Hamilton Lane INC Q1 FY2023 Earnings Call

Good morning. My name is Chris and I will be your conference operator today. At this time I would like to welcome everyone to the Hamilton Lane First Quarter Fiscal 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. A supplemental slide presentation to accompany the prepared remarks can be found on the company's website. After the speakers' remarks, there will be a question-and-answer session. Please limit yourself to one question and one follow up. Thank you. At this time, I would like to turn the call over to John Oh, Investor Relations Manager. Mr. Oh, you may begin.

Thank you, Chris. Good morning and welcome to the Hamilton Lane Q1 fiscal 2023 earnings call. Today, I will be joined by Erik Hirsch, Vice Chairman; Brian Gildea, Head of Investment Solutions; and Atul Varma, CFO. Before we discuss the quarter's results, we want to remind you that we will be making forward-looking statements based on our current expectations for the business. These statements are subject to risks and uncertainties that may cause the actual results to differ materially. For a discussion of these risks, please review the risk factors included in Hamilton Lane's fiscal 2022 10-K and subsequent reports we filed with the SEC. We will also be referring to non-GAAP measures that we view as important in assessing the performance of our business. Reconciliation of those non-GAAP measures to GAAP can be found in the earnings presentation materials made available on the Shareholders section of the Hamilton Lane website. Our detailed financial results will be made available on our 10-Q filed. Please note that nothing on this call represents an offer to sell or a solicitation to purchase interest in any of Hamilton Lane's products. Beginning with the financial highlights. For the quarter, management and advisory fee revenue grew by 16%, while our fee-related earnings grew by 10% versus the prior year period. This translated into GAAP EPS of $0.91 based on $33.5 million of GAAP net income and non-GAAP EPS of $0.92 based on $49.6 million of adjusted net income. We have also declared a dividend of $0.40 per share this quarter, which puts us on track for the 40% increase over last fiscal year, equating to the targeted $1.60 per share for fiscal year 2023. The targeted dividend marks the fifth consecutive annual increase since going public in 2017, each over 10% and with an average increase of over 18%. With that, I'll now turn the call over to Erik.

Thank you, John, and good morning everyone. We've had another extremely strong quarter reflecting the strength and diversity of our platform, as well as the resiliency and attractiveness of the overall asset class in which we operate. The markets clearly remain challenged — shrinking asset bases, rising rates, increased overall volatility. Fundraising is harder and our teams are working diligently to identify sources of capital. The results, however, speak clearly to the strength of the business that offers a diversified solution suite that is globally strong. Our separate account advisory back office and technology offerings are, in the vast majority of cases, the sole service provider for our clients. In order for our clients to remain active in the asset class and to continue to grow their exposure, which they want to do, their relationship with us continues. We also look to lean on our various strategic technology investments and partnerships that are clear differentiators and are further advancing our brand and market position. We are proud of the results this quarter and our continued growth, and we remain optimistic and encouraged by what we see in the pipeline. Our total asset footprint, which we define as the sum of our AUM, assets under management, and AUA, assets under advisement, stood at approximately $832 billion and represents a 10% increase to our footprint year-over-year, continuing our long-term growth trend. AUM growth year-over-year, which was $16 billion, or 18%, came from both our specialized funds and customized separate accounts. As for our AUA, similar to that of our AUM, growth was from across client types and geographic regions and came in at $59 billion or 9%. Total fee-earning AUM stood at $51.1 billion and grew $8.4 billion or 20% relative to the prior year, stemming from positive fund flows across both our specialized funds and our customized separate accounts. Taken separately, $5.4 billion of net fee-earning AUM came from our customized separate accounts and over the same time period, $3 billion came from our specialized funds. Our blended fee rate across both customized separate accounts and specialized funds remained steady. Moving to the two components that make up our fee-earning AUM, I'll start with our customized separate accounts. Fee-earning AUM from our customized separate accounts stood at $31.7 billion, growing 20% over the past 12 months. We continue to see the growth coming from across client type, size, and geographic location. Over the last 12 months, more than 80% of the gross inflows into customized separate accounts came from our existing client base and continue to be a steady source of growth for our separate account business. With that, I'll turn this over to Brian to cover the specialized funds update.

