SCU (2021 - Q4)

Good morning, everyone, and welcome to Sculptor Capital's Fourth Quarter and Full Year 2021 Earnings Call. 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 and at Sculptor Capital. Ellen Co

Thanks, Peter. 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 Web site. 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. Yesterday, we reported our fourth quarter 2021 GAAP net loss of $5.8 million or $0.23 per basic and $0.75 per diluted Class A share. For full year 2021, we reported a GAAP net loss of $8.6 million or $0.34 per basic and $0.56 per diluted Class A share. Fourth quarter distributable earnings were a loss of $56 million or $0.94 per fully diluted share. For the full year 2021, distributable earnings were income of $83 million or $1.38 per fully diluted share. We did not declare a dividend this quarter. All earning metrics discussed by both Jimmy and Dava will be on our non-GAAP economic income and distributable earnings metrics. I'll now hand the call over to Jimmy for a few words.

Good morning, everyone. Thanks for joining the call. I’m going to give some high-level thoughts about 2021 and about where the business stands before handing it over to Dava to get into 2021 in more detail. So, 2021 was an inflection point for the business. After years and years of hard work against what at times felt like some pretty tough odds, we are now in a place where we have actual tangible results across almost every metric we use to measure the health of the business: Our investment performance, our client flows, our income statement and our balance sheet. So, starting with performance, 2021 was an exceptional year for opportunistic credit, an exceptional year for ICS, an exceptional year in our real estate business, and in our multi-strategy funds, we met investor objectives, albeit at the lower end of the range. If you blend that across our entire platform, we would describe 2021 as a good year overall in terms of performance. On client flows, and this is probably the area where there's obviously been the most focus and the most talk in this forum, and it is a critical measure of our long-term success, we turned that corner over the past several years in our real estate business, in our ICS business and our opportunistic credit business. Multi-strategy funds, albeit less than 30% of AUM have been a focus internally and externally. It's certainly a focus for us, and we understand it's obviously a focus for all of you. In 2021, we had $1.2 billion of gross inflows into multi-strategy. And importantly, the first year of positive net flows, for the first time since 2014, those inflows in 2021 were 11.3% of our beginning AUM. And just to put that into historical context, because this is what gives us confidence about the future, if you go back to the era after the financial crisis, 2010 to 2014, that was a great era for hedge funds. It was a great era for multi-strategy funds, and it was before our firm had any of its challenges. And average annual gross inflows at that time were about 14% of beginning AUM. Then you move to 2015 to 2019. Obviously a tough for the firm and gross inflows went to virtually zero, about 2% annualized. Go to where we are today, back to 11.3% in 2021. 2022, first couple of months, $450 million of gross inflows on a starting place of $11 billion. We feel really good about that chart, and understand the questions are always where do we go from here? We don't -- we can't forecast the exact flows. We’ve tried, it's just not an exercise that’s particularly fruitful. But zooming out of that, it's a pretty powerful trend. We watched years and years of observant -- observation points at low to mid-teens numbers, and we saw the number go to zero, and then we saw it go back to the low double digits and seemingly off to a great start in 2022. And the context for that top down, as just described, feels good and bottoms up feels great. We know what our touch points are. We know what our client engagement is. We know the comes up certainly feels like a pretty tremendous accomplishment. On to the income statement. Today we’ve meaningful earnings power. We generally think about this in two buckets. First bucket, management fees less fixed expenses, or said differently, earnings without the impact of incentive income and the variable bonus expense against that incentive income. And the second is inclusive of that incentive income and that variable bonus expense against. So, in the first bucket, we look at it as management fees less fixed expense, and this went from a meaningfully negative number to what is now a meaningfully positive number, and that’s the simple result of a couple of things. It's growing management fees, while reducing or maintaining fixed expenses. And the growth in the management fees comes from the flow dynamic we discussed, and it comes from compounding capital within our evergreen funds. And so, where that leaves us today is just shy of $1 of earnings per share from our