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Edited Transcript of OZM earnings conference call or presentation 2-Nov-18 12:30pm GMT

Q3 2018 Och-Ziff Capital Management Group LLC Earnings Call

NEW YORK Nov 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Och-Ziff Capital Management Group LLC earnings conference call or presentation Friday, November 2, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Willkomm

Och-Ziff Capital Management Group LLC - Head of Business Development and Shareholder Services & MD

* Robert Scott Shafir

Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director

* Thomas M. Sipp

Och-Ziff Capital Management Group LLC - CFO & Executive MD

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Conference Call Participants

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* Gerald Edward O'Hara

Jefferies LLC, Research Division - Equity Analyst

* Michael Anthony Needham

BofA Merrill Lynch, Research Division - Associate

* 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 Oz Management's Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference call is being recorded.

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

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Adam Willkomm, Och-Ziff Capital Management Group LLC - Head of Business Development and Shareholder Services & MD [2]

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Thanks, Chris. 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 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 third quarter 2018 GAAP net loss of $15 million or $0.08 per basic and diluted Class A share. As always, you can find a full review of our GAAP results in our earnings release, which is available on our website.

On an economic income basis, we reported third quarter 2018 distributable earnings loss of $5 million or $0.01 per adjusted Class A Share. Excluding a $19 million legal provision incurred in the quarter, third quarter 2018 distributable earnings were $11 million or $0.02 per adjusted Class A share. We declared a $0.02 dividend for the third 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.

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [3]

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Thanks, Adam, and good morning, everyone. We are happy with our credit and real estate performance in the quarter, and we believe we held our ground in multi-strategy against the difficult market backdrop. The Oz Master Fund was down 0.4% net for the quarter and up 4.0% net for the first 9 months of 2018. In our opinion, our disciplined consistent approach continues to deliver. All of our major strategies within the Master Fund were positive for the first 9 months of 2018. In the quarter, we experienced strong performance in corporate and structured credit, which we will touch on in a moment. The strong credit performance was offset largely by merger arbitrage as well as soft performance in Asian equities.

October was particularly challenging for the Master Fund returning negative 2.8% net as global equity markets moved decidedly downward and volatility increased. On a relative basis, we outperformed global market benchmarks in October, which were down approximately 7.5%. Our portfolio hedge overlay and single-name shorts performed strongly in the month, it helped offset losses. Periods like this demonstrate the value of our multi-approach and our portfolio hedge strategy. We also tend to view the investing landscape as target rich in the periods following these corrections, which we think bodes well for prospective returns.

Oz Co. our global opportunistic credit fund was up 2.4% net for the third quarter and 8.8% net for the first 9 months of 2018 and 12.7% annualized net since inception. Our credit business continues to be -- to see strong, differentiated returns despite the recent difficult environment, October included. Corporate credit was a large contributor this quarter as our active involvement in 2 large restructuring situations yielded positive results. In structured credit, we had strong performance across all subsectors.

In real estate, we continued to deploy capital in our opportunistic and credit real estate funds, while also realizing investments. In the third quarter, we had full or partial realizations of 9 investments, 7 from our most recent opportunistic real estate fund, which were realized at an average gross multiple of 1.8x. In total, we have committed approximately 2/3 of our most recent opportunistic real estate fund, generating a 23% annualized net return for investors since inception. Our real estate credit fund is currently 22% deployed.

We continue to consider avenues to expand our real estate platform, which include tax-exempt real estate credit investments, secured by affordable housing properties in the United States. We believe this strategy is a logical expansion of both our real estate and credit capabilities.

Our CLO franchise continues to perform and we remain an active issuer. In the third quarter, we closed a new European CLO adding $480 million in new assets under management and refinanced 4 existing U.S. CLOs. We expect additional CLO issuance and refinancing throughout year-end.

Turning to flows. On November 1, assets under management were $32.3 billion, down 4.7% versus the end of the second quarter and essentially flat versus year-end 2017. Our flow picture largely remains the same as what we described last quarter. In real estate, our third opportunistic fund is roughly 2/3 deployed, and we expect further increases in AUM. In opportunistic credit, the flow pipeline is building on the back of our continued strong performance. In Institutional Credit Strategies, we continue to be optimistic about our ability to issue CLOs and we anticipate more opportunities coming from our efforts in aviation with our partner, GECAS.

