Sculptor Capital Management (SCU) Q2 2021 Earnings Call Transcript

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Sculptor Capital Management (SCU)
Q2 2021 Earnings Call
Aug 05, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, everyone, and welcome to Sculptor Capital's second-quarter 2021 earnings call. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Elise King, head of corporate strategy and shareholder services at Sculptor Capital.

Elise King -- Head of Corporate Strategy and Shareholder Services

Thanks, Stacey. Good morning, everyone, and welcome to our call. Joining me are Jimmy Levin, our chief investment officer and chief executive officer; Wayne Cohen, our president and chief operating officer; and Dava Ritchea, 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 measure are available in our earnings release, which is posted on our website. No statements made during this call should be construed as an offer to purchase shares of the company or an interest in any of our funds or any other entities. Earlier this morning -- sorry, yesterday, we reported second-quarter 2021 GAAP net income of $22 million or $0.87 per basic and $0.40 per diluted Class A share.

Distributable earnings were $67 million or $1.12 per fully diluted share. We declared a dividend of $0.54 per Class A share. I'll now pass the call over to Jimmy for a few words.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Good morning, everybody. Thanks for joining. You all have seen we made some additional changes to the way we communicate earnings. Hopefully, that was well received.

The idea was to provide some additional disclosures, as well as significant color commentary around issues we felt were important. Those issues may evolve over time. So depending on what's relevant in future quarters, we'll choose to highlight different things or conceivably add more to that communication. This will, again, hopefully, allow the call to be much more based on a Q&A, and we can really learn more about the business and discuss what's going on with you all.

A few things I would highlight from the quarter. First, we had a great quarter, both on an absolute basis, as well as on a quarter-over-quarter basis. Some of that, as we wrote about and as I see some of you have written about so far, is a cyclical effect of what was a booming market, and that led to some terrific performance, COVID recovery, outsized crystallization. But probably more importantly, underneath those numbers is also a significant progress toward the long-term goal of meaningfully improved SRE meaningfully improved margins and hopefully, the ability to keep compounding our long-term earnings power.

So the underlying factors were pretty healthy. And of course, we'll take a performance tailwind like that one when we can get it. Fund performance across multi-strategy, across credit, across real estate, both on a year-to-date basis, as well as, again, more importantly, on a one-, three-, five-year basis really continues to be somewhere between good and terrific. And so we're pleased with that, our clients are pleased with that, and we see that that continues to have a positive impact both on the net inflows we're now receiving, as well as the dialogues we're having and the pipeline we see coming from that.

Our real estate credit fund, REC I, is now fully deployed. As we published, it's doing a 12% net return. Again, a number we're really excited about, and we think one that bodes well for the future of that franchise. SRE IV, which is the most recent vintage of our real estate equity fund, is now 40% committed.

So we're careful, in that culturally, we don't like to celebrate wires going out in the investment business. We like to celebrate when those wires come back in. That said, the fact that we're at 40% committed relates to the fact that it's been a great investment environment. Some of that obviously has been COVID driven, and we've been able to take advantage of it and feeling good about where we stand there.

In addition to that, you'll have seen some additional real estate AUM in the form of a large co-invest vehicle that was created during this quarter. There was another large one that had been created during the prior quarter. That co-invest process allows us to, one, go after bigger deals and speak for bigger size in the real estate market, which is a helpful tool; and it also allows us to satisfy demand from the allocator community to do more with us in real estate. So again, healthy trends in a micro and a macro sense.

CLO business -- sorry, back to flow. So second quarter, again, net inflows into the multi-strategy funds. We don't know if it's a straight line up from here or not. And I know that's the question that everybody likes to talk about.

What we do know is we went through a multiyear period of pretty significant net outflows. We were able to stem that in terms of both reducing those gross outflows and beginning to generate gross inflows. And now after a pretty long slog, we've had a couple of quarters in a row of achieving at least the directionality we want to achieve, which is net inflows. And so we're excited about that, and it seems like it's a pretty positive sign.

Within the CLO business, it was extremely active quarter. It's been an extremely active year, a significant number of new issues, a significant number of reset, refi restructuring activity of existing deals. I'm sure we'll get into more of that during Q&A. On the balance sheet front, adjusted net assets north of $300 million, up $74 million in the quarter.

