Och-Ziff's (OZM) CEO Dan Och on Q3 2017 Results - Earnings Call Transcript

Och-Ziff Capital Management Group LLC (OZM) Q3 2017 Earnings Conference Call November 2, 2017 8:30 AM ET

Executives

Dan Och - Chairman, Chief Executive Officer

Alesia Haas - Chief Financial Officer

Adam Willkomm - Head of Business Development and Shareholder Services

Analysts

Robert Lee - KBW

Gerald O'Hara - Jefferies

Mike Needham - Bank of America

Jack Huller - Citigroup

Will Cuddy - JPMorgan

Jonathan Casteleyn - Hedgeye

Operator

Good morning, everyone and welcome to the OZ Management’s Third Quarter 2017 Earnings Call. At this time all participants are 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, Adam Willkomm, Head of Business Development and Shareholder Services at OZ Management.

Adam Willkomm

Thanks Leandra. Good morning everyone and welcome to our call. Joining me are Dan Och, our Chairman and Chief Executive Officer; and Alesia Haas, our Chief Financial Officer.

Today’s call may include forward-looking statements, many of which are inherently uncertain and outside of our control. Before we get started, I need to remind you that OZ Management’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 businesses 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 entity.

Earlier this morning we reported third quarter 2017 GAAP net income of $6 million or $0.03 per basic and diluted Class A share. As always, you can find a full review of our GAAP results in our press release, which is available on our website.

On an economic income basis, we reported third quarter 2017 distributable earnings of $39.8 million or $0.07 per adjusted Class A share. We declared a $0.02 dividend for the third quarter. If you have any questions about the information provided in our press release or on our call this morning, please feel free to follow up with me.

With that, let me now turn the call over to Dan.

Dan Och

Thanks Adam and good morning everyone. I apologize for a little bit of a sore throat. Our third quarter results demonstrate continued execution on our priorities. Our performance continues to be strong and broad based across funds and strategies. We are encouraged by the number and nature of clients and perspective client conversations and we continue to make progress on our financial plan.

We were pleased with the breadth of our multi-strategy fund games as our five main strategies were positive for the quarter. The OZ Master Fund, our largest-multi strategy fund, returned 2.1% net for the quarter and 9.7% net for the first nine months of 2017. For the last twelve months through September 30, the Master Fund posted a 12.7% net return.

Global markets continue to rally with the S&P 500 rising each month in the third quarter. This grind higher has been notable for its consistency and lack of volatility. The largely pull back in the S&P 500 this year has been under 3% and the VIX completed the calmest quarter in its history. This market dynamic combined with historically low rates leaves us to look for alternative ways to generate entire factor risk-adjusted returns.

We are constantly casting a wide net in search of opportunities, seeking solutions that are complex, process driven, those with catalysts or have an otherwise explodeable niche element to generate returns.

Opportunist credit continues to post strong returns. OZ CO our largest credit fund was up 2.2% net in the third quarter, 8% net for the first nine months of the year 14.3% net over the last 12 months. Structured and corporate credit continued to demonstrate strong performance across all geographies this quarter as we made favorable progress in a number of process driven situations.

During the third quarter we closed two new CLOs one in the US and one in Europe, adding just over $1 billion on assets. We already priced a $11 million CLO in October that will close during the quarter and we are optimistic that we may price two more CLOs before year end. Total CLO issuance year-to-date, including refinancing now total $6.1 billion.

In real estate we continue to focus on deploying capital in our current funds and harvesting investments in our legacy funds. We have committed approximately 60% of our third opportunistic real estate fund and 18% in our recently closed real estate credit fund.

During the quarter our real estate funds realized nine investments across funds with an average multiple of two times. We are extremely pleased with our performance across all our businesses during the first nine months of the year and have started the last quarter of the year off strong with the Master Fund posting a 1.75% net return for October bringing the year-to-date net return to 11.7%.

Our October 1 net outflows continue to trend down from those experienced July 1, and were primarily concentrated in our multi-strategy funds. While our multi-strategy funds in the near term will remain negative on a net basis until off set by corresponding inflows, we are focused on building a pipeline of client mandates across all of our businesses. We continue to believe that the strong performance we have exhibited is the right first step to attracting new capital and are encouraged to hear positive feedback on our recent performance. At some point we believe this will translate into inflows.

