Earnings Call Transcript - HLNE Q4 2020

Operator, Operator

Good morning. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hamilton Lane Incorporated Fourth Quarter Fiscal Year 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. John Oh, Investor Relations Manager, you may begin your conference.

John Oh, Investor Relations Manager

Thank you, Jason. Good morning and welcome to the Hamilton Lane fiscal Q4, 2020 earnings call. Today, I will be virtually joined by Mario Giannini, CEO; Erik Hirsch, Vice Chairman; and Atul Varma, CFO; as we continue to work remotely from our Pennsylvania Headquarters. 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 the Hamilton Lane fiscal 2019 10-K and subsequent reports we file 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, which we will be referencing throughout the call and will also be shown on the webcast. These materials are available on the public Investor Relations section of the Hamilton Lane website. Our detailed financial results will be made available when our 10-Q is 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 on Slide 3, for the fiscal year our revenue from management and advisory fees grew 12% versus the prior year. This translated into full year non-GAAP EPS of $2.01 based on approximately $107 million of adjusted net income, and GAAP EPS of $2.15 based on approximately $61 million of GAAP net income. Lastly, our Board has approved a 13.6% increase to our annual fiscal dividend to $1.25 per share, or $31.25 per share per quarter. With that, I'll now turn the call over to Mario.

Mario Giannini, CEO

Thank you, John, and good morning. Let me start by simply saying thank you. Thank you to those on the frontlines. Thank you to those putting themselves in danger to protect us. Thank you to all of those making sacrifices for the good of their communities. And a special thank you to so many of our clients whose members are part of the frontlines. You're all very much in our thoughts. For Hamilton Lane, we've had certain offices in a remote work situation since December, and while some of our international offices have already begun to reopen, the majority of our offices continue to work remotely, including our headquarters here in Pennsylvania. I'm pleased to report that despite the challenges we are all facing, our ability to work and service our clients is incredibly strong. Our long-standing commitment to technology and data is serving us well in these times. We are leaning heavily on a combination of purchased and proprietary systems and solutions that continue to benefit our clients. I am very proud of our teams and the effort they exert every day, servicing our clients while simultaneously managing their own lives and families. To them, I also say thank you. While this time brings uncertainty and discomfort, the Hamilton Lane spirit of creativity and innovation remains strong and is keeping us close together. A quick glance through our Slack channels, aside from all the work-related content, would find pictures of working at home with pets, barbecue tips, videos of family concerts, and reading suggestions. What you would also see are weekly town hall video updates by me, featuring updates from various teams and employees throughout the firm, ensuring that communication is frequent and transparent. Our already strong culture is getting even stronger through this trying time, and I'm proud to be a part of this firm. Now at this point, you’ve heard plenty of public company CEOs tell you this environment is unprecedented, and it is. So rather than till that same ground, we're simply going to give you some of our perspective on what we know at this point and what we don't. I'll start by answering some questions that we have been fielding from investors. First, how much of our revenue is fixed versus variable? We continue to be a management fee-heavy business. Even with a strong year carried interest, management and advisory fees