In multi-strategy, inflows continue to disappoint, but we are actively engaged with both existing and potential clients across the U.S., Europe and Asia. The effort is starting to have some success, specifically, in the private banking channel. Private banks have historically been a significant source of flows for multi-strategy. We expect this channel to reopen in the near future, which we anticipate will lead to a resumption of flows. The fourth quarter outflow picture should be a more positive one as we anticipate that our gross outflows will be the lowest on a percentage basis since the fourth quarter of 2015.

As we move into year-end, we continue to be disciplined and focused on execution. We have seen particularly good performance for the year in credit and real estate and have protected capital in multi-strategy. We have the right products and history of generating returns for our clients and believe that this market correction and accompanying volatility often creates a variety of compelling investment opportunities.

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

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [4]

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Thanks, Rob, and good morning, everyone. As Adam mentioned at the beginning of the call, we reported third quarter 2018 distributable earnings of $11 million, excluding the legal provision incurred in the period. Revenues for the quarter were $89 million, down 29% as compared to the third 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 third quarter of 2018, 8% lower than a year ago and 1% higher than the prior quarter. The year-over-year management fee decrease was driven primarily by lower multi-strat assets, partially offset by increased assets in Institutional Credit Strategies.

Incentive income was $19 million for the third quarter of 2018, 62% lower than the year ago and 44% lower than the prior quarter. Again, this is based on timing of redemptions and incentive from extended fee-paying investors, which is highly variable from quarter-to-quarter. As of the quarter-end, our accrued but unrecognized incentive was $358 million, up 5% as compared to the prior quarter. The increase was primarily due to performance in credit and real estate. 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. We expect to realize a majority of this accrued but unrecognized incentive over the next 3 years.

Other revenues were $3 million for the third quarter of 2018, down 14% versus the prior quarter, primarily due to the sale of certain risk-retention investments in our U.S. CLOs, accompanied by a corresponding decrease in interest expense related to CLO risk-retention liabilities.

Now turning to our operating expenses. Our third quarter total expenses were $95 million. Excluding the $19 million legal provision that we'll discuss shortly, third quarter expenses were $76 million, flat year-over-year and down 9% versus the quarter -- second quarter of 2018.

During the third quarter of 2018, we accrued an additional $19 million provision related to the shareholder class action suit, previously described in our SEC filings, which has now been settled in principle. The settlement allows us to take another big step in terms of putting our legacy issues behind us. For the third quarter of 2018, compensation and benefits were $47 million, up 7% year-over-year and down 3% sequentially.

Salaries and benefits were $22 million for the quarter, down 9% from the third 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. Bonus expense was $24 million for the quarter, flat from the prior quarter and 26% higher than the third quarter of 2017, primarily due to an increase in the minimum annual bonus accrual. We expect that full-year minimum annual bonus accrual for 2018 will be consistent with previously communicated guidance of between $80 million and $90 million.

For the third quarter of 2018, G&A expenses, excluding interest in the previously mentioned legal provision, were $25 million, down 5% from the third quarter of 2017 and down 12% from the prior quarter as a result of our focus on expense reductions. We expect these expenses to be higher -- at the higher end of our $100 million to $110 million guidance for the full year.

Our interest expense was $5 million in the third quarter, down 14% year-over-year and down 36% sequentially. The decrease on a sequential basis was attributable to the 50% reduction in our corporate debt in the second quarter of 2018 as well as the payoff of certain CLO risk-retention financings.

In summary, while there were 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 the balance sheet. We continue to have a healthy cash balance and our outstanding corporate debt was $200 million as of September 30, 2018. As we begin to get clarity on fourth quarter distributable earnings, our first priority is to continue to strengthen our balance sheet. After that, we will evaluate dividends, share repurchases and investments in the business, based on what we believe is in the best long-term interest of shareholders.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Gerry O'Hara with Jefferies.

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Gerald Edward O'Hara, Jefferies LLC, Research Division - Equity Analyst [2]

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I guess the first would be around the comments given from -- for the multi-strategy fund and obviously, the optimism around 4Q gross flows. But perhaps you could elaborate a little bit on what gives you confidence with respect to the private banking channel? And also perhaps more broadly, how conversations are evolving, especially given the track record for lower volatility risk-adjusted returns within choppy markets?

