Sculptor Capital Management, Inc. (NYSE:SCU) Q1 2023 Earnings Call Transcript

Sculptor Capital Management, Inc. (NYSE:SCU) Q1 2023 Earnings Call Transcript May 4, 2023

Operator: Good morning, everyone, and welcome to Sculptor Capital’s First Quarter 2023 Earnings 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. 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.

Ellen Conti: Thanks, operator. 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 or an interest in any of our funds or any other entities, and they are not intended as such. Today, we reported GAAP net income of $8.5 million for the first quarter of 2023 or $0.34 per basic and $0.05 per diluted Class A share.

Our distributable earnings were $14.2 million for the first quarter or $0.25 per fully diluted share. Additionally, we declared a cash dividend of $0.06 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: Good morning. Appreciate everyone joining for the call today. I’m going to cover the investment and performance highlights for the first quarter and then hand it over to Dava to cover the business and financials in more detail. Taking a step back on the overall macro environment during the first quarter, despite a series of economic shocks, deteriorating fundamentals and tightening credit conditions, most major asset classes were up for the period. The market was impacted by dislocation in the banking sector and interest rate volatility not witnessed since the 1980s. Amidst this turbulent market environment, our funds were able to deliver a solid absolute performance and relative outperformance versus peer indices.

In opportunistic credit, our Credit Opportunities Master Fund generated a gross return of 3.6% for the quarter, with all underlying strategies generating strong absolute returns. The fund delivered strong performance both on an absolute basis and relative to the HFRI fixed income credit index, which was up 1.7% for the quarter. We’re seeing continued signs of stress across global markets as rate volatility, poor liquidity and a general sense of fragility are prompting fast-changing market conditions. We believe these factors will provide favorable risk/reward investment opportunities for investors that can provide capital nimbly. Given our flexible and opportunistic investment mandate, we believe we should be able to continue to capitalize on this opportunity set.

In credit, higher base rates, wider excess spreads and greater investor protections have led to an attractive and building investment pipeline. Said simply, it’s a great time to be an opportunistic credit investor, in our opinion. On the real estate side, we continue to invest and harvest capital successfully. Our focus on nontraditional niche asset classes within real estate has continued to produce returns that are less correlated to the broader markets and to traditional real estate markets. We think that such a risk/return profile is even more appreciated in times like this. Both the Real Estate Equity Fund III has generated over a 30% gross IRR life to date, and Sculptor Real Estate Credit Fund I has generated over an 18% gross IRR life to date.

Both of these funds are now in harvest mode, focused on returning capital with fund investors. In multi-strategy, our Master Fund generated a gross return of 5.7% for the quarter. This fund also delivered strong performance, both on absolute and relative to the HFRI fund-weighted composite index, which was up 1.3%. We were pleased to see high returns generated on a historically low risk position for the portfolio. Due to our overall assessment of the economic environment, the fund has been running with historically low gross and net exposure. And so while we’ve been enjoying strong returns, we have done so with a trailing 3-month to global equities of about 0.2% — sorry, 0.2 on average and realized 3-month volatility of approximately 5% or about 1/3 of the equity market’s volatility.

Overall, we were pleased with our ability to generate strong performance across the platform in the first quarter and believe the market environment will continue to provide favorable risk reward investment opportunities for our fund investors. We are well positioned due to our diverse set of investment capabilities across geographies and asset classes and the strong team we have in place. While many things change over time, there is one which does not: Our number one focus is to deliver great investment results to our fund investors. Dava?

Dava Ritchea: Thank you, Jimmy, and good morning, everyone. I’ll cover both business and financial highlights for the quarter, providing commentary on the drivers of our results. For the first quarter, we generated $14 million of distributable earnings or $0.25 per fully diluted share. First, turning to our AUM for the quarter. We started the year with $36 billion in AUM and ended the quarter relatively flat at $36.1 billion. Our positive fund performance and opportunistic credit and multi-strategy was offset by net outflows across the platform. As we discussed last quarter, we saw fundraising continue to be challenging during the first quarter, consistent with the second half of 2022, impacted primarily by the uncertainty and perceived instability created by public actions taken by the founder and former CEO of Och-Ziff, along with other factors, including broader industry trends.

We expect our overall flow picture to be challenged until there’s a resolution of this externally driven legacy corporate noise. On our revenues, we had management fees of $60 million for the first quarter, down from both the prior quarter and the first quarter of 2022, primarily from lower multi-strategy AUM. Incentive income was $40 million for the quarter, driven by crystallizations in our real estate and opportunistic credit funds. This incentive income highlights the benefits of fund diversification on our platform, which is the result of building blocks we put in place over the last decade in credit and real estate. As Jimmy mentioned, our performance for the quarter across the board was strong. We have substantially recovered our losses and opportunities to credit and have made meaningful progress in multi-strategy against the high watermarks year-to-date.

