Sculptor Capital Management, Inc.
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Operator:]

Good day ladies and gentlemen and welcome to the Och-Ziff Capital Management Group's 2017 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Adam Willkomm, Head of Business Development and Shareholder Services at Och-Ziff. Please go ahead.

[Adam Willkomm:]

Thanks, Candice. 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. 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 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 Och-Ziff fund or any other entity. Earlier this morning, we reported a first quarter 2017 GAAP loss of $7.2 million or $0.04 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 2017 first quarter distributable earnings of $35.7 million or $0.07 per adjusted Class A share. We declared a $0.02 dividend for the first quarter. If you have any questions about the information provided in our press release or on the call this morning, please feel free to follow up with me. With that, let me now turn the call over to Dan.

[Dan Och:]

Thanks, Adam, and good morning, everyone. Our strong first quarter represented the fourth consecutive quarter of broad based positive performance across our funds and strategies. In multi-strategy the OZ Master Fund, our largest multi-strategy fund was up 4.1% net for the quarter and 11.9% net for the last 12 months to March 31. In opportunistic credit OZ CO, our largest credit fund was up 3.2% net in the first quarter and 20.6% net over the last 12 months. The first quarter began with a continuation of the general post election trend and ended with that rally beginning to falter. Industries that were in favor during the rallies saw gains reversed in some cases sharply and other industries previously gained unlikely beneficiaries of policy change began to see gains. Additionally interest rate fluctuated while volatility lulled and then accelerated. Through these shifting market shifting market conditions the OZ Master Fund maintained positive performance highlighting our security selection and asset allocation ability in quickly evolving markets. The fund's first quarter gains were driven primarily by realized catalyst and positive developments in a number of our larger positions. While certain positions were outside contributors to performance there were many more singles and doubles. We saw strength across merger arbitrage, corporate credit, long short equity, structured credit and convertible and derivative arbitrage. At a position level many of the cost contributors benefited from company specific news that showed security prices in our favor rather than macro market moves. We did not make any major portfolio shift this quarter and our modestly increased in our gross exposure as we enter this second quarter given our enthusiasm for the composition of our portfolio. We believe we are well-positioned in our multi-strategy funds to continue the positive momentum we have experienced over the last 12 months. Opportunistic credit continues to outperform high yield indexes. As I previously mentioned in credit OZ got a strong first quarter with a 3.2% net return and a 20.6% net return over the last 12 months to March 31. The quarter began with a rally in the U.S. corporate credit markets driven by political optimism coupled with positive technical trends. The quarter ended with the reappearance of modest volatility similar to other risk markets which we view as a healthy dynamic. Notwithstanding what is generally not been a value investors market in credit we continue to find an ample supply of compelling investment opportunities across the different asset classes and geographies within credit, favoring investments with U.S. having a low bid into the market and the economy. Despite these opportunities we are keeping significant dry powder in credit even where we believe we are in the cycle. Performances once again driven by realizations and structured credit and successful resolutions in various distressed situations in corporate credit. Our CLO business spent the first quarter repricing existing deals and building a new issuance pipeline. To that end we closed the refinancing of three CLOs totaling $1.3 billion of par value in the first quarter. CLO refinancing lowers the deals cost to capital which can lead to increased equity returns. We are focused on being a CLO manager that actively manages the capital structure for the benefit of our clients which has helped us continue to bring new MLP clients into our CLOs. In addition, we priced the first of our 2017 CLOs yesterday which is expected to close in the second quarter with an approximate size of $400 million. In real estate we are seeing elevated valuation levels which are creating opportunities to harvest investments in Funds 1 and 2 at attractive returns for our clients. Notwithstanding these valuation levels we are finding opportunities to make money to work and we have committed over $150 million or more than 10% of funds raised since the beginning of the year. We have committed over half of this fund at this point leaving approximately $717 million to invest. As we have said many times we are a performance driven business and we believe our strong absolute and relative returns across funds, strategies and regions over the first quarter and more importantly over the past 12 months is a leading indicator of our firm's future financial performance. We believe the current market dynamics favor our business model as security selectors and asset allocators. In general, the financial markets continue to be influenced by the changing global geopolitical landscape. New policy initiatives are likely to create volatility amid rapidly changing circumstances which in turn should create openings for security selectors and thus the opportunity to generate returns for our clients. Turning to flows our April 1st net outflow has decreased to those experienced January 1st but we're still elevated. Similar to January net outflows were primarily concentrated in our multi-strategy funds. We believe that the redemption cycle that started in the second quarter of last year has largely ended and we are one quarter away from substantial all clients having had the ability to redeem since this cycle began. From that point forward we believe that multi-strategy flows will return to being primarily driven by our performance and broader industry trends. We are very pleased with the results of the Master Fund over the last 12 months and believe this performance is resonating with clients. As we have said before, we are also focused on growing our opportunistic credit, real estate and CLO businesses on the back of their respective multi-year strong returns. To that end we are pleased to have held a subsequent closing in one of our closed-end funds. To close, I am very pleased with our strong performance in the quarter which continued to enable with the OZ Master Fund posting 1% growth and 68 basis points of net return for the month. We are in a good position to continue to execute across all aspects of the firm for the rest of 2017. With that, let me turn the call over to Alesia.