management fees less fixed expenses. Now, let's do a deeper dive on the all-in earnings or the earnings inclusive of earnings power, I should say, inclusive of incentive income and the variable expense against it. And I think it's instructive here to look at the last 2 years because they're two very different years, 2020 and 2021. What they have in common is good performance. Good or great performance, I should say, for 2020 and 2021, but constructed in a very different way. So, in 2021, we had good performance at the firm level. We had exceptional performance in credit, which results in significant ABURI generation relative to incentive fees and thereby a higher compensation ratio from fund performance in that year. In 2020, we had a great performance here at the firm level. We had exceptional performance in multi-strategy, and we had a large crystallization event for multiple years of ABURI generation which led to a lower comp ratio, so most of that compensation from the ABURI crystallization was expensed in prior periods. So, in 2021, we generated DE of $1.38 per fully diluted share, but we created $98.6 million in net new ABURI for the year. So, when considering the ABURI generation, we think of that economically as about $3 adjusted per share. In 2020, our adjusted DE, excluding legal settlements and provisions, was $7.22 per share. But we net crystallized $125 million of ABURI, which when we think of that, excluding the ABURI crystallization is about $5 of adjusted all-in earnings. So, if you think about that in terms of today's earnings power, and the franchise is growing, not shrinking. In today's earnings -- in today's structure, that's all-in earnings power when considering the ABURI timing of $3 to $5 per share in years where we have good to great performance with roughly $1 of that coming from management fees less fixed expenses. And we understand there's -- it's a complicated issue to look through, and Dave is going to spend more time bridging that, but when we think of the health of the business, the health of the income statement and our earnings power, that's the way we view it internally. In addition to annual earnings or annual earnings power, we built significant value in our balance sheet. So historically, our balance sheet was a pretty significant net liability. And after years of earnings power, which we were able to retain that earnings power or, I should say, retain the results of that earnings power, we’ve now been able to create a significant net asset position. So, our adjusted net assets were roughly $381 million at the end of the year, plus our ABURI balance of roughly $227 million. So, if we combine how we think about recurring earnings outside or before the impact of incentive fees, and we combine that with the potential incentive fees and the variable bonus expense against it, and we combine that with a materially net asset balance sheet, we really like the starting point that we can build on from here. So, when we talk about building on it from here, there is pretty meaningful operating leverage in the core business. And what that really means is as we add additional AUM in existing products or closely related products, we generally do that with pretty minor incremental fixed expense. And so, the flow-through on that can be pretty powerful, and so -- where do we get that incremental revenue that comes from again, compounding capital and from net flows. And I think the power of compounding capital in our evergreen funds shouldn't be discounted. It's a real benefit in the model and probably one which is relatively underappreciated. Just compounding in the passage of time is a pretty good creator of fund capital for us, I should say. So, with the income statement health that we now have, the balance sheet strength that we now have, that allows us to plant seeds for growth outside of our core existing businesses. And we are constantly evaluating the best use of that capital, that balance sheet capital and that income statement capital, and we are being really thoughtful on that and we are going really slowly on that. The power of the core business and the earnings power associated with that in our minds is so tremendous that while we have to keep an eye on the distant future, right now, we are trying to execute on the core. And we will continue to plant seeds, and we will continue to explore planting seeds, and there are a whole host of things we can do that relate to new distribution channels for our existing products and new products for our existing capabilities, but we are going to be really judicious about how we spend that balance sheet and how we spend that income statement and frankly, how we spend that time. So, wrapping up, looking at the business internally and looking at our underlying earnings drivers, strong performance, good flows, rigorous cost framework and a growing balance sheet we can deploy, we are quite excited about the years to come. With that, I will hand it over to Dava.

