Sculptor Capital Management (SCU) Q3 2021 Earnings Call Transcript

Sculptor Capital Management (SCU)
Q3 2021 Earnings Call
Nov 04, 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 third 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, Molly. 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 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 for interest in any of our funds or any other entities. Yesterday, we reported third quarter 2021 GAAP net loss of $4 million, or $0.17 per basic and diluted Class A share.

Distributable earnings were $35 million, or $0.58 per fully diluted share. We declared a dividend of $0.28 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. Welcome to the call. I want to start with just two high-level comments about the business. If you think about the key pieces we need to generate fund performance.

And of course, we need to have assets to manage. And as far as that AUM, we care about the quantity, the quality, and importantly, I don't know for all of you, the kind of direction of travel for that AUM over time. And both on the performance and on the AUM side, we feel really good, and we feel we had a great quarter of performance, a great year-to-date period of performance. We think it's now been a multiyear period of somewhere between good and terrific performance across almost everything we do in the platform.

And on the AUM side, I would say same concept. Obviously, there's a huge focus on that issue and particularly within the open-ended funds. And if we step back a little bit from kind of counting each month and counting each quarter and try to at each of our releases, which, of course, is part of what we all do, we went from an extended period of time where we had very little inflow and frankly, quite elevated outflow. But now being in a period of time where we're getting pretty material or significant inflows measured in excess of $1 billion on the multi-strat side year to date and outflows that represent, frankly, normal churn.

And so when I look at those couple of big stats, I say, we're moving in the right direction. Will it continue? Obviously, we can't predict that perfectly. But everything we look at shows we're in a wildly different place than we were over the last several years. And it seems like that trend ought to continue.

So that's something we feel really good about. And if I almost stop the conversation right there and said performance and flows AUM, generally feeling good. And that's most of the business. Now moving forward into greater detail, I want to talk about continued growth in the balance sheet.

Again, a topic we've spent a lot of time discussing with you all. We are going to keep building the balance sheet. There's no specific target for that in mind, but what we continue to observe is the alternative asset management industry has gotten much more sophisticated, much more complex operating across a greater range of products, distribution channel structures. Most of which involve the need for capital from the management company itself.

Kind of take the simplest example of that. If we think we do a terrific job of managing real estate style investing XYZ. And we decided that we want to raise a fund for real estate investing style XYZ. That fund requires a GP capital commitment.

That's kind of the simplest, and I'll call it almost old-fashioned version of a usage of capital. And then there's a whole great wide world out there that you observe across certainly the public alts that are quite a bit more complicated than that and involve quite a bit more capital to that. So in order to be in that conversation and have a chance to plant those seeds, we want to plant and we're going to keep building our capital. Another topic that we hit on in the letter is slightly more mundane one, but I know is important in the current context is just the timing of our earnings, timings of our revenue and timing of our expenses.

So we had materially outsized earnings in the fourth quarter of 2020 because we crystallized significant buy that we had already largely paid compensation expense for in the first three quarters of this year, I'd say a similar phenomenon in terms of revenue recognition without variable bonus expense against it due to the policy, which David can talk about in more detail of when we recognize that bonus expense, which is particularly at the end of the year in excess of whatever our fixed accrual is. This year, we, No. 1, have created and hopefully will continue to create significant a berry on the credit side for which there will be compensation, but no -- or I should say, not no, without full revenue recognition. And then the intra-quarter effect of having crystallized revenue from incentive during the year without the associated year income for that.

So that will create some timing differential, which, again, has smoothed out, if you look at it from last year into this year into next year and future years, it sort of works out over time, but we did want to flag that for everybody's attention. I think with that, we can jump into Q&A. 

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question is from Bill Katz with Citigroup. Please proceed with your question. 

Bill Katz -- Citi -- Analyst

Thank you very much. You guys hear me OK? 

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yeah. Hey, Bill.

Bill Katz -- Citi -- Analyst

OK. Thank you. Good morning, everybody. So I guess my first question, can picking up to the balance sheet commentary and they're using that as an opportunity to grow the business.