accounted for approximately 90% of our total fiscal year 2020 revenue. Second, do you expect limited partners (LPs) to default on their capital commitments? We don't. These commitments are legally binding and carry financial penalties for defaulting. In 2008, we did not experience any meaningful level of LP defaults during that entire recession. Hamilton Lane only experienced a single partial default of $1 million LP across our entire client base. Third, will the drop in plan values (i.e., the denominator effect) cause LPs to pull back from the asset class? Generally, we think the answer here is no, though this will partially depend on where the markets go from here. As of yesterday's close, we simply haven't seen a drop significant enough to cause concern. While there may be instances of some LPs finding themselves stretched for various reasons and choosing to pull back, we believe there will also be plenty of examples of LPs who are more determined to lean into what feels like an interesting buying opportunity. We believe that LPs have now seen the data for vintage year performance following past market downturns, 2000 and 2001, and again with 2009 and 2010, and understand that following times of economic correction, the private markets provide a strong investment opportunity. Fourth, what are your expectations around carried interest payments over the next 12 months? No question they will be lower until the markets normalize, but there are a few things to remember about our carry. First, carry represented around 10% of our revenues last fiscal year. Second, our carry is incredibly diversified across over 60 vehicles with thousands of underlying companies. We see some natural hedging as a result of this diversity. We don't control these positions and thus we don't control the timing of the exits. Fifth, will you be able to achieve your same levels of historical growth? Today, this is a tough question to answer as we are essentially two months into our fiscal year in a very unstable and unprecedented environment. We remain optimistic about our ability to grow and have continued to close new business as well as re-ups in the month of April and May. Our sales team remains active, our pipeline remains strong, but our inability to travel to see our clients and host events are challenges. While we did grow through the 2008-2009 timeframe, I think it should provide additional comfort regarding the denominator concern in a very different environment. Again, our current inability to interact with potential investors, particularly limited partners with whom we don't currently maintain a relationship, will create some challenges. Now, let me turn to the results for the quarter which was strong across the board. Beginning on Slide 4, we highlight our total asset footprint defined as the sum of our assets under management (AUM) and assets under advisement (AUA). Total assets for the footprint for the quarter stood at approximately $503 billion and represents a 4% increase year-over-year, continuing our long-term growth trend. AUM growth year-over-year, which was over $7 billion, or 12%, came from both our specialized funds and customized separate accounts and continues to be diversified across client type, size of clients, and geographic region. Our focus remains on growing and winning across both lines of business, and we are pleased with our success. Moving to AUA, we have seen growth year-over-year of approximately $12 billion, or 3%, from across client types and geographic regions. We will emphasize that no direct correlation exists between the scale of AUA dollars and revenue generation. The continued growth and scale of our AUA remains a long-term focus, given the advantages those dollars bring. However, growth and scale will not supersede our disciplined approach to ensure that we find the appropriate match between our services and the needs of the particular client. Let me now turn it over to Erik.