Thank you, Erik, and good morning. Moving to our specialized funds, growth here continues to be strong. Fee-earning AUM from our specialized funds stood at $19.4 billion at quarter-end. Over the past 12 months, we achieved positive net inflows of $3 billion representing growth of 18% relative to the prior year period. This growth stems from additional closes for funds currently in market, robust investment activity, and continued growth of our Evergreen platform. On July 6th, we announced the final close for our inaugural infrastructure opportunities fund and site fund, which totaled nearly $575 million of investor commitments. While this fund marks our first commingled infrastructure vehicle, Hamilton Lane has been a longstanding active investor in the infrastructure space for the past 22 years, managing separate accounts and providing advisory solutions for clients of all sizes. We began raising this fund just as the pandemic started to take hold and are proud of the fact that we were able to execute well while having to navigate a remote environment where we could not physically meet with investors during much of the fundraise. What's more, the last few months of the fundraising period, typically a strong period for traditional fundraisers, also occurred in a challenging market environment, which only adds to our pride in getting this kind of first-time fund done. Nearly half of the investors that came into the fund were new relationships for Hamilton Lane. The success here also speaks to the power of our global platform, where we were able to leverage existing client relationships and a global distribution network. Next is our annual direct credit series. We're currently raising our seventh installment of this series and the momentum continues to be strong. During the quarter, we held multiple closes that totaled over $573 million of LP commitments and now bring the total amount raised to over $890 million for this installment. We will look to hold the final close in the coming months, but as it stands, this installment already marks the largest in the series. As a reminder, this capital reflects a single-year investment vehicle with management fees charged on invested capital. We've already begun deploying this capital and we'll begin fundraising for the next series shortly after holding the final close for this installment. Moving on to our direct equity fund, fundraising continues to progress well. During the quarter, we held closes that totaled over $190 million of LP commitments, which generated approximately $600,000 in retro fees for the quarter. Post quarter-end, we held an additional close for the fund that totaled nearly $72 million and will result in retro fees that we recognize in Q2 of fiscal 2023. Stepping back, the total amount raised for the fund now stands at nearly $1.8 billion, a level that surpasses the size of the prior fourth fund and already makes this our largest direct equity fund to date and with which we will still be in market through the fourth quarter of this year. Let me now turn to an update on our secondaries platform. On our prior earnings call, we announced that we had held the first close on April 22nd for our sixth secondaries fund. That close totaled over $611 million. Subsequently on July 21st, we held the second close on nearly $450 million, which will result in a modest amount of retro fees that will be recognized next quarter. The combination of the first two closes brings the fund to nearly $1.1 billion and demonstrates the continued demand from investors for this strategy coupled with our strong track record of delivering results. We are pleased with the early days of the fundraise and we are appreciative of the meaningful investor support to date. We will remain actively in market for 24 months from that April 2022 close date and look forward to providing you with updates on future closes over the coming quarters. Let me now turn it back to Erik to cover our Evergreen platform.