Could you maybe take that down a layer or two and sort of speak to when you look at sort of the evolution of the alternative asset management space? When you look at where the opportunity might, what are the products or areas that you need to continue to build capital to as we participate in? And how quickly do you think you could transition actually trying to related businesses against that?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Well, I'll give you some. It may not be as much as you'd like, but we generally think of it in three buckets, and I tried to put this language into the letter. There is new products for our existing investment capabilities. There are new distribution channels for our existing products.

And then there's new areas altogether. And I'd say, across that spectrum, that's kind of the order of priority, the order of probability and order of the timing, right? So maybe in two or in certain ways or could swap spots in certain places. But the example, like sort of the mock example that I gave just now at the beginning of the call, something we're doing already in our existing funds. And this is what's given rise to a lot of what our new businesses have been over time as part of our strategy business or our credit business or our real estate business, we find ourselves doing one type of thing, and it seems like we do it really well.

Over time, we create stand-alone products or stand-alone funds for that. And so that's the idea of creating products out of our existing expertise. And the list for that is pretty long. But from our perspective, it has to really make sense.

We have to believe it can really scale. We have to believe it can be additive to whatever investment product gave rise to it in the first place. But the list of that type of productization is a long list, not a short list. And historically, for us, that's probably been the lowest lead time item for growth, if you will.

But again, on the capital front, it takes capital, right? Any new fund requires a commitment and so that takes capital. That type of growth doesn't tend to add a lot of incremental cost, though, because you're generally doing the thing you were already doing, just doing it in a different way. On the new distribution channels -- sorry. And just to shed a little more color, that probably most applies to various areas across our credit and real estate business in terms of what we're focused on going forward there.

In terms of new distribution channels for our existing products, this is where in the last several years, particularly where our organization was focused on other things, there has been a massive proliferation of product. And if you look across certainly the public alts, which are getting quite big relative to us is on a market cap basis, as far as the peer comparison goes. But on some of those large public alts, whether it's the retail space, the non-traded REITs or BDC space, the insurance space and insurance itself has an unlimited number of sub-bullets at this point. Those are all areas where it effectively represents new distribution channels for existing products we have or existing capabilities we have, which are very long lead time requires significant capital and also, in certain cases, require significant expense.

Those are areas that probably have even higher long-term payoffs, but that's kind of why it's No. 2 in our list as far as ease probability, timing, etc., relative to that first bucket. And the third bucket is new areas altogether. And frankly, this is a catch-all for always making sure that we're thinking of what comes next in the world.

But does it represent some specific next quarter's announcement, so to speak.

Bill Katz -- Citi -- Analyst

OK. Thank you for that color. And maybe one for Dave. Just can you break down what the typical realization cycle is as the opportunity credit to trying to think about like, I guess, the revenue catch up to the comp from? And then more broadly, as you think about variable comps or variable incentives over time, I know you don't give guidance on this, but is there any reason to think that your structure is any different than what you're seeing in some of your key peers of how they sort of detail, the compensation on incentive-oriented income?

Elise King -- Head of Corporate Strategy and Shareholder Services

I can take that one. So on the first question, if you think about our opportunistic credit bucket, we really have two separate fund platforms. One is a customized credit platform, and that is about half of the AUM in that platform, and that is what creates our bury balance in those years. If you remember back in Q4 of last year, we crystallized a significant portion of that brewery balance related to the credit platform.

And this year, you are starting to see that build. And the reason is that is a multiyear fund that largely crystallizes at the end of that period. So it will be a multiyear period today. And we will see the bulk of that incentive crystallization occur at that point.

On the second question that you had, which relates to revenue recognition, we are slightly different than our public peers. Most of them have a different revenue recognition policy, allows them to recognize their incentive fees along the way as opposed to our revenue recognition methodology, which only allows us to recognize that revenue once it has been fully crystallized and no longer subject to clawback. So our policies are a bit different than our peers in terms of that recognition. 

Bill Katz -- Citi -- Analyst

Thank you. 

Operator

Our next question comes from the line of Gerry O'Hara with Jefferies. Please proceed with your question. 