[Alesia Haas:]

Thanks Dan. Let me start with a report of our economic income results. For purposes of this discussion comparisons to the first quarter of 2016 exclude the impact of the FCPA settlement expense in that period. Our first quarter revenues were $133 million down 24% year-over-year due to a decline in management fees. Management fees were $81 million 44% lower versus the year ago primarily due to the redemptions from our multi-strategy fund and the management fee reduction that took effect in the fourth quarter of 2016. Our incentive income was $52 million for the quarter. The majority of the incentive was earned from previously accrued, but unrecognized amounts. In addition we generated incentive from annual clients with first quarter renewal date. As of March 31, 2017 our gross accrued but unrecognized incentives generated from the extended fee paying clients was $350 million an increase of $21 million quarter-over-quarter. This is driven by an increase of $61 million due to the strong first quarter performance of our multi-strategy and opportunistic credit funds and offset by incentive realization of $40 million. I want to remind you that with the exception of our real estate and energy funds the remainder of this balance has never succeeded [ph] compensation as compensation on these balances was paid in earlier periods. During the remainder of 2017 we now estimate approximately $30 million were contractually crystallized excluding any impact of future fund performance, either positive or negative. In addition approximately $71 million of accrued but unrecognized incentives and our opportunistic credit funds is deep in the money and will crystallize when we harvest the remaining investments in these funds. Now turning to our operating expenses, our first quarter expenses totaled $89 million down 2% year-over-year. For the quarter compensation and benefits were $46 million up 37% year-over-year driven by our decision to provide for a minimum annual discretionary cash bonus that we began to accrue on a straight-line basis this quarter. Salaries and benefits were $26 million essentially flat from the fourth quarter and our bonus expense was $21 million which included the accrual for the quarterly minimum discretionary cash bonus as well as an amount for real estate carry payments as a result of incentive crystallized in the first quarter. In the first quarter non-compensation expenses were $43 million down 26% year-over-year and down 4% sequentially. The sequential decline was primarily due to a decline in our insurance expense. Our expectations for the remainder of 2017 are unchanged from prior guidance given on our fourth quarter call. To recap this guidance we estimate our salaries and benefit expense will range between $100 million and $105 million for the full-year 2017. Our estimated discretionary cash bonus accrual for the remaining three quarters in 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 including interest expense. All guidance reflects our best estimates at this time. As consistent with our practice we intend to update these amounts quarterly as we move forward. Now turning to our balance sheet. As we mentioned last quarter, we closed on the second tranche of the $150 million preferred funding in January. We used a portion of these proceeds to repay the $120 million previously borrowed under our revolving credit facility in March. The combination of these and other activities reduced our outstanding debt by approximately 30% and increased our cash division by 7%. To wrap up, we are proud of this quarter's overall performance and while we are particularly proud of the underlying business drivers, namely our investment performance, we continue to be focused on our long-term objective of providing our clients strong investment returns and client service, growing our assets under management, prudently managing our total expenses and strengthening our balance sheet. With that, we will open the line now for questions.

[Operator:]

[Operator Instructions] And our first question comes from Robert Lee of KBW. Your line is now open.

[Robert Lee:]

Great, thanks for taking my questions. I guess my first question will be, Dan you mentioned I guess there was a subsequent quarter end closing in the closed-end fund, could you may be, was that in credit and I'm assuming we will see those assets flow in in the second quarter, is there any way of sizing that?

[Alesia Haas:]

Thank you for your question Robert. This is Alesia and I'll respond to that. As we are in the marketing period we can't be very specific on the activities that we are undertaking right now and so we'll be able to provide more clarity on the second quarter call, but yes we won't be in the ebb and flow in the second quarter which is our closed-end fund.

