StepStone Group Inc. Q1 FY2022 Earnings Call

Good afternoon, everyone, and welcome to StepStone's Fiscal 2022 First Quarter Earnings Conference Call. Please note that all participants are in a listen-only mode and the conference is being recorded. After the presentation, we will have a Q&A session. I would now like to turn the conference over to Seth Weiss, StepStone's Head of Investor Relations. Please proceed.

Thank you, and good afternoon, everyone. Joining me on the call today are Scott Hart, Co-Chief Executive Officer; Jason Ment, President and Co-Chief Operating Officer; Mike McCabe, Head of Strategy; and Johnny Randel, 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 would 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 a number of risks or other factors that are described in the Risk Factors section of StepStone's most recent 10-K. Turning to our financial results on slide 3 for the first quarter of fiscal 2022, we reported GAAP net income of $126.5 million for the quarter ended June 30, 2021. GAAP net income attributable to StepStone Group was $41.7 million. Fee-related earnings for the quarter was $23.1 million, an increase of 27% as compared to the first fiscal quarter of the previous year. Adjusted net income for the quarter was $40.5 million, up 162% from the first quarter of fiscal 2021. Finally, we reported adjusted net income per share of $0.41. The quarter reflected retroactive fees resulting from additional closes of StepStone's growth equity fund that contributed $0.9 million to revenue and $0.8 million to fee-related earnings and pre-tax adjusted net income. In comparison, there were no retroactive fees reflected in the first quarter of fiscal 2021. I'd now like to turn the call over to StepStone's Co-Chief Executive Officer, Scott Hart.

Thank you, Seth, and good afternoon, everyone. In the first fiscal quarter of 2022, we posted our strongest quarter ever for fee-related revenues and adjusted net income. We continue to grow assets under management at a robust pace, which helps drive a predictable and recurring stream of fee-related revenue. Additionally, our strong investment performance coupled with a very healthy realization environment led to exceptional realized performance fees and investment income. Moving to slide 4, we manage $90 billion of investments and advise on an additional $375 billion of assets with a leading market presence in private equity, real estate, infrastructure, and private debt. We have a wide global reach with offices in 19 cities across 13 countries. This global and local approach is a deliberate strategy. Our global scale creates a substantial competitive advantage as it yields unparalleled data, insights, and deal flow while our localized presence allows us to provide the personalized attention needed to deliver customized solutions designed specifically for each client's needs. We are very excited to enhance our capabilities with the acquisition of Greenspring Associates, which we announced last month and which we expect to close by the end of this calendar year. We believe the combination of StepStone and Greenspring will create the clear market leader in venture and growth equity, which will be a sector focused within our private equity asset class. Mike McCabe will speak about Greenspring in more detail in a few minutes. Moving to slide 5, as Seth mentioned, we generated $40.5 million in adjusted net income for the quarter or $0.41 per share, up 162% from the prior year's first quarter. We generated fee-related earnings of $23.1 million, representing 27% year-over-year growth as our fee-earning AUM grew to approximately $53 billion, up 27% from a year ago. We also expanded FRE margins by 100 basis points year-over-year and by 200 basis points from the fourth quarter of fiscal 2021, which positively contributed to the growth in fee-related earnings. Net realized performance-related fees, which include incentive fees, were a combined $33 million in the quarter, our highest ever, up more than fourfold versus the first quarter of fiscal 2021 and double the previous peak of $16 million in the third quarter of fiscal 2021. We also benefited from strong realized investment income of over $2 million. While these sources of income tend to be less predictable than fee-related earnings, our performance fees have trended steadily up over the last two years and our accrued carry balance of $1.1 billion is more than three times the size it was a year ago, a positive signal for future performance fees. Johnny Randel will discuss the financials in more detail. As we mentioned last quarter, we have reopened our offices on a voluntary basis and resumed in-person business development and due diligence in a measured way. We are eager to see our existing clients face-to-face and to resume travel to foster new relationships. We recognize the return to normalcy will not be a straight line and we are closely monitoring the evolution of travel restrictions and how COVID variants may impact the health and safety of our employees and clients. We remain optimistic about the future and our ability to adapt to changing circumstances. With that, I will turn the call over to Mike McCabe, our Head of Strategy.

