Business context and reporting period
The filing is Oaktree Capital Group, LLC’s unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The request metadata names Brookfield Oaktree Holdings, LLC, but the filing identifies Oaktree Capital Group, LLC as the registrant. Oaktree is an alternative investment manager; its results depend on management fees, incentive income and returns on investments. Consolidated statements include certain managed funds and CLOs, so reported totals include substantial third-party fund activity.
Key financial and operating metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $634.1 million | $282.7 million | $923.6 million | $537.2 million |
| Net income attributable to Oaktree | $117.3 million | $49.0 million | $172.2 million | $77.1 million |
| Net income per Class A unit | $1.83 | $0.78 | $2.71 | $1.24 |
| Adjusted net income per Class A unit (non-GAAP) | $1.73 | $0.79 | $2.59 | $1.24 |
| Distributable earnings per Class A unit (non-GAAP) | $1.61 | $0.71 | $2.48 | $1.34 |
| Fee-related earnings per Class A unit (non-GAAP) | $0.31 | $0.37 | $0.59 | $0.70 |
- Revenue mix: Q2 management fees were $180.0 million, down 7.7%; incentive income was $454.0 million, up from $87.7 million. For the first half, management fees fell 8.3% to $361.0 million, while incentive income rose to $562.7 million from $143.6 million.
- Cash flow: Consolidated operating cash flow was negative $73.7 million for the first half, versus negative $240.5 million a year earlier; investing cash flow was positive $299.4 million and financing cash flow positive $1.2 million. These consolidated cash flows include funds’ investment activity. Cash and cash equivalents at period-end were $1.202 billion, including $601.7 million held by consolidated funds.
- Corporate liquidity and debt: Management reported $1.2 billion of cash, Treasuries and time deposits and $746.3 million of Oaktree debt obligations, with no borrowings under its $500 million revolving facility. It reported compliance with financial covenants. The filing says sources of liquidity are expected to cover working-capital needs for at least 12 months.
- Balance sheet: Total assets were $8.514 billion and total liabilities $5.917 billion at June 30, 2017. These totals include consolidated fund assets and liabilities; CLO debt obligations were $3.100 billion and nonrecourse to Oaktree.
- AUM: $99.3 billion at June 30, 2017; management fee-generating AUM was $79.8 billion and incentive-creating AUM $30.8 billion. Uncalled capital commitments were $21.5 billion, including $12.8 billion of shadow AUM not yet generating management fees.
Material changes versus the prior comparable period
- Net income attributable to Oaktree more than doubled in Q2 and for the first half, primarily due to higher incentive income and investment income.
- The exceptional incentive-income increase was principally driven by the AdvancePierre Foods sale, which generated $427.8 million of incentive income for Oaktree Principal Opportunities Fund IV (POF IV). Higher incentive compensation partially offset the revenue benefit.
- Management fees declined as closed-end funds entered liquidation; Oaktree cited an aggregate $23.5 million Q2 decline from this factor, partly offset by growth in other fee bases. Fee-related earnings fell 17.0% in Q2 and 15.4% for the first half.
- AUM decreased 1.0% from March 31, 2017, mainly from closed-end fund distributions and open-end fund net outflows, partly offset by market appreciation and favorable currency translation. Fee-generating AUM edged higher over the quarter.
- Investment income increased to $60.6 million in Q2 and $119.0 million for the first half, reflecting higher returns on fund investments. Consolidated fund unrealized investment gains also improved versus the prior-year periods.
Outlook, commentary, risks and unusual items
- No formal earnings guidance is provided. Management noted that Opps Xb, representing $8.8 billion of shadow AUM, was not expected to begin its investment period and generate committed-capital management fees until sometime in 2018; most other shadow AUM was expected to generate fees gradually as capital is drawn.
- On July 13, 2017, Oaktree agreed to become investment adviser to Fifth Street Finance Corp. and Fifth Street Senior Floating Rate Corp. for $320 million in cash at closing, then expected in Q4 2017.
- On July 27, Oaktree announced a $1.31 per Class A unit distribution related to Q2, payable August 11 to holders of record August 7.
- Incentive income is volatile and depends on fund performance, realizations and contractual hurdles. Fund-level accrued incentives were $1.780 billion gross and $866.7 million net of estimated associated compensation at June 30; these are not recognized as company revenue until applicable recognition conditions are met.
- Risk exposures include changes in investment values, fundraising and AUM, incentive-income timing, interest rates, foreign exchange, liquidity and counterparty performance. A 10% decline in consolidated fund investment values was estimated to reduce unrealized appreciation by $474.0 million, of which approximately $178.0 million would affect net income attributable to Oaktree. A 10% decline in investment values was also estimated to reduce investment income by $284.6 million; these sensitivities are estimates, not forecasts.
- Oaktree reported no pending legal or regulatory proceedings expected to have a material financial impact and no material changes to the risk factors in its 2016 Form 10-K. Tax examinations were ongoing; up to approximately $5.9 million of previously accrued Operating Group income taxes could potentially be released over the next four quarters. The filing states that outcomes remain uncertain.
- Fair values for some investments rely on unobservable inputs and management judgment; realized proceeds may differ materially from reported valuations. Adoption of new revenue-recognition guidance was expected in 2018, with incentive-income recognition identified as a potentially significant area of change.
Important facts for investors to verify
- How much of the Q2 earnings surge reflects the one-time AdvancePierre/POF IV realization, and what earnings remain after incentive compensation?
- Whether fee-generating AUM and management fees stabilize as closed-end funds liquidate, open-end flows evolve and shadow AUM begins generating fees.
- How much of reported liquidity is available to the corporate manager rather than held within consolidated funds, and how the $320 million Fifth Street acquisition will be funded.
- The assumptions and realizability behind accrued fund-level incentives, Level III valuations and the estimated market-risk sensitivities.
- How non-GAAP adjusted net income, distributable earnings and fee-related earnings reconcile to GAAP results and inform distributions; distributions remain at the board’s discretion.