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Sculptor Capital Management (NYSE:SCU)
Q2 2020 Earnings Call
Aug 06, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, everyone, and welcome to the Sculptor Capital's second-quarter 2020 earnings call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Elise King, head of shareholders services at Sculptor Capital.

Elise King -- Head of Shareholders Services

Thanks, Tomeka. 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 construed as an offer to purchase shares of the company or an interest in any of our funds or 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 have joined through the conference call and would like to follow along, you can find the presentation on the Investor Relations page of sculptor.com at the 2Q earnings release link. If you joined through the webcast, you can navigate through the presentation on the webcast screen. Earlier this morning, we reported a second-quarter 2020 GAAP net loss of $25 million or $1.12 per basic and $1.77 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 a second-quarter 2020 distributable earnings loss of $91.1 million or $1.62 per fully diluted share. In the second quarter, we recorded a legal provision of $116.9 million in addition to the previous $19.1 million provisions taken in the third quarter of 2019, which we will get into the details of in a moment. Second-quarter adjusted distributable earnings, which excludes the legal provision and related legal fees, were $27.3 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.

Rob Shafir -- Chief Executive Officer

Thanks, Elise, and good morning, everyone. Before we begin our usual comments, I'd like to say that the Sculptor team hopes that you and your families are staying healthy during this time. We have continued to operate at a high level, and almost all of our employees are working from home. We are grateful to our employees for how they have seamlessly adapted to this new environment and gone beyond their job descriptions to provide for our clients and shareholders.

Times like these remind us that our employees truly are our greatest asset. Additionally, I'd like to address the $116.9 million legal provision that was taken this quarter, in addition to the previous $19.1 million provisions taken in the third quarter of 2019. As publicly announced, we have conditionally agreed in principle with the claimants in the Africo matter to $136 million restitution amount. This amount is more than we believe the law requires us to pay and we stand by our shareholder price analysis.

However, we are willing to pay the proposed amount as a compromise to end the matter in the near term, allowing us to close out the last of our Africa-related matters. We caution that this proposed settlement is conditional on it providing full closure and finality, and must be approved by the judge. Should the $136 million settlement in principle be approved, we will be willing to pay out of cash, cash equivalents, and longer-term U.S. government obligations.

Tom will cover this in more detail later on. Now moving on to performance, global markets staged an unprecedented recovery during the quarter on the heels of extraordinary government and central bank support, coupled with encouraging economic indicators. That said, there continues to be a wide band of outcomes for the way forward, reflected in the elevated levels of volatility and dispersion across and within asset classes. We believe the environment creates an abundance of opportunities for fundamental investors, such as Sculptor, who can nimbly allocate capital in the face of rapidly evolving markets.

One area where this was relevant during the quarter was the expanded need for fresh capital. Corporates rushed to raise capital, as capital markets reopened following the COVID-19 shutdown, boosting issuance to record levels throughout global bond markets. Sculptor Master Fund benefited from deploying significant capital near the March troughs, helping drive a return of 13.4% net for the second quarter. This has propelled the Master Fund to a year-to-date gain of 6% net, which compares favorably to the MSCI World index, which was down 5.1%.

The Master Fund was up 1.3% net in July, bringing year-to-date performance through July to up 7.4% net. The Master Fund generated positive performance across all strategies in the second quarter, lifted by a broad rebound in risk assets, which helped to deliver strong performance in the majority of the positions we added at the depths of the COVID-19 crisis. Our active repositioning of the portfolio amid record volatility and diverging markets was also meaningful in contributing to a second-quarter return that drove the Master Fund to year-to-date gains. Following the massive stimulus thrown at markets, credit led quarterly performance as spreads compressed rapidly and markets broadly healed from the first quarter sell-off.

In corporate credit, we experienced a significant narrowing of spreads for many of the investment-grade and high-yield new issue positions, which we had added at attractive levels as companies braced themselves to endure the crisis by issuing record amounts of debt. The combination of uncharacteristically wide spreads and new issue concessions for high-quality companies made the deployment of capital from investors such as ourselves extremely compelling. This was followed later in the quarter by a rebound in several of our core process-driven investments, which had lagged in earlier stages of the market recovery. In structured credit, profits were mostly the result of significant retracing of non-Agency RMBS positions that we purchased aggressively at extremely discounted prices in March and April when levered investors reeling from margin calls were forced to sell high-quality securities at fire-sale prices.

