StepStone Group Inc. (STEP) Q2 2024 Earnings Call Transcript

Thank you. 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 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'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. In addition, 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. Turning to our financial results for the second quarter of fiscal 2024. Beginning with Slide 3, we reported GAAP net income of $59.3 million, GAAP net income attributable to StepStone Group Inc, was $26.2 million or $0.42 per share. Moving to Slide 4, we generated fee related earnings of $43.8 million, up 12% from the prior year quarter. And we generated an FRE margin of 31%. The quarter reflected retroactive fees resulting from interim closings at StepStone private equity secondaries fund and StepStone's multi-strategy global venture capital fund, which in total contributed $3.7 million to revenue, $3.4 million to fee related earnings and pre-tax adjusted net income and 160 basis points to FRE margin. There were no retroactive fees in the second quarter of fiscal 2023. Finally, we earned $30.2 million in adjusted net income for the quarter or $0.26 per share. This is down from $37.3 million or $0.33 per share in the second fiscal quarter of last year, driven by lower net realizations and partially offset by higher fee related earnings.

Thank you, Seth. And good afternoon, everyone. Despite a number of continuing challenges in the macro environment, including volatility in asset prices, higher for longer interest rates and heightened geopolitical risks, StepStone continued to generate steady results. These results are driven by the breadth of our offering, specialization of our strategies and positive momentum in areas in which we've invested for growth. Although it is a difficult operating environment for asset managers, we believe we are well positioned in the industry and that we are setting the stage for strong, continued growth in the years ahead. We remain on track to at least double our fee related earnings within the next five years, as we laid out at our Investor Day this past June. Last month, we hosted the StepStone 360 conference, our annual event for private markets clients and investors. During times like these, our clients have a strong desire to understand the real-time trends and developments that we're seeing in the market and in our portfolios. The 360 conference gives us the opportunity to share our data and insights present on our full suite of products and solutions, and importantly hear directly from many of our clients and prospects. Our clients remain extremely engaged with the private markets and continue to turn to StepStone for help in meeting their long-term investing goals. Secondary is a strategy that continues to resonate with our clients in today's environment. While the general slow pace of realizations has created near-term market appetite for some private market investments, demand for secondaries across asset classes remains very strong and is a key area of differentiation for StepStone. Our deep relationships with general partners supply a large pipeline of investment opportunities and our superior data and expertise allow us to identify the best of these opportunities enabling us to buy high quality assets at attractive prices. We are beginning to see greater willingness of sellers to transact as they adjust to the new valuation environment and as other avenues for realizations continue to lag, which should result in an acceleration of our pace of deployment. During this most recent quarter, we executed a successful first close of approximately $1.25 billion in our venture capital secondaries fund and an interim close of nearly $400 million in our private equity secondaries fund. We expect to activate the venture capital secondaries fund in the first half of our fiscal 2025, while our private equity secondaries fund is active and currently generating fees.

Thanks, Scott. And I'd like to echo your words of appreciation for Johnny Randel and congratulate David Park. Turning to Slide 7, we generated $15 billion of gross AUM inflows during the last 12 months, with $6 billion coming from our commingled funds and $9 billion coming from our separately managed accounts. Slide 8 shows our fee earning AUM by STRUCTURE and asset class. Fee earning AUM was flat relative to the prior quarter due to a few moving pieces, this quarter related to activations, as well as step downs that impact the near-term timing of our fee earning asset growth and management fees, but do not disrupt our long-term growth trajectory. Johnny will provide some commentary on the financial impact. But I would like to take a few minutes to walk through the effect on our fee earning AUM and on our undeployed fee earning capital. First, our venture capital secondaries fund had a very successful first close of approximately $1.25 billion, which currently resides in our undeployed fee earning capital balance. This fund is still in market and we continue to see strong interest. We anticipate further closings over the next six to nine months. We expect that the capital raised this quarter plus additional funds raised hereafter will be activated and become fee paying in the first half of fiscal 2025. We are encouraged to see transactions pickup in real-estate particularly in the secondary recapitalizations and we see significant opportunities for future deployment.

Thank you, Mike. Before speaking to the quarter, I would like to say a very, very sincere thank you to my colleagues here at StepStone. It has truly been my privilege to work alongside you and I look forward to seeing what StepStone does next. I want to also add my congratulations to David Park. David has been a great friend, a great partner these past four years and I know that he will be a fantastic leader of the finance organization going forward. Now, I'd like to turn your attention to Slide 11, to speak to our financial highlights. We earned management and advisory fees of $142 million for the quarter up 19% from the prior year, driven primarily by growth in fee earning AUM. Our FRE margin for the quarter is 31%, retroactive fees in this quarter had a positive impact on the margin of 160 basis points. For the trailing 12 month period, we have reported an FRE margin of 31%. Turning to expenses, compensation was up about $5 million sequentially. As we mentioned on the last earnings call, we had relatively limited hiring in our first fiscal quarter. So this quarter reflected some incremental hiring. General and administrative expenses were flat sequentially. But we do expect an uptick in the next two quarters driven by seasonal expenses associated with investor conferences.

