiyear arrangement for us with them. So I think it's hard to model it frankly but I'd say that there is potential for that to grow quite materially over time. But I don't know if it's Adam or Tom, whether we would literally be able to quantify that sizing at that point. I think it would be a bit premature to do that.

It's a big -- this is Tom. It is a large market. The -- I think from a modeling perspective, Gerald, I would model it similar to CLO fee rates. But we do believe it's a big opportunity in a big market. But as Rob said, it is early days.

Okay. And just maybe a quick one on the legal provision. Is that something that we should -- is this sort of isolated to the current quarter? Or is there potentially something we should consider modeling kind of going out into future quarters?

Gerald, no, no. This is associated with pending litigation that we're limited in what we can say. The bulk of this provision is against the specific shareholder class action suit. The provision is really our best estimate of the outcome, the probable outcome based on current discussions. We believe the maximum exposure would be an additional $18.8 million.

Your next question comes from Alex Blostein from Goldman Sachs.

This is actually Ryan on behalf of Alex. I'm just wondering, you previously spoken to potential opportunities to optimize the expense base. So as we look out to 2019, are there still opportunities around noncomp where you can see some reductions?

Yes. This is Tom. There are opportunities that we're working hard to drive efficiencies across the platform. I think there's opportunities from a technology standpoint. And really, this year, we've had elevated legal and professional fees associated with settling some of our historical issues that we don't expect to continue in 2019. So I think overall, from an operating platform perspective, we are continuing to make the platform more efficient. So we think we will improve in 2019 and beyond.

Yes, this is Bob. I think to Tom's point, you obviously have, as we are putting legacy issues behind us, doing things like restructuring debt and so forth, there's probably some one-off nature to part of that expense base. But in addition to some of the efficiencies that we're going to achieve this year and Tom's contemplated going forward in terms of things like efficiencies around technology and so forth, we have reduced headcount. So our headcount is down from 482 to...

Our current -- our beginning-of-the-year headcount's 483. The end of quarter's 442.

Right.

So I think that will affect some noncomp expense associated with headcount. But obviously, it will affect our salary and benefits as well going forward.

Got it. And then I guess maybe just one more talking about the multi-strat fund. I'm wondering if you could give us some color around conversations you've been having with clients. In particular, which clients are most interested in the fund right now. And kind of squaring that with some thoughts about returning to positive flows there?

Yes, sure. As I said, I think we are still experiencing some of the hangover from some of our legacy issues that we've gone through in the last couple of years. And I'd say in general, different businesses are sort of turning green faster than others. As you know, you've seen obviously very nice growth in our CLO franchise. We believe that real estate, when we announced our next up-and-coming funds, will be well received as well.

My view on multi-strat has always been that I think it's a very timely product in a market where rates seem to be going up and vol seems to be more prevalent than it has been, certainly in the previous few years. So products that are -- that have nimble capital, that can invest across asset classes, that are lightly levered in low-vol products, that are consistent-returning products from a performance standpoint, I think are very timely products in this marketplace. And that is what our multi-strat product is right now.

It has been a consistent performer over time. It protects client money very well. I believe on a gross basis, that fund has lost money only twice in its history of 24 years, and that includes the crisis. And if you look at our performance this year, we're up nicely in that business, 4.4% on a net basis. So I feel very good about performance there.

And I'd say the client conversations there have gone from red in the context of where we were on a legacy basis, to what I'd characterized as yellow. I'd say our pipeline is building. But it's very difficult to predict when we can start converting those things to green. But my philosophy is that the product is timely, our performance is strong and that I think with time and distance from our legacy issues, we will ultimately begin to turn those lights green. Hard to say when. I don't want to overpromise and underdeliver, but we're very much committed to sticking to our knitting there.

Your next question comes from Mike Carrier from Bank of America.

It's Mike Needham in for Mike Carrier. The first one I have is on disclosure. Sorry if I've missed. Did you give the quarter-to-date flows? It looks like the press release changed a bit, and I couldn't find it there.

This is Adam. Which flow number are you specifically looking for?

Just quarter -- third quarter to date.

The -- yes, we don't...

I thought in the past, you guys gave like day 1 and then the current fund...

Yes, we released that in our 8-K this morning. The AUM as of July 1 was $33.3 billion, and the AUM as of August 1 was $33.5 billion.

Okay. Got it. But just in terms of flows.

Yes. So we just -- in the 8-K, we got our performance for the month and the ending assets, the assets as of 8/1.

