Aug 2, 2017
Executives
Adam Willkomm - Head of Business Development and Shareholder Services Dan Och - Chairman and Chief Executive Officer Alesia Haas - Chief Financial Officer
Analysts
Bill Katz - Citigroup Alex Golten - Goldman Sachs Ken Worthington - JPMorgan Jonathan Casteleyn - Hedgeye
Operator
Good morning, everyone. And welcome to the OZ Management Second 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 turn introduce your host for today’s conference Adam Willkomm, Head of Business Development and Shareholder Services at OZ Management.
Please go ahead, sir.
Adam Willkomm
Thanks, Christy. 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 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 entity. Earlier this morning, we reported a second quarter 2017 GAAP net income of $13 million or $0.07 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 second quarter 2017 distributable earnings of $53.3 million or $0.10 per adjusted Class A share.
We declared a $0.02 dividend for the first quarter. If you have any questions about the information provided in our press release or on the 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. Our second quarter results demonstrate successful execution on our priorities.
As we stated on our last call, we are focused on providing our clients a strong investment returns and client services, growing our assets under management, prudently managing our total expenses and strengthening our balance sheet. Against these objectives, we posted the fifth consecutive quarter of positive performance across our funds and strategies, began to see a normalization of outflows, actively engaged in fund raising discussions with existing and potential clients across the globe, reached a new meaningfully lower level in our non- compensation expenses and strengthen our balance sheet.
Each of the five core investment strategies in our multi-strategy fund, long short equity, merger arbitrage, corporate credit, structured credit and convertible and derivative arbitrage generated positive returns this year, resulting in the OZ Master Fund, our largest-multi strategy fund, returning 3.2% net for the quarter and 7.5% net of the first half of 2017. For the last four months through June, the master fund posted a 14% net return.
In the U.S. market benchmarks generated positive returns in the quarter.
However, the waters were not uniformly calm. Oil and gas prices, quand factor rotations, currency moves and European rates all presented challenges from market participants.
We are pleased with the performance of our funds and strategies amidst this backdrop. Looking forward, we believe it appears increasingly likely that central banks are moving towards reducing monetary stimulus, creating the potential for increased volatility ahead.
We believe we are well positioned in our multi- strategy funds to continue to perform in an environment in which our flexibility and an opportunistic approach to security selection and allocation are essential. Opportunistic credit continues to pose strong returns.
OZ CO our largest credit fund was up 2.4% net in the second quarter, 5.7% net for the first half of the year and 19.5% net over the last 12 months. Performance was broad based across corporate and structured credit.
In the second quarter, we closed on a $410 billion U.S. CLO and then in the third quarter we expect to close two more transactions which will add an additional $1 billion in AUM.
Since the third quarter of 2016 we have priced 12 CLOs with a total par value of over $5.5 billion and are CLO calendar for the back half of 2017 is strong. We attribute this trend to robust loan fundamentals and performance, coupled with a high appeal for floating rate CLO liabilities that have pushed funding costs lower, all of which have driven demand for CLOs.
As to OZ specifically the market has appreciated our best in class equity returns, combined with strong credit quality metrics. In real estate, we are pleased to announce that in June we held a final close on our debut US real estate credit fund totalling $736 million.
This private equity style closed end fund will invest in a range of real estate credit assets in the U.S., leveraging the investment expertise in both our credit and real estate businesses. As of June 30th, we have committed almost 20% from this fund.
We are excited to complete this next step in building out a real estate investment activities, as we think there is significant room to grow this business over time by expanding the platform and geographies. Real estate funds rate has deployed approximately 12% year-to-date, taking us to over 50% committed in the fund.
We also realized one investment this quarter at a 35% gross IRR and 2.1 times our cost. We continue to harvest investment in Fund 1 and Fund 2 and in the quarter realized one investment in Fund 1 at 4.1 times our crossed and a gross IRR at 63%.
We are extremely pleased with the performance across all of our businesses in the first half of this year and at start of the second half strong with the master fund posting a 1.25% net return for July, bringing the year-to-date net return to 8.8%. Now turning to Flows.
