Sculptor Capital Management (SCU) Q2 2022 Earnings Call Transcript

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Sculptor Capital Management (SCU)
Q2 2022 Earnings Call
Aug 03, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, everyone, and welcome to Sculpture Capital second quarter of 2022 earnings conference call. At this time, all participants in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ellen Conti, head of corporate strategy at Sculptor Capital. Please proceed.

Ellen Conti -- Managing Director, Head of Corporate Strategy

Thanks Maria. 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 Sculpture 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 financials that are not prepared in accordance with US 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 any other entities. Today, we reported a GAAP net income of $8.1 million for the second quarter of 2022 or $0.32 per basic and $0.89 per diluted Class A share. Our distributable earnings were $32 million for the second quarter or $0.55 per fully diluted share.

Additionally, we declared a cash dividend of $0.13 per Class A share. All earnings metrics discussed by both Jimmy and Dava will be on our non-GAAP economic income and distributable earnings metrics. I will now hand the call over to Jimmy.

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Good morning everybody. Thanks for joining. Let's start with the macro environment. From a financial market perspective, the first half of the year has been one of the worst on record and while pretty much all major asset classes experienced dramatic declines, I think it's most informative to think about the 60-40 portfolio because some version of that represents the vast majority of both institutional and retail capital allocations.

And the 60-40 portfolio had its worst performance in 90 years for the start of the year. Of course, that was driven by the laundry list of all the issues we all now know too well, deteriorating global GDP growth outlook, record inflation, rising interest rates, central bank tightening, supply chain disruptions, the rolling and disparate COVID impacts being felt around the world, and last but not least, a war in Europe, all this taking place against the backdrop of what's been pretty significant value distortion and risk assets over the last two-plus years. Notably, within that, credit markets, which had been relatively well behaved for the initial part of the year that contingent hit toward the end of the second quarter and started to create meaningful dislocations across pretty much all types of credit assets, both public and private. As it relates to Sculpture, this has created a robust and ever-expanding universe of attractive investment opportunities for our funds.

Across our businesses, we do a lot of different types of investing, but I would say, simply said, the same type of investments that nine or 12 months ago offered mid-single-digit rates of prospective return, today offer mid-double-digit rates of prospective return. From a top-down standpoint, as it relates to how we deploy capital, notwithstanding what I just said, we think we need to remain disciplined. The economy is probably getting worse. Inflation is likely to be more stubborn than consumers, companies or central bankers hope.

I'd say that hope has most definitely become more hopeful over the last month. And we're not sure that's quite warranted yet. For this type of environment, flexible capital is required to capitalize on the opportunity set, and we think we're well positioned across all our funds, given, our funds are generally opportunistic and generally unconstrained in their approach to investing. So simply dislocation can be good for our business, in terms of increasing the number of attractive opportunities for our funds to invest in that help create future returns and in our ability to showcase outperformance against other risk asset classes in the present moment.

In the second quarter, we delivered solid financial results for shareholders and relative outperformance for our fund clients, notwithstanding the challenging market environment. Opportunistic credit funds delivered what we think are exceptional returns, relative during the quarter and continue to compound on year-to-date outperformance versus pretty much all relevant benchmarks. Our real estate funds continue to achieve terrific realizations on existing investments, and are now able to deploy capital into the type of environment that we think sets up for similarly successful future investments. Our multi-strategy funds have experienced a portion of the drawdown in risk assets year-to-date, more than we targeted, but better overall than the market and were broadly in line with expectations.

That being said, incentive income is, of course, based on absolute performance, and our multi-strategy funds are in a year-to-date loss position. I will say this is not the first time, nor will it likely be the last time that such as temporarily the case. We've seen periods of market dislocation historically act as a catalyst for fundraising in certain areas, particularly credit and real estate related and a dampener for fundraising more broadly. And this is what we hear in the market, we see in the market.

You hear it from our peers, capital allocators of all shapes and sizes in the type of market environment that I described in the opening tend to pause and look inwards during a period of time, kind of take inventory and reset, especially when that stress is so broad-based across the typical portfolio. I think historically there's been, periods of dislocation where one asset class as worse, one asset class does better. I think in this environment where all the major food groups of an institutional allocation have suffered, so significantly that generally creates a slowdown in all activities. Short-term flows are always difficult for us to forecast in the current time of market stress, I would say, even more so the case.

Notwithstanding that, I'd say a highlight or an area to focus on -- within all that is the Sculptor Tactical Credit Fund we call that STAX, where we held a second closing on July 1st with $250 million, bringing total committed capital to $370 million. That is a private credit drawdown style fund, building on the track record of six or seven similar funds over the last decade as well as our open-ended opportunistic fund. This is an asset class where we've long had expertise. We believe we have a great reputation.

And we believe that in this environment, it's particularly relevant to clients and specifically in a private credit format. We plan to have additional closes in that fund. And we plan to continue to grow that offering overtime into one of our core areas. We also had, as we discussed before, our first close on our second real estate credit fund, that was in the first quarter.