Similar conditions in the convertible market improved steadily throughout the quarter, as we saw frictions abate and volumes increase, resulting in a tightening of convertible arbitrage spreads. Record new issuance, specifically in the U.S., where year-to-date levels have now exceeded all annual volumes since 2007, provided a fruitful environment for our convertible and derivative arbitrage strategies. Fundamental equities was also a significant positive contributor to performance during the quarter. Gains were driven by a combination of our largest and highest conviction secular growth positions and more cyclically exposed companies directly impacted by the crisis that we added at depressed valuations during the quarter.

Our global opportunistic credit fund, Sculptor Credit Opportunities Fund, was up 10.8% net for the second quarter of 2020 and was down 11.4% net year-to-date through June 30. The fund has generated an 8.6% annualized net return to life to date through June 30, which has outperformed the BAML Global high-yield index by 2.9%. The fund was up 1.5% net in July, bringing year-to-date performance to down 10.1% net. In a similar manner to the multi-strategy funds, the noteworthy healing of credit markets during the quarter propelled returns, particularly among the investments we made as a result of extreme mispricings during the market downturn.

This performance also represented strong returns seen in several of our largest process-driven investments, which traded up late in the quarter, having lagged during the initial recovery in credit markets. We believe the heightened dispersion seen across credit markets continues to generate opportunities for the funds to nimbly deploy capital. As we conveyed after the first quarter, we still see an embedded upside from the majority of our assets that we had owned prior to the crisis, as well as those that we've added during the sell-off. Our real estate funds continue to deploy capital and generate strong returns with an 18.4% net annualized return in our third opportunistic fund.

Fund IV closed last month and has already taken advantage of recent dislocations in public equities, distressed public debt, and forced sellers in private real estate. Turning to flows, as you can see on Page 7, as of June 30, our assets under management were $35.4 billion with net inflows in the second quarter of $1.2 billion and performance-related depreciation of $1.5 billion. As of August 1, our assets under management were $35.5 billion, which was driven by an estimated $340 million of performance-related depreciation and $5 million of net inflows, partially offset by $275 million of distributions in July. Turning to Page 8, multi-strategy funds had assets of $9.4 billion as of June 30, which included $108 million of net outflows and $1.1 billion of performance-related appreciation in the second quarter.

From June 30 to August 1, multi-strat had net outflows of approximately $61 million and an appreciation of $147 million. We continue to be encouraged as the net outflow numbers remain low. We believe this is a testament to how Sculptor protected clients' capital during the market lows in March. Given our performance and ability to protect capital in the midst of volatile markets, we see an increased opportunity to raise capital once our firm's legal issues are fully behind us.

Real estate had total assets under management of $4.7 billion as of June 30. The increase in the quarter was driven by $774 million of inflows, primarily due to the closings in Real Estate Fund IV. The fund raised $2.59 billion in total with an additional $400 million in co-investment vehicles. We feel the success of this fund highlights the strength of our investment team's historical performance and is a vote of confidence from new and existing clients investing long-term capital in Sculptor.

We are fortunate to have a large amount of dry powder to take advantage of the current target-rich real estate environment. Opportunistic credit had $5.9 billion of assets as of June 30, which included $472 million of net inflows in the second quarter and $463 million of performance-related appreciation. In addition, we saw net inflows of $63 million and appreciation of $77 million in opportunistic credit from June 30th to August 1st. We are encouraged by the renewed interest in opportunistic credit, specifically the Sculptor Credit Opportunities Master Fund, and are continuing to have positive conversations with current and potential clients.

Institutional credit strategies had total assets of $15.4 billion as of June 30, with distributions and other reductions of $619 million in the second quarter. This was driven by a reduction in assets under management in certain aircraft securitizations. We expect the new issue aircraft ABS market to remain closed in the near-to-medium term as the market looks for more clarity around the direction of air travel and its associated impact on airline credit, lease rates, and residual values. As the market reopens, we are confident in our abilities to grow the business.

Currently, the CLO market is beginning to open, albeit under challenging conditions and terms. New deals tend to have shorter reinvestment periods, tighter fees, and elevated return requirements on equity. Based on our long-term performance and market position, we are confident that when the CLO market recovers, we will be well-positioned. With that, let me turn the call over to Tom to go through the financials.

Tom Sipp -- Chief Financial Officer

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 a second-quarter 2020 distributable earnings loss of $91.1 million and an adjusted distributable earnings gain of $27.3 million. We did not declare a dividend this quarter. Revenues were $97 million for the second quarter, remaining relatively flat from the second quarter of 2019 and up 35% from the previous quarter.

Management fees were $56 million in the second quarter, down 2% from the second quarter of 2019 and down 6% from the previous quarter. We are no longer recognizing cash deferrals for CLO subordinated fees. This has reduced our management fees in the second quarter by $6.2 million, which includes a $2.6 million reversal from the first quarter. We have deferred fees on 12 CLOS, but estimate that some of our CLOs will recover to a point that we'll recognize a portion of year-to-date fees in the third quarter.

