Q4 2022 Sculptor Capital Management Inc Earnings Call

Speaker 2: Good morning, everyone, and welcome to Sculptor Capital's fourth quarter and full year 2022 earnings call. At this time, all participants aren't a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time.

Speaker 2: If anyone should require assistance during the conference, please press star and then zero on your touchtone telephone. 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 go ahead.

Speaker 3: Thanks operator. Good morning everyone and welcome to our call. Joining me are Jimmy Levin, our Chief Investor and Chief Executive Officer, Wayne Cohen, our President and Chief Operating Officer, and David Richie, our Chief Financial Officer.

Speaker 3: 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 capitals' actual results may differ, possibly materially, from those indicated in these forward-looking statements. Please refer to our most recent SEC filing.

Speaker 3: for description of the risk factors that could affect our financial results, our business, and other matters related to these statements.

Speaker 3: 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. gap.

Speaker 3: Information about and reconciliation of these non-GAT measures to the most directly comparable GAT measures are available in our earnings release, which is posted on our website.

Speaker 3: New 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 gap net income of $1.7 million for the fourth quarter of 2022, for seven cents per basic, and a loss of 19 cents per diluted classic share.

Speaker 3: For the full year 2022, we reported a gap net loss of $12 million or $48 cents per basic and $1.77 per diluted class A share. Our distributable earnings were a loss of $5.4 million for the fourth quarter or $0.10 per fully diluted share. For the full year 2022, distributable earnings were $56.4 million or $96 cents per fully diluted share.

Speaker 3: Additionally, we declared a cash dividend of 20 cents per class they share.

Speaker 3: All earnings metrics discussed by both Jimmy and Dave will be on our non-GAP economic income and distributable earnings metrics. I will now hand the call over to Jimmy. Good morning everyone.

Speaker 4: appreciate you all joining the call this morning. I'm going to start with a review of our business for 2022 and then I'm going to hand it over to David to cover the financials in more detail.

Speaker 4: Overall, 2022 was a historically challenging year for financial markets. Against that backdrop, the business made $56.4 million of distributable earnings for 96 cents per fully diluted share in 2022. We were able to achieve this result thanks to the diversity of our fund platform. Because of our multiple revenue streams from various funds, we can still generate...

Speaker 4: back to talk about the overall macro environment. 2022 was an unusual year for the markets and one of the most volatile years on record. Global equities had their worst years since 2008. Balance 60-40 portfolios were down almost 20 percent in 2022 as well stocks and bonds declined. Their worst since awaited by a wide margin. Special funds took their second biggest financial account. So we here has witnessed efforts to deliver a certain income to

Speaker 4: Overall, it was a big down year across pretty much most risk assets. Turning to our own performance for 2022, an opportunistic credit our funds experience significant relative out performance in 2022 versus relevant benchmarks and indices. Recall our strategy here benefits from largely duration neutral exposure.

Speaker 4: bringing annualized excess gross returns versus the BAMO Global Hailed Index to 8.2% since inception.

Speaker 4: Our 2022 performance builds on exceptional performance in 2021, where our op credit funds returns represented their largest annual access return over high yields. In that case, 22% versus 1.4%. The current credit environment provides attractive opportunities for our style of investing.

Speaker 4: The increase volatility in markets, tight financial conditions, higher rates, constrained capital markets, all help provide an attractive backdrop for our style of investing. In real estate, we continue to invest in harvest capital successfully.

Speaker 4: We focus on non-traditional niche asset classes within real estate, producing returns that are less correlated to the broader markets and to traditional real estate markets. This diversification and unique structuring of deals also leads to less exposure to rising interest rates versus broader real estate markets.

Speaker 4: It's fun 3 currently in the Tervis period.

Speaker 4: The overall portfolio saw a 15% increase in value year over year in a falling real estate market.

Speaker 4: This was driven by the monetization of some exceptional investments during the year, bringing light-to-date annualized growth returns for the fund to 30%.

Speaker 4: In fun for we remain well positioned with drive powder to capitalize on opportunities that may arise from current market conditions.

Speaker 4: In multi-strategy, we were down 11.6% gross in 2022.