Thanks, Scott. Now turning to Slide 7, I will briefly summarize the Greenspring acquisition and highlight the financial and strategic merits of the transaction. Greenspring is one of the largest venture capital and growth equity specialists and serves as a value-added, life cycle partner for fund managers and entrepreneurs, investing across all stages of venture capital through a combination of primary, secondary, and direct investments. As of March 31, Greenspring had approximately $9 billion of fee-earning AUM, $17 billion of AUM, and trailing 12-month fee-related earnings of $28 million. For more details of the transaction, please reference the presentation we gave on July 7 and our public filings. There are several strategic and financial benefits I would like to highlight. Beginning on the financial side. First, the acquisition will be immediately accretive. We anticipate that the transaction will increase adjusted net income per share by the high single digits during the 12 months following the close of the transaction and by more in the future. To be clear, we do not assume any revenue or operating synergies to achieve this target, but we do anticipate benefiting from synergies over time. Second, the initial revenue stream is all fee-related, providing a highly predictable and recurring source of earnings. Furthermore, since we are buying full ownership of Greenspring, 100% of the fee-related earnings will flow to pre-tax adjusted net income. Third, the addition of Greenspring will be additive to our FRE margin. Even before accounting for any efficiencies or benefits from operating leverage, which may develop over time. As of March 31, Greenspring generated an FRE margin of 40% over the last 12 months, above our trailing 12-month FRE margin of 31%. And fourth, Greenspring should enhance our pace of revenue growth. Over the last three years, Greenspring has increased management and advisory fees at a 34% compounded annual growth rate. Moving to the strategic merits. First, the addition of Greenspring makes us the best-in-class player in one of the fastest-growing and best-performing segments within private equity. Over the last decade, venture capital fundraising and deployment have grown at a 15% to 20% pace. While venture capital internal rates of return have outpaced broader private equity by IRRs by approximately 500 basis points. Second, the combination of the two firms provides the Greenspring team with the resources, reach, and scale to deepen relationships with fund managers and further accelerate growth, including an expanded data and technology advantage, greater geographic reach, and access to our global marketing, business development, and shared services support. Third, StepStone and Greenspring have limited overlap between existing clients. This provides both StepStone and Greenspring an opportunity to leverage each other's relationships to expand our collective footprint. Finally, the acquisition will expand our assets under management to well over $100 billion, further enhancing the positive network effects we enjoy from being a large, diversified, and global participant in the private markets. As Scott mentioned, we continue to expect the transaction to close by the end of the calendar year. The consent process with Greenspring's LPs is progressing well. We expect to finance the upfront cash portion with a mixture of debt and cash on hand. Now turning to Slide 8, we generated nearly $13 billion of gross AUM in the last 12 months, with approximately $2 billion coming from our co-mingled funds and roughly $11 billion in separately-managed accounts. Among our SMAs, approximately 90% of assets were raised from existing relationships. International continues to be a significant source of flows, with over 90% of our gross AUM additions coming from outside of North America. International LPs are still in the early stages of investing in private markets. So we anticipate that this will be a source of outsized AUM growth for the considerable future. Slide 9 shows our fee-earning AUM by structure and asset class. For the quarter, we grew fee-earning AUM by just under $1 billion with half of the growth coming in our private equity asset class. Growth in assets is inherently lumpy. So we think it is most productive to look at our fee-earning growth on a longer-term basis. Over the last year, we have grown fee-earning AUM by 27%. And when looking over the last three years, we have grown fee-earning assets by a 30% compounded annual growth rate. As of quarter-end, we had $13.6 billion of undeployed fee-earning capital, which we anticipate will generate management fees as capital is deployed into the coming years. We continue to make strong progress in CPRIM, our private markets fund for individual investors. Since launching in October of last year, we have grown this fund to approximately $150 million of net asset value and that delivered an exceptional 45% net return for investors. Slide 10 shows the evolution of our management and advisory fees. Using fiscal 2018 as the base year, our management fees have grown at a 32% compounded annual rate. This is a similar pace as our growth in fee-earning AUM. The blended fee rate of 52 basis points has stayed relatively steady throughout the last three years. While the blended fee rate may fluctuate slightly due to the mix of asset class and account type, the pricing trends of the underlying services remain very stable. And with that, I'd like to turn the call over to our Chief Financial Officer, Johnny Randel, to discuss our financials in more detail.