For comparison purposes only, total management fees adjusted for CLO fee deferrals were $63 million in the second quarter, up 5% from the first quarter of 2020. This increase in management fees is attributable to growth in hedge funds and real estate assets. Incentive income was $38 million in the second quarter, up $3 million compared to the second quarter of 2019 and up $29 million from the previous quarter due to Master Fund performance for annual clients that crystallize incentives. As seen on Page 10, as of June 30, 2020, our accrued but unrecognized incentive was $227 million, up $87 million from the prior quarter.

The increase was driven by $91 million in positive performance with the majority coming from the customized credit platform. We continue to expect a large portion of the opportunistic credit bureau to crystallize in the fourth quarter of 2020. Turning back to Page 9, other revenues were $2 million in the second quarter, down 52% versus the second quarter of 2019 and down 18% from the previous quarter due to lower rates impacting interest income. For the second-quarter 2020, total expenses were $181 million.

Total adjusted expenses were $63 million, up 1% from the second quarter of 2019, and down 4% from the previous quarter. In the second quarter of 2020, compensation and benefits expense was $41 million, remaining relatively flat from the second quarter of 2019 and from the previous quarter. Bonus expense was $21 million for the second quarter, up 3% from the second quarter of 2019 and up 6% from the previous quarter. We expect full-year bonus accrual to be between $75 million and $85 million for fixed bonuses.

Salaries and benefits were $20 million for the second quarter, relatively flat from the second quarter of 2019 and down 4% from the previous quarter. The decrease quarter over quarter was due to lower headcount. We expect full-year salaries and benefits to be between $75 million and $80 million. In the second quarter, general and administrative expenses were $137 million.

Adjusted general and administration expenses were $18 million, down 8% from the previous quarter of 2019, and down 15% from the previous quarter. The lower adjusted G&A quarter over quarter was due to seasonality of accounting fees and lower costs due to employees working from home and travel restrictions. Expense savings associated with work-from-home also impacted the year-over-year decrease. We expect full-year adjusted G&A to be between $75 million and $80 million.

Interest expense for the second quarter of 2020 was $4 million, up 61% from the second quarter of 2019, driven by the first full quarter of interest accrual for our debt securities and relatively flat from the previous quarter. We expect full-year 2020 interest expense to be between $15 million and $17 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 14% to 18%. As a reminder, tax estimates are subject to many variables, including the timing of the potential Africo settlement and year-end performance 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, as of June 30, 2020, total cash, cash equivalents, and long-term treasuries were $334 million. The outstanding balances of our liabilities included $8.5 million of term loan, $204 million of preferred units and $200 million of debt securities.

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. As Rob mentioned earlier, a $136 million restitution amount has been conditionally agreed to in principle between as Oz Africa and Africo. An additional $116.9 million legal provision was taken this quarter in addition to the previous $19.1 million provisions taken in the third quarter of 2019. This will be funded from our cash, cash equivalents, and long-term treasuries, and we are comfortable with the resulting cash levels.

With that, let me turn it back to Rob.

Rob Shafir -- Chief Executive Officer

Thanks, Tom. We are very pleased with the way the firm has performed during the crisis and our nimble investment approach is proving advantageous in the current market environment. We are excited by the growth in our client franchise as evidenced by the real estate fund close and inflows into opportunistic credit. We have shown discipline in maintaining our expense base, and we remain committed to reducing our liabilities over time.

We have conditionally agreed to a restitution amount in principle, which would put the final Africa legacy issue behind us. As part of this progress, we are very excited to have announced that Jimmy Levin will be taking over from me as Chief Executive Officer in April of 2021. Jimmy has been at the firm for 14 years and is the right person to lead Sculptor Capital based on his proven leadership and ability to manage capital through market cycles. This appointment is a natural evolution of the company's senior management team.

Jimmy will be keeping the role of CIO but will have the support of a tenured investment and operational team. We are looking forward to this next chapter in the leadership of Sculptor. With that, let me turn the call back over to the operator.

Questions & Answers:


Operator

[Operator instructions] Your first question comes from the line of Patrick Davitt with Autonomous Research. Please proceed with your question.

Patrick Davitt -- Autonomous Research -- Analyst

Good morning, guys. Thanks. Could you perhaps try to frame the extent to which the Africa situation has kept clients from allocating to the multi-strat fund? Maybe broadly, what percent of potential wins have been on hold because of this overhang or anything like that?

Rob Shafir -- Chief Executive Officer

It's Rob. I'll take that. I mean, look, it's very difficult to comment on something where we have sort of existing litigation outstanding and we're in the process of going through that. So I can really just kind of turn back to what I said in the comments earlier.