Speaker 4: with balanced 60-40 portfolios down 19.1% per year. As a reminder, our investment approach in the multi-strategy fund is not market neutral.

Speaker 4: As a result, we historically have and would continue to expect some downside capture in the multi-strat fund in major down years for risk assets. Given the market backdrop, we would have expected the multi-strat fund to be down 8 or 9%.

Speaker 4: in a given year and we evaluate that over a longer period of time. Recognizing that in the multi-strategy business there have been years of outperformance and years with performance that did not meet our expectations.

Speaker 4: Before 2022, we had entered the year with some of our best trailing performance for the multi-strap fund with three-year annualized growth returns of 18% and five-year annualized growth returns of 13%. So, passing our stated investment objectives.

Speaker 4: So far in 23, I'll be a short period of time. We've had a good start to the year with the Credit Opportunities Fund up 2.3 net in January and multi-strategy up 4.1 net in January . And February will not finalize. We've also been off to a strong start with solid performance in both areas.

Speaker 4: Our second goal was fundraising, with a focus on growing longer-term AUM by maintaining and accelerating real estate and credit flows while continuing to turn the tide on capital raising for our multi-strategy funds. We headed into 2022 in a strong fundraising position after reaching an inflection point in 2021 in terms of flows.

Speaker 4: On the back of this, the first quarter of 2022 was one of the best fund raising quarters since 2014, raising almost $500 million into multi-strategy and $1.4 billion across the

Speaker 4: In the first quarter, we also held first closes for our real estate credit fund to the second vintage in that series. Our sculptor tactical credit fund, we call it stacks, which is the latest vintage in our series of seven closed-end opportunistic credit funds.

Speaker 4: These products grow our longer term AUM, adding additional stability, diversification, and duration to our platform. Our momentum in the first half of the year across the platform slowed dramatically in the second half of the year. Our third goal was to launch new initiatives with a focus on those that fit our investment philosophy, capabilities, and culture.

Speaker 4: capabilities to the insurance industry and a structure tailored to the specific objectives of those clients. We continue to evaluate and work closely on other similar initiatives.

Speaker 4: Our last goal was on efficient balance sheet management. We spent the last several years focused on growing our balance sheet from a deficit to a net asset position. 2022 proved how important this initiative was because when the markets got worse instead of needing to play defense, we were able to play offense by investing in our business and repurchasing shares when our stock price dropped.

Speaker 4: We bought back $32.5 million worth of stock during the year. We'll now hand the call over to Dava. Thank you, Jimmy, and good morning, everyone. Before we get into the drivers of our earnings for 2022, we wanted to step back and give some perspective on the year.

Speaker 3: Against the backdrop of one of the toughest years for the financial markets since 2008, our business made 56.4 million of distribution earnings, or 96 cents per fully diluted share.

Speaker 5: This result is a direct outcome of some of the building blocks we put in place over the past several years to strengthen our business, including building management fee earnings, diversifying our product mix, aligning our cost structure, and strengthening our balance sheet.

Speaker 5: I'll discuss each of these and the impact of them on our 2022 results. The first building block is management fee earnings. Our platform as it stands today has significant embedded scalability in the core franchise. What I mean by that is we can materially increase our AUM and our core products without materially increasing operating expenses.

Speaker 5: We illustrated that from 2019 to 2021 as we grew our management fee earnings as fund appreciation drove AUM growth. AUM increased during this period from $32.5 billion at the beginning of 2019 to $38.1 billion at the end of 2021.

Speaker 5: But we largely kept our fixed cost flat. Our management fee margins expanded over this period, and we could have materially expanded them further by continuing to increase AEM without materially increasing our fixed cost. We reversed that trend in 2022. Thank you.

Speaker 5: We started the year with 38.1 billion in AUM, our highest start of the year since 2016. However, over the course of the year, and largely as a result of fund appreciation, AUM decrease to 36 billion.

Speaker 5: Given the starting balance for the year, we still had a contribution to earnings from management fees in 2022.

Speaker 5: but our 2023 run rate will be lower. This will impact management-free margins in 2023 as we do not expect material changes to our fixed cost base.

