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Edited Transcript of OZM earnings conference call or presentation 2-May-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Och-Ziff Capital Management Group LLC Earnings Call

NEW YORK May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Och-Ziff Capital Management Group LLC earnings conference call or presentation Tuesday, May 2, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Willkomm

* Alesia J. Haas

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

* Daniel Saul Och

Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD

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Conference Call Participants

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* Craig William Siegenthaler

Crédit Suisse AG, Research Division - Global Research Product Head for the Asset Management Industry

* Daniel Thomas Fannon

Jefferies LLC, Research Division - Senior Equity Research Analyst

* Michael Roger Carrier

BofA Merrill Lynch, Research Division - Director

* Robert Lee

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* William R Katz

Citigroup Inc, Research Division - MD

* William V. Cuddy

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Och-Ziff Capital Management Group's 2017 First Quarter Earnings Call. (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.

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Adam Willkomm, [2]

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Thanks, Candace. 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 cents 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 turn the call over to Dan.

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [3]

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Thanks, Adam, and good morning, everyone. A 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 from 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 postelection trends and ended with that rally beginning to falter. Industries that were in favor during the rally saw gains reversed in some cases sharply, and other industries previously deemed unlikely beneficiaries of policy change began to see gains. Additionally, interest rates fluctuated while volatility lulled and then accelerated.

During shifting market conditions, the OZ Master Fund maintained positive performance highlighting our securities selection and asset allocation ability in quickly evolving markets. The fund's first quarter gains were driven primarily by realized catalysts and positive developments in a number of our larger positions. While certain positions were outsides' contributors to performance, there were many more singles and doubles. We saw a strength across merger arbitrage, corporate credit, long/short equity, structured credit and convertible and derivative arbitrage. At a position level, many of our cost contributors benefited from company specific news as well as security prices in our favor rather than macro market moves. We did not make any major portfolio shifts this quarter and are modestly increasing our growths exposure as we enter the 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 indices. As I previously mentioned in credit, OZ Co. had a strong first quarter with a 3.2% net return and a 20.6% net return over the last 12 months through 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' marketing credit, we continue to find an ample supply of compelling investment opportunities across the different asset classes and geographies within credit, favoring investments we view as having low [bid] into the market and the economy. Despite these opportunities, we are keeping significant dry powder in credit given where we believe we are in this cycle. Performance was once again driven by realizations in structured credit and successful resolutions in various distress 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 3 CLOs, totaling $1.3 billion in par value in the first quarter. CLO refinancing lowers the deal's cost of 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 and repeat clients into our CLOs. In addition, we priced the first of our 2017 CLOs yesterday, which was expected to close in 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 Fund I and Fund II at attractive returns for our clients. Notwithstanding these valuation levels, we are finding opportunities to [put] money to work and we’ve committed over $150 million, or more than 10% of [Fund III] 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 1 net outflows decreased from those experienced January 1, but were 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 substantiating our clients having had the ability to redeem since this cycle begin. 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 the respective multiyear 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 in April with the OZ Master Fund posting 1% gross 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.

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [4]

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Thanks, Dan. Let me start with the report of our economic income results. For purposes of this discussion, comparison to the first quarter of 2016, exclude the impact of 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 a year ago, primarily due to the redemptions from our multi-strategy funds 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 dates. As of March 31, 2017, our growth accrued, but unrecognized incentives generated from the extended fee paying clients was $350 million, an increase of $21 million quarter-over-quarter. This was 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 no associated compensation, as compensation on these balances was paid in earlier periods.

During the remainder of 2017, we now estimate approximately $30 million will contractually crystallize, excluding any impact of future fund performance, either positive or negative.

In addition, approximately $71 million of accrued but unrecognized incentives in 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 accruals 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, noncompensation 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 3 quarters in 2017 will be between $18 million and $20 million per quarter. We estimate that our noncompensation 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 position by 7%.

To wrap up, we are proud of this quarter's overall performance. And while we are particularly proud of the underlying business fibers, 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 up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Robert Lee of KBW.

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Robert Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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I guess my first question would be, Dan, you mentioned, I guess, there was a subsequent quarter-end closing in the close end fund, could you maybe -- was adding credit and is there -- and I'm assuming we'll see those assets flow in the second quarter, is there any way of sizing that?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [3]

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Thank you for your question, Robert. I'm -- this is Alesia, and I will respond to that. We're in a marketing period, we can't be very specific on the activities that we are undertaking right now. And so we will able to provide more clarity on the second quarter calls, but yes, we will see (inaudible) flow in the second quarter with regards to that close end fund.

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Robert Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay, maybe just a little kind of modeling follow up. Did you mention that the $30 million you expect to crystallize in second quarter, is that correct?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [5]

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No, that's over the remainder of 2017.

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Robert Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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Okay. And maybe just one last question. I'm looking at kind of the flows -- kind of year-over-year, there was a big outflow from other assets under management. Can you just remind us which strategies are in that other bucket that drove the big outflow? Or suffered the big outflow?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [7]

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I think with all of the other nonmajor strategies including our energy funds in some of our smaller strategies and our managed accounts are in this bucket.