Erik Hirsch, Vice Chairman

Thank you, Mario, and good morning. Let me also begin by adding my thanks to those working hard to protect all of us, as well as to our employees and clients. Moving on to Slide 5, we highlight our fee earning AUM. As a reminder, fee earning AUM is the combination of our customized separate accounts and our specialized funds with basis point driven management fees. We will continue to emphasize that this is the most significant driver of our business as it constitutes over 80% of our management and advisory fees. Relative to the prior year period, total fee earning AUM grew $5.1 billion or 15%, stemming from positive fund flows across both our specialized funds and our customized separate accounts. Approximately $2.4 billion of net fee earning AUM came from our customized separate accounts and over the same time period nearly $2.7 billion came from our specialized funds. Growth continues to be driven by four key components: one, re-ups from our existing clients; two, winning and adding new clients; three, growing our existing fund platforms; and four, raising new specialized funds. Our fee rates continue to remain steady. Moving to Slide 6, fee earning AUM from our customized separate accounts stood at $24.5 billion, growing approximately 11% over the last 12 months. We continue to see growth coming from a variety of avenues. Re-ups from our existing client base remain a key component of that growth. In addition, we continue to expand our existing client base by winning and adding brand new relationships, which provide a growing base for future re-up opportunities. As for our specialized funds, growth was strong. Over the past 12 months, we achieved net positive inflows of nearly $2.07 billion, resulting in a 23% increase in our fee earning AUM for our specialized funds. The main driver of this growth continues to be our current secondary fund. We held a close on March 31 that totaled over $350 million of commitments. This now brings the total dollars closed on this product to over $1.7 billion. We have until October 2020 to complete the fundraising. Given that fees on this fund started in the prior quarter, this closing did generate retroactive fees. The next largest drivers of AUM inflows were from our continued credit fundraising, as well as our semi-liquid product. The net flows for the quarter were approximately $100 million. We are encouraged by this dynamic, and we believe it speaks to both the trust we have engendered, as well as the investment results we are generating. However, the current market environment presents challenges that we and our distribution partners have never experienced. While we can't help but be encouraged by the progress to date, we simply do not know what the coming months will look like. That said, we remain committed and long-term focused and believe strongly in the prospects for this product. Rounding out the AUM growth was continued success across our various white label initiatives. When we initially announced our evergreen product launch, we mentioned that the targeted audience is retail investors based outside the United States, principally in Australia, Europe, and Asia, due to certain regulatory hurdles. However, we are currently pursuing the opportunity to launch an evergreen offering in the U.S. This is still in the early stages, and the current market will undoubtedly make this process harder and slower. Nonetheless, we are long-term focused and view this as a marathon, not a sprint. This is an important milestone, and we are excited about the prospects here. Let me now shift to two strategic topics. First, our latest balance sheet investment, on March 23, iCapital Network announced the closing of a financing round. Hamilton Lane participated in this round and we now join a powerful group of iCapital investors that include BlackRock, Goldman Sachs, Blackstone, and UBS, among others. We believe that iCapital has built the premier marketplace for private asset opportunities, and their recently announced acquisition of Artivest furthers their position of strength. Using technology, they have democratized access to private investment opportunities for high-net-worth investors. Making the ability to select and subscribe to investment opportunities simple and efficient. We are excited about this investment and this partnership. Hamilton Lane product is currently available on the iCapital platform. As we have said before, our approach to technology investing is simple; identify unique technology solution providers who we believe can make us and the industry better, and put our balance sheet capital behind them, forming a mutually beneficial partnership. iCapital is another strong example of this positioning. Lastly, I wanted to provide some insight and progress update on our joint venture with IHS Markit, called Private Market Connect or PMC. We created this in June 2017 to help solve the existing data challenges faced by limited partners and address the information efficiencies that exist throughout the private market. PMC focuses on scaling, automating, and normalizing the information flow between general partners and limited partners with the ultimate goal of providing straight-through data processing. PMC primarily serves as the managed data services segment of iLEVEL, a SaaS offering in which we were an early investor and remain a key client. iLEVEL streamlines data collection and drives best practice monitoring, analytics, valuation, and reporting for all types of players in the private market. For some background, prior to the formation of PMC, Hamilton Lane maintained a dedicated team focused solely on data entry and reporting. When the JV was formed, Hamilton Lane contributed this team and moved the cost of data entry and reporting to PMC, a third-party service provider. IHS Markit contributed technology and a sales force, linking the sales of iLEVEL with the support provided by PMC. The economic relationship here is threefold: one, we jointly own the company with IHS Markit; two, as the business scales, we benefit from a declining rate card; and three, as the business generates excess cash, it pays out a dividend. Since its formation in 2017, the Board of PMC, which includes two executives from IHS Markit and two from Hamilton Lane, has approved two rate card adjustments and a dividend payment to its shareholders. We continue to remain encouraged by the growth we have witnessed at PMC, and we feel it speaks to the power of the combined private markets presence of IHS Markit and Hamilton Lane. We look forward to providing you with additional updates as they unfold. And with that, I will now turn the call over to Atul to cover the financials.