Thanks, Jimmy. I first want to highlight some of the key drivers behind 2021 full year results, and in particular, the fourth quarter. I will then finish up with some topics that have an impact on our overall financials. Both our full year and fourth quarter results highlight timing issues that can impact our earnings, and in some periods like this year, the impact of those timing issues can be pretty significant. The main timing issue in our business comes from the differences in our revenue recognition of incentive income versus the recognition of related bonus expenses. First, to the 2021 results. In analyzing our 2021 -- in analyzing these results, we think it's helpful to evaluate our 2020 results alongside. Both of these years were significantly impacted by the timing differences I described, albeit in opposite directions. This makes comparison between the years, on an absolute basis, quite challenging. Let's unpack that a little. The 2021 results are best described as follows: multi-strategy performance met investor expectations, but was lower than 2020, which resulted in lower overall incentive income. We had exceptional fund performance and opportunistic credit, which was largely not crystallized into incentive fees in 2021, but increased our ABURI balance. And we had a relatively higher compensation ratio as bonus expenses related to the opportunistic credit performance were accrued in 2021 without all of the corresponding incentive income. In 2020, on the other hand, we had exceptional multi-strategy performance, an outside crystallization of incentive fees from our opportunistic credit funds as one of these vehicles crystallize incentives that was generated over a multiyear period. And we had a relatively lower compensation ratio as bonus expenses related to this crystallization event had been expensed from prior periods. Putting numbers behind all of this, we had $83 million of distributable earnings in 2021 versus $406 million of adjusted distributable earnings in 2020. This equates to $1.38 per fully diluted share in 2021 versus $7.22 per fully diluted share in 2020, or a difference of $5.84 per fully diluted shares between the two periods. The primary driver of this difference in earnings per share is the timing difference I discussed. This represents $3.88 of that earnings delta or about two-thirds of the overall difference. We calculate this as follows. In 2021, we created $98.6 million of net new ABURI from the strong performance in our opportunistic credit and real estate funds. In 2020, we reduced ABURI on a net basis by $125.4 million, largely due to the outsized realization from our opportunistic credit funds. The $98.6 million of net new ABURI in 2021, combined with $125.4 million reduction in ABURI for 2020, resulted in a swing of $224.1 million or $3.88 per share. The remaining delta between 2020 and 2021 is largely explained by it being a great performance year in 2020 versus a good performance year in 2021. Now, let's shift gears to the fourth quarter results and discuss how this timing issue impact between the incentive income and related bonus expense impacted the quarter. In 2021, we earned $312.4 million of incentive income. Of that incentive income, $119.6 million was recognized over the first three quarters of the year, with the remainder recognized in the fourth quarter. The incentive income generated over the first three quarters was largely related to investors that have off-cycle crystallization dates, and therefore, they crystallize in those periods. Compensation expense related to the incentive income earned during the first three quarters of this year was either expensed in the fourth quarter of 2020 or the fourth quarter of 2021. This is because we accrue incentive related bonuses in the fourth quarter in the year that the fund performance is generated. Due to these timing differences, the first three quarters earnings were elevated as there was a limited compensation expense related to the incentive income, while the fourth quarter 2021 earnings were depressed as it contained compensation expense related to revenues that were received in prior quarters. It should be noted that 2021 experienced a relatively higher proportion of incentive income recognized during the first three quarters as a percentage of full year incentive income than is normal. This is because the performance period for the incentive fees generated over these three quarters was largely during the second half of 2020 and the first half of 2021, when our multi-strategy funds had exceptional performance. We do not expect the magnitude of this quarterly timing difference to be as proportionately large again this year. Given the timing differences we described on both our quarterly and annual results, it's best to evaluate our business with ABURI in mind and over a multi-year period. I want to end the discussion on 2021 by highlighting some of the fundamental earnings drivers that Jimmy discussed earlier. These are all trending favorably year-over-year. Management fees are up year-over-year, $281 million for 2021 versus $250 million for 2020, or an increase of 12% year-over-year. Fixed expenses are down year-over-year. $25 million for 2021 versus $238 million for 2020, or down 5% year-over-year. Adjusted net assets are up year-over-year. We ended the year at $381.4 million versus $42.3 million at the end of 2020. This is driven both by the paydown of our liabilities and the growth in our assets. Now, let's shift gears and focus on a few other topics that impact our financials. First, we had a new management compensation framework that was approved by the Board in December. This framework creates further alignment for our management team with our clients and our public shareholders. The framework is performance-driven, and compensation is tied directly to our fund performance and share price. The performance-based equity grants are only granted if shareholders experienced significant returns, with tranches vesting up 50% to 149% from the stock price at the time of the award. On a dividend-adjusted basis from today's stock price, we have to almost double to hit that first tranche. On annual compensation, our structure is aligned with our fund performance and reduces our fixed minimum bonus success. Lastly, the framework provides additional structural protection through restricted covenants, vesting terms and clawback policy. The impact of our financials of the performance-based equity award is as follows. On a GAAP basis, the equity award is expensed based on the grant date fair value recognized over the requisite service period. There is no impact on an economic income basis as share-based compensation is excluded from economic income. However, the shares will be reflected in our fully diluted shares outstanding once the stock price is above the shareholder return target. Next topic I would like to cover is our SPAC. In the fourth quarter, we sponsored the SPAC as part of our real estate business. This SPAC allows us to evaluate different types of opportunities that we currently evaluate in our funds and can generate a meaningful ROI for our shareholders in the event of a successful business combination, founder shares and warrants in the SPAC. This SPAC is included in AUM under our real estate business, but is non-fee paying. This SPAC is fully consolidated in our GAAP financial statements but has no impact to economic income. Once we find a target and complete an acquisition or if the SPAC is liquidated, the SPAC AUM will be reduced to zero. Future economics will be from our partial ownership of the go-forward Company and will largely be reflected through investment income. Turning to guidance for 2022. As we’ve stated previously, we do not plan to provide explicit expense guidance for 2022. However, there is nothing in our core business that should result in material differences to our fixed expenses. Lastly, an update on the distribution holiday and our dividend policy. As a reminder, we need to earn $600 million of distributable holiday economic income and the distribution holiday. As of the end of the fourth quarter, we have $130.3 million remaining. As we near the end of the distribution holiday, we are asked from time-to-time on our go-forward dividend policy, and wanted to provide some additional clarity. As a reminder, during the distribution holiday, we paid 20% to 30% of distribution holiday economic income as dividends to Class A shareholders. Unitholders do not receive any dividends. We are still evaluating, but expect to pay between 50% and 75% of distributable earnings as dividends post the distribution holiday. We anticipate that we will still be focused on building our balance sheet, and we have lots of interesting ideas for which we want to deploy that capital. So, it's unlikely that the dividend will be more than 75% of distributable earnings. We would potentially pay for less than 50%, but there was a great use of capital that could be attractive buybacks, M&A, amongst other opportunities. As a reminder, our executive managing directors have a significant ownership interest, and so we are very aligned to utilize that capital to make investments that maximize long-term returns to shareholders or to return capital to shareholders via buybacks or dividends when appropriate. We can now turn to Q&A. I will turn the call over to Peter to facilitate the Q&A. Peter? Is there anyone on the Q&A?