Speaker 5: This overall period from 2019 to 2023 highlights how our management team margins are impacted by changes in AOM. As Jimmy mentioned, we had a strong start to the year with one of our best fund raising quarters in Q1 and continued momentum into Q2.

Speaker 5: Our net inflows for the first half of 2022 were 1.6 billion across the platform. However, in the second half of the year, we saw fundraising slow dramatically, impacted by the resumption of legacy corporate noise, along with broader industry trends.

Speaker 5: In the second half of the year, we had net outflows and distributions across the platform, as normalized redemptions occurred with limiting, with limited offsetting inflows. The net outflow and distributions in the second half of the year offset the net inflows and distributions in the first half of the year. Overall, redemptions for 2022 represent enormous levels in multi-short.

Speaker 5: into credit and real estate and as a result our 2022 incentive income was primarily driven from these areas.

Speaker 5: In real estate, incentive income was primarily driven by fund three. Over its life, this fund has delivered a 2x multiple uninvested capital and a 30% gross IRR. This fund is in harvest and had several large realizations this year as it's returning capital to investors. The fund has delivered a 3x multiple uninvested capital to investors.

Speaker 5: In opportunistic credit, incentive income was driven by crystallizations of our Burry balance. In multi-strategy, we did not generate meaningful incentive income in 2022. Our multi-strategy funds have high water marks, so we will need to earn back this performance before collecting incentive income.

Speaker 5: As Jimmy mentioned, we had a strong start to 2023 in terms of fund performance in January for both opportunistic credit and multi-strategies. Including February performance to date, which is not yet finalized, we have substantially recovered our losses and reduced our high water marks in opportunistic credit and has made meaningful progress on this in multi-strategies.

Speaker 5: approximately 10 million of elevated legal expenses related to the books and records action and the activities of the special committee of our Board of Directors.

Speaker 5: We would expect to see these elevated levels continue into 2023.

Speaker 5: Our normalized GA&O spend however it remained relatively in line with the prior year. On to variable compensation. As a reminder, our variable bonuses are based on fund performance. Given our absolute performance in 2022 with weaker than it was in 2021 in both opportunistic credit and multi-strategy, our variable bonuses were down meaningfully year over year in line with performance. What largely drove variable bonus in 2022 was carried interest profit share.

Speaker 5: funds and CLOs less our debt. Adjustment and assets was down from 2021, primarily from share repurchases, as we return capital to investors and we experience some depreciation of our fund investments and CLOs.

Speaker 5: This is largely due to mark-to-market on our CLOs and our structured alternative and Biden's solution. If we look at the longer-term trend, adjusted net assets is up significantly from 2018 when it was a deficit of $55.8 million. In addition to our adjusted net asset balance, we have significant expected value from our very balanced, which is our

Speaker 6: on the appreciation.

Speaker 5: Our Abury Balance for Real Estate is primarily driven by Real Estate Fund 3, which is currently in Harvest Mode.

Speaker 5: We would expect to continue to see the sub-Berry crystallize into incentive income as capital is returned.

Speaker 5: Real estate fund 4 is in its investment period, so we would expect to see a Burry balance from this fund increase over time as we continue to invest capital. As a reminder, as real estate a Burry is crystallized into incentive income, we expense the associated compensation. In opportunistic credit, the next major crystallization event for our Burry balance is expected to be in 2025. Difference and in real estate, as opportunistic credit a Burry is crystallized into incentive income.

Speaker 5: we announced the cash dividend of 20 cents per class A share, bringing full year dividends to 20% of distributed earnings. As a reminder, we only pay dividends to class A share holders during the distribution holiday. To date, we have earned 528 million of the 600 million distributed holiday economic income target. We will continue to evaluate the best uses of our capital while maintaining an ample balance sheet.

Speaker 5: details about that process until it's appropriate to do so. So there is no update for this call.

Speaker 5: To wrap up, our focus for 2023 is first and foremost generating successful returns for our clients. Given the likelihood of continued volatility in the market, we think this presents an opportunity to showcase the value of our investment capabilities while delivering long-term value to both fund investors and public shareholders. With that, I'll hand the call over to the operator and open it up to any questions. Thank you. If you have a question at this time, please press star followed by one on your-

Speaker 4: One that was tailored for insurance clients, but hoping you might be able to add a little bit of color as to what other new products might be in the works if it's appropriated this time. Sure, so we had a first close last year on a closed-end Opportunistic Credit Fund.

