Nov 2, 2018
Operator
Good morning, everyone. And welcome to OZ Management's Third Quarter 2018 Earnings Call [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.
Please go ahead.
Adam Willkomm
Thanks Chris. Good morning everyone and welcome to our call.
Joining me are Robert Shafir, our Chief Executive Officer; and Tom Sipp, 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 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 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 entity. Earlier this morning, we reported third quarter 2018 GAAP net loss of $15 million or $0.08 per basic and diluted Class A share.
As always, you can find a full review of our GAAP results in our earnings release, which is available on our Web site. On an economic income basis, we reported third quarter 2018 distributable earnings loss of $5 million, or $0.01 per adjusted Class A share.
Excluding $19 million legal provision incurred in the quarter, third quarter 2018 distributable earnings were $11 million, or $0.02 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 turn the call over to Rob.
Robert Shafir
Thanks, Adam and good morning, everyone. We are happy with our credit and real estate performance in the quarter, and we believe we held our ground in multi-strategy against the difficult market backdrop.
The Oz Master Fund was down 0.4% net for the quarter and up 4% net for the first nine months of 2018. In our opinion, our disciplined consistent approach continues to deliver.
All of our major strategies within the Master Fund were positive for the first nine months of 2018. In the quarter, we experienced strong performance in corporate and structured credit, which we will touch on in a moment.
The strong credit performance was offset largely by merger arbitrage, as well as solid performance in Asian equities. October was particularly challenging to the Master Fund, returning negative 2.8% net as global equity markets moved decidedly downward and volatility increased.
On a relative basis, we outperformed global market benchmarks in October, which were down approximately 7.5%. Our portfolio hedge overlay and single name shorts performed strongly in the month to help offset losses.
Periods like this demonstrate the value of our multi-strategy approach and our portfolio edge strategy. We also tend to view the investing landscape as target rich in the periods following these corrections, which we think bodes well for perspective returns.
Ozco, our global opportunistic credit fund, was up 2.4% net for the third quarter and 8.8% net for the first nine months of 2018 and 12.7% annualized net since inception. Our credit business continues to see strong differentiated returns despite the recent difficult environment, October included.
Corporate credit was the large contributors this quarter as our active involvement in two large restructuring situations yielded positive results. In structured credit, we had strong performance across all subsectors.
In real estate, we continue to deploy capital in our opportunistic and credit real estate funds, while also realizing investments. In the third quarter, we had full or partial realizations of nine investments, seven from our most recent opportunistic real estate fund, which were realized at an average gross multiple of 1.8 times.
In total, we have committed approximately two thirds of our most recent opportunistic real estate fund, generating a 23% annualized net return for investors since inception. Our real estate credit fund is currently 22% deployed.
We continue to consider avenues to expand our real estate platform, which includes tax-exempt real estate credit investments secured by affordable housing properties in the United States. We believe this strategy is a logical extension of both our real estate and credit capability.
Our CLO franchise continues to perform and we remain an active issuer. In the third quarter we closed a new European CLO adding $480 million in new assets under management and refinanced four existing U.S.
CLO's. We expect additional CLO issuance and refinancing throughout year end.
Turning to flows. On November 1st, assets under management were $32.3 billion, down 4.7% versus the end of the second quarter and essentially flat versus year end 2017.
Our flow picture largely remains the same as what we described last quarter. In real estate, our third opportunistic fund is roughly two third deployed and we expect further increases in AUM.
In opportunistic credit, the flow pipeline is building on the back of our continued strong performance. In institutional credit strategies, we continue to be optimistic about our ability to issue CLO's and we anticipate more opportunities coming from our efforts in aviation with our partner GECAS.
In multi-strategy, inflows continue to disappoint but we are actively engaged with both existing and potential clients across the U.S., Europe and Asia. The effort is starting to have some success, specifically in the private banking channel.
Private banks have historically been a significant source of flows for multi-strategy. We expect this channel to reopen in the near future, which we anticipate will lead to a resumption of flows.
The fourth quarter outflow picture should be more positive one as we anticipate that our gross outflows will be below lowest on a percentage basis since the fourth quarter of 2015. As we move into year-end, we continue to be disciplined and focused on execution.