Okay. All right. Fair enough. Let's see, so the other -- on the real estate fund, I think you said you committed 60%. The returns are -- have been good. And I guess, what's the time line for raising the next-generation fund?

I don't think we have a specific time in mind yet. But we are about 65% invested in the fund right now. So it's something that we are in the process of gearing up for. I don't know. We have not had an official date for any specific fund launch at this moment yet though.

Okay. And just last one on multi-strat. Inflows tracking a bit below your prior expectations. Is that still the past legal issues that are the problem? Is that the biggest pushback you get from investors?

I think that's a big part of it. I certainly think that -- I think that, frankly, the legal issues, the CEO transition issues and so forth definitely put investors on pause. And I think, obviously, stability in performance and time and distance, as I said just a minute ago, I think is going to be the cure for that.

We're somewhat frustrated that we haven't seen those flows turn positive. If I were to give you some more color on that, I think what you're starting to see is on an outflow basis, those outflow numbers beginning to normalize or in the process of normalizing. There is typically an element of churn in something like a multi-strat fund, given the liquidity provisions of that fund. What we're not yet really seeing are the significant inflows to offset that or more than offset that. And that speaks to the pipeline, and speaks to clients turning from yellow to green.

As I said, I do think there's a lot of healthy conversations going on. I do think there's a good story. But I do not want to sit here and overpromise and underdeliver. I'd rather deliver. So it will happen when it will happen. But I do believe the product is timely. I do think our performance is there, and I think time and distance will be helpful to us. Hard to say exactly when, but we believe that it will turn positive.

Your next question comes from Bill Katz from Citigroup.

Question number one is what -- how far do you have to get invested in the real estate fund before you'll start marketing a new fund?

75%.

Okay. You said you're at 65% right now.

Yes. Plus or minus, yes.

Okay. That's helpful. And then just in terms of capital management from here, could you sort of walk us through how you sort of see the second half of this year and '19 playing out in terms of priorities?

Yes, I mean -- this is Tom. I mean, as you know, a lot of our incentives are realized in the fourth quarter. The -- our priorities are to continue to strengthen our balance sheet. The -- we'll make recommendations to the board at the end of the year based on our cash position regarding dividends and working capital needs. But we do want to continue to strengthen our balance sheet throughout 2018.

Okay. And just a little bit of the modeling question. How much can we expect the other revenue line to come down as a likely offset to the interest expense reduction?

The other revenue, it's -- I would model around $1 million, $1 million reduction.

Okay. And then just to come back to the discussion on the feedback on the hedge fund discussion. You mentioned a little more time and distance. So what -- if you could tier it out -- and I know you gave a little color to another answer. But if you could tier it out in terms of, is it a full year of results? Is it this pending legal thing that's now sitting out there that may spill into the third quarter? Or is it just combination of all that? Just trying to get a sense for when you might uptake it. And then related question, the last question, is pricing an issue as it relates to how it's priced versus maybe other vehicles that are out there?

Yes. Bill, it's hard to pinpoint the specific asset. And obviously, these things are, to some degree, is idiosyncratic to the specific client. I just think it's the combination of things that have, I think, put clients on pause. As we said, the performance story is great. I don't think I've had one conversation with a client since I've been here that's been anything but pleased with our performance thus far. And it really has not been a pricing discussion either regarding that. I think it's more specifically to just getting comfortable, frankly, with me in my seat and getting some of the time and distance, as I said before.

The fact that we're getting more clarity on some of these legal provisions and beginning to put these things in the rearview mirror -- and we are hopeful that we will make significantly more progress on that in the very near term, will be a good fact. Is it one specific thing versus the other? I'm not really sure. It's probably, in my mind, just a bit of a combination. And just sort of getting things settled down, back on track and continuing to do what we do, we think is going to be good for us.

And in addition to that, there's obviously a lot of new client conversations going on as market conditions have changed and different clients are thinking about things differently in terms of where they want to allocate money. So there is healthy dialogue, and it takes time. But we -- as I said, hard to say where and when. But again, I think it will be hard for us not to turn this thing into a more positive direction here if we continue to perform, in my view.

Your next question comes from Patrick Davitt from Autonomous Research.

I think July might be the first month the Master Fund underperformed the HFRX Indices. I'm just curious if you could give us any color around positions that may have caused that. And/or any concerns around that slight underperformance?