With that, let me now turn the call over Alesia.

Alesia Haas

Thanks Dan. I'll start with the report of our economic income results. Our third quarter revenues were $125 million, down 10% year-over-year. Management fees were $72 million, $47 million lower than a year ago, primarily due to the redemptions from our multi-strategy fund and the management fee reduction that took effect in the fourth quarter of 2016.

Our incentive income was $51 million for the quarter, an increase of $32 million year-over-year. As of September 30, 2017 our growth accrued, but unrecognized incentive generated from extended fee paying assets was $402 million, up $31 million quarter-over-quarter. Again we would like to remind you with the exception of the balance associated with our real estate and energy funds, the remainder of this balance has no associated compensation expense, as this was paid in the earlier period.

Our third quarter expenses, totaled $75 million down 8% year-over-year. For the quarter compensation and benefits were $44 million, up 21% year-over-year, driven by our decision to provide for a minimum annual discretionary cash bonus accrual over the year.

Salaries and benefits were $24 million for the quarter, an 11% decrease from the third quarter of 2016 and essentially flat from the prior quarter. Our bonus expense was $19 million. In the third quarter non-compensation expenses were $32 million, down 30% year-over-year and down 3% sequentially. We continue to focus on opportunities to further reduce our operating expenses.

We expect full year 2017 salaries and benefits and non-compensation expenses to be near the low end of the range of our previously communicated guidance. As a reminder our guidance was $100 million to $105 million though salaries and benefits and $140 million to $155 million for non-compensation expenses, including interest expense.

Our tax receivable agreement and other payables were 20% of economic income for the quarter. Our guidance for the full year tax receivable agreement and other payables remains unchanged at 16% to 22% of our economic income. As a reminder, these estimates are subject to many variables that won't be finalized until the fourth quarter of this year and therefore could vary materially. All guidance reflects our best estimates at this time. We anticipate providing 2018 guidance on our fourth quarter 2017 earnings call.

Now an update on the balance sheet. As we mentioned last quarter, we are investing in our own CLOs to satisfy risk retention requirements by sending vertical strips in respect to each CLO on our balance sheet and financing this investment with third party financing.

On account of our strong level of CLO issuance in the quarter, our investments increased by $133 million and our reported debt obligations increased by $111 million this quarter. We want to remind you that this debt only has recourse to our CLO manager entity and is not a general obligation of the management company. This risk retention related CLO activity has also driven a increase in other revues and interest expense.

Lastly, as we look to the fourth quarter and consider our potential full year 2017 incentive income, we are optimistic that we may see a meaningful amount of annual incentives based on the strong year-to-date performance of our funds. This will likely translate to a healthy amount of distributable earnings.

Our top priority is to use fourth quarter distributable earnings to continue to strengthen our balance sheet by retaining cash. After that, we will evaluate increased dividend and share repurchases based on what we believe is in the best long term interest of shareholders.

With that, we will open the line up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Robert Lee with KBW. Your line is open.

Robert Lee

Great, thank you and thanks for taking my questions. Dan, I got on the call a little bit late, so I apologize if you made these comments. But could you just update us on outside of the multi-strat, some of the fund raising priorities right now. I think you mentioned the one real estate strategies is about 60% invested. So I assume that next generation of that fund will be coming up soon. Maybe just update us on fund raising priorities?

Dan Och

Sure. Well look, I don’t want to comment on any specific funds for obvious reasons. But you are correct, we made clear that our real estate group, both on the equity side, as well as the real estate credit side has generated very, very strong returns and our plans are to grow both of those businesses, hopefully in a substantial ways.

So we did point out, I don’t know if you missed it on the call, that real estate fund was 60% invested. Once again, no specific comment on the plans, but you are absolutely correct that that fund is doing extremely well and we do plan to continue to grow the real estate platform going forward.

On the credit side, CLO issuance is strong, you heard those numbers during the quarter. We are going to continue to execute. Performance there continues to be extremely good. On the credit side we are focused in all of our different product areas. So performance everywhere is hitting on all cylinders and this benefit is historically lows have followed performance. So at Oz here’s we provide people and clients with everything they are looking for in addition to performance and historically flows have already followed performance that is what we are focused on.

