StepStone Group Inc. (NASDAQ:STEP) Q3 2024 Earnings Call Transcript
StepStone Group Inc. (NASDAQ:STEP) Q3 2024 Earnings Call Transcript February 8, 2024
StepStone Group Inc. beats earnings expectations. Reported EPS is $0.37, expectations were $0.25. STEP isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Company Participant: Scott Hart - Chief Executive Officer Jason Ment - President, Co-Chief Operating Officer Mike McCabe - Head of Strategy David Park - Chief Financial Officer Seth Weiss - Head of Investor Relations
Conference Call Participant: Kenneth Worthington - J.P. Morgan Ben Budish - Barclays Michael Cyprys - Morgan Stanley Alexander Blostein - Goldman Sachs Adam Beatty - UBS
Operator: Thank you for standing by, and welcome to StepStone's Fiscal Third Quarter 2024 Earnings Conference Call. At this time all participants are on a listen-only mode. After the speaker's presentations, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's call is being recorded. I would now like to introduce your host for today, Mr. Seth Weiss, Head of Investor Relations. Please go ahead.
Seth Weiss : Thank you and good afternoon, all. Joining me on today's call are Scott Hart, Chief Executive Officer; Jason Ment, President and Co-Chief Operating Officer; Mike McCabe, Head of Strategy; and David Park, Chief Financial Officer. During our prepared remarks, we will be referring to a presentation, which is available on our Investor Relations website at shareholders.stepstonegroup.com. Before we begin, I'd like to remind everyone that this conference call as well as the presentation contains certain forward-looking statements regarding the company's expected operating and financial performance for future periods. Forward-looking statements reflect management's current plans, estimates and expectations and are inherently uncertain and are subject to various risks, uncertainties and assumptions.
Actual results for future periods may differ materially from those expressed or implied by these forward-looking statements, due to changes in circumstances or a number of risks or other factors that are described in the Risk Factors section of StepStone's periodic filings. These forward-looking statements are made only as of today and except as required, we undertake no obligation to update or revise any of them. Today's presentation contains references to non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in our earnings release, our presentation and our filing with the SEC. In addition to our financial results, we filed an 8-K that details an agreement under which StepStone will buy in the non-controlling interests of the infrastructure, private debt, and real estate businesses over time.
Scott and Mike will provide commentary in their remarks. Turning to our financial results for the third quarter of fiscal 2024, beginning with slide three, we reported a GAAP net loss of $23.4 million. GAAP net loss attributable to StepStone Group Incorporated was $20.2 million or $0.32 per share. Moving to slide four, we generated fee-related earnings of $50.7 million, up 19% from the prior year quarter, and we generated an FRE margin of 33%. The quarter reflected retroactive fees resulting from interim closings of StepStone's Private Equity Secondaries Fund, StepStone's Multi-Strategy Global Venture Capital Fund, and StepStone's Infrastructure Co-Investment Fund, which in total contributed $8.6 million to revenue. There were no retroactive fees in the third quarter of fiscal 2023.
Finally, we earned $42.1 million in adjusted net income for the quarter or $0.37 per share. This is up from $31.2 million or $0.27 per share, in the third fiscal quarter of last year, driven by higher fee-related earnings and higher net performance fees. I'll now hand the call over to StepStone CEO, Scott Hart.
Scott Hart : Thank you, Seth, and good afternoon everyone. We delivered solid performance in our fiscal third quarter, generating robust earnings, fundraising and asset growth, setting StepStone up for continued success in 2024 and beyond. As Seth mentioned, we are also excited to announce that we have entered into agreements to acquire the remaining stakes in each of our infrastructure, private debt, and real estate businesses over the coming years. Mike and I will provide additional detail later in our comments. Beginning with our results, gross new commitments were $6 billion in the quarter. While the slower capital market conditions of the last two years have created a more challenging fundraising backdrop, we've continued to engage with existing and prospective clients who remain very constructive on the private markets and more specifically, many of the strategies that StepStone is able to offer.