By July 1st net outflows continue to trend down meaningfully from those experienced April 1st, but were still elevated as was our expectation when we spoke to you last quarter. Similar April 1st net outflows primarily concentrated in our multi-strategy funds.
Going forward, we believe the flows will be driven by how we perform and how the industry does. We do believe the industry outflow trend remains elevated, as compared with our past experience.
While our multi-strategy flows in the near term will remain negative on a net basis until offset by corresponding inflows. We are focused on building a pipeline of client mandates across all of our businesses and believe that the strong performance we have exhibited is the right first step to attracting new capital.
With that, let me turn the call over to Alesia.
Alesia Haas
Thanks, Dan. I'll start with the report of our economic income results.
For purposes of this discussion, comparisons to the second quarter of 2016 exclude the impact of the settlement expense in that period. Our second quarter revenues were $142 million, effectively flat year-over-year.
Management fees were $75 million, $59 million lower than a year ago, primarily due to the redemption from our multi-strategy fund and the management fee reduction that took effect in the fourth quarter of 2016. Our incentive income was $66 million of the quarter, an increase of $58 billion year-over-year.
The majority of this incentive was earned from previously accrued, but unrecognized amount. As of June 30, 2017 our growth accrued, but unrecognized incentives generated from extended fee paying assets with $371 million, up $21 million quarter-over-quarter.
I want to remind you that with the exception of our real estate and energy funds the remainder of this balance has no associated compensation expense, as this was paid in the earlier period. During the remainder of 2017 we now estimate approximately $20 million will contractually crystallize, excluding any impact of future fund performance, either positive or negative.
In addition, approximately $70 [ph] million of accrued, but recognized incentive in our opportunistic credit fund is deepen the money and will crystallize when we harvest the remaining investment in these funds. Now turning to our operating expenses, our second quarter expenses totalled $76 million, down 12% year-over-year.
For the quarter compensation and benefits were $43 million, up 20% 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, a 16% decrease from the second quarter of 2016 and our bonus expense was $19 million.
In the second quarter non-compensation expenses was $33 million, down 36% year-over-year and down 24% sequentially. Our expense saving initiatives in year have resulted in year-over-year declines in all of our non-compensation expense categories.
Now turning to our guidance expectations for the remainder of 2017. Our expense guidance remains unchanged.
We estimate salaries and benefits expense will range between $100 million and 105 million for the full year 2017. Our estimated minimum discretionary cash bonus accrual for the third quarter will be between $18 million and $20 million.
The total amount of our discretionary cash bonus for the full year, which is ultimately recognized in the fourth quarter is depended t on a variety of factors, including fund performance for the year. We estimate that our non-compensation expense will range between $140 million and $155 million for full year 2017, including interest expense.
Our tax receivable agreement and other payables were 19% of economic income for the quarter. We have lowered our expectations for the full year tax receivable agreement and other payables to between 16% to 22% of our economic income.
As a reminder, these estimates are subject to many variables that they 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.
As consistent with our practice, we intend to update these amount quarterly as we move forward. Now an update on our balance sheet.
In the fourth quarter of 2016 we began to invest in our own CLOs to satisfy risk retention requirements. While we evaluated many different structures to meet the requirements, we concluded that the most attractive economic option is to fund the CLO vertical strip on our balance sheet and finance this investment with third party financing.
It is worth noting that holding the finance vertical strip on balance sheet generates positive economic return in addition to supporting our business needs. On account of the strong level of CLO activity we anticipate going forward, we see these investments and the related financing is growing steadily by the end of the year.
While our reported debt obligations will be increasing, 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. To close, we are pleased to be able to share our successes on multiple fronts with you this quarter.
While we can’t expect every quarter to see as many advances across our, we remain focused on driving value in all aspects of our business and we look forward to updating you as we move forward. With that, we will open the line up for questions.
Operator
Thank you. [Operator Instructions] Your first question comes from the line of Bill Katz with Citigroup.
Your line is now open.
Jack Keeler
Hi, good morning. Thanks for taking the question.
This is Jack Keeler filling in for Bill. First question on capital allocation here, obviously $0.10 distributable earnings with only at $0.02 distribution.