Gerry O'Hara -- Jefferies -- Analyst

Great. Thanks. I think several quarters ago, you kind of mentioned how you've been building out sort of sales and distribution to a certain extent. Hoping we might be able to be able to get an update there and perhaps any other areas you are sort of specifically investing for future growth.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yes. I think the sales and distribution kind of might be a little -- some of that commentary might be a bit dated. We had certainly made some changes in additions to that team over the last several years, but I'd say that project is largely complete and kind of has been so for some time. The second part of the question, sorry, Gerry, what was that?

Gerry O'Hara -- Jefferies -- Analyst

I was just -- are there other areas that perhaps you were investing either from a team or infrastructure standpoint across the business?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

So not one specific area. But I would say it's starting to be a little bit of everything, and that's a good thing. I forget if it was in the prior letter or the one before that. We talked about no longer giving the fixed expense guidance on the salaries and benefits because we felt like the moves were relatively immaterial, but we wanted to start investing, and we frankly hope that we're able to spend more in that category.

So that's not meant to -- certainly, not meant to sound scary or like there's some enormous change coming that we know about it. But across almost everything we do, we want to be back in offense mode. We've been playing defense for quite a lot of years on our balance sheet, on our expenses, on our AUM, etc. And we feel like we're back closer to firing on all cylinders.

And so we want to capitalize that and find great ways to spend expense in the business to facilitate future growth. So it's not one specific area we're trying to build out. But if there's a handful of things we're trying to achieve, and we want to get one or two or three people in any number of those areas, then we're looking to invest some capital across the business. But no, not one specific build-out.

And on the specific point around sales and distribution, I think that might be a bit dated. 

Gerry O'Hara -- Jefferies -- Analyst

OK. Fair enough. And then perhaps just one on, I guess, the modeling side. Can we get a bit of an update as it relates to the CLO dynamic and how those are, I think, kind of resetting as they near end of life? Is that something we should sort of expect to kind of continue for the next several quarters or even years? Or just kind of how we can better contextualize that a little.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yes. So there's a couple of different and I'll talk about each. The first dynamic is just when you start a platform from scratch in 2011 or '12 on structures that have about a five to 10-year life, you eventually get to the point where you're not just creating new deals, you're also facing what happens at the end of old deals. And that can manifest itself in a call where the deal completely goes away in an amortization where the shrink.

Or in some version of a refi, reset restructure, which is where there's a whole bunch of moving pieces and a deal ends up carrying in some version of its prior self. And so the first issue is we're just -- we're at that level of maturation where we've created billions of dollars of deals that are later in their life of deal. There is a second factor and probably the more important one for everything we all follow and certainly, for our own CLO management platform, which is that headline fees today are lower than headline fees in 2012. And so we put out some information to tell you about what those average management fees are, but there's also an unlimited amount of publishing on this topic in the industry.

And so not only are deals getting to end of life, but new deals we create are at typically a lower management fee than a decade ago. And as certain end-of-life deals get extended or recreated through these various refis, resets, restructurings, they're generally getting recreated at spot economics as opposed to the decade ago's economics. And so the -- now against that, we have healthy issue in it. So we are back to creating, what I'd say is a pretty good calendar of new issue in the U.S.

and Europe each year. Again, that is a spot economics. All this is getting to the punch line of when do -- when does the accident portfolio of deals have today's spot economics in terms of average fee, we think that happens sometime in the next 12 to 24 months, probably on the earlier side than the later side, but that's an inexact science. So sometime over the next year or two.

And again, it could be on the front end of that. You're going to have spot economy, you're going to have extent economics start to look like spot economics and then growth is growth. Meaning from there, you're not facing this decade ago economics versus today's economic compression, you're just facing the typical are we creating capital in excess of capital that's rolling off, which we would certainly expect to be doing.

Gerry O'Hara -- Jefferies -- Analyst

Got it. That's actually -- that's really helpful. All right. That's it for me.

Thanks, guys. 

Operator

Our next question comes from the line of Patrick Davitt with Autonomous Research. Please proceed with your question. 

Patrick Davitt -- Autonomous Research -- Analyst

Hey. Good morning. Another follow-up on the balance sheet capital discussion. Should we take this to mean that perhaps you're pivoting away from distributing so much of your cash flow and maybe even take it closer to 10%, 15% or maybe even zero to the extent there are opportunities to invest that in the business? One.