We have seen particularly good performance for the year in credit and real estate and have protected capital in multi-strategy. We have the right products and a history of generating returns for our clients and believe that this market correction and accompanying volatility often creates a variety of compelling investment opportunities.
Now, let me turn the call over to Tom to go through the financials.
Tom Sipp
Thanks Robin and good morning, everyone. As Adam mentioned at the beginning of the call, we reported third quarter 2018 distributable earnings of $11 million excluding the legal provision incurred in the period.
Revenues for the quarter were $89 million, down 29% as compared to the third quarter 2017 and down 15% versus the prior quarter, driven primarily by lower incentive income. As a reminder, the bulk of our incentive income is recognized in the fourth quarter and the timing of incentive recognition in the first three quarters of the year is not consistent from period-to-period.
Management fees were $66 million for the third quarter 2018, 8% lower than a year ago and 1% higher than the prior quarter. The year-over-year management fee decrease was driven primarily by lower multi-strat assets, partially offset by increased assets in institutional credit strategies.
Incentive income was $19 million for the third quarter 2018, 62% lower than a year ago and 44% lower than the prior quarter. Again, this is based on timing of redemptions and incentives from extended fee paying investors, which is highly variable from quarter-to-quarter.
As of the quarter end, our accrued but unrecognized incentive was $358 million, up 5% as compared to the prior quarter. The increase was primarily due to performance in credit and real estate.
As a reminder, with the exception of the balance associated with our real estate funds, most of the remaining balance has no associated compensation expense as this was paid in earlier period. We expect to realize a majority of this accrued but unrecognized incentive over the next three years.
Other revenues were $3 million for the third quarter 2018, down 14% versus the prior quarter, primarily due to the sale of certain risk retention investments in our U.S. CLO's accompanied by a corresponding decrease in interest expense related to CLO risk retention liabilities.
Now, turning to our operating expenses. Our third quarter total expenses were $95 million.
Excluding the $19 million legal provision that we'll discuss shortly, third quarter expenses were $76 million flat year-over-year and down 9% versus the second quarter of 2018. During the third quarter 2018, we accrued an additional $19 million provision related to the shareholder class action suit, previously described in our SEC filings, which has now been settled in principle.
The settlement allows us to take another big step in terms of putting our legacy issues behind us. For the third quarter 2018, compensation and benefits were $47 million, up 7% year-over-year and down 3% sequentially.
Salaries and benefits were $22 million for the quarter, down 9% in the third quarter of 2017 and 4% lower than the prior quarter due to lower headcount. We continue to expect full-year 2018 salaries and benefits to be between $90 million and $95 million.
Bonus expense was $24 million for the quarter flat from the prior quarter and 26% higher than the third quarter of 2017, primarily due to an increase in the minimum annual bonus accrual. We expect that full-year minimum annual bonus accrual for 2018 will be consistent with previously communicated guidance of between $80 million and $90 million.
For the third quarter 2018, G&A expenses excluding interest and the previously mentioned legal provision, were $25 million, down 5% from the third quarter 2017 and down 12% from the prior quarter as a result of our focus on expense reductions. We expect these expenses to be higher at the higher end of our $100 million to $110 million guidance for the full year.
Our interest expense was $5 million in the third quarter, down 14% year-over-year and down 36% sequentially. The decrease, on a sequential basis, was attributable to the 50% reduction in our corporate debt in the second quarter of 2018, as well as the payoff of certain CLO risk retention financing.
In summary, while there were some expense variations quarter-to-quarter, we are confirming our previous guidance for all of our three major expense categories. Our guidance for the full year 2018 tax receivable agreement and other payables remains unchanged at 10% to15%.
As a reminder, tax estimates are subject to many variables that won't be finalized into the fourth quarter of the year and therefore could vary materially from the estimates provided. Now, an update on balance sheet.
We continue to have a healthy cash balance and our outstanding corporate debt was $200 million as of September 30, 2018. As we begin to get clarity on fourth quarter distributable earnings, our first priority is to continue to strengthen our balance sheet.
After that we will evaluate dividends, share repurchases and investments in the business, based on what we believe is in the best long-term interest of shareholders. With that, we will open the line for questions.
Operator
[Operator Instructions] Our first question is from Gerry O'Hara with Jefferies. Your line is open.