Robert Lee

Okay, thank you, and then maybe just a follow-up for Alesia. If I have my numbers correct, I think last year kind of total incentive comp for ’16 was about 30% of total revenues roughly. So given that Alesia, currently where we sit you are going to have – should have a pretty good incentive quarter in Q4 given the year-to-date performance. You know how should we be thinking about kind of that revenue to kind, you know comp to total revenue for the full year and kind of how much should we assume that we’ll see some improvement last year. Kind of keep it steady, kind of how should we think about it?

Alesia Haas

So first of all, I would share the you are correct. That we also anticipate generating strong annual incentive in the fourth quarter, which will result in us paying higher additional discretionary bonuses beyond our minimum bonus accrual that we have set forth. However, we are not prepared to provide guidance around what this amount maybe at this time.

Robert Lee

Had to try, so

Alesia Haas

No problem, I understand.

Robert Lee

Okay, that was it. Thank you.

Operator

Your next question comes from the line of Gerald O'Hara with Jefferies. Your line is open.

Gerald O'Hara

Great, thanks for taking my question. Just actually one, staying with you Alesia on expenses you sort of mentioned here, non-comp expense decrease quarter-over-quarter was just you know reductions across various other expenses. Could you perhaps elaborate as to if that’s kind of related to some initiatives that are going on or just you know kind of any specificity you might be able to add with respect to the quarter-over-quarter change.

Alesia Haas

We are activity exploring cost saving opportunities and taking a very disciplined approach to our expenses. So each of those opportunities are one off. I wouldn’t say there’s a general trend, but as we look across our non-compensation expense category, we are actively trying to identify opportunities to lower each of those sockets and bring them down every quarter. So nothing specific, but it a high priority of the firm.

Gerald O'Hara

Okay, fair enough. And then just a quick follow-up on the comments just a moment ago on the real estate fund being or the latest vintage being 60% investor committed. Is there typically a threshold there, you know whether it be 70, 75 and it doesn’t necessarily have to be for this fund in particular. But, that you target before you start you know entering the conversation for raising a follow-on fund or something to that effect.

Dan Och

Most funds have an either contractual threshold or an understanding with investors.

Gerald O'Hara

Okay, fair enough.

,

Dan Och

And if you follow up – thank you.

Operator

Your next question comes from the line of Mike Carrier with Bank of America, your line is open.

Mike Needham

Hi, good morning. This is Mike Needham in for Mike Carrier. Just first on I guess cash. Did I hear it right that you’re planning to retain most of the fourth quarter distributable earnings and then if you could provide the quarter end cash balance and what you plan to do with the cash you are going to hold?

Alesia Haas

Sure. So we are filing our 10-Q this evening and we will have the full balance sheet in the Q that you can review tonight. Our cash as we’ve been sharing over the past few quarters, we haven’t set forth the exact amount that we plan to withhold and the amount that we plan to distribute. We have said that we plan to strengthen our balance sheet and we use that balance sheet strengthening for purposes of debt repayment, giving new business opportunities and considering increased dividends or share repurchases, in addition to providing additional optionality to the business.

Mike Needham

Okay, and just on the language, is it right that you are going to – you are planning to retain most of fourth quarter fee.

Alesia Haas

I wasn’t specific. We are focused on strengthening our balance sheet and we will evaluate what that means in the fourth quarter once we determine the full about of earnings for the year. As we don’t know what our full year incentive will be until the fourth quarter, it’s hard to be specific on an exact amount today.

Mike Needham

Okay, and the other one of the credit business, I think assets are up somewhere around 20% from last year. What’s the margin upside for that business as you built it out and what are some of the things you are planning outside of the CLOs?

Alesia Haas

We haven’t announced specific plans and we explore opportunities in the normal course. The margin opportunities, obviously the CLO business is a management fee business that we believe has very attractive margins to the company, both on the investment that we make with regards to its retention as well as just the management fees contributed too for each CLO that we raise. We do not disclose the specific margin of that business.

Dan Och

And maybe I’ll comment on your question about future plans for growth in that area, because we have, we do have many many plans in that area. Our focus historically as you’ve seen, create the best investment platforms, be opportunistic as well as strategic, so developing a CLO business was more strategic. The opportunistic credit funds obviously were more opportunistic, something like real estate credit had already fell somewhere in the middle with strategic in terms of developing the real estate business and the structural credit business and then opportunistic in terms of the opportunity.

