Earnings Call Transcript - HLNE Q2 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Hamilton Lane Second Quarter Fiscal 2024 Earnings Call. This call is being recorded on Tuesday, November 7, 2023. And I would now like to turn the conference over to John Oh, Head of Shareholder Relations. Please go ahead.

John Oh, Head of Shareholder Relations

Thank you, Nina. Good morning, and welcome to the Hamilton Lane Q2 fiscal 2024 earnings call. Today, I will be joined by Mario Giannini, CEO; Erik Hirsch, Vice Chairman; and Jeff Armbrister, CFO. Earlier this morning, we issued a press release and slide presentation, which are available on our website. Before we discuss the quarter's results, we want to remind you that we will be making forward-looking statements. Forward-looking statements discuss our current expectations and projections relating to our financial position, results of operations, plans, objectives, future performance, and business. These forward-looking statements do not guarantee future events or performance and are subject to risks and uncertainties that may cause our actual results to differ materially from those projected. For a discussion of these risks, please review the cautionary statements and risk factors included in Hamilton Lane's fiscal 2023 10-K and subsequent reports we file with the SEC. 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. 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 when our 10-Q is filed. Please note that nothing on this call represents an offer to sell or a solicitation of an offer to purchase interest in any of Hamilton Lane's products. Beginning with the financial highlights. Year-to-date, our management and advisory fee revenue grew by 20%, while our fee-related earnings also grew by 20% versus the prior year period, translated into GAAP EPS of $1.92 based on $73 million of GAAP net income and non-GAAP EPS of $1.83 based on $99 million of adjusted net income. We have also declared a dividend of $0.445 per share this quarter, which keeps us on track for the 11% increase over last fiscal year, equating to the targeted $1.78 per share for fiscal year 2024. With that, I'll now turn the call over to Mario.

Mario Giannini, CEO

Thank you, John, and good morning, everyone. I'll start by addressing the CEO transition announcement we made several weeks ago. At the beginning of calendar 2024, I will be stepping down as CEO of Hamilton Lane after having served the last 22 years in that capacity. I will move into an executive co-chair role alongside Hartley Rogers, our current Chairman. At that time, Erik Hirsch and Juan Delgado-Moreira will become the new co-CEOs of Hamilton Lane. I want to emphasize that I will not be moving on from Hamilton Lane and, in fact, quite the opposite. I'm a significant shareholder and I plan to remain very active and do my part in continuing to grow and scale our business. Once, as a fund manager, I was asked how you know if someone is a good CEO. The answer was that you don't know until a couple of years after that person is no longer CEO. Because the mark of a good CEO is that his or her transition to another CEO is smooth and the successor continues to run the business successfully. That's the measure that I am certain I will be regarded as a good CEO, because this transition has and will continue to be seamless, and Juan and Erik will be great CEOs at Hamilton Lane. I've worked with both of them over many years here, and there has been no decision or strategic discussion over the last 15-plus years of which they haven't been an integral part. Their thoughts and judgments have been a key part of Hamilton Lane's success and we would be nowhere near what we are today without them helping to spearhead the growth of the business over the last decade and longer. Both Erik and Juan have highly complementary investment and strategic management skill sets and bring fresh perspectives on the future of our business. Juan will primarily focus on leading Hamilton Lane's global sales effort and client service organization, while Erik will take the lead on the strategic direction and operations of the firm. Erik and Juan will jointly lead our global investment team. We look forward to working with them as Hamilton Lane builds on its market leadership position. I will now turn the call over to Erik.