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [3]

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Sure, it's Rob, I'll take that. I think a couple of things. On the -- as I said on the outflow side, we have very good visibility on the fourth quarter. And with multi-strat there's always some element of churn, just given the liquidity of the fund, but those outflow numbers, obviously, are trending down and that is at least -- it seems to be a positive sign. In terms of inflows, on the private banking channel, we're beginning to see that channel open up, as I said, one of the major private banks has greenlighted us, and we are in extensive discussions with a couple of the other ones to achieve the same thing. Typically those channels, it takes a while to get those channels up and running again, but we do think that they are a very important segment for multi-strategy investors because we think a multi-strategy product, particularly in more choppy environments is a very sensible product for private banking clients. So I think, over time, we think that could be material. In addition to which, I say it in the institutional channels, I mean, look it has been slower than I would've expected, we start to see the inflows there. But as I've talked about on other calls, where a lot of the lights were red in the beginning of the year, post some of the disruptions and were turning more yellow, we are getting upgrades from some of the important consultants out there. So again, early signs of optimism, I would not want to create an expectation that we're going to have some massive inflows in the short term, but I think it's about forming a base, continuing to stabilize, continuing to perform and to start getting that inflow picture trending positively going into 2019.

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Gerald Edward O'Hara, Jefferies LLC, Research Division - Equity Analyst [4]

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Great, thanks for that color. And then perhaps one for Tom. Just around the comment there on the balance sheet and continuing to strengthen metrics in the balance sheet. But perhaps, you could give a little context there, as how we can start to think about what that dividend might look like? Or what the cash balances might need to be before you start to kind of increase the dividend? Anything that sort of gives us a little color or context as to how we can think about that going into fourth quarter and next year.

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [5]

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Yes, sure. The -- I mean, regarding dividend our practice has been to -- our recent practice is to have a consistent dividend on the first 3 quarters of the year. The full-year dividend will obviously be based, we've got to finish the year, understand our distributable earnings, our performance for the year and then the board will make the decision. So we're going to have to wait for the year to play out to make that decision. The balance sheet, we will look to improve the balance sheet, have a priority to pay down our debt and retain cash over the next couple of years. So the dividend will be a relatively modest payout ratio, but we will evaluate that as we finish the year and as we continue to outperform.

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Operator [6]

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Our next question is from Bill Katz of Citigroup.

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William R. Katz, Citigroup Inc, Research Division - MD [7]

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Just a couple, you mentioned some optimism also, I think, on real estate and CLOs. Where are you in terms of the opportunity to, sort of, raise the funds for? There has been some news out there about the potential sizing of that. So is there any way maybe you can give us some color or sense on how that might be going? And then is there a way to, sort of, size the pipeline on the CLOs?

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [8]

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Yes, sure, Bill. On the real estate side, typically, we get to 75% or above in terms of invested assets on the prior fund. And as I said, we're getting close to that number, we're not quite there yet. And as we get there, we'll think about exactly when to launch fund for. And as you know, and as we've talked about on these calls, performance in the real estate funds has been very, very strong. And we see a lot of investor demand out there for that product. So we'll get the fund -- we'll get to a point where we can launch that fund and we'll think about timing as we get close to the year-end and we'll be talking about that then. But I think, the net of it is we're very optimistic about our ability to raise that fund, just given the performance of the prior funds and what we see as investor demand there. On the CLO business, we priced, actually this week a $500 million European CLO and we were in price talk, we should price it in the next few days. And I would expect to see more consistent growth there as we've seen. One of the things we talk about a lot on these calls, appropriately so, is the multi-strat. But the other side of the coin is the firm has successfully, over the last few years, diversified its platform. And things like the growth of the CLO business in particular has offset a lot of that. You've seen in our management fee line actually slightly up quarter-over-quarter here. And as we even go beyond just pure CLOs with, for example, the aviation story, and the GECAS product and other things that we're seeing as opportunities on the aviation side, it's just continued diversification within the core verticals that we are betting our future on here. So I think the diversification story is a good one. That being said, we obviously want to turn multi around because we do believe in the product.

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William R. Katz, Citigroup Inc, Research Division - MD [9]

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Okay, that's helpful. And just a couple more things taken this morning. Just in terms of the flows, you had mentioned you had some good insight or line of sight into some of the maybe pending outflows that are out there. How confident are you, just given that, my sense is that you -- maybe the bigger lump that might still come out could be at the end of the year or just into the January subscription period? Or is that already taken into consideration in your comments?

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [10]

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The only thing we have visibility on is actually what we technically -- we will report for the fourth quarter. So I couldn't tell you at this point because I just don't know, what that's going to look like until we get to the actual redemption notice periods for the quarter for what will hit January 1. So I really don't have visibility on it yet.