Atul Varma, CFO

Thank you, Erik, and good morning everyone. Slide 8 of the presentation shows the financial highlights for fiscal year 2020. We continue to see very solid growth in our business with management and advisory fees up 12% versus the prior year. Our specialized funds revenue increased $18.7 million, or 20% compared to the prior year, driven by over $1.7 billion raised in our latest secondary fund in the current fiscal year, and over $200 million raised between periods for our latest co-investment fund. We recognized $2.8 million in retro fees from the co-investment fund for fiscal 2020, compared to $1.7 million in fiscal 2019. Investors that come into later closes in the fund raise for many of our products pay retroactive fees dating back to the fund's close. Therefore, you typically see a spike in management fees related to that fund for the quarter in which subsequent closings occur. Revenue from our customized separate accounts increased approximately $5.5 million compared to the prior year, due to the addition of several new accounts and re-ups from existing clients. Revenue from our advisory and reporting offerings was relatively flat compared to the prior year. The final component for revenue is the incentive fee, which for the period were $29.1 million, or approximately 11% of total revenue. Noteworthy this year was that we saw an additional six vehicles move into a realized incentive fee position, which shows a positive trend of strong performance and the increasingly diversified sources of carried interest. Moving to Slide 9, we provide some additional detail on our unrealized carry balance. We saw strong growth this quarter with the balance up 35% from the prior year, even as we recognized $29.1 million of incentive fees in fiscal 2020. The growth came from both adding new carry generating funds and appreciation in existing vehicles. As Mario mentioned earlier, we don't control the positions and thus we don't control the timing of exit. Given the current market conditions, we would expect to see distributions slow down. Turning to Slide 10, which profiles our earnings, our fee-related earnings were up over 12% year-over-year due to the revenue growth we discussed earlier. In regard to our expenses, total expenses increased $9.7 million compared with the prior year. G&A increased $8.9 million primarily due to increases in technology-related expenses, consulting and professional fees, and commissions from fund closings in the current year. Total compensation and benefits increased slightly by $0.8 million due to increased salary expense from additional headcount in the current year period compared to the prior year period. This was partially offset by the non-recurrence of the earn-out expense from our real assets acquisition included in the prior year. Moving to our balance sheet in Slide 11, our largest asset is investments alongside our clients in our customized separate accounts and specialized funds. The growth of this asset, which increased 31% compared to the prior year, reflects the growth of our business. In regards to our liabilities, our senior debt is our largest liability. In March, we announced a comprehensive amendment package to our existing credit facility, successfully securing a lower interest rate, extending out the maturity date, and increasing our borrowing capacity through added $75 million fixed-rate term loans, which may be drawn at our discretion up to a year after closing. With that, we thank you for joining the call and are happy to open it up for questions.

Operator, Operator

Your first question comes from Ken Worthington from JPMorgan. Your line is open.

Ken Worthington, Analyst

Hi, good morning. Thank you for taking my question. Maybe generally, can you talk about the impact that state and municipal finances, as well as the need for cash at various sovereign wealth funds might have on gross inflows over the next few quarters, if not the next few years? It seems that there's probably a couple of places where at least potentially Hamilton Lane might have some vulnerability. I was thinking one might be where clients just don't have the money to fund new commitments, such as government skipping pension fund payments. So any thoughts there? And then another might be rainy day funds, which is what many sovereign wealth funds are, which would at least get drawn down or maybe just not contributing to new funding. So any guess on what exposure you might have there? Thanks.

Mario Giannini, CEO

Hi, Ken. It's Mario. Let me take it in two parts. In terms of the pressure on pension funds, state and local governments, any of that pressure would be future contributions that may or may not be made by those states or municipalities. It would be similar to what we saw in ‘09 and ‘10. If you look at the pension funds, there's nothing that affects their existing book of assets. From their perspective, their growth is primarily tied to that existing book of assets today. When you think about their situation in a low interest rate environment, which I assume we will stay in for longer than we initially anticipated, the desire and need for a higher return increases. Alternatives really lend into that, whether on the equity or on the debt side, infrastructure, real assets—wherever you put it. So if you're saying, will pension funds grow at the rate that we might have anticipated five or ten years from now? It's hard to say. But I don't think it will have any impact in a three to five-year timeframe in terms of the sorts of assets they might put into private markets. Sovereign wealth funds are a little different—some are rainy day funds, and while some of their assets may come out, they are often structured such that a portion is held in cash or liquid investments that they feel comfortable having for situations like this. So again, that doesn't really impact what they are looking to put into private markets today, and the same dynamics that impact pension funds will affect them in terms of needing a higher return. You've probably seen publicly that some of them are announcing that they’re looking to do more in private markets. So if you look at a three to five-year timeframe, I just don't think the dynamics are going to change significantly due to those two kinds of pressures.

Ken Worthington, Analyst

Okay, great. Thank you very much.

Michael Cyprys, Analyst

Hey, good morning, and thanks for taking the question. Just curious, given the environment maybe falling on Ken's question regarding pension funds and investors that may be more cash-strapped. How are you thinking about the implications for the growth in the secondary market in terms of investors already in the asset class looking to monetize and exit certain positions and potential additional funds that may be raised? I know you're raising the secondary fund now; you have until October 2020 to complete that. Just curious if there are any thoughts around the sizing of that raise or another vehicle alongside it and any thoughts on the ability to extend the timeframe on raising that fund, given the environment in the work from home?

