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Edited Transcript of OZM earnings conference call or presentation 7-Nov-19 1:30pm GMT

Q3 2019 Sculptor Capital Management Inc Earnings Call

NEW YORK Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Sculptor Capital Management Inc earnings conference call or presentation Thursday, November 7, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Elise King

Sculptor Capital Management, Inc. - Head of Shareholders Services

* Robert Scott Shafir

Sculptor Capital Management, Inc. - CEO, Executive MD & Director

* Thomas Michael Sipp

Sculptor Capital Management, Inc. - CFO & Executive MD

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Conference Call Participants

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* William R. Katz

Citigroup Inc, Research Division - MD

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Sculptor Capital Management's Third Quarter 2019 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, Elise King, Head of Shareholder Services at Sculptor Capital Management.

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Elise King, Sculptor Capital Management, Inc. - Head of Shareholders Services [2]

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Thanks, Bonita. Good morning, everyone, and welcome to our call. Joining me are Robert Shafir, our Chief Executive Officer; and Tom Sipp, our Chief Financial Officer. Today's call contains forward-looking statements, many of which are inherently uncertain and outside of our control.

Before we get started, I need to remind you that Sculptor Capital'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, including those in our most recent 10-K, 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 entities.

Our earnings press release from this morning also included an earnings presentation. We will be referring to this report during the call. If you would like to follow along, you can find the presentation on the public Investors page of sculptor.com at the 3Q Press Release link.

Earlier this morning, we reported a third quarter 2019 GAAP net loss of $25 million or $1.20 per basic and diluted Class A share. As always, you can find a full review of our GAAP results in our earnings release.

On an economic income basis, we reported third quarter 2019 distributable earnings of $2.3 million or $0.04 per fully diluted share. In the third quarter, we recorded a legal provision of $19.1 million, which will be -- which we will provide further detail on during the financial update.

Adjusted distributable earnings, which excludes the legal provision net of [TRA] and other payables, were $17.7 million or $0.32 per fully diluted share for the third quarter of 2019. 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.

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Robert Scott Shafir, Sculptor Capital Management, Inc. - CEO, Executive MD & Director [3]

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Thanks, Elise, and good morning, everyone. Starting with investment performance, this is a challenging quarter for our funds. Markets continued to react to developments in the U.S.-China trade war and shifting sentiment over global growth as well as sizable movements in interest rates and abrupt factor rotations in equities.

Sculptor Master Fund was down 2.8% net for the third quarter but is up 8.5% net year-to-date through September 30, comparing favorably with the HFRI fund-weighted composite index year-to-date return of 6.8%. In addition, the Master Fund was up 1.9% net in October, bringing year-to-date net performance to 10.5% through October 31.

Performance in the third quarter was primarily the result of a handful of negative company-specific developments for some of our larger fundamental equity positions. Corporate credit was also a net detractor, attributable in part to our modest exposure to energy-related companies and idiosyncratic weakness in a small number of positions.

Looking deeper into the Master Fund performance, I'd like to point out that there were a number of positive developments, which helped to counterbalance losses, which we believe are illustrative of the benefits of our opportunistic approach and the breadth of our investment capabilities. Several of our largest and most complex positions in merger arbitrage, corporate credit and convertible and derivative arbitrage achieved significant milestones consistent with our investment thesis.

It is also worth noting that we held net and gross equity exposure comparatively low during the quarter as higher implied volatility increased the cost of maintaining convexity in our hedge strategy. This involved a number of disciplined reductions in equity positions that have outperformed year-to-date, an effort that we believe has been prudent given the potency of key headline risks related to the escalation of the trade war, changes in monetary policy expectations, mixed economic data and Brexit.

The Sculptor Credit Opportunities Fund, our global opportunistic credit fund, was down 2.2% net for the third quarter 2019 and is up 1.1% net for the first 9 months of the year. While challenges for a handful of positions have driven the near-term underperformance, the fund continues to demonstrate strong and differentiated long-term returns, with a 10.8% net annualized return since inception.