Thanks, Brian. I'll wrap up this section with an update on the Evergreen platform. In total, the platform now stands at nearly $2.8 billion and we had another quarter of strong net inflows. The months of April and May saw net inflows over $100 million each month. Similar to comments you have heard from other private market managers, this quarter we also experienced some softness in June and July and expect much of the same for August. The outflows we saw, while modest, largely came from our Asian investor base. Again, similar to what you have heard from other private market managers. We attribute the softness to a combination of summer doldrums across the retail sector and significant public debt and equity decline that have caused investors to simply pause their investments. Performance of the product is strong, significantly outpacing the public equity markets. Our focus continues to be on expanding our channel penetration and building relationships across the space. In addition to flows into our Evergreen products, these relationships are also delivering flows into our traditional specialized funds. Our latest secondary fund, as an example, has already seen commitments totaling more than $145 million from retail investors and represents nearly 14% of the total capital raised in the fund so far. Again, this is capital raised from this segment separate and apart from the Evergreen flows. As the public market stabilized a bit and as we push into fall, we expect to see a rebound in inflows and reward for the expansion of relationships. Let me now take a moment and introduce our newest strategic technology-oriented investment of our balance sheet. On June 28th, we announced our participation in the most recent fundraising round for CAIS, where we joined other strategic investors such as Apollo, Motive Partners, and Franklin Templeton. CAIS operates a technology-enabled open marketplace for alternative investments where financial advisors and asset managers can engage and transact directly. CAIS' platform empowers over 5,300 unique advisor firms and teams, who oversee more than $2 trillion in network assets. CAIS provides financial advisors with a broad selection of alternative investment strategies coupled with a powerful learning system, CAIS IQ, to help those advisors drive adoption and improve client outcomes. This investment represents the latest example of our strategic technology thesis and commitment to enabling broader access to the private markets by investing in and partnering with those companies, who we believe are on the cutting edge of driving that accessibility. CAIS now joins our other strategic partners in the wealth space, iCapital and TIFIN, and will be able to provide their clients with seamless tech-enabled access to Hamilton Lane funds while we leverage the infrastructure and trust that these companies and their platforms have built within the vast private wealth universe. We are excited to begin this mutually beneficial journey with CAIS and look forward to providing you with updates in the future. And with that, I'll now turn the call over to Atul to cover the financials.

Thank you, Erik, and good morning everyone. For the first quarter of fiscal year 2023, we achieved strong growth in our business with management and advisory fees of 16% versus the prior year period. Our specialized funds revenue increased by $10.3 million or 31% compared to the prior year driven primarily by $1.5 billion increased fee-earning AUM at our Evergreen platform, more than $600 million raised from our latest secondary fund in the quarter, and over $1.7 billion raised through June from our latest direct equity fund. Retro fees for the quarter were approximately $600,000, stemming primarily from our direct equity fund versus a minimal amount in the prior year period. As a reminder, investors that come into later closes during the fundraise pay retroactive fees dating back to the fund's first close. We expect to generate additional retro fees as we hold subsequent closes for both our latest direct equity fund as well as our latest secondary fund. Moving on to customized separate accounts, revenue increased by $3.9 million or 16% compared to the prior year period due to re-ups from existing clients, the addition of several new accounts, and continued investment activity. Revenue from our advisory, reporting and other offerings decreased by $2.1 million compared to the prior year period due primarily to a decrease in revenue from our distribution management business. Lastly, the final component for our revenue is the incentive fee. Incentive fees for the quarter totaled $49.6 million. The relative increase in incentive fees compared to the prior quarters is due primarily to the fact that a number of our specialized funds entered into the GP catch-up portion of their respective fund waterfalls. We typically find GP catch-ups in connection with the European style waterfalls, which is the most conservative method related to earning carried interest and represents the method that the vast majority of our funds employ. While this method does delay the receipt of carried interest, it is more favorable to the client and avoids any clawback risk, thereby representing stability for our shareholders. Our performance across our funds remains strong, as evidenced by this continued move towards greater performance fees. For those less familiar with how the European style waterfall works, investors are first allocated dollars that result in all of their invested capital fees and expenses being satisfied, followed by a preferred return. After that, Hamilton Lane, as the manager, is then allocated a share of value that puts us level with investors and equals our stated carried interest percentage, which is the catch-up portion of the waterfall. While that is satisfied, the remaining value is allocated based on the carried interest percentage. During this GP catch-up period, you typically see an outsized amount of value flowing to the GP, which is what we experienced this quarter. Let me now turn to some additional color on our unrealized carry balance. The balance is up 36% from the prior year period, even if we recognized $98.1 million of incentive fees during the last 12 months. The unrealized carried balance now stands at $1.1 billion. Moving to our expenses, total expenses increased $29.7 million compared with the prior year period. Total compensation benefits increased $25.5 million driven primarily by compensation associated with the increased amount of incentive fees in the quarter. G&A expenses increased $4.3 million, which included increases in travel costs. For the quarter, our fee-related earnings were up 10% relative to the prior year as a result of the management fee revenue growth we discussed earlier. I’ll wrap up here with some commentary on our balance sheet. Our largest asset continues to be our investment alongside our clients in our customized separate accounts and specialized funds. Over the long term, we view these investments as an important component of our continued growth and will continue to invest our balance sheet capital alongside our clients. Regarding liabilities, we continue to be modestly levered. And with that, we thank you for joining the call and are happy to open it up for questions.