The first question is from Gerry O'Hara with Jefferies. Please go ahead.

Great. Thanks and good morning. Clearly, some -- I think, optimism in the tone as it relates to future fund flows. But perhaps you could elaborate a little bit as it relates to conversations or dialogue with kind of the consultant community and gatekeepers, and perhaps LPs that sort of is driving some of that confidence?

Sure. So, I think the simplest way to say this, and we tried to highlight it with this kind of 12-year view, we were in the business of raising capital into multi-strat funds and other funds prior to the firm issues. And we, I will say, won our fair share of market share of those flow dollars. And for a long period of time, we were simply out of the market. It was -- the firm had issues where it was really challenging for new investors to allocate new dollars. And to go from that place of zero, effectively zero, I should say, to go to a place of activity is a significant difference that we can observe a bunch of different ways. We can observe the actual flows and we can observe the fact that we are in the dialogue now. When there is an RFP, we have a pretty good chance of being in it. When there is a new mandate out, we’ve a pretty good chance of being in it to win it. When an institution with a consultant adviser relationship is looking to meet managers, we get an introduction to that institution through the private wealth channel. The private wealth channel is now, I will say, largely open to us, the way we define that channel. And frankly, it was not necessarily largely open to us during those years that were more dormant. So, it's really -- it's pretty stark when we look at it top down in terms of being essentially out of the market versus now being in the market. Now, we still need to do a great job. We still need to win business. We still need to earn trust. We need to execute, but we have a horse in the race today.