And so one of the structures of our firm is to have all these different business units working together to find solutions, think of solutions for clients, think of opportunities for clients. They look to us not only to invest capital for stable consistent strong risk adjusted returns, but they look to us for unique investment opportunities as well as solutions.

Mike Needham

Okay, thank you.

Operator

Your next question comes from the line of Bill Katz with Citigroup your line is open.

Jack Huller

Hi, good morning. Its Jack Huller filing in for Bill, thanks for taking the question. First one for Dan, there is a number of articles out in the hedge funds industry suggesting there is a shift toward a lower management feels and potentially higher performance fees. Have you put any thought into this for your products and fees something that you would like to potential drive growth sales given that your performance is good, but it seems like growth sales are kind of sold out here.

Alesia Haas

So Jack, I think that you know a year ago we reduced management fees across a number of our multi strategy clients, and we believe this is a one-time event to right size our fees to the industry. At this time we don’t anticipate any additional broad fee cut, but we certainly work with clients in exchange for size and duration. And with regards to the incentive fees, at this time we don’t anticipate any change to our 20% incentive fee.

Jack Huller

Got it. And then Alesia, following through on expenses it seems like your tracking forward but you guided to ending of the year at the low end of your previous guidance for 2017. Any early read into how you might think about expenses for 2018?

Alesia Haas

We’ll be providing that guidance on the fourth quarter 2017 earnings call.

Jack Huller

Got it. Thanks for taking my questions.

Operator

Your next question comes from the line of Ken Worthington with JPMorgan. Your line is open.

Will Cuddy

Good morning. This is Will Cuddy filing in for Ken. Thanks for taking our questions. So with Method 2 coming into effect in January, how are you thinking about the impacts of Method 2 for Och-Ziff?

Alesia Haas

We’ve been preparing for Method 2 over the course of 2017 and at this time do not believe it to have a material impact to our business, but we will be in full compliance by the beginning of 2018 and have been working towards updating all of our practices and all our season procedures that they have stated with compliance.

Will Cuddy

Okay. So my second question is the longer term AUM disclosure has multi-strat long term AUM decline to $630 million down from the $1.2 billion last quarter and $2.3 billion in 1Q. Can you please talk about the drivers of those decreases quarter-on-quarter and from the beginning of the year, I mean should we expect this to continue to trend downward, particularly for multi strategy.

Alesia Haas

I believe we shared with you on past calls, we did see elevated redemptions on our multi-strat business coming out of the settlement in 2016. As we shared with you I believe on the second quarter earnings, we do believe that the investigation related redemptions are largely behind us and going forward we believe that redemptions, as well as “in the multi-strat business” will be largely reflecting industry trends as well as our performance, and as Dan shared with you earlier we believe that our performance is the best indicator of flows and we are very proud of our performance year-to-date and we hope that this will lead to inflows at some point.

Will Cuddy

Okay, thank you for taking our questions.

Operator

Your next question comes from the line of Alex Golten with Goldman Sachs. Your line is open.

Unidentified Analyst

Good morning. This is [inaudible] filling in for Alex. Just kind of taking a step back and bigger picture, just given the increasing number of alternative managers looking to expand into their credit space seemingly, how are you thinking about the competitive landscape there on the credit size and the opportunities that it represents?

Dan Och

Well look, that landscape has been extremely competitive with a number of very good firms before we started our dedicated products every day since we have. Quite frankly we have that in every area of our business. So you are correct that there are a number of very good firms. Our growth and performance has occurred against the backdrop of those very good firms and going forward we know that a lot of our competition is extremely good and we welcome that challenge.

Unidentified Analyst

Thank you very much.

Operator

Your next question comes from the line of Jonathan Casteleyn with Hedgeye. Your line is open.

Jonathan Casteleyn

Hi, good morning. I wanted to talk about the accrued unrecognized incentive fee balance; obviously pretty strong growth here plus $30 million quarter-to-quarter. The language around this capital though talks about these are funds that we still within their three year commitment period. I was curious though, that doesn’t mean that that’s a three year starting point from the date of reporting, correct. I mean these funds could be…

Alesia Haas

That is correct.

Jonathan Casteleyn

Okay, so is there any way to describe the duration that’s left on these funds. I understand that they were initially under three year commitments, but I mean if you think about a weighted average distribution schedule for these funds, can you describe any sort of duration there?