Our expenses for the quarter were driven by our fixed expenses, which consists of salaries and benefits, minimum discretionary bonus and general, administrative and other expenses, along with carried interest profit sharing on our real estate business. There is no change to the fixed compensation guidance we discussed last quarter, and we would expect 2023 full year fixed compensation to be largely in line with prior years. Bonus was driven by our minimum discretionary bonus accrual of $18 million and carried interest profit sharing on real estate incentive income. Our general, administrative and other expenses were impacted by approximately $7 million of elevated professional services expenses, largely related to legal spend for the activities of the special committee of our Board of Directors.

We would expect to see elevated levels continue into the second quarter. Our normal spend, however, remained relatively in line with the prior year. Turning to our balance sheet. Our adjusted net assets were $269 million for the quarter, which is equal to our cash plus investments in funds and CLOs, less our debt. Adjusted net assets were down from the prior quarter, largely due to typical seasonality in our cash balance related to the timing of certain receivables and payables. This typical seasonality primarily relates to the timing of payments for prior year bonuses dispersed in the first quarter of the current year. We feel good about our overall adjusted net asset position and the longer-term trend. If we look at the year-over-year change in adjusted net assets, we had $283 million as of Q1 2022 versus $269 million as of Q1 2023.

A large driver of this decrease was the $38 million of capital returned to shareholders through our share repurchase plan and dividends. For the first quarter, we announced a cash dividend of $0.06 per Class A share, which represents 10% of distributable earnings. We will plan to target 10% of distributable earnings for the second and third quarters and true up our dividend in the fourth quarter to be 20% to 30% of distributable earnings on a full year basis, in line with our stated policy and our practice in 2022. As a reminder, we only pay dividends to Class A shareholders during the distribution holiday. To date, we have earned $546 million of the $600 million distribution holiday economic income target. In addition to our adjusted net asset balance, we have significant expected value from our ABURI balance, which is our accrued but unrecognized incentive income.

Our ABURI balance for the end of the first quarter was $163 million. Lastly, regarding the formation of the special committee. The special committee is comprised solely of independent directors to explore potential interest from third parties in a transaction with a company that maximizes value for shareholders. We are not going to provide any more details about the process until it is appropriate to do so. So there is no update for this call. With that, I’ll now hand the call back over to the operator to open it up for any questions.

Q&A Session

Operator: Our first question is from Bill Katz with Credit Suisse.

Michael Kelly: This is Michael Kelly on for Bill Katz. I was wondering if we could just get an update on real estate credit fundraising. I believe I saw that you guys had your second close of the credit funds. So I guess, if you guys could give us an idea of the timing for additional closes and ultimate target size. And then an update on the committed deployment in the Real Estate Fund IV and the sightline to begin fundraising for Fund V.

Jimmy Levin: Okay. Ellen, you are free to answer.

Dava Ritchea: Great. Okay. This is Dava. And Mike, thanks so much for the question. On the real estate credit fund, we would expect to have additional closes over the course of the year. As we stated on the call earlier, fundraising overall has been challenged given the legacy corporate noise. Jimmy, do you want to take the Real Estate IV question in terms of deployment?

Jimmy Levin: Sure. I don’t know if we disclosed, Dava. Did we disclose exactly what — where we are in the deployment of the existing fund? Yes.

Dava Ritchea: Yes.

Jimmy Levin: So we are around 60% deployed. There’s different ways to calculate that number, but that’s a good rough number. And generally speaking, when you get to that point is when you start looking towards the next fund. So I would assume a next year type of event. Is there a third question in there, Mike?

Michael Kelly: No, that was great. And if I could just have one more follow-up.?

Jimmy Levin: Sure.

Michael Kelly: What is the — have you guys stated the target size for STAX? You have the $475 million in total commitments thus far, another $100 million in 1Q. Do you guys have a target for that? And how do you — how should we think about the framing for ultimate size there?

Jimmy Levin: Yes. So what we’ve generally said on that is that we try to make each fund larger than its predecessor fund. I think the last opportunistic close-end fund was around $500 million. Dava, any additional color?

Dava Ritchea: I think again, on this one, it’s something that we’ll continue to raise or look to raise capital for over the course of the remainder of the year. And again, I stated earlier, the trends on capital raising remain a little challenging for us at this time.

Operator: Thank you. There are no further questions at this time. I’d like to turn the call back over to Ms. Conti.

Ellen Conti: Thank you, operator, 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.