Okay. That’s helpful. And then I wanted to, I guess, expand a little bit on the operating leverage comments, both from your press release and prepared remarks. And if you could maybe just sort of help us frame that against, "no material change in expenses". Should we think that that rate of expenses or at least operating core expenses should remain sort of at a similar level? Or are there sort of some other kind of metrics that we should be focused on to kind of get a sense of how leverage in the business could develop going forward?

Thanks, Gerry. So, I think when you're talking about core expenses, again, we don’t anticipate there being any real material change from the guidance that we had given last year around core expenses and from our experience this year. In terms of starting to see that operating leverage, the first place you are going to see that is in management fees. And as we said this year, even with the growth that we had, those were up 12% year-over-year. Maybe I will turn it over to Jimmy to talk a little bit more about some of the future pieces.

Yes. Bigger picture, when we look at our -- at this point, pretty significantly larger public peers, and think about the focus areas there, whether it's the insurance market, the retail market, non-traded REITs, non-traded BDCs and permanent capital vehicles and the list goes on, those are all areas we understand deeply, see the opportunity and currently don’t do. Should we be pursuing any of those in a significant way? Obviously, those are going to cost money. Right now, we are focused on the core, and we are focused on capturing the operating leverage in the core, but I think we would be doing a disservice long-term if we weren't thinking about those other things. So, at some point, we are going to have to plant seeds for what the business looks like in a decade. And it probably doesn't look exactly the way it looks today in a decade, and we are only going to be in that position if at some point, we start planting those seeds. And when we do, it will cost operating expenses, but we are not at a point where we need to focus on that right this second.

Okay. That’s helpful. And then just maybe one last one, if I could. The -- clearly, the timing issue is complicated and perhaps just sort of a function of the size and the structure of your current business. But is there anything that you could sort of take away from the past 2 years in terms of philosophy and process as it relates to the comp accruals that might help sort of streamline or simplify that? Or is it just sort of something that we kind of have to deal with for the present time?

I will let Dava try to answer it differently a few ones , but I think you nailed it with the second part of your question there. At our current scale, it's just magnified. The way we do it is the way we’ve always done it and the way that I would say the substantial number of our peers, albeit most of them at this scale are not public, also handle compensation. It's, of course, magnified in the context of our scale and our scale as a public company, but I think that’s something we’ve learned to live with. We obviously have tried to in this call, and more recently leading into this call, give a little more clarity on how we think of it and what to expect, and we tried to foreshadow that on our third quarter call, because there's quarterly issues and there's annual issues. Those are inherent to our business. And our accounting policy, which is more of a Dava question, follows the inherent nature of the business. So should we be so fortunate to get to a totally different scale someday, and at some point in the past, many years ago, we were -- where these issues were there, they were just frankly less noticeable, so that will be obviously a high-class problem should we get to that scale again. But we have a business that has certain inherent attributes, and the way we run it and our accounting for it is going to have to follow the inherent fundamentals of the business.

I think that's right, Jimmy. And I would also say on the compensation side, the way that we pay provides greater flexibility to us in terms of running the business as opposed to doing it in a different fashion, which might make the accounting line up a little bit easier, but we think from an actual running of the business perspective, doesn't give us the flexibility. And so, over the long-term perspective, we think this is the right way to do it. We will continue to provide as much guidance as we can, and we will incur -- we will continue to work with you in terms of looking at that ABURI balance and understanding where we are in different parts of the process. But as we stated before, looking at compensation ratios with ABURI in mind and over multi-year periods is really the best way to be evaluating our business.

Okay, great. Thanks for taking my questions this morning.

Thank you. I’m not showing any further questions. I will now turn the call over to Ms. Conti.

Thank you, Peter, and thanks everyone for joining us today and for your interest in Sculpture Capital. If you have any questions, please don't hesitate to contact me at 212-719-7381. Thank you.

This concludes today's conference. You may now disconnect your lines. Thank you for your participation.