Erik Hirsch, Vice Chairman

Thank you, Mario, and good morning, everyone. Before I get into detail around the quarter's results, I want to take this opportunity to thank the Board, Hartley, and Mario for entrusting me and Juan with this new responsibility. We are excited to continue to build on the firm's strong position and momentum. Juan will join the next earnings call to introduce himself to you all. But our plan going forward is that future calls will be led by me, Jeff Armbrister, and John, to keep our interaction with you and the market consistent. With that, let's move on to the results for the quarter. I'll start with our total asset footprint, which we define as the sum of our AUM and AUA. This stood at $854 billion and represents a 4% increase to our footprint year-over-year and highlights our continued and steady growth as a firm. AUM stood at $119 billion at quarter-end and grew $12 billion or 11%. The growth came from both our specialized funds and customized separate accounts. AUA was up $18 billion or 3% year-over-year, primarily as a result of the addition of reporting and advisory mandates. As a reminder, AUA can fluctuate for a variety of reasons, but the revenue associated with AUA does not necessarily move in lockstep with those changes. Let's turn now to fee-earning AUM, which continues to be the largest driver of management fees. And despite a challenging fundraising environment over recent quarters, we have experienced strong growth in both our customized separate accounts and specialized funds. Our total fee-earning AUM stood at $61.4 billion and grew $8.7 billion or 17% relative to the prior year period. Taken separately, $3.9 billion of net fee-earning AUM came from our customized separate accounts, and over the same time period, $4.8 billion came from our specialized funds. Our blended fee rate across the platform also continues to increase. This stems from the continuing shift in the mix of our fee-earning AUM towards higher fee rate specialized funds, most notably our Evergreen products where growth is strong. Moving now to additional detail on our customized separate accounts. Fee-earning AUM from our customized separate accounts stood at $36.2 billion, growing 12% over the past 12 months. We continue to see growth across type, size, and geographic location of the clients. Over the last 12 months, more than 80% of the gross inflows into customized separate accounts came from our existing client base. While this clearly speaks to the power of a recurring relationship model, it also tells you that the remainder of the flows, despite a very large installed base, is coming from new relationships, as the market continues to offer plenty of opportunities. Moving to our specialized funds. Momentum here continues to be strong. Fee-earning AUM from our specialized funds stood at $25.2 billion at quarter-end. Over the past 12 months, we achieved positive net inflows of $4.8 billion, representing an increase of 24% relative to the prior-year period. This growth stemmed from additional closes for funds currently in market, robust investment activity, and continued expansion of our Evergreen platform. Moving on to some detail around the drivers of specialized fund flows, I'll begin with our secondary fund currently in market. During the quarter, we held two additional closes that totaled approximately $622 million of LP commitments, and that brings the total raised here to over $3 billion. As a quick reminder, we raised $3.9 billion for our prior secondary fund, and we are on target to surpass the prior fund size with this current fund. Capital raised this quarter generated $6.1 million in retro fees. Originally, we had until the calendar fourth quarter of 2023 to finish raising this fund. However, demand and opportunity remain strong, and our existing investors have granted us an extension to the end of March 2024. Overall, the fund continues to perform well, and we continue to be encouraged by the momentum heading into the final stages. Moving on to our strategic opportunities fund, which is our annual direct credit fund targeting institutional LPs. As a refresher, this series of funds is effectively always in market as we raise and deploy capital with short investment periods and charge management fees on invested capital. We are currently in market with our eighth series. Since our last update, we've held additional closes totaling over $230 million of LP commitments, bringing the total raise for this current series to nearly $570 million. We expect to hold the final close of the series sometime before the end of calendar 2023. I'd like to highlight that our direct credit platform has continued to experience strong growth over the past few years, with this annual institutional series now being complemented with other sleeves of credit-focused capital including various separate accounts and our Evergreen Funds. Together, the platform remains on solid footing with the opportunity to continue to grow and scale. Before I move on to our Evergreen Funds, I'm happy to announce that we've held the first close for our second Infrastructure Opportunities Fund. Our first fund raised nearly $575 million of investor commitments in and alongside the fund, and recall that this strategy focuses on transaction-based investments, namely direct equity and secondaries in the real assets and infrastructure space. For this first close of our second fund, we secured more than $300 million of commitments. We are pleased with the progress and momentum, having raised over 50% of Fund I's capital with this second close. Let's turn now to our Evergreen Funds, where growth remains robust. We continue to witness strong demand coming from across the globe as the non-institutional channel seeks access to the private markets via our semi-liquid funds. As of the end of September, total AUM across the Evergreen complex stood at nearly $4.9 billion. For the first 9 months of calendar 2023, we are averaging net monthly inflows of nearly $160 million across the entirety of the platform. For our U.S. private markets offering, we continue to generate solid traction with the wirehouses that we've onboarded earlier this year. As of the end of September, we've generated nearly $440 million of flows and have achieved that level of success in just a few short months of being live on those platforms. Our success demonstrates our strength in providing access to the private markets for the non-institutional investor. We believe that we are still very much in the early stages of this exciting business and look forward to expanding our presence in this space. Before I turn the call over to Jeff, I'd like to take this opportunity to highlight our newest strategic technology investment from our balance sheet. On August 8, we announced an investment and partnership with IDR. IDR is an investor onboarding platform that securely streamlines the onboarding process for private market managers and their fundraising efforts by providing a central, globally accepted and standardized investor onboarding solution, connecting all parties involved in the investment process and supporting onboarding workflow across know-your-customer, tax, and anti-money laundering services. Our investment in partnership with IDR is yet another example of our commitment to increasing efficiency and improving the private markets user experience for all parties: investors, fund managers, and even our own teams. We have implemented IDR onboarding services in our portfolio of fund offerings to help maintain consistent oversight and to streamline our KYC and AML processes. This has led to continued operational efficiencies as well as cost, time, and resource savings. Other users today include leading fund managers and fund administrators. We are excited to embark on this journey with IDR and look forward to providing you with future updates. And with that, I'll now turn the call over to Jeff to cover the financials.