Sure. I don't think -- we will not talk specifically about positions. I guess I would say that it's hard to bat a thousand in this business and get every month right. I think if you look at our overall track record, not only in the course of this year in terms of what our performance is, but over the history of these funds, I think it's been quite remarkable. As I said earlier, I think we've had 2, on a gross basis, down years in the context of the history of this fund, which is greater than 20 years since inception. But I would also say, if you look at our performance in the first half of the year, we were, on a strategy basis, positive in all strategies. And on one regional basis, as a mentioned in the comments, which was Asian equities, we were slightly down but significantly outperformed the market there.

In the course of July, a couple of positions did not go the right way for us, which will happen from time to time. But I would point out to you that in spite of that, we were down very slightly on an absolute basis. So we certainly were able to protect the capital of our investors, even in a scenario where some of the positions went against us.

I think the last thing I'd say is our focus is more on the longer term in terms of our investment performance. And we feel, as I said, very good about our people that are managing money on behalf of our clients. We feel very good about our process in terms of how we do it. So -- but once in a while, we will get it wrong, and it was not our finest month.

That's helpful. And then, I guess you mentioned GECAS. Obviously, you've had a lot of success in credit and real estate, extending away from the Master Fund. Just curious if there's a pipeline of other kind of step-out businesses or new businesses coming through that we'll be hearing about over the next year.

That one is the one that's just sort of in front of us right now. I mean, there's -- as I've said in terms of just the core strategy of the firm, it is about really kind of sticking to the core verticals that we are involved in. As we talked about in the first quarter, what we tried to do is eliminate things that we thought were noncore. So things like some of our peripheral activities, which were not really part of either multi-strat or credit platform or real estate, we are eliminating. And the purpose of that is to focus on what I think these core businesses are.

The reason why we're doing that is because we happen to think that we're good in these businesses, we have the performance to sort of back up our story, and we actually think there's a lot of greenfield opportunity in those businesses. As I said, I think multi-strat is a place where we think it is a very timely product, given where the markets are and we believe are likely to be in the foreseeable future. We think we're extremely good in credit and in real estate. I think what you will see is extensions that are logical adjacencies to those core businesses. So if you think about something like GECAS, it is right in the strike zone of what we're good at. Credit is a place where we have tremendous strength. Within credit, our structured products capability, our securitization, technology and so forth and how we think about complex transactions is kind of the special sauce of how we think about a lot of the things we do in credit. And to apply that technology and know-how into a different asset, i.e. the aviation asset class, to me, is a logical extension.

So as I said earlier, it's hard to sort of say exactly how big it is. There's definitely other transactions we will be working on in that space alongside of GECAS. But the philosophy is to leverage our strength in those core verticals and grow there rather than start lots of new initiatives that are not core to our mission.

Your next question comes from Ken Worthington from JPMorgan.

This is Will Cuddy filling in for Ken. So as we think about the much-stronger growth of the CLO-like businesses with a management fee of about 50 bps and the slower growth of some your other businesses, like multi-strat, if this continues, how should this mix shift impact your salary and benefit as a percent of management fees over time? Should we expect salary and benefits, as a percent of management fees, to continue to grow over time?

Yes, I think one -- I think the CLO average fee rate would be a little lower than that 50 basis points. The -- but as the mix shifts, we'll continue to manage our expense base across the board. The -- so we don't model or have a specific target on the salary and benefits, but we will -- if fee mixes change over time, we will obviously plan for that and react and be more efficient over time.

I guess I would add a couple of things to that. I mean, if you think about things like our CLO business, there's an economy-of-scale element to that business. So the marginal cost of being able to scale those businesses materially from where we are right now will have some operating synergies in it, some operating leverage and so forth. So I think that will mitigate some of that potential pressure.

And to be clear, it is not our expectation that over time, that asset -- we're going to continue to see material outflows in some of the higher-margin products. Obviously, we have not seen those lights turn green. We've been pretty transparent about that. You know how we're thinking about that. And strategically, we will, again, be disciplined about our expense base. We'll get some operating leverage in things like the CLO businesses, which will mitigate things. But our intention is to grow things like multi-strategy and some of the other high-margin products. That is core to what we are trying to do here and expect to be able to do over time.

I'm not showing any further questions. I will now turn the call over to Mr. Willkomm.

Thanks, Kim. Thanks, everyone, for joining us today and for your interest in Oz. If you have any questions, please don't hesitate to contact me at (212) 719-7381. Media inquiries should be directed to Jonathan Gasthalter at (212) 257-4170. Thanks very much.

This concludes today's conference call. You may now disconnect.