Thank you, Mike. I'd now like to turn your attention to Slide 12 to touch on a few of our financial highlights. For the quarter, we generated fee-related earnings of $23.1 million, pre-tax adjusted net income of $52.3 million, adjusted net income of $40.5 million, and ANI per share of $0.41. Our FRE margin for the quarter was 30%, up 100 basis points year-over-year, and up more than 200 basis points from the prior fiscal quarter. The receipt of retroactive fee payments benefited both the current and the previous quarter by roughly 70 basis points each while the first quarter of the prior fiscal year benefited from the absence of public company expenses. Normalized for these items, year-over-year margins improved by over 300 basis points. Backing out noncore items, fee-related expenses were down from the prior quarter driven by the timing of bonus accruals, which were elevated in the fourth quarter of fiscal 2021 and due to slightly lower general and administrative expenses. Gross realized performance fees were $58.2 million for the quarter, our strongest period ever. The environment has been very supportive for performance fees, as positive market performance and robust capital market conditions have elevated realizations. Furthermore, incentive fees paid by certain accounts are tied to the first fiscal quarter each year, which provided a seasonal boost to our results. As a reminder, realized performance fees can fluctuate significantly in any given quarter. So we believe a longer-term view of performance fees is more appropriate. Slide 26 in the appendix provides quarterly and last 12 months trends of net performance fees. Turning to Slide 13, I will speak to core revenue trends on a year-over-year basis for the quarter, and on a longer-term basis looking at the trailing 12 months compared to a base year of fiscal 2018. I'll start with management and advisory fees at the top. Total management and advisory fees were up 23% year-over-year, although longer-term trends show that such fees have grown at a compounded annual growth rate of 26%. A more detailed breakdown of fee revenue is provided on Slides 27 and 28 in the appendix. Gross realized performance fees were up 440% compared to the first quarter of fiscal 2021 and all the longer-term trends show that such fees have grown at a CAGR of 47% since fiscal 2018. The bottom chart shows adjusted revenues, which is a sum of the top two figures. Adjusted revenues increased 83% as compared to the first quarter of fiscal 2021 with a longer-term CAGR of 31%. Performance fees as a percentage of adjusted revenues was 43% for the quarter and 29% for the last 12 months. This is above our historic ratio of around 20%. We may continue to benefit from strong performance fees in the near term if the exit environment remains favorable. I would highlight that we generally do not control the exit of these investments; there will be variability in any given quarter. Turning to our core profitability metrics on slide 14. Fee-related earnings of $23 million for the quarter were up 27% relative to the same quarter a year ago. For the last 12 months, we generated fee-related earnings of $94 million, representing a CAGR of 53% relative to fiscal 2018. Fee-related earnings growth has been driven by higher fee-earning AUM, lower travel and entertainment expenses, and positive operating leverage. Margins have been offset somewhat by the layering in of public company expenses. Adjusted net income of $41 million grew by 162% as compared to the same quarter last year. For the trailing 12 months, we generated an ANI of $110 million, representing a longer-term CAGR of 42% driven by FRE growth and strong net performance fees. On slide 15, we highlight a couple of key balance sheet items. Gross accrued carry continued to increase driven by strong underlying investment performance ending the quarter at nearly $1.1 billion. This is up 20% from the prior quarter and up over 225% over the last 12 months. As a reminder, changes in our accrued carry balance reflect our share of the unrealized gains or losses of our client portfolios on a one-quarter lag. On the bottom chart, our own investment portfolio ended the quarter at $83 million, up 11% from the prior quarter and up 64% over the prior year, reflecting both market appreciation and net contributions. Unfunded commitments to these programs are $54 million as of quarter-end. Moving to slide 16, we manage a large pool of over $43 billion in performance fee eligible capital. Importantly this capital is widely diversified across approximately 130 programs with about 90 of these programs reflecting an accrued carry position as of June 30th. Nearly 70% of our unrealized carry was tied to programs with vintages of 2016 or earlier, which means that these programs have entered harvesting mode. 65% of this unrealized carry is sourced from vehicles with deal-by-deal waterfall, 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.

We will now begin the question-and-answer session. The first question comes from Alex Blostein from Goldman Sachs. Please go ahead.

Thanks. Good afternoon. Thanks for taking the question. I wanted to start with the performance fee dynamic, obviously, very strong in the quarter and accrued carry balances continue to improve here, not surprisingly I guess given the backdrop in the market. How are you guys thinking about the cash flow utilization of the business given the pickup in performance fees, which is likely going to continue here?