Jeff Armbrister, CFO

Thank you, Erik, and good morning, everyone. As this is my first HLNE earnings call as Hamilton Lane's CFO, I'd like to start by conveying how excited I am to be working alongside the Board, Erik, Juan, and the rest of the senior leadership team here. With the last 5 years leading and growing Hamilton Lane's direct equity platform, I'm looking forward to this exciting opportunity to continue to help drive growth at the firm. Let's move on now to the financial results. Fiscal year-to-date, we achieved strong growth in our business with management and advisory fees up 20% versus the prior year period. Specialized funds revenue increased by $29 million or 32% compared to the prior year period. This was driven primarily by a $1.8 billion increase to fee-earning AUM in our Evergreen platform in the last 12 months and over $3 billion raised since inception in our latest secondary fund. Retro fees for the fiscal year were $8.8 million from our secondary funded market versus $1.2 million from our direct equity fund in the prior year period. As a reminder, investors who come into later closes during a 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 secondary Fund VI. Erik mentioned earlier, we received an extension for the final close for secondary Fund VI out to calendar Q1 of 2024, which will extend the timing of receiving the associated retro fees. This has potential to cause interim movements in our quarterly FRE margins. But on an annual basis, we expect to maintain our current levels. Moving on to customized separate accounts. Revenue increased $6 million or 10% 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 $784,000 compared to the prior year period, due primarily to the sale of the 361 Capital assets, partially offset by increases in revenue coming from our technology solutions. Lastly, the final component of our revenue is incentive fees. Year-to-date, incentive fees totaled $37 million and are down 66% relative to the prior year period. Recall that last fiscal year we generated a large amount of incentive fees due to the catch-up period that several of our carry-eligible vehicles were in. Let me now turn to some additional detail on our unrealized carry balance. The balance is up 17% from the prior year period, while we have recognized $84.1 million of incentive fees during the last 12 months. The unrealized carry balance now stands at approximately $1.2 billion. Moving to expenses. Year-to-date total expenses decreased $15 million compared with the prior-year period. Total compensation and benefits decreased by $23 million, driven primarily by lower compensation associated with the decreased amount of incentive fees. G&A increased $7 million, driven primarily by revenue-related expenses, which are the third-party commissions related to our U.S. Evergreen products being offered on our wirehouses that we discussed last call. I'd like to remind you that the flows that come in through the wirehouse channel have an associated upfront fee from the dollars raised there. That payment is made and applied to the total amount when those dollars close into the fund. However, the corresponding management fees we earn from those dollars come in over the course of the year for as long as the client is invested in the fund. It creates a timing mismatch between the cost of bringing those dollars on and the revenue associated with those flows, which causes our G&A to increase with the eventual offsetting revenue to come in during subsequent quarters and years. Said more simply, we bear the full cost upfront and then receive our revenue over time. Lastly, our fee-related earnings were up 20% relative to the prior-year period as a result of the management fee and fee-earning AUM growth discussed earlier. I'll wrap up here with some commentary on our balance sheet. The largest asset continues to be our investments 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 we will continue to invest our balance sheet capital alongside our clients. With regard to our liabilities, we continue to be modestly levered. With that, we will now open up the call for questions.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. And your first question comes from the line of Kenneth Worthington from JPMorgan.