Our real estate funds continued to deploy capital and generate strong returns, with a 20% annualized net return in our third opportunistic fund through September 30.

Turning to flows. As you can see on Page 7, as of November 1, our assets under management were $33 billion. Our net inflows in the third quarter were $15 million due to the closing of a new CLO and inflows into our opportunistic credit strategy partially offset by redemptions in the Sculptor Master Fund. In addition, from October 1 to November 1, we had net inflows of $930 million driven by the first close of Sculptor Real Estate Fund IV.

Turning to Page 8. Real estate had total assets under management of $1.8 billion as of September 30, which included reductions of $1.1 billion in the third quarter due to the expiration of the investment period for Real Estate Fund III. From October 1 to November 1, real estate had approximately $1.2 billion in subscriptions due to the first close of Real Estate Fund IV and related co-investment vehicles. There has been high demand given our strong performance and tenured team, and we look forward to additional closings over the next year.

In addition, we continue to see opportunities to expand real estate's product offerings. Opportunistic credit has $6 billion of assets as of September 30, which included $97 million of net inflows in the quarter from October 1 -- inflows to the quarters. From October 1 to November 1, there were an additional $76 million of outflows from former executive managing directors as part of the strategic actions announced in December 2018. We continue to see room for future opportunistic credit product adjacencies.

Institutional Credit Strategies had total assets of $14.9 billion as of September 30 and net inflows of $259 million in the third quarter, primarily driven by the closing a U.S. CLO. We expect additional refinancing activity in the fourth quarter.

In addition, last month, we priced our first collateralized bond offering, which utilized our capabilities across bond and loan investing. Once closed, the CBO will add around $270 million to AUM. We intend to opportunistically issue CBOs in the future.

Our multi-strategy products had assets of $9.1 billion as of September 30. Net outflows in the third quarter were $351 million and approximately $83 million from former executive managing directors. From October 1 to November 1, there were approximately $23 million of outflows from former executive managing directors.

Getting deeper into multi-strat. We had expectations that there would be inflows in 2019 and it has taken longer than our original expectation. I want to directly address the point we have alluded to many times. Simply put, the FCPA settlement cast a long shadow on the firm. The settlement, subsequent corporate events and reputational overhang of these matters are the primary reason why material inflows have not resumed in our core open-ended funds. We have been aware of this negative impact and have taken necessary steps to address the issue and move the firm forward.

The firm that got into trouble 10 years ago in Africa does not exist today. Sculptor today has completely new management, compliance controls and governance structure. No one who was involved in the FCPA matter remains at the firm. We now have a team and governance structure in place that leaves us highly confident not only that we will avoid regulatory problems in the future but also that we can maintain a stable, professional and highly transparent investment organization.

To mark this change, we have a new name, which sends the message to our clients' constituents that we have entered a new chapter. The firm has made necessary changes to demonstrate to potential clients that Sculptor is a prudent choice for capital allocation. Clients and potential clients have reacted positively to these changes, and while the length of the sales process means it will take time to see results, we feel confident knowing we've done everything we can to position the firm for success.

We are excited to compete in the marketplace for new mandates on the merits of our team, track record, investment capability and client service.

With that, let me turn the call over to Tom to go through the financials.

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Thomas Michael Sipp, Sculptor Capital Management, Inc. - CFO & Executive MD [4]

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Thanks, Rob, and good morning, everyone. As Elise mentioned at the beginning of the call, and as you can see on Page 9, we reported third quarter 2019 distributable earnings of $2.3 million. Adjusted distributable earnings for the quarter were $17.7 million, and we declared a cash dividend of $0.03 per Class A share.

Turning to Page 10. Revenues were $93 million for the quarter, down 4% from the previous quarter and up 5% from the third quarter of 2018. Management fees were $59 million in the third quarter, up 3% from the previous quarter and 11% lower than the third quarter of 2018. The year-over-year decrease in management fees was primarily driven by lower multi-strategy assets and by the change in Sculptor Real Estate Fund III's management fee calculation from committed capital to invested capital. This was partially offset by increased assets in Institutional Credit Strategies and Opportunistic Credit Funds. The increase quarter-over-quarter was attributable to opportunistic credit and CLO inflows.