Mario Giannini, CEO

Well, I think the secondary opportunity is interesting, especially in terms of the way the market is developing, even apart from a market downturn or dislocation. If history is any guide—and we think it is—the market opportunity on the secondary side is going to be very interesting, driven by limited partners looking to rebalance portfolios or general partners working with limited partners. So that whole market is growing, and during this time period, it will generate a fair amount of deal flow, which remains encouraging. Regarding fundraising, we are in the market with our fund and while there are challenges around fundraising and Zoom, investors understand the opportunity set, particularly, in secondaries, credit, and how they have seen these situations before. They want to invest in places where it might be possible to get assets at better prices than before. There is strong interest in the secondary market, which is an encouraging sign for us.

Michael Cyprys, Analyst

And then just as a follow-up on the evergreen strategy. It sounds like you're looking to pursue that in the U.S. Just curious if anything's changed or if any implications from the recent safe act that might make it more feasible to bring this to the U.S. And any color you could provide around the structure compared to how it looks elsewhere?

Erik Hirsch, Vice Chairman

Sure. Mike, it’s Erik. I would say nothing has been a big change. The processes in the U.S. are complex, and we’ve put considerable effort into working through that. Again, since we're kind of in the filing process, I can't give a lot of details. But our view is that this will pursue something very similar to what we're doing outside the U.S. So we don't see this being fundamentally different.

Alex Blostein, Analyst

Hey, good morning. Thanks for taking the question. I was hoping you could talk a little about the co-investment business, which is a meaningful part of what you do. It sounds like activity on the secondary front could be significant over the next couple of quarters and years, but what changes do you anticipate in the appetite for the co-invest piece of the model?

Erik Hirsch, Vice Chairman

Sure. Alex, it's Erik. I think one of the nice things about our vehicles, whether it's the credit vehicle, co-investment, or secondary, is that we have a lot of flexibility. Clients have trusted us to work with the right partners in the right deals at the right time. While our credit co-investing has largely been performing credit to date, we can pivot if we start to see non-performing credit emerge, and the same goes for equity co-investment. We have the vehicles in place to adjust our investment strategies based on market conditions.

Alex Blostein, Analyst

Got it. Thanks. And maybe just a tactical question near-term: curious about your thoughts around expenses over the next few quarters, as obviously, there's no travel, and some kind of natural savings are running through the model. Any thoughts around near-term expense guidance would be helpful.

Erik Hirsch, Vice Chairman

Yes. Alex, it's Erik again. That's exactly right. While we view ourselves primarily as a growth company and continue to invest in that growth, we are continuing our technology spending. T&E is a significant portion of our budget and has drastically decreased. Our offices in Asia and parts of the Middle East have begun to see some level of normality, but in the near term, you'll see lower expenses, which will flow through as a result.

Chris Harris, Analyst

Thanks. Hey, guys. Another question on fundraising. You mentioned that you're still able to get some activity done through Zoom and other virtual means. What percent would you say of your fundraising activity is potentially being impacted by the lack of travel? Is it the fundraising that you're trying to do for potentially new customers? Or is it existing clients also being impacted by not having in-person meetings regarding new funds?

Erik Hirsch, Vice Chairman

Yes. Chris, it's Erik. Thanks for that. I'll start. We've closed business in April, May, and that has been a combination of existing relationships and new ones. The challenge is that part of our growth relies on finding and meeting new people. Our industry typically thrives on in-person meetings to foster relationships, so that element has become harder. However, we think better brands will benefit in this environment. Being a well-known player in the market may help us have an advantage over smaller competitors in these challenging times.

Chris Harris, Analyst

In terms of your AUM growth, you have seen much faster growth in specialized funds versus separate accounts. Looking at your pipeline, do you think that trend will likely continue?