Unidentified Analyst, Analyst

This is Alex on for Ken. Maybe to double-click on the Evergreen platform, and congratulations on all the continued success there. Maybe just initially to get a better sense of the decision process that you're making across choosing to launch new products versus trying to onboard existing products onto some of the larger distribution platforms, which is the wirehouses you discussed. Maybe if we can start there, please.

Mario Giannini, CEO

Sure, Alex. It's Mario. The decision is fairly straightforward in the sense that, obviously, these products that we have on the platforms are having great success. And so we fully intend to expand the product offerings. As you're aware, we have a credit offering outside the United States on those platforms. So we have already expanded. And we look at it and think that we will have an additional number of offerings. But really, it's a function of making sure that we have the right investment platforms that both the platforms want and in which there is space to provide them. But we would expect that we will continue to be providing products into that platform and expanding our own platform there.

Unidentified Analyst, Analyst

Got it. And maybe as a follow-up, some of your peers that also had Evergreen products have been looking at some more innovative structures such as ticker subscriptions and things of that nature. Do you see merit there? And is that something that you're considering? Or how are you framing that question?

Mario Giannini, CEO

Alex, it's Mario again. Look, I think everyone is looking at developments in that market. What does the market want? And clearly, as you see in our numbers, the market wants what we're offering. So as we think about whether we need to change that in order to increase demand, we just haven't seen that need. With that said, I would expect that you'll continue to see innovation around things like you described where either it's necessary or the market requires it. But as I said, in terms of the existing products we have, we've not had much demand for people saying, if you tweak it this way, you will get more incremental demand. You've seen the flows, and they're healthy. So I would not expect any time soon that we're going to be changing that. But sure, products looking forward, I think as the markets change, we will certainly change and hopefully be ahead of some of them.

Operator, Operator

And your next question comes from the line of Michael Brown from KBW.

Evan Holeman, Analyst

This is Evan Holeman on for Mike Brown. The FRE margin has been fairly stable the last several quarters. And as the Evergreen platform continues to grow its contribution to the business, is there an embedded operating leverage that can support further expansion? Or is there further investment that would limit this dynamic? And if so, can you just kind of help us quantify that?

Erik Hirsch, Vice Chairman

Sure, Evan, it's Erik. Thanks for the question. I think as Jeff said in his section, we're thrilled with the success we're having, particularly with the wirehouses, but that does come with that kind of upfront cost and then revenue coming later. So I think what you're seeing with margin right now, I think, is actually noteworthy. In an environment where we're certainly seeing margins falling across peers in the market segment, the fact that we're holding steady with this growth and those upfront costs I think shows that management is doing a good job on managing all of those dynamics. Going forward, you would say in a vacuum that margins could be rising as you've now paid the upfront cost and now you're just benefiting from revenue. That would be a margin enhancer, particularly given the margin on this product. That said, I think management's focus here continues to be on growth and investing in growth. To Mario's point, new product expansion and continuing to build out the sales force. So I think our focus today is not on can we increase margins further; it's how can we continue to invest smartly in the business to ensure that we're continuing to put up these significant growth numbers.

Evan Holeman, Analyst

Great. That's helpful. And then maybe just a quick follow-up on any color or visibility you guys have to additional wirehouses that the Evergreen product may be added to, just as we think through that dislocation in revenue and expenses, that would be great.

Erik Hirsch, Vice Chairman

Sure. Our team is working both in the U.S. and internationally, focusing on placing the product in as many appropriate locations as possible. We aim to ensure that once the product is there, it is supported effectively. There's a significant demand for education and customer support. We see this as a long-term journey, and we are just beginning. While we are pleased with our current achievements and are already partnered with some wirehouses, you can expect to see more distribution partners and products added, as well as ongoing investment in our resources in these areas. From management's perspective, we view this as a lengthy process, which is exciting. This represents a major growth opportunity for the future of our business, but it will take time to fully realize.

Operator, Operator

Mr. Erik Hirsch, there are no further questions at this time. Please proceed.

Erik Hirsch, Vice Chairman

Again, thank you for the time. We know it was a very, very busy day for a number of you. So we appreciate your participation. And again, wish everyone well. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating. You may all disconnect.