Sure. Thanks for the question, Alex. This is Scott. I'll start with a brief comment on the ongoing trend in performance-related earnings that you mentioned, and then I'll ask Johnny to discuss the cash flow dynamics you referred to. We agree that the trend you highlighted is something we've discussed over the past few quarters. It reflects several factors: first, the market activity, with all exit routes being open and available to us; second, the continued maturation of our carry programs, which we've broken out by vintage year to show their development over time; and third, the performance we've seen in both realized performance fees and accrued carry balances. Now, Johnny, I'll turn it over to you to briefly comment on the cash flow utilization.

Yeah. Sure, Scott. I think, as Mike mentioned, with the closing of the Greenspring transaction, we do anticipate using some cash on the balance sheet. As we've talked about before, we'll continue to look at dividend levels and just making sure we're using the cash in the most strategic way. But I think in the near term, some amount will be used for Greenspring and just continue to make sure we're prepared to support the growth of the business and anything else we may need to pursue. I think we talked before, we do have a fair amount of GP commitment that will need to be funded over time. So we're conscious of making sure we have the right liquidity profile as well.

Got it. That's helpful. Thanks. And then secondly, I was hoping we could just get an update on sort of conversations you guys have with the partners and principals of your other subsidiaries where StepStone doesn't own 100% of the economics. Obviously, it's great to see Greenspring coming in with no NCI. You guys will own 100% of that capital stream, given that StepStone share price had a nice move here. Does that at all accelerate the equity swap perhaps with some of the partners from those subsidiaries? So maybe just a rough sort of understanding of how those conversations are going and the timing of anything sort of potentially happening? Thanks.

Sure. Mike McCabe, do you want to take that one?

Yeah. Thanks, Scott. And thanks for the question. As we've discussed in the past, we remain actively in dialogue with the various teams, infrastructure, private credit, and real estate. And as we discussed in the past, they are all experiencing significant growth at various levels. And I think as the passage of time continues, that conversation will continue. And when the time is right, I think you can expect to see integration conversations picking up. You raised a good point about the value of our stock and certainly it is a very attractive currency to utilize something like that. At the moment, the teams are still growing their businesses and we'll keep you posted as and when the timing should change there. But at the moment, there's nothing really to report that's actionable, Alex.

The next question comes from Ken Worthington with JPMorgan. Please go ahead.

Hi. Good afternoon. Thank you for the additional comments on Greenspring. Could you provide more insight into the communications from limited partners since the deal was announced? Also, could you remind us how many of the top venture capital managers Greenspring has access to as new products are released, considering that the VC community is relatively small and many esteemed managers are closed?

Sure. Thanks, Ken. On the LP communication front, look, clearly there's been a tremendous amount of communication with both the existing StepStone clients as well as the Greenspring LPs. I would say that communication has been quite positive, I think similar to the conversations that we've had with many of you, the strategic rationale for the combination is well understood, I think is viewed as being consistent with the track record of M&A and really bringing on experienced sizable teams to really build out or accelerate the build-out of our capabilities. They certainly understand the fact that this creates a market leader in the venture capital and growth equity solutions space and understand that this will allow us to do some things that neither of us would have necessarily been able to do individually prior to the combination. So that's sort of from the StepStone angle; I think from the Greenspring angle as well, again, very well understood in terms of the rationale for the transaction. And I think we're making good progress in conversations with LPs there.

Okay. Great. And then just on CPRIM I think you were at maybe $135 million of assets in March, $150 million now so we're growing nicely. How is that pace of interest in CPRIM growing? I think you were on maybe 50 platforms last quarter. How is that continuing to build out? And how is that education process ramping? And then lastly here, I think these products get to a certain size where they can really start to take off. Merrill wouldn't want to be 50% of any given fund. So, is there a size where the growth on this fund might really start to inflect and just go completely ballistic or vertical? If so, what might that level be?

Sure. Jason Ment, do you want to take that one?

