Sculptor Capital Management, Inc. (NYSE:SCU) Q4 2019 Earnings Conference Call February 13, 2020 8:30 AM ET
Elise King – Head, Shareholders Services
Robert Shafir – CEO
Thomas Sipp – CFO
Conference Call Participants
William Katz – Citigroup
Patrick Davitt – Autonomous Research
Gerald O’Hara – Jefferies
Good morning, everyone, and welcome to Sculptor Capital Management’s Fourth Quarter 2019 Earnings Call. [Operator Instructions].
I would now like to introduce your host for today’s conference, Elise King, Head of Shareholder Services at Sculptor Capital Management.
Thanks, Brandy. 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 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 considered 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 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 4Q press release link.
Earlier this morning, we reported fourth quarter 2019 GAAP net income of $48 million or $2.29 per basic and $0.80 per diluted Class A share. The full year GAAP net income was $51 million or $2.48 per basic and $1.57 per 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 fourth quarter 2019 distributable earnings of $58 million or $1.05 per fully diluted share. For the full year 2019, distributable earnings were $171 million or $3.11 per fully diluted share. Fourth quarter adjusted distributable earnings were $66 million. Full year adjusted distributable earnings were $161 million.
If you have any questions about the information provided in our press release or on our call this morning, please feel free to follow up with me.
With that, let me turn the call over to Rob.
Thanks, Elise, and good morning, everyone. We were pleased with our investment performance in the fourth quarter, which benefited from idiosyncratic outperformance. On a macro level, the period was marked by a reduction of recession fears, a robust third quarter earnings season and encouraging developments in U.S.-China trade negotiations.
Sculptor Master Fund was up 5.8% net for the fourth quarter, comparing favorably with the 3.5% return of the HFRI fund weighted composite index. For the full year 2019, Master Fund was up 14.8% net compared to 10.4% for the HFRI. In addition to this solid result relative to the index, it was the fund’s best annual performance in a decade with positive contributions across all strategies. In addition, the Master Fund was up 2.6% net in January while the S&P was down 0.04% for the month.
Fourth quarter performance in the Master Fund was led by fundamental equities. Main performance drivers included the impact of third quarter earnings, outperformance of our core China-related positions and successful navigation of U.S. health care volatility. Merger arbitrage was also a positive contributor as we exited a number of positions in technology, health care and specialty retail. Convertible and derivative arbitrage made a solid contribution with profits from mandatory convertibles for arbitrage positions and robust capital markets activity. Structured credit ended the year on a high note with the realization of a long-held European position in which we have been actively involved through multiple restructurings.
Coming off strong performance in 2018, our global opportunistic credit fund, Sculptor Credit Opportunities Fund, was up 0.3% net for the fourth quarter of 2019 and was up 1.4% net for the full year. The fund has generated 10.5% annualized net returns life to date, which has outperformed the BAML global high yield index by 3.6%. We are confident about the portfolio and the opportunity set heading into 2020. Our real estate funds continued to deploy capital and generate strong returns with a 20% annualized net return in our third opportunistic fund.
Turning to flows. As you can see on Page 7, as of December 31, our assets under management were $34.5 billion with net inflows in the fourth quarter of $2.1 billion. As of February 1, our assets under management remained $34.5 billion, which was driven by a $330 million close in real estate Fund IV and $217 million of performance-related appreciation in January that was offset by approximately $480 million of net outflows in our multi-strategy and opportunistic credit funds.
Turning to Page 8. Our multi-strategy product had assets of $9.3 billion as of December 31, which includes $555 million of performance-related appreciation, partially offset by $306 million of net outflows. From December 31 to February 1, Master Fund had net outflows of approximately $200 million.
Real estate had total assets under management of $3.4 billion as of December 31. The increase was driven by $1.6 billion of inflows into Sculptor Real Estate Fund IV and a related co-investment vehicle. An additional close in January added over $330 million to the fund. We are happy with the high demand for the fund and attribute the success to our strong performance and tenured team. We anticipate a final close in the first half of this year. In addition, we continue to see opportunities to expand real estate’s product offerings.
Opportunistic credit had $6 billion of assets as of December 31, which included $39 million of net outflows in the fourth quarter. Since the end of the year, opportunistic credit has had $283 million of net outflows. Institutional credit strategies had total assets of $15.7 billion as of December 31, with net inflows of $790 million in the fourth quarter, primarily driven by closing our first collateralized bond obligation and third GECAS aircraft securitization vehicle.
With that, let me turn the call over to Tom to go through the financials.
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 fourth quarter 2019 distributable earnings of $58 million and full year distributable earnings of $171 million. Adjusted distributable earnings were $66 million for the fourth quarter and $161 million for the full year 2019. Please see Page 10 for a full reconciliation from distributable earnings to adjusted distributable earnings. Additionally, we declared a cash dividend of $0.53 per class A share.
