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Hamilton Lane Incorporated  (NASDAQ:HLNE)
Q3 2019 Earnings Conference Call
Feb. 05, 2019, 11:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning. My name is Shelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hamilton Lane Incorporated Third Quarter Fiscal Year 2019 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. (Operator Instructions) Thank you.

Ms. Karen Greene, Head of Investor Relations, you may begin your conference.

Karen Greene -- Head of Investor Relations

Thank you, and good morning. Welcome to the Hamilton Lane Q3 earnings call. This is Karen Greene, Head of Investor Relations. And I'm joined on the call today by our Chairman, Hartley Rogers; Erik Hirsch, our Vice Chairman; and Randy Stilman, our CFO.

Before we discuss the quarter's results, I 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 2018 10-K. Management will also be referring to non-GAAP measures that they view as important in assessing the performance of the business. Reconciliation of those non-GAAP measures to GAAP can be found in the earnings presentation materials, which are available on the IR section of the Hamilton Lane website.

Please note that nothing on this call represents an offer to sell or a solicitation to purchase interest in any of Hamilton Lane's funds or stock. The company's detailed financial results will be made available when the 10-Q is filed. Finally, for the call this morning, we will be referencing pages in the earnings release presentation available on the Hamilton Lane IR website and shown on the webcast version of this call.

With that, I will review our third quarter highlights. Slide three of the presentation summarizes our financial performance for Q3 of fiscal 2019. Year-to-date, our revenue from management and advisory fees grew 9% versus the prior year period. This resulted in non-GAAP EPS year-to-date of $0.0155 based on over $82 million of adjusted net income. Our GAAP net income year-to-date with over $25 million, which translated into GAAP EPS of $0.0108. You will notice that both non-GAAP EPS and GAAP EPS experienced a significant move during the quarter.

Hamilton Lane's effective tax rate dropped from 27% to 23.7% due to changes in our state income allocation, which were finalized with the filing of the first full year corporate income tax returns for the public company. This has resulted in significant cash savings and we'll continue to do so on a go-forward basis, assuming no change to current tax law. The change has reduced Q3 GAAP EPS by $0.27 due to a one-time reduction of our deferred tax assets and TRA liability more than offsetting the lower tax rate.

Q3 and year-to-date non-GAAP EPS increased by $0.18 due to the lower tax rate. Despite the negative movement to GAAP EPS, we see the increase to non-GAAP EPS and continued beneficial cash impact as a very positive development. Lastly, as in the prior quarter, we declared a quarterly dividend of $0.2125 per share, which keeps us on track for our full fiscal year target of $0.85 per share.

With that, I will turn the call over to Erik, who will review additional operating highlights.

Erik R. Hirsch -- Vice Chairman

Thanks, Karen, and good morning. I will begin with our AUM build. The theme on Page four remains similar to what you have heard on prior calls; AUM continues to grow and with it our size, scale and market influence. Our asset footprint of approximately $469 billion was up 10% versus the prior year period. This continued growth drives best-in-class deal flow, data and proprietary information and increases our negotiating leverage, all benefiting our clients.

The expansion in our asset base is coming from a diverse set of clients from around the globe. Broadly speaking, we are seeing new client additions coming from three types of clients: one, those who are brand new to the asset class; two, those who have chosen to switch service providers; and three, those who previously took an in-house approach to investing in private markets and are now seeking a partner. We are also continuing to see positive fund flows across different geographies and from different types of investors, as we continue to have success with both our specialized fund offerings and our customized separate account solutions.

Lastly, over 40% of our revenue comes from clients outside of the US. And given that this number has remained relatively stable over the past several years, it tells you that despite a much more mature market, we are seeing similar growth inside the US, as we see in non-US markets.

On Slide five, we highlight a byproduct of our asset growth, that being fee earning AUM. This is a combination of our customized separate accounts and our specialized funds. Our total fee earning AUM was up over $2.5 billion, or nearly 9% versus the prior year with solid growth across both our specialized products and our customized separate accounts for the quarter. As we have stated in the past, the fee earning AUM as a significant driver of our business as it makes up approximately 85% of our management and advisory fees. Our growth continues to be driven by three simple themes: one, reups from existing clients; two, us adding brand new client relationships; and three, raising new specialized funds.

At the risk of being repetitive from prior calls, we want, again, to emphasize the embedded organic growth in our model, as we view it as one of the most important and powerful aspects of the business. Across our separate accounts, the vast majority of those clients where we have fully committed their first tranche of capital have reupped for another tranche. That level of reups has driven over 70% of our separate account fee earning contributions for the last four fiscal years. This is in part due to a nuance of our asset class. Clients need to continually commit new capital to reach and maintain their target allocations. Our managers return the capital when they exit a deal, thus reducing a client's exposure to the asset class. In order to maintain, let alone grow exposure as most investors are trying to do. Clients must commit additional capital to us to deploy for them.

Second, as we've noted before, many of our clients are not yet at their targeted allocations and are still building their exposure. They need to continue to deploy new fresh capital and they do this by allocating capital to Hamilton Lane in subsequent tranches.