Yes, Ken. This is Jason. We are currently on almost 60 platforms, including US RIAs and IBDs as well as non-US platforms. The education process is ongoing, and we’re having numerous meetings with new platforms to discuss the value of private markets, StepStone, and specifically CPRIM. These discussions have been very encouraging, reflected in the increasing number of platforms that have approved us. We have now reached a scale where IBDs are typically aligned with us from a size perspective, and we are pleased about this critical mass. Additionally, our post-period flows have been strong this past month, indicating potential growth. While I won't describe this growth as "ballistic," we are certainly enthusiastic about our current position. Regarding the wires, we consider two main factors: the size of the fund and the monthly flows. We're now looking at these considerations in terms of months instead of years concerning our eligibility for those platforms.

Outstanding, okay. Thank you so much.

The next question comes from Michael Cyprys from Morgan Stanley. Please go ahead.

Good afternoon. Thank you for the question. As we review your fee-earning capital, which continues to see good growth year-on-year, could you confirm if the fee-earning capital is based on invested or deployed capital? Looking across the industry, we've observed numerous GPs deploying capital in the June quarter, and there are expectations for this trend to continue strongly through the end of the year. When I evaluate your gross contributions, I might have anticipated them to be somewhat higher than reported. Could you clarify some of the factors affecting the contributions in your separate accounts this quarter? Additionally, comparing this to the significantly higher contributions in the March quarter, was there any anticipation of large deployments in the June quarter? How are you forecasting gross contributions for the September and December quarters?

Thanks, Mike, for the question. This is Scott. We had about $1 billion in fee-earning AUM additions for the quarter. To address your question on whether we paid on invested or committed capital, it's a mix of both. We have several commingled funds and separate accounts where we paid on committed capital. However, the undeployed fee-earning capital we mentioned is linked to accounts that will pay on invested capital and will convert to fee-earning AUM as they are invested. Of the $1 billion in fee-earning AUM additions this quarter, around $700 million came from deployment, with a couple of hundred million from the commingled fund side. This included growth equity fund activity, which closed on an additional $130 million, as well as commitments to CPRIM and deployment from our private debt funds. Compared to the $5 billion in fee-earning AUM from the previous quarter, this figure is more modest. Still, we view this as a solid quarter following a very strong one previously, highlighting the variability that can occur from quarter to quarter. This variability emphasizes the importance of looking at long-term trends, as fee-earning AUM, management advisory fees, and fee-related earnings continue to grow year-over-year at mid-20% to high 20% rates. From a deployment perspective, private equity has been quite active across various strategies this quarter. While some strategies, like secondaries, saw more activity in funds that pay on committed capital rather than invested capital, private debt experienced a slight slowdown compared to the prior quarter, where activity was robust. We've noted an increase in activity in both real estate and infrastructure, with real estate showing signs of recovery after a slow period. However, not all of this activity occurs in accounts that pay on invested capital. We still believe there are significant opportunities to remain active in investments and feel optimistic about our pipeline. For instance, our private equity co-investment fund recently completed its first closing with approximately $500 million in capital, which occurred after the quarter-end and will be activated as the fund starts investing. Ultimately, timing is crucial in these situations.

Great. And if I could just ask a follow-up question on the fee-related earnings margin that continues to come in ahead of expectations, about 30% or so in the quarter. I guess the question here is, how much of the new public company costs would you say are in the run rate at this point? What's left in terms of what might be coming in, imagine, with eventual some normalization in T&E coming through, maybe into the second half, or into calendar 2022? Just how much pressure could we see from here on the FRE margin? How do you see that trending? And maybe you could talk through some of the puts and takes.

Sure. So certainly, at this point, the bulk of the public company expenses are incorporated there, but I might just turn it to Johnny to comment in more detail there.

Yes, we believe that most of the public company expenses have already been accounted for. We anticipate some increases due to SOX compliance and D&O insurance, which continue to rise significantly. However, for the most part, that has been addressed. As you mentioned, we do expect travel and expenses to return. When we compare this quarter to the same quarter last year, there was about a 300 basis point improvement that may not be immediately noticeable. It's difficult to predict when travel and expenses will fully return, but we do anticipate some pressure as we move into the latter part of the year and start traveling again. Previously, we had indicated that we expect to be in the high 20s range when things are fully operational, but the exact timing remains uncertain in the near term.

Great. Thank you.

This concludes the question-and-answer session. I'd like to turn the conference back over to Scott Hart for any closing remarks.

Great. Well, thanks, everyone for joining the call. We certainly appreciate the continued interest and the questions and we look forward to updating you in future quarters. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.