This quarter represents the fruition of many of those conversations and reflects the strength of our client relationships, many of which we've cultivated over decades. We continue to have a strong pipeline for fundraising across both new and existing clients. As we have commented in the past, we believe fundraising should be evaluated over a multi-period horizon. The dynamics of our business may result in episodic inflows, particularly in separately managed accounts, where we raised $4.3 billion this quarter. However, as managed accounts largely pay fees on deployment rather than commitments, the contribution to fee-earning AUM and fee-related earnings tends to be steadier. Additionally, because of our strong retention rate, which is greater than 90%, our separately managed account relationships are extremely sticky and provide meaningful revenue visibility.
Shifting to commingled funds, we generated gross inflows of $1.7 billion. We closed on $625 million in our private equity secondaries fund, where we have raised approximately $3 billion to-date. We also had additional closes in our special situation real estate secondaries fund, our multi-strategy global venture capital fund, our infrastructure co-investment fund, and our multi-strategy growth equity fund. We continue to see strong momentum in our evergreen private wealth products, where we raised over $300 million of subscriptions for the quarter and over $1 billion in subscriptions for the last 12 months. We are excited to further expand our private wealth platform with our recent filing of the StepStone Private Credit Income Fund, or what we are calling CredEx [ph].
This is an interval fund for U.S. investors. The fund will focus primarily on U.S. direct lending and specialty credit, and will deploy capital through co-investments and secondaries. Like SPRIM, our all Private Markets Fund, and STRUX, our Infrastructure Fund, CredEx will allow for daily subscriptions and will be investable via a ticker. We believe that the combination of bespoke separately managed accounts, commingled funds, and our growing suite of private wealth offerings drives a sustainable pace of growth that will allow us to achieve the goal we set out at last June's Investor Day of doubling fee-related earnings by fiscal 2028. The strength of our platform creates a powerful flywheel, which helps propel StepStone forward. But our most important asset continues to be the people that work so diligently to enable our success.
To that end, I'm thrilled to highlight StepStone's recent recognition from pensions and investments as one of the best places to work in money management. We are a fast-growing multinational asset manager with capabilities across the private markets. We have made a concerted effort to develop a strong, distinct and unified culture at StepStone by embracing our diversity in both backgrounds and capabilities. Our success has been and will continue to be dependent on our ability to attract, develop and retain talent. Now, turning to the economic integration of our asset class teams, we are thrilled to announce that we have entered into agreements to purchase the non-controlling interest in each of these businesses over the coming years. As a reminder, when we made the strategic decision nearly 10 years ago to expand our business from private equity into infrastructure, private debt and real estate, there were a couple of things that were clear to us.
We needed to build large, experienced senior teams who had built their careers in each of these asset classes to maximize our combined success. And we felt that offering equity ownership in the businesses that they were building would be critical to attract high-quality teams and incentivize a type of entrepreneurial behavior that has made StepStone itself a success. Since the time of our IPO three years ago, we have been consistent in telling you three things. First, this structure has been working well and has had its intended result. As we outlined during our Investor Day last June, the infrastructure, private debt, and real estate businesses have been on a similar trajectory to that of our private equity business during its first 10 years.
We attribute much of that success to the quality of our team and the incentive structure driving their behavior. Second, there has always been a shared vision that as these asset classes continue to scale, we would execute an equity exchange to improve our alignment for the next phase of StepStone's growth. And third, any transaction will be done on an accretive basis for our shareholders. We believe that the transaction agreements we’ve entered into achieve all of this and more while benefiting all stakeholders. The structure will continue to incentivize our asset class teams to drive growth in their businesses, while improving StepStone's ability to participate in that growth. The long-term nature of the agreements help ensure that there will be no disruption to the client experience.