Turning to Page 10. Revenues were $267 million for the fourth quarter, up 61% from the fourth quarter of 2018. For the full year 2019, revenues were $575 million, up 19% from 2018. Management fees were $60 million in the fourth quarter, up 2% in the previous quarter and 6% lower than the fourth quarter of 2018. Management fees were $237 million in 2019, 10% lower than 2018. The year-over-year decrease in management fees was driven primarily by lower multi-strategy assets. This was partially offset by increased assets in institutional credit strategies.
Incentive income was $203 million in the fourth quarter, up $105 million compared to the fourth quarter of 2018. Incentive income was $322 million for the full year 2019, 59% higher than 2018. The higher incentive income was due to higher performance in our multi-strategy funds. Please note that given multi-strategy fund performance in 2018, our 2019 incentive income was reduced by a loss carryforward.
As seen on Page 11, as of the end of 2019, our accrued but unrecognized incentive was $254 million, down $4 million or 2% from the prior quarter. The decrease was primarily driven by recognized incentive income, partially offset by positive performance. We continue to expect a large portion of the opportunistic credit of BURI to crystallize in the fourth quarter of 2020.
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 back to Page 10. Other revenues were $4 million in the fourth quarter, down 3% from the previous quarter and down 17% from the fourth quarter of 2018. Other revenues were $16 million for the full year 2019, remaining relatively flat compared to 2018. Now turning to our operating expenses. For the fourth quarter of 2019, total expenses were $204 million, bringing full year total expenses to $439 million, up 11% from 2018. Excluding settlements, provisions, related legal fees and recap-related costs, total expenses were $395 million for the full year 2019, up 19% from 2018.
In the fourth quarter of 2019, compensation and benefits expense was $174 million bringing our full year compensation and benefits expense to $304 million, up 39% from 2018. Bonus expense was $154 million for the fourth quarter, bringing full year 2019 bonus expense to $224 million, up 73% from 2018. The year-over-year increase was driven by higher compensation payments associated with higher performance in 2019. As a reminder, we pay bonuses based on current year performance, which is not necessarily when we realize the related incentive income. This causes our bonus as a percentage of incentive to vary year-over-year. We expect full year annual bonus for — minimum annual bonus for 2020 to be between $80 million and $90 million. Salaries and benefits were $20 million for the fourth quarter, flat from the previous quarter. Salaries and benefits were $80 million for the full year 2019, down 11% from 2018. The decrease year-over-year was due to lower headcount in 2019. We expect full year 2020 salaries and benefits to be between $75 million and $85 million.
In the fourth quarter, general and administration expenses were $29 million, bringing full year G&A expenses to $125 million. Excluding settlements, provisions, related legal fees and recap-related cost, G&A was $21 million for the quarter, down 11% from the previous quarter, bringing full year 2019 G&A to $81 million, down 9% from 2018. The lower G&A in 2019 was due to disciplined expense management. We expect G&A to be between $80 million and $85 million in 2020. This guidance excludes any legal fees, reserves or settlements associated with outstanding legal matters. Additionally, we are happy to report that in January, the independent compliance monitor appointed in connection with the SEC and DOJ settlements concluded and certified that the company’s corporate compliance program is functioning effectively.
Interest expense for the full year 2019 was $10 million, down 57% from 2018. The decrease, driven by reducing the term loan balance from $250 million to $45 million. Looking forward to 2020, we want to remind you that the debt securities started to accrue interest on February 1, and we expect full year 2020 interest expense to be between $15 million and $20 million. Please note that our preferred units started accruing dividends in February and will not impact economic income. However, it will be treated as a reduction to distributable earnings.
Our guidance for the full year 2020 tax receivable agreement and other payables as a corporation is 12% to 16%. As a reminder, these estimates are subject to many variables that won’t be finalized into the fourth quarter of the year, and therefore, could vary materially from the estimates provided. Now an update on our balance sheet. At year-end, total cash, cash equivalents and long-term treasuries were $388 million. Subsequent to quarter end, we paid down the term loan by $27 million, resulting in an outstanding balance of $18 million. We continue — we plan to continue to strengthen our balance sheet by using a majority of our earnings after public shareholder dividends to pay down our existing term loan, followed by our preferred units and debt security instruments.
With that, let me turn it back to Rob.
Thanks, Tom. We are happy to wrap up 2019 having accomplished many of our goals. To highlight a few, we are pleased with our investment performance as seen by the 14.8% net return of the Master Fund. We have seen great traction in Sculptor Real Estate Fund IV’s fundraising. We rebuilt our sales force with a few strategic hires. We are now operating under our new brand, Sculptor Capital Management. We successfully transferred equity from retired executive managing directors to existing managing directors. We improved our balance sheet by reducing the term loan from $250 million to $18 million. We successfully converted to a C corporation, and we have made significant progress in optimizing our expense base across the business.