Speaker 4: on the section close at Real Estate Credit Fund on the structural alternative solution. We mentioned we had done one of those in 2022. We also have a non-traded REIT in the works where there's been some coverage of that topic. So all in our key areas of focus, all sort of consistent with the theme of long dated capital in the areas that we're really excited about. Again, a lot of that momentum came out in the back half of the year, but the products are the products.

Speaker 7: Fair enough. And then, David, perhaps one for you, I know there wasn't specific guidance looking forward to 2023, but was that one clarifying question. The 10 million of elevated legal fees, I believe that was for full year 2022. I think it was back and loaded though, so just trying to get a sense of how to kind of think about that on a...

Speaker 5: in terms. So you're right on the $10 million elevated legal fees, you know, about 70% of that was in the fourth quarter. We would expect some of that to continue into Q1 and we can provide further updates at that point in time on that. On the salaries and benefits portion, I think that's up there.

Speaker 7: overall run rate could be leveraging. Okay, great. Thanks for taking my questions this morning. Next question, Patrick DeVitt. With AutoNotness Research, please go ahead. Hey, good morning. Could you speak to what extent the portfolio management capabilities of the credit real estate and multi-strat businesses are easily siloed?

Speaker 4: or would it be tough to slice those into distinct, separate standalone businesses? Yeah, it's a pretty well-integrated investment platform. We've run that way since the beginning. It's a certain investment capabilities are more distinct than others, but a lot of the value we've historically been able to deliver, we think, comes from the collaboration across areas. So it's been a key part of the culture. Certain areas are more tightly intertwined than others.

Speaker 7: Okay, thanks. And starting to see signs of a little bit more stress in office credit. So could you update us on how exposed your real estate business is to both office equity and debt, how that bucket of position for what it looks like and how that bucket of position for what looks like an increasingly tough outlook there? Not a material part of what we do. Got it. Thank you. Next question comes from Bill Kat with Credit Suisse. Please go ahead. Thanks so much. So just question for you as you look at where the stock is trading today.

Speaker 8: Okay, let me ask a question on this cap, so as you think about this year, I think part of it Jimmy was getting the balance sheet and grade shape which you've done and then using that to both invest into the business and grow. Where are you in terms of that reparation of the balance sheet? What new areas do you think you need to invest in? What do you think you need to invest in?

Speaker 4: much balance sheet one would want to build and say more is more that said as we were building that we said when things come up we're going to want to spend what we built if we think the returns payoff. The first.

Speaker 4: material opportunities for that came up both during the year 2022. One was to support a lot of those growth initiatives we talked about in the first half of the year that were assisted by the use of our balance sheet. And secondarily on a buyback when the market gave us the opportunity in terms of the price action you described.

Speaker 4: It's an imperfect answer, but we're going to keep building and keep every day evaluating what those uses are and if the uses are better than the build then fire away. And that I think 2022 should give you some good insight into that risk-reward analysis.

Speaker 8: Okay, and this may one last for Pete. Thanks for taking the questions. Some of your peers are starting to talk about growing opportunity for liquid alternatives after normalization of interest rates and more volatility. Certainly have a very good long-term track record, but you mentioned the corporate governance issues as well, hindering gross sales.

Speaker 4: How do you think about that opportunity set into 2023 and when you look at your organic growth for the year, where do you see the best actual opportunity to grow? Yeah, so I think you answered both parts of it yourself successfully, which is that is a key area. I don't know if liquid alternatives exactly the right word, but the more liquid end of our credit capability being something that some of the peers are focused on is also something we are focused on that also is more topical today. And the reason it's more topical today is because rates are higher and spreads are wider and suddenly the absolute returns available from that type of activity.

Speaker 4: you know, sort of catch a lot of attention, frankly, across a pretty broad swath of investor types. So that is not lost on us. We are actively forming capital around that, particularly in the insurance space. But as you mentioned, some what we have going on on the corporate side, doesn't necessarily help accelerate that process. So yes and yes, I guess is the answer to your question.