The transaction creates a path to 100% ownership and reduces complexity over time. An evaluation mechanism, which Mike will describe in more detail, ensures an accretive transaction. We worked incredibly closely with each of our asset class heads, James, Marcel, and Jeff, and their teams over nearly a decade, and we look forward to the next phase of our partnership in the years ahead. I'd now like to turn the call over to Mike, who will speak to our growth in the quarter and will provide greater detail on the buy-in of the non-controlling interest.
Mike McCabe : Thanks, Scott. Turning to slide seven, we generated $17.5 billion of gross AUM inflows during the last 12 months, with over $11 billion coming from separately managed accounts and over $6 billion coming from commingled funds. Slide eight shows our fee-earning AUM by structure and asset class. For the quarter, we grew fee-earning assets by $2.1 billion. While most of the net growth came from our commingled funds, we had positive gross contributions in both commingled funds and separately managed accounts. We experienced $1.7 billion of distributions, including a large distribution of approximately $1 billion from our infrastructure managed account, offsetting the gross AUM contributions, resulting in a flat fee-earning AUM growth within our SMAs. This is consistent with the expectation we set out on our previous earnings call and represents a relatively low fee-paying mandate.
We had a record-breaking quarter on two important operating metrics. First, we increased our undeployed fee-earning capital or UFEC, to over $21 billion, our highest level ever, which points to the future earnings power of StepStone. This increase comes from a strong SMA fundraising, particularly re-ups alongside some of our longstanding relationships. Our $21 billion UFEC includes $2.4 billion of commingled funds that are already raised and will be activated over the coming quarters, including $1.5 billion in our VC secondaries fund, which we anticipate activating in the middle of this calendar year, and approximately $900 million in our real estate secondaries fund, which will come off fee holiday at the beginning of March. Second, we generated over $300 million of inflows this quarter on our private wealth platform.
On the grounds of this success, along with feedback from our distribution partners, we launched our infrastructure product, STRUX, this past fall, and as Scott mentioned, we recently filed CredEx, a private credit fund we expect to activate later this year. Slide nine shows the evolution of our management and advisory fees. We generated a blended management fee rate of 58 basis points over the last 12 months, higher than the 54 basis points for the last fiscal year as we benefited from retroactive fees. We produced over $4.90 per share in management advisory fees over the last 12 months, representing an annual growth rate of 22% since fiscal year 2019. We generated an FRE margin of 33% for the quarter, which also includes the benefit from retroactive fees.
As a reminder, we expect our FRE margins will continue to expand from a combination of operating leverage and strategic cost-saving opportunities. We executed on one such initiative this past quarter with the sale of our non-core subsidiary, Greenspring Back Office Solutions, or GBOS. We acquired GBOS as part of the Greenspring acquisition in 2021. GBOS was the fund administration platform for our venture capital funds, as well as a select number of third-party VC funds. We sold GBOS to the team, who will continue to run the business, now branded VIRIDIS, and will service our VC funds as our third-party administrator, consistent with our operating model. The run rate net benefit from this transaction is expected to increase fee-related earnings by $2 million annually.
Before handing the call to David, I would like to take a moment to discuss the structure and timeline of the buy-in of the non-controlling interests mentioned by Scott earlier. We filed an 8-K this afternoon, which includes the full transaction agreement, but I'll outline a few of the key points. As you are likely aware, StepStone currently owns 100% of our private equity business and roughly 50% of the infrastructure, private debt and real estate asset classes. The agreement we announced today pre-wires a systematic buy-in of the interests that StepStone does not own over the coming years. We deliberately structured this as a gradual exchange to ensure our teams remain incentivized to grow their asset classes. The primary consideration for these buy-ins will be StepStone equity, thereby maintaining an important alignment of interest with a smaller portion in cash.
The first exchange is expected to take place this summer, subject to customary closing conditions, and will account for approximately one-tenth of the 50% of the business owned by the infrastructure, private debt and real estate teams. We plan to execute subsequent buy-ins of approximately equivalent size each year with the option to accelerate the remaining full exchange after five years if mutually agreed. As Scott mentioned, each exchange will occur on an accretive basis, with each buy-in occurring at a discount to the prevailing step multiple. As a result, the rate of growth of income attributable to NCI should begin to slow and eventually go away as we accumulate full ownership. I'd now like to pass the call over to our recently appointed Chief Financial Officer, David Park.