Incentive income was $31 million in the third quarter, down 12% from the previous quarter and up 59% compared to the third quarter of 2018. Please note that given Master Fund's performance in 2018, we have a loss carryforward in 2019. Our performance thus far into 2019 has us in a gain position, but this remains dependent on full year performance.

As seen on Page 11, as of the quarter end, our accrued but unrecognized incentive was $258 million, down 18% or 6% from the prior quarter -- down $18 million or 6% from the prior quarter. The decrease was primarily driven by the recognition of $17 million of incentive in the third quarter.

As a reminder, with the exception of the balance associated with our real estate funds, most of the remaining balance has no associated compensation expense as this was paid in earlier periods.

Turning to Page 10. Other revenues were $4 million in the third quarter, down 28% from the previous quarter and up 9% versus the third quarter of 2018.

Now turning to our operating expenses. For the third quarter 2019, total expenses were $91 million, up 39% from the previous quarter and down 5% versus the third quarter of 2018. Excluding the $19.1 million legal provision recorded in the third quarter of 2019 and $18.8 million in settlement expenses recorded in the third quarter of 2018, total expenses were down $5 million or 6%.

In the third quarter of 2019, compensation expense and benefit expense was $46 million, up 15% from the previous quarter and flat from the third quarter of 2018. Bonus expense was $27 million for the third quarter, up 29% from the previous quarter and up 9% from the third quarter of 2018. The increase was driven by higher compensation payments associated with realized incentive income in the quarter. We continue to expect full year minimum annual bonus for 2019 to be between $85 million and $90 million.

Salaries and benefits were $20 million for the third quarter, down 1% from the previous quarter and down 12% from the third quarter of 2018 due to lower headcount. We continue to expect full year 2019 salaries and benefits to be between $80 million and $85 million.

In the third quarter, general and administrative expenses were $42 million, up 90% from the previous quarter. Excluding the legal provision in the third quarter of 2019 and the settlement expense in the third quarter of 2018, G&A was down $2 million or 6%. We expect G&A to be between $85 million and $95 million in 2019. Please note, this guidance excludes strategic action expenses and the legal provision.

Our interest expense was $2 million in the third quarter of 2019, down 14% from the previous quarter and 57% lower than third quarter of 2018 due to the reduction in our term loan balance. We continue to expect full year 2019 interest expense to be between $10 million and $15 million.

Our guidance for the full year 2019 tax receivable agreement and other payables as a corporation remains unchanged at 18% to 22%. 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.

Going back to the previously mentioned litigation reserve associated with the Africa matter. Based on the current facts, our African subsidiary accrued a $19.1 million provision due to the outstanding claim. There was no previous expense recorded in relation to the matter in prior periods. The provision is based on what accounting rules dictate and based on the detailed analysis undertaken by our team, which includes external experts. We feel that we have strong arguments to make and look forward to presenting them to the court.

Now an update on the balance sheet. At quarter end, total cash, cash equivalents and long-term treasuries were $389 million. Subsequent to quarter end, we paid down the term loan by $5 million, resulting in an outstanding balance of $45 million. We will continue to strengthen our balance sheet by using the majority of our earnings after public shareholder dividends to pay down our existing term loan, followed by the new preferred and debt created as part of the strategic actions.

With that, let me turn it back over to Rob.

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Robert Scott Shafir, Sculptor Capital Management, Inc. - CEO, Executive MD & Director [5]

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Thanks, Tom. To wrap it up, this has been a more difficult quarter for performance, but we remain highly confident with our strong year-to-date multi-strategy performance and longer-term opportunistic credit performance.