Hey, good morning. Thanks for taking the question. Maybe just first off on the performance, if I hear you right. It sounds like the point on the incentive fees in the quarter being so strong relates to the catch-up period as a fund or account entered into the European waterfall stage point where the GP is taking care. If I have that right, I hope you might be able to elaborate on which fund or account this related to? And can you recall when you last had this sort of meaningful impact as you look back over the past couple years? And if you were to look forward, which sort of fund or strategy might you see something getting closer to the point of entering the catch-up, which fund or strategy might that be?

Yes, Mike. It’s Erik. I’m happy to take that, although I’m going to answer that generally without getting into specifics. We have a tremendous amount of value across many different vehicles. The majority of our specialized funds utilize the European waterfall. Once we move into our separate account space, it varies. Some of them are deal-by-deal, some are American, some are European. This has occurred before, and we certainly have had this happen in the past when large vehicles roll over and move into that GP catch-up phase. You can see as we report out kind of where we are on dollars invested and dollars distributed on our specialized funds, which of those funds are getting closer to that. This is an event that has occurred in the past, and it’s an event that with strong performance continuing over our history, that we will again see in the future.

Understood. Okay. Thanks. And then just maybe follow-up question on fundraising. I think Erik, you mentioned that you were seeing the broader fundraising environment getting a bit harder. I’m just hoping you might be able to elaborate a bit on that. Just what are you seeing across the industry? How does that impact your outlook in terms of magnitude and timing for what Hamilton Lane can be looking to raise in both the institutional marketplace, but maybe you could also comment on the retail side as well? Thank you.

Sure, Mike. It’s Erik, I’ll stick with that. It’s what you’ve heard generally reported in prior earnings calls from other managers, which is to say you’ve had a lot of value knocked out of both institutional and retail investors over the last several months. That just means that there’s kind of less capital in the markets that’s available for people to raise, invest, etc. So we’ve been talking about the denominator effect; it’s real. That said, once you see volatility in the public markets, you also see investors begin to reassess their allocation strategy. I think it’s important to remember that they have a goal, and that goal tends to be a kind of 6% to 8% plus target rate of return. And they need to do that to continue to sort of meet their funding obligations and their investment needs. If they believe they’re not going to achieve that in their current asset allocation model, they’re going to redo that model to tilt towards higher returning strategies which, in this case, would be the private markets. So today I think you’re just seeing a combination of factors. One, it seems like everyone and their cousin, except for all of us that are working hard today, is on vacation. You’ve definitely seen a summer slowdown, as people are kind of returning to a bit more normalcy. But you’re also seeing just again, capital tight and investors just not in a hurry to make decisions today. But as you heard me state earlier, our pipeline is big. People are back on the road, beginning to travel, and events are returning. We remain very focused on continuing to deliver the same growth rates that we’ve been delivering over our history.

Great. Thank you.

Hi, good morning. Thanks for taking the question. Following up on that. So from a macro perspective, to what extent does secondary activity act as a barometer for private market investment sentiment? And to the extent it does, what is it telling you about sort of the near term and the intermediate term outlook for private market investing? And are there different messages being sent by asset class in terms of private equity, real estate credit, or infrastructure, or are you starting to see divergences in the way investors are sort of looking at those asset classes based on the macro market conditions we’re seeing today?