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William R. Katz, Citigroup Inc, Research Division - MD [11]

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Okay. And then just last one for Tom. On your guidance for the G&A being at the upper end of the range. Is that inclusive or exclusive of the legal charge? I'm sorry, it wasn't clear to me.

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [12]

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Yes, that's -- that excludes the legal provision.

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Operator [13]

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(Operator Instructions) And our next question is from Michael Carrier with Bank of America Merrill Lynch.

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Michael Anthony Needham, BofA Merrill Lynch, Research Division - Associate [14]

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This is Mike Needham in for Mike Carrier. First one I've got is, kind of, as you think about the full year, markets have been kind of weak in the Master Fund, it's down a bit in October. If the Master Fund is -- it kind of looks like it's going to have a light year this year, how do you think about managing your cost appropriately for the full year back in 2015 and '16, when performance was, kind of, similar? We saw losses or breakeven quarters for the fourth quarter, so just wondering how you are thinking about that.

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [15]

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I'll start and maybe, Tom, you can jump in specifically on the cost side. It's obviously difficult to predict the year, particularly the volatility in the markets right now. But -- and as we know, you've seen how much the markets gave back in October, which put most of the markets around the globe either, sort of, flat or slightly down or in some cases, more than slightly down in the year. So I think we're more than holding our own on the performance side there. And in other products areas as we talked about earlier, particularly credit and real estate, we've done quite well. But in the context of what we would see today, it is conceivable that we would have somewhat of a lighter performance number than for example last year, but again, it's hard to say. You've seen what the markets have done in the last 2 days. But look, I think on the cost side, we have to balance the short term and the long term here. We have to be and are being disciplined around our cost base and Tom can speak more specifically about not only what we're doing right now, but what a lot of our plans are. You've seen our headcount reduce pretty substantially over the course of this year. And we're focusing on a lot of things, some structural and some more tactical, in terms of managing our cost base. That being said -- and by the way, part of that is also sort of narrowing our focus on the key areas that we've really sort of planted our flag in of multi-credit and real estate and getting out of some of the smaller peripheral businesses. That being said, I think for the long-term strategically -- look, believe in the platform and we believe that these products have the potential to grow. So while we want to cut our run rate around a lot of things and get more efficient and I think we have the opportunity, absolutely, to do that, we do want to maintain our global capability in these markets so that we can take advantage of the investment opportunities and have a platform that we can grow back into in the longer term, but Tom, I don't know if you want to add to that.

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [16]

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Yes, I would just add that, we would expect our salaries and benefits to continue to decrease quarter-over-quarter as we become more efficient and we reduce headcount. The G&A we talked about we will still be at the higher end of 100 to 110 range. And then the bonus payments for this year will balance, some will be, obviously, variable with the performance. And some will be balanced with retaining our talent over the medium and long term. So obviously, with lower performance the overall bonus payments will be lower, but you're going to balance that out between short-term performance and investing in the platform long term.

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Michael Anthony Needham, BofA Merrill Lynch, Research Division - Associate [17]

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Yes. I understand that...

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Robert Scott Shafir, Och-Ziff Capital Management Group LLC - CEO, Executive MD & Director [18]

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This is Rob again. I do think longer-term as we look out beyond this year, I think there is a decent amount of room in a lot of these expense buckets for us to make much more improvement, particularly as we get past this year, where we've done a lot of pruning and strategically moving some things around as we get into a more normalized run rate state.

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Michael Anthony Needham, BofA Merrill Lynch, Research Division - Associate [19]

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Got it. And just as a follow-up on the headcount. Can you give me an update on the change this year. And if you have it roughly, how much headcount is down from the peak?

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [20]

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From the peak, what a few years ago?

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Michael Anthony Needham, BofA Merrill Lynch, Research Division - Associate [21]

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Yes. If not, it's fine...

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Thomas M. Sipp, Och-Ziff Capital Management Group LLC - CFO & Executive MD [22]

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Year-end '16 was 524, year-end '17 was 483, we're at 428 now. We would expect to -- we think there are additional opportunities to be more efficient. There are some outsourcing activities that are in process. So we would expect that to be -- to continue to be a little lower going forward.

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Operator [23]

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

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Adam Willkomm, Och-Ziff Capital Management Group LLC - Head of Business Development and Shareholder Services & MD [24]

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Thanks, Chris. 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.

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Operator [25]

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Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Thank you.