We have seen our strategic -- we have seen our strategies produce positive results across investment cycles and believe that this is aligned with clients' long-term objectives. We remain committed and focused on our core products and believe in their viability for our investors, as evidenced by the strong demand and successful first close of Real Estate Fund IV. We continue to focus on our key objectives of performance, building out our distribution capabilities and managing our expense base.

With that, we'll open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Bill Katz with Citi.

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William R. Katz, Citigroup Inc, Research Division - MD [2]

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Okay. I apologize for any background noise. So just -- thank you, first of all, for the expanded disclosure. It's very helpful. And maybe a question to Tom. So on the litigation reserve, how should we think about any upsize to that? So I wonder if you could go into -- from the accounting side of things, is this sort of what you think is the full liability. Or how might we link that thing, sort of residual exposure to that?

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Thomas Michael Sipp, Sculptor Capital Management, Inc. - CFO & Executive MD [3]

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Yes. Thanks, Bill. I mean this is our best current estimate of exposure in the case, what's informed by our internal work and external experts. We're continuing to work vigorously to defend the matter. And unfortunately, we're not at liberty to comment any further as it's open litigation.

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William R. Katz, Citigroup Inc, Research Division - MD [4]

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Okay. And just on that, is it still a mid-December type of resolution in terms of the core proceedings? Or are there different set of dates to be looking for?

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Thomas Michael Sipp, Sculptor Capital Management, Inc. - CFO & Executive MD [5]

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We're not going to comment on the exact dates of the proceedings.

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William R. Katz, Citigroup Inc, Research Division - MD [6]

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Okay. And then just another one for you. In terms of -- as you think about that at the end of year, I appreciate that we've got another 1.5 months to go in terms of performance, what have you. But how should we think about maybe variable compensation as a percentage of incentive compensation -- percentage of revenues, excuse me.

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Thomas Michael Sipp, Sculptor Capital Management, Inc. - CFO & Executive MD [7]

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Yes. Bill, we don't guide our compensation as a percentage of revenue, especially on a quarterly basis because our compensation is not realized depending on our strategies and our products. At the same quarter, there can be differences in timing. So we don't guide a specific comp ratio.

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William R. Katz, Citigroup Inc, Research Division - MD [8]

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Okay. And just maybe one last one. Rob, maybe one for you. Just in terms of the frustration with the hedge fund platform not turning as fast as you anticipated. That being said, if you look at your net flows, x some of these former employees [and it is about flat] now. As you think about 2020, maybe update us on your -- conversations you're having around the new distribution efforts? And any incremental platforms that might be sort of an opportunity as well.

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Robert Scott Shafir, Sculptor Capital Management, Inc. - CEO, Executive MD & Director [9]

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Yes. Sure, Bill. Obviously, the actual results are pretty hard to predict. But I sort of stand by our thesis all along here. We -- when we look at our products in the hedge fund space, whether it's our multi-strategy product or our credit products, we feel very good about not only our performance of these products but the timeliness of the products. What we've done over the course of this year is obviously address a lot of the overhang, the things that I talked about in my remarks regarding sort of things from our past, which I think, culminated with the new name of the firm, which really, I think, is sending the message that this really is a new firm run by different people with a very, very tight governance structure.

We have invested in our sales force. We've made senior hires pretty much across the globe at all 3 regions. We've gotten the Reg D waiver this year. We've made investments in our wealth platform as well. So we feel good about the conversations. We feel good about the performance. It has taken longer than we -- than I expected it to, and I want to be clear about that. But I still feel confident that, over time, if you have good products that make sense for clients, and good performance, and we're getting that message out and we have addressed the issues that this firm had in its past history, I think, ultimately, we are going to prevail there. It's hard to predict exactly when that's going to happen. But I think we're doing all the right things and trending the right way.

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Operator [10]

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(Operator Instructions) I'm not showing any further questions. I will now turn the call over to Ms. King.

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Elise King, Sculptor Capital Management, Inc. - Head of Shareholders Services [11]

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Thanks, Bonita. Thank you, everyone, for joining us today and for your interest in Sculptor Capital. 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. Thank you.