How are you thinking about capital allocation from here, as part of this to see new products and what are you thinking about the debt that's currently on your balance sheet? Thanks.
Alesia Haas
Happy to answer the question. Good morning, Jack.
As noted, we are strengthening our balance sheet by building a healthy cash position, which is providing a optionality. We are evaluating using our cash to continue to fund our new business and opportunities, as we are doing our CLO business.
We are seeing several other interesting new business opportunities which may represent attractive ways to deploy capital. We also are considering additional dividend, share repurchases and debt repayments and we'll base these evaluation of actions on what we deem to be in the best interest of long-term shareholders.
As the majority of our potential incentive is not known until the fourth quarter, we're making these evaluations in the fourth quarter, in light of our overall earnings.
Jack Keeler
Got it. Thanks for that.
And then Dan, probably a question for you, some of your peers have been talking about the retail opportunity. One of your peers mentioned potentially moving into the 401K space as part of an allocation within targeted data funds, another sub advising mutual funds.
Given your strong performance any consideration in trying to reinvigorate gross sales in the retail channel?
Dan Och
While we have no specific plans in the in the channels that you mentioned right now, but we've always maintained, not just performance, but we think that our brand and everything that we're about makes us one of the best candidates for those channels as they evolve. And so our plans to constantly grow our brand and capability and evaluate new channels as they develop, not just the ones you mentioned, but others are absolutely intact.
Jack Keeler
Great. Thanks for taking the questions.
Operator
Your next question comes from the line of Alex Golten with Goldman Sachs. Your line is now open.
Ryan Bailey
Good morning. This is actually Ryan Bailey filling in for Alex.
I was wondering if I could ask you a little bit about the outlook for additional fund raising from some of your closed end fund strategies, as we look throughout the rest of ‘17 and into ‘18 anything we should be keeping in mind?
Dan Och
Well, its up - we don't have anything specific that we're announcing now about closed end funds, as we said we did just closed the real estate credit fund. We do have plans to do more things and we will certainly update you and others at the appropriate time.
Ryan Bailey
Got it. And then just maybe one question, it looks like on to the share creep it was pretty meaningful in 2Q.
Just wondering what the outlook is for the rest of the year, excluding I guess your comments on potential buyback?
Alesia Haas
The share creep in Q2 was all attributed to the activities that took place in the first quarter, and so I think you're speaking about the weighted average share count versus the – and the period share count, and so of the shares were issued in the first quarter of this year. As we talked about on our calls earlier in the year, those all pertain to year end [indiscernible] activities, as well as the key units and other retention awards that work grants at that time.
Many of those were onetime options and we don't see those to be going forward. But however, we do anticipate resuming annual activities that you would see likely in the first quarter of 2018.
Ryan Bailey
Got it. Thank you very much.
Operator
Your next question comes from the line of Ken Worthington with JPMorgan. Your line is now open.
Will Cuddy
Good morning. This is Will Cuddy filling in for Ken.
So first there was an article yesterday about Och-Ziff removing its application for a waiver from the Department of Labor. Could you please talk about the direct and indirect implications of one removing your application and to that potential ramifications if you don't receive a waiver at some point?
Alesia Haas
Sure. I’ll just quickly comment.
Please note that QM status does not materially impact our business and our efforts to seek exemptive relief are active and ongoing at this time.
Will Cuddy
Okay. Thank you.
Operator
[Operator Instructions] Your next question comes from the line of Jonathan Casteleyn with Hedgeye. Your line is now open.
Jonathan Casteleyn
Hi, good morning. I'm just wondering if you could remind us of the main factors that drive your monthly performance and multi-strat, just the main factors that drive performance there?
Dan Och
Well, are you asking for what was the attribution during the month or quarter, as we have five core strategies?
Jonathan Casteleyn
I'm saying very broadly, if you think about the main economic factors that drive performance in multi-strategy, could you just remind us, describe them what the perfect environment is to generate performance in multi-strat. I understand there's a lot of strategies in there, but if you're just describing the sort of top three items or indicators, yeah.
Dan Och
Well look, each strategy has its own set of corporate environment. It's a combination of opportunity created within that strategy, as well as their different more macroeconomic factors for each strategy.