Gerry O'Hara
I guess the first would be around the comments given from our multi-strats fund and obviously the optimism around 4Q gross flows. But perhaps you could elaborate a little bit on what gives you confidence with respect to the private banking channel and also perhaps more broadly how conversations are evolving, especially given the track record for lower volatility risk-adjusted returns within choppy markets.
Robert Shafir
I think a couple of things. As I said on the outflow side, we have very good visibility on the fourth quarter and with multi-strats there is always some element of churn, given the liquidity of the fund.
But those outflow numbers, obviously, are trending down. And that is, at least -- it seems to be a positive sign.
In terms of inflows, on the private banking channel, we're beginning to see that channel open up. As I said, one of the major private banks has green lighted us and we are in discussions with a couple of the other ones to achieve the same thing.
Typically, those channels -- it takes a while to get those channels up and running again. But we do think that they are a very important segment for multi-strats investors, because we think a multi-strategy product, particularly in more choppy environment, is a very sensible product for private banking clients.
So, I think over time we think that could be material. In addition to which, I'd say in the institutional channel -- it's been slower than I would've expected to start to see the inflows there.
But as I've talked about on other calls where a lot of lights were red in the beginning of the year closed under the disruptions and we’re turning more yellow, we are getting upgrades in some of important consultants out there. So again, early signs of optimism.
I would not want to create an expectation that we're are going to have some massive inflows in the short-term. But I think it's about forming a base, continuing to stabilize, continuing to perform and start getting that inflow picture trending positively going into 2019.
Gerry O'Hara
And perhaps one for Tom, just around the commentary there on the balance sheet and continuing to strengthen metrics in balance sheet, but perhaps if you give a little context as to how we can start to think about what that dividend might look like or what the cash balances might need to be before you start to increase the dividend. Anything that's that gives us a little color or context as to how we can think about that going into the fourth quarter and next year.
Thank you.
Tom Sipp
Regarding the dividend, our practice has been to -- our recent practice is to have a consistent dividend on first three quarters of the year. The full year dividend will obviously be based -- we've got to finish the year, understand our distributable earnings, our performance of the year and then the board will make the decision.
So we're going to have to wait for the year play out to make that decision. The balance sheet, we will look to improve the balance sheet, have a priority to pay down or debt and retain cash over the next couple years.
So the dividend will be a relatively modest payout ratio but we will evaluate that as we finish the year and as we continue to perform.
Operator
Our next question is from Bill Katz, Citigroup. Your line is now open.
Bill Katz
Just a couple. You mentioned some optimism also, I think on real estate and CLOs.
Where are you in terms of the opportunity to raise funds for? There has been some news out there about potential sizing of that.
So any way maybe you give us some color or sense of how that might be going. And then is there a way to size the pipeline on the CLOs?
Robert Shafir
On the real estate side, typically, we get to 75% or above in terms of invested assets on the prior fund. And as I said, we’re getting close to that number we're not quite there yet.
And as we get there, we will think about exactly when to launch fund for. As you know and as we've talked about on these calls, performance in the real estate funds has been very, very strong and we see a lot of investor demand out there for that product.
So we will get to a point where we can launch that fund and we will think about timing as we get close to the year-end, and we will be talking about that. But I think the net of it is we’re very optimistic about our ability to raise that fund just given the performance of the prior funds and what we see as investor demand there.
On the CLO business, we priced actually this week $500 million European CLO. And we were in price talk and we should price it in the next few days.
And I would expect to see more consistent growth there. As we've see one of the things we talk about a lot on these calls appropriately so is the multi-strats.
But the other side of the coin is the firm has successfully, over the last few years, diversified its platform. And things like the growth of the CLO business, in particular has offset a lot of that, and you've seen our management fee line actually slightly up quarter-over-quarter here.
And as we even go beyond just pure CLOs, for example, the aviation story and the GECAS product and other things that we're seeing as opportunities on the aviation side, it just continue diversification within the core verticals that we are betting our future product here. So, I think the diversification story is a good one.
That being said, we obviously want to turn multi-around, because we do believe in the product.
Bill Katz
And just a couple more things taken this morning. Just in terms of the flows, you mentioned you have some good insight or line of sight some depending outflows that are out there.
How confident are you just given that -- my sense is that you had may be the bigger lump that might still come out could at the end of the year or I guess into January subscription period, or is that are we taking any consideration in your comments?