Hi. Good evening, and thanks for taking the questions. Maybe first for Scott. You talked a little bit about the pipeline of new SMAs and re-ups looking robust, but it can take some time to materialize. I wonder if you could unpack that a little, know what are you seeing kind of real time and what is sort of the reason for, I don't know, the delay or what does the pipeline look like in terms of either investor type or the type of assets they're looking to invest in? Any color around that would be helpful. Thanks.

Sure. Thanks, Ben, for the question. So as I mentioned in the prepared remarks, the pipeline is building and developing nicely. I think one of the changes that we've seen relative to COVID and a couple of years since when much of the SMA activity was really driven by re-ups and expansion of existing client mandates, there has been a very healthy mix of new relationships and new mandates of late as well, particularly when you look at this current quarter, in the last couple of quarters. So that's obviously encouraging and clearly builds the pipeline of future re-ups and potential expansion opportunities. So that's certainly one trend that we're seeing. Second, the driver to your point of perhaps slight delays in re-ups is really driven by deployment, right. It's a matter of fully investing the prior vehicle and coming back around to that re-up opportunity.

Thanks, Ken. This is Mike. I think what I might do is invite Jason Ment to address that a bit more specifically since he looks after the private wealth channel.

Thank you, Mike and Ken. The ticker has been very well received, especially by the RIA community. It significantly simplifies their operations, and we anticipate that some independent broker-dealers will adopt the ticker, although the larger firms may take longer to follow suit without a clear timeline for their adoption. Regarding brand education and cross-selling, when I analyze the distribution syndicate for SPRIM, which is all U.S.-based, I find that approximately one-third of these distribution partners have also engaged with SPRING. Conversely, more than two-thirds of the SPRING distribution base consists of SPRIM partners. This clearly demonstrates that brand awareness is beneficial. If you appreciate the StepStone narrative in private markets, you are likely to find it compelling in venture and growth as well.

Yes. And thanks for the question. This is Scott. Maybe I'll start and Mike may jump in here as well. Obviously, he spent quite a bit of time on this topic during the Investor Day. But a few things, I mean you referenced some of the step downs and distribution activity that took place this quarter obviously that didn't come as a surprise to us. It doesn't really have an impact on our five year plans that we laid out and one of the things that we talked about during the Investor Day was the fact that there are multiple ways for us to get there and to achieve those targets.

Good evening guys. Just maybe I'll piggyback on Adam's question around operating leverage. When it comes to the wealth channel, I believe there is a revenue share or kind of equity ownership share agreement within the channel. As you sort of build it out. Can you give us a sense at what level of assets or revenue base does it start to sort of break profitability and contribute more to the bottom line? Kind of, look on a net basis, sort of like net of minority interest and are we already there and kind of how do you expect that to scale and actually add to the kind of net of minority interest or non-controlling interest, FRE?

Yes, I'll start and then others can add. The reality of it is kind of varies. I mean, I think we are getting there given the scale we've seen and the team we've got attached to it as Scott mentioned there is the investment process, which is a big part of what's we think driving the success in terms of the returns that are being produced that's helped driving the scale.

Yes. So Mike, thanks for the question. I think in the private credit space, we continue to see and hear about quite a bit of interest amongst our existing and prospective clients even during the course of this year. I think the interest as our private debt team travels the world has continued to grow. We clearly view it as a very attractive risk reward when you can think about not only have base rates increased, but spreads have remained fairly consistent. And when you're talking about 12% type gross asset yields investing at the highest part of the capital structure.

Good evening. Thanks for taking the question. I just want to ask about private credit. I was hoping you could talk about the opportunity set that you see in private credit today, particularly as banks are pulling back. Which of your strategies would you say are best positioned here and which strategies might be able to raise meaningful capital as you look out over the next 12 to 24 months in private credit and I think you have a retail vehicle launching in the credit space as well so maybe you can provide an update on that too?

I believe a lot of what we’ve discussed over the past 18 months has centered around the denominator effect and how it has largely been a matter of being over allocated. As we’ve seen a slowdown in distributions for about 18 months, we currently find that both capital calls and distributions have decreased compared to previous years. However, distributions have decreased significantly more, meaning that most limited partners are facing more capital calls than distributions. Consequently, this could lead to liquidity pressure for some LPs, prompting them to consider tapping the secondaries market for liquidity and realizations.

Our first question comes from Ben Budish with Barclays. Your line is open.

Great. Well, thanks everyone for joining the call today and for your continued interest in the StepStone story. We look forward to continue the conversation in the quarters ahead. Thank you.