We've reached a compromise that obviously has a ways to go, and our view is that to the extent that we can finally put these things fully behind us, that will be good for the firm, putting all of the Africa legacy issues behind us. I think beyond that, it's very difficult to comment specifically on what that means for our pipeline.

Patrick Davitt -- Autonomous Research -- Analyst

OK. Fair enough. Thanks. And then a quick follow-up, are there accounts that have crystallizations with the multi-strat fund in 3Q like we saw in 2Q?

Tom Sipp -- Chief Financial Officer

There are some. Yes.

Patrick Davitt -- Autonomous Research -- Analyst

OK. Thank you.

Operator

Thank you. I'm not showing any further questions. I will now turn the call over to Ms. King.

I do apologize. There does appear to be a question. No. I do apologize once more.

Please go ahead, Ms. King.

Elise King -- Head of Shareholders Services

Tomeka, can you please reprompt for questions one more time?

Operator

Certainly. Thank you. [Operator instructions] And we have a question from the line of Bill Katz with Citigroup. Please proceed with your question.

Bill Katz -- Citi -- Analyst

Thank you for the extra prompt. That was what I was waiting for, star one. So a couple questions for you this morning. Thanks for the prepared commentary.

Just I think in the press release I read that you had sort of called out a change in the base fee on the hedge fund. I was just sort of wondering if you could speak to that to start.

Tom Sipp -- Chief Financial Officer

Really our fees have been pretty stable. There are additional breakpoints at the higher end. But our overall average fees are very consistent and we really are not experiencing hedge fund fee compression. There are large clients that may achieve -- or large investors that may achieve a lower average fee.

But overall, our fee levels are pretty stable. We think that will be consistent going forward.

Bill Katz -- Citi -- Analyst

OK. So there wasn't a pricing change here. It's just as an AUM sketch. I wanna make sure I understand that correctly.

Tom Sipp -- Chief Financial Officer

Yes. I think so. I'll have to look at, Bill, exactly what you're referring to. We could take it offline and I'll see the exact quote that you're referencing.

Bill Katz -- Citi -- Analyst

Great. OK. Thank you. And then just on the P&L, and I think I'd appreciate maybe some timing from the end of the year in terms of how some of the realizations may have crystallized.

But if you look at your variable comp, the variable incentive ratio, that was about 55% or so. And I certainly appreciate you reinstalling guidance. That's very helpful. How should we be thinking about that ratio as we look to the full year?

Tom Sipp -- Chief Financial Officer

Well, we've talked about this a lot in the past. The ratio does vary quarter to quarter and year to year. Our compensation program is really paid annually based on P&L that's delivered by the investment team. Where crystalized can happen annually, three years, five years; so there's a natural mismatch.

So I think you've got to be a little careful that that percentage will vary. I think this year it will be lower, as we have crystallization from the five-year incentive from a long-term client. Depending on how that plays out the rest of the year, a lot of that compensation has been paid over the years. But again, that ratio does vary period to period and it is somewhat misaligned on a short-term basis, but obviously is aligned on a long-term basis.

Bill Katz -- Citi -- Analyst

All right. OK. And then I just wanted one clarification. You had mentioned that there could be some reversal of the CLO deferred base fee or subordinating fee.

Is that in the third quarter? Did I hear that correctly? I'm sorry. You were going through numbers very quickly. If you wouldn't mind just going through that one more time?

Tom Sipp -- Chief Financial Officer

So yes, so in Q1 we recognized the revenue, even though we had $2.6 million of cash deferrals. In Q2, we changed the accounting where we're not recognizing the revenue. So we reversed the $2.6 million from Q1 and we didn't recognize $3.6 million of deferrals that occurred in Q2. Looking forward, the CLO picture is improving.

The number of deals that we have that are in deferrals due to the collateralization tests are decreasing. So we think we're going to collect additional fees in Q3 and actually start to recoup some fees that were deferred back in Q1. So the accounting change happened in Q2, but the overall performance of the CLOs is definitely improving. The CLOs that are still not passing the test are getting a lot closer.

So we, based on current marks and current market environment, we think that's going to continue to improve.

Bill Katz -- Citi -- Analyst

OK. Thank you. Thank you for taking the questions.

Operator

I'm not showing any further questions. I will now turn the call back over to Ms. King.

Elise King -- Head of Shareholders Services

Thank you, Tomeka. 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.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Elise King -- Head of Shareholders Services

Rob Shafir -- Chief Executive Officer

Tom Sipp -- Chief Financial Officer

Patrick Davitt -- Autonomous Research -- Analyst

Bill Katz -- Citi -- Analyst

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