Robert Shafir
The only thing we have visibility on is actually what we technically report to the fourth quarter. So I couldn’t tell you at this point because I just don't know what that's going to look like.
And so we get to the actual reduction in those periods for the quarter for what will hit January 1st. So I really don’t have visibility on it yet.
Bill Katz
And then just last one for Tom. On your guidance for the [D&A] being at the upper end of the range.
Is that inclusive or exclusive of the legal charge? I’m sorry it wasn’t clear to me.
Tom Sipp
Yes, that excludes the legal provision.
Operator
[Operator Instructions] And our next question is from Mike Carrier with Bank of America Merrill Lynch. Your line is now open.
Mike Needham
It's Mike Needham for Mike Carrier. First one I've got is as you think about the full year your margins have been week in the Master Fund.
It was down a bit in October. If the Master Fund, looks like it's going to have a light year this year.
How do you think about managing our costs appropriately for the full year back in 2015 and '16? And performance was similar we saw losses or breakeven quarters for the first quarter.
So just wondering how you're thinking about that.
Robert Shafir
I'll start and may be, Tom, you can jump in specifically on the cost side. It’s obviously difficult to predict the year, particularly the volatility in the markets right now.
And as we know, you've seen how much the markets get back in October, which put most of the markets around the globe either flat or slightly down, or in some cases more than slightly down in the year. So I think we’re more than holding our own on the performance side there and in other product areas as we talked about earlier, particularly in credit and real estate we've done quite well.
But in the context of what we would see today, it is conceivable that we would have somewhat of the lighter performance number than, for example, last year. But again hard to say.
I mean, you've seen what the markets have done in the less few days. But look I think on the cost side, we have to balance the short-term and in long-term here.
We have to be and are being disciplined around our cost base. And Tom could speak more specifically that not only what we’re doing right now but a lot of our plans are.
You've seen our headcount reduce pretty substantially over the course of this year and we are focusing on a lot of things, some structural and some more tactical in terms of managing our cost base. That being said -- and by the way part of that is also narrowing our focus on the key areas that we've planted our flag in of multi-credit and real estate and getting out of some of the smaller peripheral businesses.
That being said, I think for the long-term, strategically, we believe in the platform and we believe that these products have potential to grow. So while we want to your cut around run rate around a lot of things and get more efficient, and I think we have the opportunity absolutely to do that, we do want to maintain our global capability in these markets.
So that we can take advantage of investment opportunities and have a platform that we can grow back into in the longer term. And Tom, I don’t know if you want to add to that.
Tom Sipp
I would just add that we would expect our salaries and benefits to continue to decrease quarter-over-quarter as we become more efficient and we reduce headcount. The G&A we've talked about, we'll still be at the higher end of the 100 to 110 range.
And then the bonus payments for this year will balance, some will be obviously variable with the performance and some will be balanced with retaining our talent over the medium and long term. So obviously, with lower performance, the overall bonus payments will be lower but you’re going to balance that out between short-term performance and investing in the platform long-term.
Robert Shafir
I do think longer term as we look out beyond this year, I think there is a decent amount of room in a lot of these expense buckets for us to make much more improvement, particularly as we get past this year, where we've done a lot of pruning and strategically moving some things around as we get into a more normalized run rate state.
Mike Needham
And just as a follow-up on the headcount. Can you give me an update on the change this year?
And if you have it roughly, how much headcount is down from the peak?
Tom Sipp
From the peak -- a few years ago?
Mike Needham
If not that’s fine…
Tom Sipp
Year end '16 was 5.24, year-end '17 was 4.83, we're at 4.28 now. We'd expect -- we think there are additional opportunities to be more efficient.
There are some outsourcing activities that are in process. So, we would expect that to be continue to be a little lower, going forward.
Operator
I am not showing any further questions. I will turn the call over to Mr.
Willkomm.
Adam Willkomm
Thanks Chris. Thank everyone for joining us today and for your interest in Oz.
If you have any questions, please don’t hesitate to contact me at 212-719-7381. Media inquiries should be directed to Jonathan Gasthalter at 212-257-4170.
Thanks very much.
Operator
Ladies and gentlemen, this concludes today’s conference call. You may now disconnect, and thank you.