We're continuing to look to hold subsequent closings as well as partner with our real estate clients across the board as we develop new areas to grow together and help to deploy capital into the space. In our ICS business, we continue to raise additional CLOs. CLO market is obviously not insulated from everything else that's going on, and that market is slower than it has been over the last several years. The breadth and depth of our investment capabilities and outperformance for our clients in our long-duration businesses has resulted in growth of our longer term AUM, both absolute and relative and it also helps to diversify the platform.

And I think we saw the benefits of that collectively in our second quarter financial numbers. It adds stability and diversity to our earnings stream, which is particularly helpful in times of market stress and like we saw in the second quarter, investments that we made across different vintages, different funds, different products that can create return streams in an idiosyncratic fashion that pay off when they pay off, and that's what we experienced in the second quarter this year. Overall, at the firm, we remain well-positioned with a strong adjusted net asset position. This is something we've talked about for the last several years.

It was an area that we felt was of absolute critical importance to build up and improve on. We said we needed to do that because we wanted to have a stronger business in tough times, for defense and we wanted to have the ability to play offense. And I would say, right now, we are doing both, we are getting the benefit of that balance sheet resilience from a defensive standpoint, and we are doing what we think is opportunistic offensively with that balance sheet strength. So, with that, we continue to repurchase shares during the quarter.

We did so at levels that we think are very attractive. We went through this math, I think, two quarters ago. But when we think about the combination of recurring earnings, the value of our balance sheet or NAV, and of course, the potential incentive income after variable bonuses that we can earn in any period of time across any number of funds. With that, the buyback screens as, frankly, a great use of capital and maybe the best use of capital.

So, while markets will continue to be volatile or I should say, may continue to be volatile near-term, we think we're in a position of strength to capitalize that on many -- capitalize on that on many fronts, both in our funds and at the level of our business. And that's by making attractive investments for our clients by being stewards of our clients' capital and protecting it, by showcasing the value of our investment capabilities, and doing that with a strong balance sheet, reasonable earnings profile, excluding incentive income, and earnings power with the benefit of incentive income. And with all that together, we think we can continue to generate long-term earnings growth. And with that, I will hand it over to Dava to get into the financials.

Dava Ritchea -- Chief Financial Officer

Thank you, Jimmy, and good morning, everyone. I'll provide some highlights on our financials for the quarter and overall capital management strategy. During the quarter, we generated distributable earnings of $32 million or $0.55 per fully diluted share despite the overall volatility in the market environment. A portion of our distributable earnings this quarter were from earnings generated on our management fees, showcasing the value of recurring earnings and the progress we've made in improving the contribution from management fees to our business.

We also had incentive income realizations of $44.6 million for the quarter, largely from our long-dated funds. This highlights the testament of our long-term performance and the value of diversification of our platform in terms of vintage, products and funds. As an offset, we had compensation expense directly linked to this incentive income, which increased our compensation expense versus our normal minimum quarterly fixed bonus accruals. As a reminder, we typically recognize compensation expense in the quarter in which we generate the income for our long-dated funds, as we did this quarter, and at year-end for our open-ended funds.

As seen this quarter, our longer dated funds can generate significant incentive realization during otherwise challenging market conditions when we perform for our clients. Turning to the balance sheet. We remain well positioned with a strong adjusted net asset level and significant liquidity. Our adjusted net assets have increased from a deficit of $55.8 million in 2018 to $304.2 million as of June 30, which is up quarter over quarter.

This balance sheet position significantly increases the resilience of our platform and has allowed us to start playing offence that we believe will lead to future long-term shareholder value, while returning capital to shareholders via our dividend and buyback. In the second quarter, we also continued to return capital to shareholders. We executed on our buyback and repurchased 1.2 million shares at an average price of $11.34 for a total of $13.2 million. This brings total life-to-date repurchases through June 30 to about 1.6 million shares for a total of $19.5 million.

At recent stock prices, we believe this is one of the most attractive uses of our capital base. We also announced a cash dividend of $0.13 per Class A share for the second quarter, which represents 10% of distributable earnings in line with the guidance that we gave last quarter. We expect to target a dividend of 10% of distributable earnings to Class A shareholders for the third quarter. And then in the fourth quarter, we expect to true it up to bring full year dividends to between 20% and 30% of distributable earnings.

As we discussed last quarter, this pace during the year is a more sensible prudent approach to our dividend policy, as it better aligns dividend payments with earnings, given the timing of incentive income and bonus expenses. Importantly, this is not a change to our annual dividend policy, just for the timing of payments throughout the year. As a reminder, during the distribution holiday, we only pay dividends to Class A shareholders. Taking the dividends and share repurchases together for the second quarter, we are returning $16.4 million to shareholders, $13.2 million via the share repurchase program and $3.2 million via our dividend.