Mario Giannini, CEO

Chris, it's Mario. My guess is that trend will persist. The growth trend is driven by factors that haven't changed. We do talk about that it's harder to see people, but the need for investors to be in either products or separate accounts hasn't fundamentally shifted. The separate account is advantageously structured since you have re-ups and established client relationships.

Chris Harris, Analyst

Okay, great. Thank you.

Chris Kotowski, Analyst

Yes. Good morning. Thank you. As a follow-up to that last one, thinking about your AUM growth during the lockdown period, how much of that was from new clients versus re-ups from existing clients?

Erik Hirsch, Vice Chairman

It's Eric, Chris. The bulk of our growth typically comes from our existing client base. On the separate account side, new flows usually consist of about 70% from existing clients and 30% from new clients. The new client prospecting hasn’t completely gone away; it will likely take time and effort. For existing clients, they might decide to do more in this environment based on the opportunities available.

Chris Kotowski, Analyst

On a longer-term, say, two-year timeframe, if there's a pause in major private equity investing, what does that do to the fundraising dynamic?

Mario Giannini, CEO

Well, Chris, it’s Mario. If you suggest that there's no activity in the private markets for 18 to 24 months, then there's no urgency for anyone to invest. However, the premise may be questionable. One of the biggest differences from the ‘09, ‘10 timeframe to now is the volume of deals being actively discussed. There are deals that are ongoing. People do not seem to be looking at this environment with the belief that everything is halted for an extended period. So though we may see changes in periods, the volume of discussions remains relatively strong.

Chris Kotowski, Analyst

Alright, that's it for me. Thank you.

Robert Lee, Analyst

Thank you for taking my questions. Sticking with the fundraising theme, could you expect to close a secondary fund either this quarter or next? What should we anticipate regarding your largest co-invest fund? Also, I am trying to gauge how you're thinking about your strategies moving ahead. Any color would be great.

Erik Hirsch, Vice Chairman

Thanks, Rob. It's Erik. The secondary fund is already investing capital, and we'll continue to pace as the opportunity set presents itself. Regarding the credit vehicles, they are essentially perpetually open and we will move into the next vehicle as time goes on. Overall, we will maintain the fundraising process and finish deploying capital, as we have in the past.

Robert Lee, Analyst

On the separate accounts, when an existing client re-ups, are they intending to increase the size of their commitments, or is it mostly keeping commitments flat? Can you give me a sense of how re-ups are trending?

Mario Giannini, CEO

Rob, it's Mario. The growth comes primarily from our existing client base. We're not seeing any significant shift in clients either increasing or maintaining their commitments, except for usual fluctuations. Most of the clients understand their long-term goals and likely anticipate market downturns. So while shifts can occur, they do so within a very structured program for investing.

Robert Lee, Analyst

And if we do a simplistic AUM calculation, it seems that fees in that business are slightly trending down. Is that due to increased fund sizes, competition, or anything else you could provide color around?

Erik Hirsch, Vice Chairman

Rob, it’s Erik. The fee compression is often linked to the growth of existing client accounts. If we're getting 70% of our growth from existing clients, they may want to see lower rates as their assets increase. It's an acceptable trade-off for us since the processes are already established.

Chris Shutler, Analyst

Maybe first on expenses, are there any more permanent impacts on the expense side due to the crisis? Just remind us how large the travel budget is?

Erik Hirsch, Vice Chairman

Yes. Chris, it's Erik. We don’t anticipate any permanent expense changes. People will want to return to a collaborative work environment. As for T&E, it's under 10% of our G&A, and as you'd expect with peers, it has come down this quarter. But in the bigger picture, it's not a substantial number.

Michael Cyprys, Analyst

As a follow-up, how do you see the opportunity set for inorganic growth today versus six or twelve months ago?

Erik Hirsch, Vice Chairman

It's a bit early to speak on specific trends, but in previous crises, we saw people gravitate toward big names for stability. We believe that pattern will emerge again, benefiting our brand. Great. This is Erik again. I want to just thank you all for taking the time to join us. We appreciate the questions and the engagement. We wish everyone stays well and healthy. Thank you very much.

Operator, Operator

That concludes today's conference call. You may now disconnect.