Sure, Ken. It’s Erik. I think the secondary market is an interesting data point because, in some cases, if you were to see higher or abnormally high LP selling volume, that might indicate that there is concern about the asset class or that there’s a need to rebalance or for liquidity. Today, the data is very clear; we’re not seeing any abnormal or elevated levels of LP selling. So if we want to use it as a barometer, I would say the barometer is probably indicating to just stay the course, it’s business as usual. Where we’ve seen a slight uptick or a change in the competitive mix is around GP-led single asset transactions. There, I think you’ve got some buyer's remorse from some folks out in the market who I think were very active in that space and may have gotten themselves a little too concentrated. Our fundraising is continuing to raise good dollars in that space, which makes us a very attractive partner in a market where capital is going to get a little bit scarcer. So I think we look at that as a net positive.

Okay, great. Thank you. And then, if you could just sort of clarify the retail fund commentary you made earlier? You mentioned, I think it was July, it was either June or July that things went from inflows of a hundred million. You talked about more elevated redemptions. Was that elevated gross redemptions? Did the retail product go into net outflows? If you could clarify your comments on the change in fund flows there?

Sure. I think, again, similar to what you’ve heard from other folks, we went into the summer after a very strong January, February, March, April, and May. June and July saw a slowdown. As I said, we’re on August 2 here, and we’ll see what the rest of the month looks like. We had softness across the board. We hadn’t really seen outflows that were worth mentioning before, other than in Asia. You see the combination in June and July of the summer lull and just market volatility. So, we did see some redemptions, but overall, we hadn’t seen anything extraordinarily significant. Looking ahead, we expect to see people start making portfolio decisions.

Great. Thank you very much.

Hey, guys. Thanks. Good morning. So just to make it clear, not net outflows in the retail products, right? Or are you guys seeing net outflows? And then as we think about the distribution of those products, I know to your point, Erik, Asia is something we’ve heard from others as well. Anyway to help frame how much of the $2.8 billion in the combined retail AUM sits with the Asia-based customer base?

Yes, Alex, it’s Erik. I’d probably not want to disclose the exact breakout of the geographic mix. Asia is certainly not the biggest driver of our asset flow. If you look at the non-U.S., a lot of flows throughout Europe and Australia, in particular. So it’s been geographically diversified across that. The numbers are still kind of getting finalized, but June was a net positive and August looks to be close to a net zero.

Got you. All right. That’s helpful. Thanks. And then my follow-up question just around the appetite for capital deployment, both in the directly control strategies, as well as what you guys are seeing on the GP partners that you have in the business. Can you help us maybe frame the amount of capital you guys have currently that has been raised that will turn on fees upon deployment? There are a couple of products, obviously, that you’re raising today still that will bill and deploy, as you mentioned earlier. So help sizing that would be helpful. And then in what areas you expect to be most active on the deployment side over the next call at 12 months?

Sure. For us, the vast majority of our assets are on committed capital. The credit vehicle that Brian highlighted as that annual series is uninvested capital, but that’s a one-year investment period. So it’s a relatively modest delay because that capital is raised and then deployed within that rolling 12-month cycle. For our larger assets, we have billions of dollars worth of dry powder that will turn on eventually. We think of this as normal; it’s the nature of the industry. Investment activity continues to be robust, and the deal flow is significant.

Sure. Thank you, Erik. As Erik talked about that dry powder, one of the real benefits is that we’ll be able to be diversified and flexible by strategy, geography, etc. The opportunity set continues to be really robust. We’re on pace to see over 1,000 new funds. That would be down slightly from last year, but that would be our second largest year of fund activity ever. In the credit space, where overall industry volumes might be down, we’re seeing our opportunity set down by about 10% year-to-date, so still a massive opportunity set across all strategies.

Thank you and good morning. Just wanted to ask about the partnership with CAIS, and I know you have other similar partnerships. Can you just remind us about the kind of product rollout strategy that you expect with that, whether that involves existing products or developing some new products around particular needs in the channel, and what the outlook is there? Thank you.