[Robert Lee:]

Okay, maybe just a little kind of modeling followup, did you mention that the $30 million you expect to crystallize in the second quarter was that correct?

[Alesia Haas:]

No, that's over the remainder of 2017.

[Robert Lee:]

Okay, thank you and may be just one last question, you know in looking at kind of the flows kind of year-over-year there was a big outflow from other assets under management. Could you just remind us to which strategies are in that other bucket that drove the big outflow?

[Alesia Haas:]

This includes all of the other non major strategies including our energy funds and some of our smaller strategies and our management counter in this bucket.

[Robert Lee:]

All right great, I'll followup with some other questions, thanks.

[Alesia Haas:]

Thank you.

[Operator:]

Thank you. And our next question comes from Mike Carrier of Bank of America Merrill Lynch. Your line is now open.

[Mike Carrier:]

Hi, thanks a lot. Yes maybe first one for you, just you've given what you said in terms of the kind of the fund cycle or the redemption cycle, I just wanted to get your sense you know when you're having conversations with investors, I mean like the distribution team, like how much of that shifted from either the industry issues, the issues that you guys had in 2016 on legal front versus your refocusing on performance and the strength that you're seeing year-to-date? I know you are probably having all those conversations, but just wanted to see how the conversations are maybe shifting over the past couple of quarters?

[Dan Och:]

The dialogue has shifted. The dialogue is primarily about the recent, the last 12 months performance, the components of the performance, the fact that it is broad-based in the multi-strategy funds in addition to the performance numbers, the fact that it's coming from different strategies and different geographic regions which is important because that's something we've done historically and that increases investors expectations that it will continue. And the other products there remained strong as well. So you are correct that there has been a shift and obviously our goal is to continue to perform and do other things to accelerate that shift.

[Mike Carrier:]

Okay, thanks and then Alesia, may be just two things on some of the comments that you made, first you mentioned the $30 million through the year and then I think you also mentioned the $70 million and I just want to make sure we understand that, the $70 million it sounds like if you sell those investments and you can realize that and given that they are deep in the money we could see some of that throughout this year, but obviously timing is dependent on the sale. And then just on the dividend in the payout, meaning the $0.02 versus the $0.07 just any update on maybe capital needs as we kind of progress through this year and next year and where that payout might settle over time?

[Alesia Haas:]

So, thank you for the questions. First I would note that as the majority of our potential incentives and the full picture of our distributor earnings will not be known until the fourth quarter as that is still and we anticipate earning the majority of incentives for the year. We do anticipate for the first three quarters of the year the dividends will be modest and I think that's reflective the $0.02 and we are going to evaluate our overall distribution capacity in the fourth quarter in light of our overall earning. As we mentioned last quarter we will be withholding some of that in capital to strengthen our balance sheet and to fund our new business initiatives. So we will be doing a full evaluation of this in the fourth quarter once our full year earnings are known and we have better clarity on the year.

[Mike Carrier:]

Okay, got it, thanks a lot

[Operator:]

Thank you, and our next question comes from William Katz of Citigroup. Your line is now open.

[William Katz:]

Okay thanks very much. Dan, I just want to clarify something you said, I think you mentioned that maybe you got a quarter away in terms of sourcing some visibility around the hedge fund flows, so just could you refine your commentary a little bit, is that just on redemptions that you're seeing pace redemptions what may be available for unlocking or maybe we assume things in the business pipeline?

[Dan Och:]

Yes, that reference is to the fact that we're one quarter away from virtually all clients having had an opportunity to make a decision post the settlement and post the announcement that this settlement was pending. So we believe we're one quarter away from that impact ending. Obviously the inflow has to do with our performance and the industry.

[William Katz:]

Okay, and on that there seems to be a lot of chatter still around hedge fund pricing has arisen questioning mutual fund businesses as well. Where are you in terms of that expectation with the LPs [ph] are you now at a point where performance matter more is there still some downward pressure for the industry maybe yourselves on the Master Fund?

[Dan Och:]

We're at where we think investors are comfortable with our pricing.

[William Katz:]

Okay, just last one from me, thanks taking all the questions, when I look across your matrix of products and maybe LPs but it is a major distribution category, where do you see the greatest traction going forward, is it credit, real estate, the Master Fund, just trying to get a sense of a number of your peers have been enjoying some very strong growth, I'm still trying to calibrate how we think about that might translate down to your platform?