And two, through that lens as the balance sheet continues to get stronger, do you foresee larger-scale M&A being a part of the pie? And what would the wish list be there, if so? 

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Sure. So on the first question, and I don't mean this to sound, I think you can take 100% distribution policy off the table. But as we roll through the distribution holiday, etc., I think you could take 0% off the table as well. Now that may not have been hugely helpful to you to know that it's going to be somewhere between zero and 100.

But the way of thinking is we want to be accumulating capital. And so against that. We feel we want to provide some baseline level of distribution for our shareholders. But the primary goal is going to be that accumulation of capital because we think the returns long term, we can earn on that are going to be wildly in excess of the returns of simply distributing it.

So we understand that as we move through the distribution holiday, we are going to need to both in our communication and certainly, in practice, tighten up that zero to 100 range for you. but we think we're going to be somewhere in between, of course. The second point which is, as you accumulate capital, how important is M&A? I think M&A is tough. We look at it a lot and we look at it across basically all the areas in which we operate and some of the areas in which we don't.

Multiples in a lot of the businesses that we are not as big in and think are exciting are, frankly, really, really high today. And I'm not saying they're undeservedly high. They just happen to be very high. And so even areas we've been excited about, we found it difficult to want to proceed on just on that basis, forgetting about all the typical concerns of M&A in the asset management space.

So M&A is a tool in the toolkit, but the organic growth opportunities that are capital consumptive as I mentioned in the letter, that feels like an unlimited landscape of opportunities now. Of course, our job is going to be how do we limit that? How do we prioritize? How do we assess? How do we measure the risk? And how do we decide where to spend that capital? And probably as important as the capital is where to spend that time. But I would say, the organic opportunities seem more exciting. Now there is a little bit of a gray area in between.

Some of these organic opportunities have -- there's an inorganic component to it, but I wouldn't call it a traditional M&A company, a bias company be sort of cash and stock.

Patrick Davitt -- Autonomous Research -- Analyst

Very helpful. Thanks. And my follow-up is on -- I know it's tough for you guys to talk about it sometimes, but you noted in the prepared remarks, you've got a few years of good multi-strat performance under on your belt. Any updated thoughts on the sales pipeline there, a better visibility to maybe see more consistent, larger wins coming through at this point?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

OK. I'm going to -- I'll give you the answer, and you may roll your eyes because it's the same one you've heard before, but it remains true. We went from a gross inflow number that looked pretty close to the number zero. I mean, not exactly, but it was in that zone of pretty low for a long time for frankly, good reason.

And then we said, as we address whatever hurdles there are to institutional participation in our funds, we expect that to build. And then we addressed all of those concerns. And it's now been a reasonable amount of time since all concerns have been addressed, which I think is hugely important. We don't talk about it a lot anymore because it's old news now.

But with those concerns addressed, in parallel with what is really good in our opinion, and we think our clients, both current and prospective opinions, one, three, five, seven, 10-year performance basically across the platform. We're starting to see it. So we went from a number that was really, really low to a number that's in excess of $1 billion at this stage through the year. And what we see on the follow feels really good.

And that's not meant to be purposely vague. No one tells us whether or not that they're going to join the fund in a year. But all the early signs, which is -- and we put some of this in the letter, I forget the exact language, whether it's RFP participation, whether it's consultant enthusiasm, whether it's just simply level of activity and interaction and data requests, all feels like the institutional community is evaluating our fund on the basis of its risk and return stream with that, which is all we can ask for. And we think on that front, we can be a winner.

So I can't put that in dollars for you in the big and small in the timing because we don't know. But certainly, all signs point to, we are on our way. 

Patrick Davitt -- Autonomous Research -- Analyst

Thanks. 

Operator

[Operator instructions] Our next question comes from the line of Bill Katz from Citigroup. Please proceed with your question. 