Alesia Haas

Yes, so in past quarters we shared with you that there are components of the accrued, but I’m recognizing incentives that are deep in the money and could be crystallized at any point that our investment professionals deem it in the best interest clients to harvest these investments, which is to say that they are contractually able to be harvested at any time and we estimate this balance to be roughly $70 million of accrued but unrecognized incentives that could be crystallized at any point going forward.

In addition from my timing perspective, in the fourth quarter we estimate approximately $14 million will contractually crystallize. This excludes the impact of any funds performance in the fourth quarter either positive or negative.

With regard to the remaining balance and on our earnings press release in the exhibit, we do estimate that the average weighted average life of the [inaudible] is between four to five years.

Jonathan Casteleyn

I see, okay. And then the drop down to dividend from this distributable cash flow, is this still under review with the broader firm policy or is this at a different distribution rate than what you’re articulating for the fourth Q and into ’18.

Alesia Haas

Our practice has always been that we will evaluate our distributable earnings and evaluate the needs of the company including debt repayment, funding of new businesses, other working capital needs of the company. Though I don’t believe this is a broader change, what I am sharing with you in the fourth quarter though is we do intend to focus as our top priority on strengthening our balance sheet.

Jonathan Casteleyn

Understood, okay, great. And then Dan you called out some, I think it was industry issuance on the CLO side, $6 billion in aggregate. I was curious just to what you think structurally is happening in the industry and is this rate of change terms, is this a growth business in ’18, is it a flat business, is it sort of picking on now with everything else?

Dan Och

The $6.1 billion, that’s the total amount that we’ve raised or refinanced during 2017.

Jonathan Casteleyn

Okay.

Dan Och

It has been a robust year in general for CLO issuance. We think we’ve done extremely well. We think it’s a combination of the two businesses I just mentioned, a market that’s been receptive, a market that’s got credit investment opportunities and opposite performance generating very strong demand for our CLO’s. We are hopeful that continues in 2018 and beyond.

Jonathan Casteleyn

Okay, so anything structurally? I mean I know the markets are wide open. Is there any sort of – are banks you know restructuring credit or is there anything schematically you think that makes sense or is this just going to – sort of a you know an open capital market schedule and that’s you know reflexive and environmental specific.

Dan Och

Well in terms of the CLOs themselves, our focus is new CLO issuance. We recently expanded into Europe, so we think that’s a big opportunity and refinancings. To the extent there are other things to do in credit, we are focused on them and some of them could relate to CLOs but more probably if other things occur there will be new types of products.

Jonathan Casteleyn

Okay, makes sense. And then lastly, you talked about the fee cut in the fourth quarter of ’16. I’m just curious, when new money comes in the door, is that eligible for the prevailing rate in ’16 or was that just for existing clients and new money goes out more of a market rate?

Alesia Haas

Its highly dependent on the fund and the investor, so I can’t answer that specifically.

Jonathan Casteleyn

Okay, understood. Thanks for your time.

Operator

Your next question comes from the line of Robert Lee with KBW. Your line is open.

Robert Lee

Thank you. Thanks for taking my follow-up. I guess I had one more fund raising related question. So some of the other alternative managers have you know talked to raise some assets and you know flexible kind of separate account mandates. I believe several years back you had something similar with the State of New Jersey. Can you maybe just update us on if those were the – if you see much opportunity for axis [ph] and if we’re seeing more of those kind of opportunities and know they are kind of hard to come by or is really kind of the core focus on just kind of you know getting your, the funds up and running, the CLOs, just trying to get a sense of your outlook for kind of flexible separate account type mandates.

Dan Och

We’re focused on both as a general matter of what the client is looking for is what the fund provides and the fund is the data solution for the client. To the extent I mentioned client solutions before, that’s about dialogue – that’s the only dialogue of clients about what they are looking to accomplish strategically. If clients of the right size and right capital duration and commitment are interested in products such as that and they fit with our mandates and commitments and obligations to all of our other clients, it’s something we’re very receptive to.

Robert Lee

Okay, thanks for taking my questions.

Dan Och

Thank you.

Operator

I am not showing any further questions. I will now turn the call over to Mr. Willkomm.

Adam Willkomm

Thank you for joining our earnings call today. If you have any questions, please don’t hesitate to give me a call. Thank you very much.

Operator

This concludes today’s conference call. You may now disconnect.