Sure. It's Erik. The strategy is really leveraging what they've built, which is an impressive platform. We chose our partners carefully and coming away with ownership stakes and strategic alignment with iCapital, CAIS, and TIFIN is noteworthy. We have a simple strategy: to take the products we currently have. Notably, secondaries already receive flows from that channel. The focus is to get the Evergreen products operating on those channels and help them as a strong partner around customer education. A big gating issue is educating the end customer and their decision-making body regarding the asset class, which is often not fully understood. That hesitation can keep them from participating. One of our advantages is that we can provide data and real insights into what’s happening in the asset class, peeling back layers of uncertainty.

Makes sense. Thank you for the comments around the process. And then turning to the institutional side, you mentioned some good success on the infrastructure front, half of the investors being new relationships. Where are you seeing the demand among new relationships or new potential relationships, certain client types or maybe geographies? Is the pause in sort of the level of demand similar to among your existing clients, or maybe not so much? Thank you.

I would say that this is largely the result of an expanding platform. We continue to hire more sales resources, open offices around the globe, and invest directly in our brand. We continue to get better at marketing and communication. The fact that we were able to raise capital during a challenging time speaks volumes regarding the strength of our platform, brand, and the caliber of our team. We are not seeing wildly different or divergent paths across geography or type, and again, the past quarter shows that there’s really not been a slowing. Decision-making is purposeful, deliberate, and that’s normal for this asset class. You must be patient and be a long-term partner.

Great, thanks. Good morning. Thanks for taking my questions. Maybe the first one is coming in the separate account business. You highlighted that 80% from re-ups; can you maybe drill down for that a little bit? When you're getting those re-ups, are you generally seeing LPs upsize their commitments or any kind of change in the level of capital that they're re-upping?

Sure, Rob. No, nothing to draw into that. Part of it is you have such a large installed base there that you’re going to have everything. You’ll have some investors that are very mature and will simply need to keep re-upping at levels that maintain their existing targets. Others are newcomers who build and thus have incrementally larger tranches. We have a broad array of scenarios, but we are not seeing any abnormal behavior or changes in sentiment. The flows to the separate accounts continue strong.

And then maybe kind of a modeling question. So obviously, inflation, compensation pressure, investing in the business in the wealth channel and elsewhere. Could you kind of update us on how we should think about expense progression from here? Is this a good run rate? Is there anything we should be thinking about as the year progresses that puts additional upward pressure from what we’re seeing? Your thoughts back.

What you saw this quarter was solid revenue growth corresponding to expense growth. Looking forward, we feel good about our revenue growth, and expenses will have to follow that trajectory. Our G&A expenses are up from a year ago, partly coming out of the COVID environment, especially in travel costs. We think G&A is a good run rate as we look forward. But compensation will move in line with revenue. So we are in growth mode, gaining assets and new clients, and hiring employees.

Hi, good morning. Mostly, you have answered for me. Just a follow-up on the earlier question on GP-led single-asset market being a bit overheated with buyers remorse. Was that more related to LPs being too concentrated or are you suggesting that deals in that part of the market have struggled?

Yes, Finian. It’s Erik. I can clarify that. If you think about the secondary space, it utilized to be where buyers are acquiring funds or large portfolios of funds, thus benefiting from the diversification of multiple positions. However, we've seen some buyers perhaps forget that benefit and we've observed concentration risks with single assets. While GP-led transactions are still popular, the number of potential buyers has shrunk, creating supply-demand imbalances favoring buyers. Given our capital readiness, we view this as an advantage.

Hi, thanks for taking the follow-up. Just on expenses, if you’re saying G&A is a good run rate and comp will grow alongside revenues, would it be fair to conclude that fee-related revenue growth should outpace expense growth from here? Thus, we should see upward lift to the FRE margin as we move forward from the 43% level in the quarter. Is that fair?

Michael, it’s Atul. That’s a fair statement. Our focus on revenue growth and aligning expenses accordingly suggests that the current FRE margin is a solid starting point for future projections. However, uncertainty around G&A and travel costs could influence that rate of expansion.

Again, thank you everyone for taking the time. We appreciate the support, the interest, and the questions. We wish you a successful completion to the summer. Thanks again.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.