We prepaid another $50 million on our term loan, taking that debt number to less than $100 million, which is something that we are thrilled about. Obviously, there's no magic to the number of greater or less than $100 million. But after, again, a pretty long slog, an objective we've had for quite some time to address something that we thought need a significant focus on our part to kind of finally be at a level like that, both on an ANA basis, as well as on a total-debt basis makes us feel pretty good about the business. Another point on that, the recapitalization transaction from a couple of years ago was specifically designed to repair the balance sheet and restore the balance sheet and allow us to rebuild that balance sheet.

We are still in the distribution holiday of that recapitalization transaction, which means, by definition, the level we are at today will be higher when we are done with the distribution holiday because in order to complete the distribution holiday, we have to continue to earn economic income, and we will continue to build the balance sheet with that economic income. So we like where we are today, and we know that by definition, should we ever get out of a DH, we will do so with an even stronger balance sheet, which hopefully makes the future world bright for us and allows us to attack that from a position of meaningful strength. So with that, we'll go back to the operator and by your way with Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] Your first question comes from Bill Katz with Citi.

Bill Katz -- Citi -- Analyst

OK. Thank you very much for taking a question. Good morning, everyone. And yes, very appreciative of the added disclosure, super helpful.

So just maybe picking up on the CLO discussion. I think in your prepared remarks in the press release, you sort of spoke a little bit about maybe the counterbalance between sort of good opportunity to sort of grow the business versus maybe the back book maturing a little bit. So is there a risk here that the CLOs just sort of moved sideways, just given some of the I used would run off, for a lack of a better word, versus where you can maybe bring in the door? And then relatedly, could you quantify how much pressure there might be on the fee rate given that mix?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Sure. So we're not going to answer the second question quantitatively, but I can describe to you what's going on, and hopefully, that will be helpful. So you've seen the absolute level of AUM has been about churning recently. And I know you've written about that and you've observed it in the numbers.

And with that, there has been some net effective fee rate compression. As you've called out, when deals get to the end of their life, and remember, we started the business in 2012. I think we did our first deal in July of '12. And so now we're well into, we have been for the last couple of years and probably will be for the next year or two, in this period of still having a pretty significant amount of outstanding CLO deals, which were issued a long time ago.

So as those deals come up, you have two choices. I mean, it's really three choices. And when I say that you -- in that case, it's really the equity investor in that deal who has the choice, but deals can either enter run off where they begin to amortize down. And you see some of that in numbers.

When we talk about distributions and other reductions, some of that is just runoff of old deals. Deals can be called, which for us shows up as liquidation of a deal. That's how we disclose that, or deals can be reset, refinanced, or restructured in some way to extend their life. The third bucket, number one, serves the investors in those deals.

If a deal is being reset, refinanced, or restructured, it's because the underlying equity and note investors are willing participants in some sort of transaction. And so we are doing a service to our investor base in that regard. And it also has the added benefit of extending the revenue life of the deal. That revenue extension is typically not done at the same economics as a new issue transaction.

So you'd certainly rather do it to both serve your investor and extend your revenue than not do it at all. But as we work through that entire existing base of issuance that's legacy, you're going to see some of that compression continue on some of those older deals that we choose to extend, which again, extending them is widely better economically than not extending them. Then there was the COVID phenomenon where the new issue market was relatively shut for a period of time. The new issue market, like many other things post COVID has come roaring back.

We've come roaring back with it, and we expect that to continue. So there was this period of chop where essentially new issue activity was pretty muted. Existing deals that we're getting late in life were being readdressed at a lower rate with some amount of additional churn or continuation of that concept. At some point in the not-too-distant future, we should be back in a position of the amount of deals we issue is in excess of the amount of deals that are rolling off and restructuring.

The existing portfolio will have already been through its extension with the associated change in economics, and we ought to regrow hopefully the AUM, the effective fee and thereby doubling the revenue, right, getting the revenue impact from the AUM and from the fee. I don't think that's starting tomorrow. And I don't think the changes between here and there are hugely dramatic, but there is some further churn that needs to happen.

Bill Katz -- Citi -- Analyst

OK. Thanks. That's helpful. So second question, maybe a broader question.