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Operator [8]

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And our next question comes from Mike Carrier of Bank of America Merrill Lynch.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [9]

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

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [10]

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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 fund in addition to the performance in 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 product [areas] remain 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.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [11]

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Okay. And then, Alesia, maybe just 2 things on some of the comments that you made. First, you mentioned the $30 million through the year and then you also mentioned the $70 million. And I just wanted 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 meeting capital needs, as we kind of progress through this year and next year and where that payout might -- may settle over time?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [12]

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Sure. So thank you for the question. First, I would note that as the majority of our potential incentives and the whole picture of our distributable earnings will not be known until the fourth quarter as that is still when we anticipate earning the majority of the (inaudible) for the year. We do anticipate for the first 3 quarters of the year that the dividends will be modest. And I think that's reflective of the $0.02. And we are going to evaluate our overall distribution capacity in the fourth quarter in light of our overall earnings. As we mentioned last quarter, we will be withholding some amount of capital to strengthen our balance sheet and to fund our new business initiatives, but we will be giving a full evaluation of this in the fourth quarter once our full year earnings are known and we have better clarity on the year.

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Operator [13]

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And our next question comes from William Katz of Citigroup.

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William R Katz, Citigroup Inc, Research Division - MD [14]

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Dan, just wanted to clarify something you said. I think you mentioned that maybe you got a quarter away in terms of sort of seeing some visibility around the hedge fund flows. I was sort of curious. Could you maybe refine your commentary a little bit, is that just on redemptions that you're seeing, the paced redemptions, what may be available for unlocking or maybe what you are seeing in terms of new business pipeline?

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [15]

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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.

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William R Katz, Citigroup Inc, Research Division - MD [16]

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Okay. And on that, it seems to be a lot of chatter around hedge fund pricing as there is across many mutual fund businesses as well. Where are you in terms of that expectation with the LPs? Are you now at a point where performance matters more? Or is there still some downward pressure for the industry maybe even yourselves on the Master Fund?

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [17]

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We're at a point where we think investors are comfortable with our price.

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William R Katz, Citigroup Inc, Research Division - MD [18]

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Okay. (inaudible) taking on the questions. When I look across your matrix of products and maybe LPs by 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. A number of your peers have been enjoying some very strong growth. And I'm just sort of trying to calibrate that how we think about that might translate down to your platform.

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [19]

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We're having dialogue with different clients in all areas. The performance, the teams, the new products, all looks strong and we believe they're all attractive and we believe clients even that way as well. Different products, opportunistic, real estate funds and drawdown credit funds tend to have a longer sale cycle tradition 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's a little bit difficult to say we're a little comfortable -- we're focused in all those areas.

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Operator [20]

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And our next question comes from Craig Siegenthaler of Crédit Suisse.

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Craig William Siegenthaler, Crédit Suisse AG, Research Division - Global Research Product Head for the Asset Management Industry [21]

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Coming back to the credit business, can you continue to ramp this business given the challenging investment backdrop, meaning the universal distress that now is quite small relative to the world of dry powder? And also, what segments and geographies are you really focused on in the investing front?

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [22]

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We absolutely believe that we can continue to ramp. The CLO business continues to grow and our performance continues to be very strong. On the opportunistic credit side, we can 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 fundraising 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.

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Craig William Siegenthaler, Crédit Suisse AG, Research Division - Global Research Product Head for the Asset Management Industry [23]

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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 and to different kind of categories or even geographies?

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [24]

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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.

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Operator [25]

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And our next question comes from Ken Worthington of JP Morgan.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [26]

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This is Will Cuddy filling in for Ken. There have been some media reports about employee turnover. Could you please compare turnover or conversely retention in 2015, 2016, and so far in 2017, please?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [27]

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Well I can't specifically comment on retention rates in each of the 3 periods, but I can say that obviously the first quarter, we do have seasonal attrition as it's the time of the year that we play bonuses 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 and replace what was needed to hire. So I think there is nothing that we are internally concerned about at this time.

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [28]

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The other thing that I will add qualitatively is if you 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.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [29]

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Okay. Second, we're getting closer to the implementation of method 2. Can you please talk about any impacts you're expecting for your business? I know you still have a couple of months, but is there anything else that you could add on what you are expecting?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [30]

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We are 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.

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Operator [31]

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And our next question comes from Dan Fannon of Jefferies.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [32]

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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 momentum building within certain products that maybe we can't see on a net basis yet?

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Daniel Saul Och, Och-Ziff Capital Management Group LLC - Chairman, CEO and Executive MD [33]

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Well, the gross sales we report in the Q, you'll see the numbers. But as that -- as a general matter, we are -- we have not seen a substantial pick up in gross inflows. Having said that, we are optimistic that we are doing the right thing such that when the industry is poised, we are well-positioned.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [34]

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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 $70 million as well? You've already booked comp against that?

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Alesia J. Haas, Och-Ziff Capital Management Group LLC - CFO and Executive MD [35]

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There are 2 different metrics. So if we look at the Exhibit 6 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 is 100% in opportunistic credit.

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Operator [36]

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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.

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Adam Willkomm, [37]

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Thanks, Candace. 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.

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Operator [38]

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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.