Looking forward to 2020, our strategic priorities expand upon our 2019 accomplishments and are as follows. As always, our main goal is to perform across products while maintaining our disciplined investment process. We continue to believe in the value proposition of our multi-strategy funds and plan to leverage the great 2019 performance to grow assets. We will focus on growing relationships with our existing clients and broadening our institutional investor footprint globally. We see opportunity in our core product verticals for further extensions in areas such as real estate credit and aviation. We will continue to strengthen the balance sheet. We are excited for what the new year and decade will bring for Sculptor and look forward to keeping you updated.
With that, we will open the line up for questions.
[Operator Instructions]. Your first question comes from Bill Katz with Citi.
Okay. Maybe just sort of start with some of the year-to-date flow dynamics, if we could. Could you maybe walk through a little bit of what’s going on in the hedge fund and maybe the opportunistic credit portfolio? A little surprised for the outflows on maybe the opportunistic credit side. And then on the real estate side, any thoughts of where you think that the fund ultimately can settle in? And I guess, you’re tracking, what, $2 billion, I think, program to date versus $1.5 billion and in the first — in the Real Estate Fund III?
Sure. Bill, it’s Rob. Let me take a stab at that. I think when you — starting, I guess, with the credit side, I think despite what have been pretty significant headwinds to the hedge fund industry, in general, our opportunities in credit funds were actually up in 2019, about $180 million in net flows. So yes, there is an outflow this quarter, and it’s really materially associated around 1 client making a portfolio change. So that really speaks to credit.
In multi-strategy, if you look at where we are right now, on the outflow side, we’re really kind of back to historical normal redemption levels, quarterly redemption levels. In fact, in some cases, we’re actually starting to trend below line there. So the real focus is going to be on getting inflows. And obviously, we’re coming off a year of very strong performance there, which we think we can leverage. As I said on the call, we do very much still believe in the value proposition of products that can be less correlated and protect downside and give you upside capture, which we feel like we can do and have done.
As you know, we’ve also invested materially in senior hires on the IR side and continue to really get our story out there as we try to expand our footprint as well as working with existing clients. So obviously, the focus will be on the inflow side, where the outflow side’s really sort of normalized.
Our capital raise in Real Estate Fund IV is around $1.7 billion. And all I can really say is that we anticipate a final close at some time in the first half of this year.
Okay. And just as a follow-up, maybe for Tom. Thanks for the guidance. Just a couple of things. Maybe on the ratio between incentive income and the compensation. I appreciate the variability of that, but that ratio has been rather wide over the last couple of years, and yet performance has been a little variable as well. But is there any way to sort of quantify how much revenue didn’t get recognized in the fourth quarter? Or how we might be thinking about that ratio as we look ahead into 2020 or beyond?
Yes. Bill, the — there’s a natural mismatch between when we realized incentive and when we pay bonuses. As an example, when you look at our current BURI, which is significant amount is going to crystallize it at the end of this year, we paid compensation over the past 3 or 4 years associated with that remaining balance. So when you look at it period-to-period, the ratio is going to be pretty variable. We do not provide a target ratio as that natural mismatch, short term, will create obviously variability.
The other factor when you look at ’18 to ’19, there was a loss carryforward, and you have some clients that crystallize in Q1, Q2 and Q3. So the performance that we delivered in 2019, where we paid bonuses on that performance, you won’t see resulting incentives until subsequent quarters. So there is a natural mismatch, and we don’t provide guidance around specific ratio externally.
All right. Is there any way to quantify how much — maybe you answered the question, I apologize for being redundant, of how much incremental revenue might still flow through the P&L from 2019 in the first half of this year?
No, we don’t disclose that externally.
Okay. And then, Rob, I heard you say $1.6 billion so far in real estate. But does that include year-to-date as well? Or is — I just want to make sure I’m not double-counting.
Yes, that includes year-to-date. So that’s where we are as of now. And obviously, as I said, we expect our final close some time in the first half of the year.
Okay. And just one last question. No mention of it, any update you can give us on the Africa lawsuit?
Yes. So our reserve is unchanged at the $19.1 million. And beyond that, we really don’t comment on pending litigation.
Your next question comes from the line of Patrick Davitt with Autonomous Research.
So in the middle of last year, I guess, you’d kind of been evolving and the description of trying to sell the multi-strat fund in kind of a stop-line — stop-light way, going from kind of red to yellow. Then we had some more African noise introduced. Obviously, had a really great performance year. So could you try to like speak through those lenses in terms of how the light is looking now when you take the 2 offsets of how performance looked against the African noise coming back?