There's not one set of two three or four that drive the portfolio overall, that's the whole point of being multi-strategy and multi-geography. So I understand - look as a general matter of course, dislocation creating opportunity does help us, events help us, some level of market volatility uncertainty, but that could be interest rate uncertainty, it could be political uncertainty.
It could be financial uncertainty, does help create opportunity. So I hope that answer your question, but there are not two three or four specific macro environment that will automatically create the opportunities.
Jonathan Casteleyn
Understood, yes. That's helpful.
And then you called out volatility specifically in your remarks, do you think higher vol and obviously it depends on the level is good for the complex or bad for the complex?
Dan Och
As a general matter higher volatility and higher uncertainty creates more opportunity for us as a general matter. But low volatility - very often the higher volatility creates the opportunities and the lower volatility allows us to harvest the opportunities that you know, I don't want to oversimplify it, but just you know, I believe that is generally how it worked.
Jonathan Casteleyn
Yeah, that make sense. And then one for Alesia, I think you still have $16.4 billion in your ‘long-term’ 36 month commitments, but I believe that means that a shareholder could roll off next month or also roll off in 35 months?
I'm just curious you know, one is that right, and two, then how do you describe the potential access windows for the shareholders, are there batches coming through or is it idiosyncratic? How can you the 36 month commitment windows?
Alesia Haas
It is choppy and there is no meaningful pattern when those investors will have their own maturities and when we will see that accrued but unrecognized manifest itself in earnings. We have provided our guidance for the remainder of 2018 and as we go forward we hope to be able to continue to provide similar…
Dan Och
And then lastly, the $16.4 [ph] billion you're referring to that's not all in three year lockup. Some of that is actually longer term post mix.
Jonathan Casteleyn
Right, okay. And then lastly, I know you called out fundraising generally and just curious which strategy is which products or seeing potentially the most demand or interest?
Dan Och
Well looking backwards the first answer would be real estate credit, where we completed the close on our funds. On the multi-strategy side, our belief is that the industry trends while they're not as negative as they were last year, we believe that as the margin industry trends remain negative.
Having said that, we really from our set perspective if we continue to generate this performance you know, clients are noting 14% net over the last 12 months. They're noting 8.8% year-to-date, they are noticing that it's broad-based across all strategies and geographies.
So we believe that our multi-strategy flows will be driven by how we perform combined with industry trends, industry trends we believe are still modestly negative. But we can't control that, we can control what we do.
Jonathan Casteleyn
Great. Really appreciate your time.
Thanks.
Dan Och
Thank you.
Operator
Your next question comes from the line of Bill Katz with Citigroup. Your line is now open.
Bill Katz
Good. Thanks for taking the follow up.
Alesia, just one more question on expenses, you’re showing strongest as things flex year-to-date and appreciate it's kind of early to look into 2018, is there any sense of where a run rate might shake out for 2018 and then given the strong performance that you've just mentioned any sense on any appetite to spend a little bit to reinvigorate grow sales and take advantage of strong performance and maybe some removal of the recent overhangs?
Alesia Haas
So let me answer on the expense guidance first. Our second quarter non-comp expense largely affects the new run rate from our savings initiatives implemented over the past year.
For the immediate future we do expect some variability to this amount based on seasonality of certain expenses and also some benefits from operational initiatives, we have planned later for 2017. But I do believe this new run rate that we expect for the foreseeable future.
And with regard to taking some of invest out of our savings and investing that into the business, as we said earlier, we are seeing some opportunity to make investments in our business and are seeing some new business opportunities that we are in the process of exploring. So we are open to all of those opportunities and are actively exploring various initiatives at this time.
Bill Katz
Good. Thank you.
Operator
I'm not showing any further questions. I will now turn the call over to Mr.
Adam Willkomm.
Adam Willkomm
Thanks, Christy. Thank you everyone for joining us today and for your interest in OZ Management.
Do you have any questions, please don't hesitate to contact me at 212-719-7381. Media inquiries should be directed to Joe Snodgrass at 212-887-4821.
Thanks, again.
Operator
And this concludes today's conference call. You may now disconnect.