Just as you think about flows and you sort of addressed a little bit in your commentary before going to Q&A around the pipeline. So I was wondering if you can maybe amplify a little bit on that. But just sort of stepping back and looking maybe even beyond the hedge fund platform, just talk a little bit about on the long-only business, where you see the greatest incremental opportunity to grow? Thank you.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

I'm not sure which specific area you mean by the long-only. Are you talking about long-term AUM? Or you meant that it was long only? Do you want to clarify that, Bill, so that I can --

Bill Katz -- Citi -- Analyst

I apologize, right. Long-term AUM, excuse me.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

OK. So long-term AUM, and again, we flesh that out and hopefully, more helpful detail in highlighting where it is, what it is, and what it isn't. And that was probably a somewhat overdue highlight for helping to understand, frankly, how much better our capital is than maybe had been otherwise assumed in terms of the duration of it. But the longer-term capital is in our -- can be in our multi-strategy funds.

It can be in our opportunistic credit funds. It's certainly within the ICS business, and it's certainly within the real estate business. And each of those represent both, as a practical matter, where we are growing and where we hope to grow. Within the multi-strategy funds, are we seeing some particular trend for the long lockup tranches versus the short lockup crunches? Probably none that's meeting.

There might be some noise there, but it's an area of focus. And on the credit side, both opportunistic and ICS, as well as the real estate side, I think as you well know, that's where we're seeing broad long-term trends as we're seeing broad long-term institutional allocations increasing. And that's where we're hoping to see some growth, again, in addition to in the multi-strat fund where we are seeing that growth today.

Bill Katz -- Citi -- Analyst

Thank you.

Operator

[Operator instructions] Your next question comes from Gerry O'Hara with Jefferies.

Gerry O'Hara -- Jefferies & Company -- Analyst

Great. Thanks, and good morning. I was hoping maybe you might be able to give us a little bit of an update on the relationship with Delaware Life and as it relates to potential new product generation, either through that partnership or perhaps just other new -- kind of new product pipeline that might be on the horizon? Thank you.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

So the Delaware Life partnership has been, at least in our assessment, an upside surprise and better than we had even hoped I would say. So number one, just their flexibility, the commercial approach they take to the relationship we have with them, and the actual capital structure in two parts investment that they have with us has been just awesome. So that's the first. Sort of away from that, we have already begun to partner in certain investment areas.

The more we do with that team, the more excited I get about what we can do in the future. Now I think we addressed this on the last quarter, just to set expectations, we are not expecting some material investments in our existing funds tomorrow. We are not expecting any sort of -- obviously, there are competitors of ours who either partially own or have a very comprehensive commercial arrangements for the entire balance sheet of the insurance company, this is not that. So I want to make sure we're clear on that.

But they're a terrific investor with permanent capital in massive size, tons of flexibility, and they're really interested in a lot of what we do and how we can productize that and how we can use our own growing balance sheet, as well as their currently ample balance sheet to go after investment areas that help to kick-start businesses that we think can be terrific for our clients and great for our business. That's the focus, and that's where we are seeing some really positive signs of what's to come.

Gerry O'Hara -- Jefferies & Company -- Analyst

OK. That's helpful. And then this one might be a little bit harder to answer. But clearly, a very strong quarter with respect to crystallization and incentive generation.

Is there anything you could perhaps point to for the third quarter to just give us a sense around what we might be able to expect either seasonally or otherwise just for modeling purposes?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

No, it doesn't -- it's not like we know it and aren't telling you. It's the nature of the business. So we know a lot more on the last day of the quarter than we do on the first day of the quarter. But sadly, there's not a lot I can offer you on that front.

Gerry O'Hara -- Jefferies & Company -- Analyst

Fair enough. Thanks for taking the questions this morning.

Operator

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

Elise King -- Head of Corporate Strategy and Shareholder Services

Thank you, Stacy, and thanks, 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.

Operator

[Operator signoff]

Duration: 19 minutes

Call participants:

Elise King -- Head of Corporate Strategy and Shareholder Services

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Bill Katz -- Citi -- Analyst

Gerry O'Hara -- Jefferies & Company -- Analyst

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