We've had the pleasure of working with David side-by-side as our Chief Accounting Officer since 2019. David.
David Park : Thank you, Mike, and I look forward to having the opportunity to work with all of you in the investment community. I'd like to turn your attention to slide 11 to speak to our financial highlights. For the quarter, we earned management and advisory fees of $152 million, up 18% from the prior year quarter. The increase was driven by growth in fee-earning AUM across commercial structures, as well as $8.6 million in retroactive fees. Fee-related earnings were about $50.7 million for the quarter, up 19% from a year ago. We generated an FRE margin of 33% for the quarter, up 250 basis points sequentially and consistent with the prior year period. Moving to expenses, total cash and equity-based compensation expense was $74 million, down $1 million from the prior quarter.
The decline was primarily driven by adjustments to our cash bonus accrual in connection with our annual bonus cycle. Looking ahead to our fiscal fourth quarter, while the sale of GBOS, which closed on December 31, will result in compensation savings, we expect to see an increase in overall compensation expense from our fiscal third quarter due to merit increases taking effect on January 1. General administrative expenses were $27 million up $4 million sequentially. Included in this quarter were expenses associated with our StepStone 360 Private Markets Conference. We will host our Annual Venture Capital Conference later this month, so expect to see a similar level of expenses in the next quarter. As a reminder, our G&A expenses tend to be seasonally highest in our fiscal third and fourth quarters due to these annual investor conferences.
Gross realized performance fees were $33 million for the quarter, up $14 million from last year and $26 million from the prior quarter. This period's performance fees reflect $15 million of realized carry and $18 million of incentive fees. Unlike carry, for which investment realizations drive the timing of revenue recognition, most of our incentive fees crystallize annually. The $18 million of incentive fees includes $9 million for spring, with the remainder from private equity and the infrastructure mandates. Our fiscal second and third quarters tend to be seasonally stronger for incentive fees in periods of positive market appreciation, given spring's annual crystallization in our fiscal third quarter, as well as other mandates that are recognized in these periods.
In terms of performance fee-related compensation, comp tied to our private equity funds have a roughly 50% payout ratio, while compensation related to our private wealth funds tends to have a higher payout ratio. Moving to slide 12, management and advisor fees per share grew 18% for the year-to-date period and 22% over the long-term period since fiscal 2019. Gross realized performance fees per share were down 56% for the year-to-date period and up 11% over the long-term period. Adjusted revenue per share was flat for the year-to-date period as growth and management advisor fees largely offset the decline in performance fees. Over the long-term period, adjusted revenue per share was up 20%. Shifting to profitability on slide 13, we grew FRE per share by 17% in our first three quarters.
The increase was primarily driven by growth in management and advisory fees. Looking over the longer term, we have generated an annual growth rate an FRE per share of 29%. Year-to-date ANI per share is down relative to last year driven by lower performance fees, but has increased at an annual rate of 24% over the long-term period. Moving to key items on the balance sheet on slide 14, net accrued carry finished the quarter at $569 million, up 6% from a year ago, driven primarily by underlying valuation appreciation. As a reminder, our accrued carried balance is reported on a one-quarter lag. Our own investment portfolio ended the quarter at $188 million. Unfunded commitments to our investment programs were $96 million as of quarter end. Our pool of performance fee eligible capital has grown to over $70 billion, and this capital is widely diversified across multiple vintage years in over 200 programs.
75% of our net unrealized carry is tied to programs with vintages of 2018 or earlier, which means that these programs are largely out of their investment periods and in harvest mode. Of this amount, 53% is sourced from vehicles with deal-by-deal waterfalls, meaning realized carry may be payable at the time of investment exit. This concludes our prepared remarks. I'll now turn it back over to the operator to open the line for any questions.
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