Bill Katz -- Citi -- Analyst

OK. Thank you so much for taking the following question. Just maybe dive a little bit more into the hedge fund pipeline. Is there any way you can dimension the improvement you've seen over the quarter in terms of the RFP activity? Any new distribution channels or any consult upgrade? How does that $1.1 billion gross inflow number compared to where you were at the end of June?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yes. So if -- I think what you're getting at is there like sort of a backlog concept. The answer to that question is no, not really. There are pieces of it, which we wouldn't share in this format publicly anyhow, but the answer really is that there's not that type of concept.

That's just simply not how the institutional capital raising process works. The way it works is do a really great job be generally approved across the universe of intermediaries, consultants, etc., be out in front of clients. And as people have a need for the things that we do, we hope to win our market share of those dollars. And again, that process feels like it's working.

It feels like it continues to work. But I don't think you can look at it in terms of kind of the -- here's what was gross inflow, Here's what's backlog, here's backlog conversion. It's just not that type of process.

Bill Katz -- Citi -- Analyst

OK. Just a couple of more for me. I appreciate all the questions. As you think about the strategic growth of the business by large balance sheet of, can you talk a little bit about how you might be able to work with Tele Life to potentially accelerate any of those inroads?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yes. So Delaware Life has been a terrific partner. They also have quite a large balance sheet, and that won't be as permanent as well. They happen to have investment preferences that in many ways align with our own.

And so all those pieces work together, and it's a tool in the tool kit. It's one that has, in certain ways already borne fruit, and we expect it to continue to do so. I will remind you, I know we've done this on prior calls, you should not interpret that as a large LP subscription into a certain fund, both older new, it's more about identifying overlapping areas of investment expertise and figuring out how that works for both of us in ways that can catalyze new business for us and create great returns for them and something they're looking at.

Bill Katz -- Citi -- Analyst

OK. Just one last one for me. Just listen to this. I look around the industry, there's been a couple of flagship transactions in the last couple of peaks or so with some very large premium multiples cash on earnings or EBITDA.

How do you think about independence of Salter versus potentially combining with a larger platform that maybe more easily to scale your system platform to accelerate since you're trying to accomplish where some of your peers are well ahead of you in terms of that opportunity set?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Yes. So we've certainly seen the headlines. We've certainly done our best to try to impute what the numbers were. And we agree with you that that looks noteworthy.

I would say a lot of the transactions that we've seen seem like a firm that's already accomplished their objectives and then is sort of going through this process to maybe get to an entirely new different phase. We are in the zone of trying to accomplish our objectives. And it feels like I don't know, six months into the job or whatever it's been exactly. There is what we think is significant low-hanging fruit.

Now that low-hanging fruit doesn't get over a quarter or a month or frankly, even a year. When you look at the businesses that just got sold, that's where a person concentrated on building that for 15, 20, 30 years. I'm not saying that's what exactly what we need to do, but there's a whole world of opportunity before us where we are now armed with for the first time, what I'll call, sort of reputational clearance. We've got all our issues sorted out, and the world seems to be behind what we're doing.

We've got terrific performance, and we've now got some capital to deploy and hopefully more capital to accumulate and deploy. The low-hanging fruit implied by all of that feels like now isn't the time to do what you're describing.

Operator

And our next question is from the line of Patrick Davitt with Autonomous Research. Please proceed with your question.

Patrick Davitt -- Autonomous Research -- Analyst

Thanks for the follow up. This is probably tough to answer, but -- and I know it's changing every day. But in particular on the potential corporate minimum tax, I think your cash tax rate has usually been below 15%. But obviously, your GAAP earnings are much different than your cash earnings.

So I'm not sure which one we should be looking at. But any ideas or thoughts on the exposure to that in particular or any of the other tax proposals out there?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

That's for Dave or Wayne.

Dave Levine -- Chief Legal Officer

Really hard to comment, Patrick. Sorry. It's a really good question, but it's really hard to comment on tax rules that are proposed and not more than that. So obviously, there is more information that comes out over time, we'll evaluate it and react to it, but it's not something we can really plan around or look at in any more detail right now.

Operator

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

Elise King -- Head of Corporate Strategy and Shareholder Services

Thank you, Molly, 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. Have a great day. 

Operator

[Operator signoff]

Duration: 33 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 -- Analyst

Patrick Davitt -- Autonomous Research -- Analyst

Dave Levine -- Chief Legal Officer

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