We will continue to be thoughtful on maintaining the ongoing balance of a strong core balance sheet, deploying capital to areas of growth and returning capital to shareholders. As Jimmy discussed, we are well positioned to endure the current market volatility, given both our positioning in our funds and on our corporate balance sheet. With that, I'll hand the call over to the operator and open for any questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Gerry O'Hara with Jefferies. Please proceed with your question.

Gerry O'Hara

Great. Thanks and good morning, folks. A question around just the incentive income and how we should about sort of the pace of crystallization and generation of that incentive as you start to shift, I think you mentioned in the prepared commentary in the earnings release that some of the products won't necessarily have the kind of year-end anniversary that we're accustomed to. So any sort of color or context there would be helpful.

Dava Ritchea -- Chief Financial Officer

Sure. We have not historically given forecast on what that incentive income could look like on a go-forward basis. For our long-dated funds this is based on realizations and harvest, which are, as you know, a little bit difficult to forecast. So that isn't something that we have given color on a long-term basis.

For annual funds, which is primarily our multi-strategy fund and our credit opportunities fund, we would expect annual crystallizations at the end of the year, should there be incentive income generated by funds.

Gerry O'Hara

OK. That's helpful. And maybe just to clarify, are there additional products coming online, or are there additional products in the mix that aren't necessarily tied to that annual year-end, or that we should at least watch for as they grow?

Dava Ritchea -- Chief Financial Officer

The main portion of that is going to be from our real estate funds, and we have a series of equity real estate funds at varying vintages, and also from our newly launched stack fund, which Jimmy had mentioned earlier. Lastly, there is a portion in our custom credit opportunity funds, which has a multiyear crystallization period, which will not be crystallizing this year but will in future years.

Gerry O'Hara

OK. That's helpful. Thanks for the explanation there. And then -- just one more for me.

Can you remind us where we are in terms of the distribution holiday, what percentage of the way through that earn-out through quarter end?

Dava Ritchea -- Chief Financial Officer

Yeah. We'll be putting this number into the 10-Q. We have about $75 million remaining of the $100 million that we had to begin with.

Gerry O'Hara

OK. Thanks for taking my question this morning. Appreciate it.

Operator

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

Patrick Davitt -- Autonomous Research -- Analyst

Good morning. Thanks. My first question is on the broader fundraising pipeline. You mentioned stacks, the second real estate credit fund on stack.

Is this something that you're expecting to always be in the market, or do you have a hard cap in mind, and in that same vein, any view on the potential size of the real estate credit fund?

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

So stack is a closed-end fund, which means it's not evergreen in the market. It has a fundraising window that I -- you want to speak to that? Yeah. I think it was a year from the July 1st close. So call it that's open for a year.

In terms of sizing, we generally look to have funds that are bigger than their predecessor funds. And I think our last closed-end credit fund was around $500 million or $600 million several years ago. The real estate credit funds, credit fund to that is give generally the same thoughts, we try to meet or exceed prior funds and Fund I was around $700 million.

Patrick Davitt -- Autonomous Research -- Analyst

That's helpful. And as we get closer to 4Q, it looks increasingly unlikely that the master plan will have a performance -- in that vein, is that form of zero, do you think like the minimum annual bonus you need to pay people would put the distributable earnings into the rack for the quarter, or is it too...

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Dava, can run through that math, our figure out of that math is within guidance we would give. But big picture, the minimum bonus accrual is meant to represent the bonuses that we think we would pay to the extent there's no annual incentive income being generated. Obviously, when we generate incentive income off of either a buy or funds that have direct carry in them, you see that bonus roll through at the same time, which is what you saw in this quarter. But the minimum bonus accrual is meant to represent the scenario you described.

Obviously, it's the best efforts on our part to try to create that accrual, but that's what we have.

Dava Ritchea -- Chief Financial Officer

That's right. And when you look at effectively the earnings from our management fee stream is what you would be looking in that scenario. And you'd be thinking about what your run rate management fees are, plus your fixed expenses, which would be salary and benefits, your fixed bonus accrual and GA. And we talked about that being a positive number for this quarter.

Patrick Davitt -- Autonomous Research -- Analyst

OK. Last one for me. Since you're -- if you're willing to, since you're not giving the monthly performance anymore, given the market reversal in July, would you be willing to give it for the last month?

Wayne Cohen -- President and Chief Operating Officer

We are not going to do that. I will acknowledge that risk assets generally had a nice move, and we participated in some of that.

Patrick Davitt -- Autonomous Research -- Analyst

Got it. Thank you.

Operator

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

Ellen Conti -- Managing Director, Head of Corporate Strategy

Thank you, Maria, and thanks, everyone, for joining us today and for your interest in Sculptor Capital. If you have any questions, please don't hesitate to reach out.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Ellen Conti -- Managing Director, Head of Corporate Strategy

Jimmy Levin -- Chief Investment Officer and Chief Executive Officer

Dava Ritchea -- Chief Financial Officer

Gerry O'Hara

Patrick Davitt -- Autonomous Research -- Analyst

Wayne Cohen -- President and Chief Operating Officer

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