[Dan Och:]

We're having dialogue with different clients in all areas. Their performance, the teams, the new products all look strong and we believe are all attractive and we believe clients see them that way as well. Different products opportunistic real estate funds and drawdown credit funds tend to have a longer sales cycle traditionally than multi-strategy funds. On the other hand we do believe from an industry perspective, the multi-strategy funds are still dealing with some of the issues of 2015 and 2016. So it is a little bit difficult to say we are comfortable, we're focused in all those areas.

[William Katz:]

Okay, thank you.

[Operator:]

Thank you. And our next question comes from Craig Siegenthaler of Credit Suisse. Your line is now open.

[Craig Siegenthaler:]

Thanks, coming back to the credit business can you continue to ramp this business given the challenging investment backdrop meeting, the University stress that now is quite small relative to the world dry powder and also what segments and geographies are you really focused on the investing front?

[Dan Och:]

We absolutely believe that we can continue to ramp. The CLO business continues to grow and our performance continues to be very strong. The opportunistic credit side we would say the same thing, our performance has been extremely good. Our teams are strong. As you know, we have some opportunities there across some of our different business lines and that is some of the fund raising that's in process right now. We believe that we're very strong in all areas of the capital structure and we have opportunities to grow in all those areas.

[Craig Siegenthaler:]

And then in the real estate business it's over $2 billion now. What are your plans to scale this business and is there any plans to move the product horizontally into different kind of categories or even geographies?

[Dan Och:]

I can't comment specifically on what we may do in terms of new funds, but the answer to both questions is yes, we do have plans to expand the real estate business. We will do it both horizontally and by geography.

[Craig Siegenthaler:]

Got it. Thank you.

[Operator:]

Thank you and our next question comes from Ken Worthington of J.P. Morgan. Your line is now open.

[William Cuddy:]

Good morning. This Will Cuddy filling in for Ken. Thanks for taking our questions. There have been some media reports on employee turnover, could you please compare turnover or conversely retention in 2015, 2016 so far and 2017 please?

[Alesia Haas:]

Well I can't specifically comment on retention rates in each of the three periods, but I can say that obviously the first quarter we do have seasonal attrition as it is the time of year that we pay bonus and the time of the year where we tend to have the most turnover in our employee base. But we don't see anything abnormal about our level of turnover at this time and feel very good about the employees that we have on staff and we've been able to hire in places where we've needed to hire, so I think there's nothing that we are internally concerned about at the time.

[Dan Och:]

The other thing that I’ll add qualitatively is if we look at our MDs, our EMDs, the investment professionals running businesses, senior infrastructure, we feel very good about what our retention has been. We also feel very good about the new people we've been able to bring in and their caliber and quality.

[William Cuddy:]

Okay, thank you. Second, we're getting closer to the implementation of method two, can you please talk about any impacts you're expecting for your business? I know we still have a couple months, but is there anything else that you could add on what you're expecting?

[Alesia Haas:]

We're still going through an internal evaluation at this time, we don’t anticipate anything material but we are updating certain processes to ensure that we are compliant.

[William Cuddy:]

Great. Thank you.

[Operator:]

Thank you. And our next question comes from Dan Fannon of Jefferies. Your line is now open.

[Dan Fannon:]

Thanks. Good morning. Dan, you talked about the redemption kind of anniversary going into next quarter and I was wondering about just gross sales trends, has there been any pick up on a gross sales side here in recent periods or as we think about obviously performance at where it is and the kind of the momentum building within certain products that maybe we can't see on a net basis yet?

[Dan Och:]

Well, the gross sales we will report in the Q you will see the numbers, but as a general matter, we are, we have not seen a substantial pickup in growth in plus. Having said that, we are optimistic that we are doing the right things, such that, when the industry is poised we are well positioned.

[Dan Fannon:]

Got it and then just to clarify on the accrued incentive, the comp has not, has already been booked for the $30 million also for the $70 million as well you've already booked comp against that?

[Alesia Haas:]

Two different metrics, so if we look at the exhibit it is fixed within our press release we give a table that shows the accrued, but unrecognized incentives by strategy and my comments with regard to compensation are with real-estate and other we owe compensation in the future, but the remaining balances which comprise our multi strategy and opportunistic credit compensation has already been paid on those amounts. We did not provide the strategy breakdown of the $30 million of contractually crystallizing incentive in 2017, this $70 million that we commented on that is deep in the money at 100% in opportunistic credit.

[Dan Fannon:]

Great. Thank you.

[Operator:]

Thank you. And I'm showing no further questions at this time. I’d like to turn the conference back over to Mr. Willkomm for closing remarks.

[Adam Willkomm:]

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

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.