Yes. Honestly, I can’t really comment on the Africa thing in terms of how that would or would not affect our flow picture. As I said earlier, you’ve got some hedge fund headwinds as a general point but, again, I think our performance is very strong. And for us, it’s really been a function of — we passed our legacy issues: Restoring confidence in the firm, which I think we’ve done; getting through the rebrand; and delivering the performance to go along with our value proposition on this thing. As I said, it’s certainly affecting our outflow situation, which is, as I said earlier, not only kind of at historical levels, it’s starting to trend below historical levels. So the focus will be, obviously, on the inflow side. So that’s really where we’re putting our efforts right now. That’s where we’ve invested in our sales force. And again, we’re off to a good start this year on the performance side. So that’s really what we’re going to be focusing.
Okay. And then you mentioned kind of step-outs. I’m sure you don’t want to get into too much detail. Could you help us frame maybe either the number or sizing or how to think about where organic growth could come from away from the real estate fund and multi-strat this year?
Well, I mean, I think away from that. You’ve got our core verticals, right? And obviously, we’ve got a lot of momentum on the real estate side, focusing on the multi-side as well as the opportunistic credit and continue to grow in our performing credit businesses. But as you know, our strategy is really to focus on those core areas and look for logical adjacencies to those areas rather than start things from scratch that are not really core to the strategy right now.
On the call, I mentioned real estate credit where we’ve had success in the past, and that’s certainly an area that we look to potentially focused on this year. At aviation business, which we’ve had a lot of success in our GECAS partnership, is some place where we, again, continue to grow. Those are examples. So where we see logical adjacencies to take advantage of where we think our core strengths are, we are going to look to grow. Those would be the two that I would probably just mention sort of off the bat.
Your next question comes from the line of Gerry O’Hara with Jefferies.
Great. Obviously, very good traction on the Real Estate side, Fund IV, but perhaps you could speak a little bit to the investor base. How many are kind of new to Sculptor versus perhaps re-ups from the predecessor fund?
Well, I think, really what we’ve tried to do is, I think, there’s a few layers to the strategy. There are our existing clients, which we’ve been focusing on. And a lot of that has manifested itself, as I said, in slowing down to lower than historic levels, the actual outflow side of the picture. So I think there’s opportunities with existing clients over the course of this year for potential top-ups. People that know us are comfortable with us, understand our strategies and are very deep in our performance. I think that is certainly one segment that we’re going to be looking at on a short-term basis.
Another place where we are looking to potentially grow this year will be on the private banking side. As you know, we got our Reg D approval last year, and it takes some time to start ramping up again with private banking platforms, which we’ve been focusing on. We made a senior hire there who will lead that effort last year. And there’s — we’re optimistic about sort of having some success in that channel in 2019.
And I think the third one, which will probably take longer than 2019, but I think actually in the long run, offers probably the biggest upside, is just really broadening our footprint out globally with the senior hires that we’ve made. A lot of clients that we’re touching now have not heard from us in years, and they are getting reacquainted with the story, which I think is a good one and who we are today. And I think as we continue to engage those clients over time, the sales cycle being what it is, we’re optimistic that we’re going to turn some of those clients on. I don’t think, for those earlier stage conversations, that’s likely to be 2019. But I think longer term, as we look at our numbers and the possibilities of success out there, that’s really where it gets somewhat exciting. So I think short term, it’s going to be existing clients and/or existing conversations that have been ongoing as well as opening up the private banking channel, and longer term, really broadening the footprint and getting back in front of clients who either don’t know us or haven’t really been sort of engaged with us for years.
All right. Okay, that’s helpful. And then, I guess, perhaps a natural segue into sort of the G&A and the expense discipline that Tom highlighted on the call. Perhaps, any additional color on whether there are any initiatives there going forward versus perhaps balancing what sounds like potential future investment in a sales platform and other kind of global distribution, knowing that it’s down the road. But any kind of color there would be helpful.
Yes. Gerry, I think we’ve made pretty material improvements in our G&A base, kind of our business-as-usual G&A base, obviously, reducing costs related to legal matters, the recapitalization, the monitor sort of fund is very helpful. The — so having those kind of onetime larger legal fees being reduced is very helpful. And then we’ve had a bunch of initiatives that we’ve executed over the past couple of years that have reduced the more business-as-usual g&A costs. A lot of those, there are further opportunities, but we’ve implemented most of those and there will be some reinvestment coming because we see opportunities to grow the business long term. And that’s investing in infrastructure, it’s investing in new products. There’s opportunities that we’re starting to see across the business.
I’m not showing any further questions, I will now turn the call over to Ms. King.
Thanks, Brandy. 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 Gashalter at 212-257-4170. Thank you.