Lastly, in addition to solid growth, we have also maintained attractive fee rates across our fee earning AUM. Slide five shows you our fee rates continue to remain steady on an annual basis.

On Slide six, we highlight our AUM build, starting with our customized separate account offering. Over the last 12 months, we have added net fee earning AUM of over $800 million to our customized separate accounts. As I just mentioned, there continues to be a steady flow of reups from our existing clients. The balance of the fee earning AUM growth comes from us from winning new clients, which furthers the long-term organic growth potential at this part of the business. Given the sheer size of our client install base, you should expect to continue to see the majority of our new growth coming from existing customers. The fact that we are generating around 30% of our growth from brand new relationships tells you our sales efforts remain strong and successful.

We have also experienced nice momentum for our specialized funds, which have added net fee earning AUM of over $1.7 billion over the last 12 months. The growth in our specialized fund fee earning AUM has been driven by the continued raise of our fourth co-investment fund, which has closed now on approximately $1.2 billion of commitments to date, including over $100 million raised during the third quarter, as well as our fund-to-funds product which has reached almost $200 million in commitments. We have until the spring of 2019 to wrap up fundraising for these funds. So we will be actively raising them over the next several months. Another important point to note is that since both of these products are already actively deploying capital, subsequent closings will result in retroactive fees.

And lastly, our credit oriented fund is also on market and early demand strong. While this product has scaled very nicely since its first launch with under $100 million in assets to its most recent iteration at over $900 million of assets, we would not expect the fund size to grow significantly from here, particularly given it's only 12-month investment period. We are, however, adding additional credit assets via our separate accounts. We are excited about the activity we are seeing across our credit platform and look to continue to grow our presence in this space.

The last area shown here on Slide six is our advisory offering with AUA up over $35 billion compared with prior year period. We have continued to expand both the number of advisory clients, as well as investors coming to us for back-office and analytical needs, both of which are here in this revenue. The important takeaway around our AUA is the sheer size of the assets we touch, as it is directly correlated to our footprint and influence in the private markets. Along with our access to data reflecting hundreds of billions of dollars of investments. There is not, however, always a direct relationship between our AUA and advisory revenue growth. While the AUA number may shift quarter-to-quarter, we are simply focused on growing revenue associated with this segment on an annual basis.

Before I turn the call over to Hartley for some market commentary, I wanted to provide a quick update on Abraaj. For any on the call unfamiliar with this topic, I would direct you to the replay of our second quarter 2019 earnings presentation. As we sit here today, our view on the materiality of the situation and our view on our exposure remains unchanged from our last call. That being, this is not a material exposure for our firm.

Since our last call, there have however been some positive progress with identifying a successor manager for three of the underlying Abraaj funds to which we have exposure. Consents are being collected with the aim to transfer 75% of our clients exposed assets to Actis, a well-regarded general partner with a great deal of experience in the emerging markets. Several respected fund managers bide for the opportunity to manage out the assets, something we see as a very good indication that sophisticated investors see real value here. The remaining 25% of the assets are in two underlying funds; one of which is in process of selecting a replacement fund manager. And the second is a fund with only two remaining assets, both of which are in process of being monetized. Necessary court approvals and investor sign-offs are required. We will provide further updates in our subsequent earning calls as appropriate. For now, however, we remain encouraged by these developments.

With that, I will turn the call over to our Chairman, Hartley Rogers, who is actually joining us from our London office, where he is there seeing clients, and Hartley will share some of his perspectives on volatility in the public markets and how it affects our business.

Hartley R. Rogers -- Chairman and Managing Director

Thanks, Erik, and good morning. The public markets are seeing increased volatility during the past few months and forecast of continuing volatility abound. Understandably, this has led to questions from shareholders regarding the impact of public market volatility on the private markets. From our clients perspective they've seen the data and experience these cycles before and many of them look forward to these periods as creating opportunities to find interesting investments at attractive prices. Regardless of whether you are a limited partner or a shareholder, we believe these questions need to be addressed using data, and as you have heard from us before, one of our unique advantages is the magnitude and quality of our proprietary databases and the suite of state-of-the-art tools that we have developed to analyze that data.

As you can see on Slide seven, today our private markets database covers more than 40 vintage years, close to $5 trillion in fund commitments over 1,500 fund managers and over 60,000 private companies, where we possess underlying financial information. So what is that data telling us. Well, as shown on Slide eight, even considering the long bull run in the public equity market, private markets returns are showing well, against the public markets over five-year and 20-year period. On a vintage year basis, as shown on Slide nine, it is a fairly similar story, private markets beating the public markets across nearly every year going back to 1997, on a pooled basis across both equity and credit strategies. Many of you are familiar with these charts, but specifically what about periods of volatility, while the data is interesting.

Looking at Slide 10, the chart on the left shows the increased volatility has correlated to lower public market return. The same is not true for private market performance as the chart on the right shows. Performance for the private markets has been more consistent regardless of the level of volatility occurring in the public markets.

Taking a closer look, turning to Slide 11, and you will see the private markets investments are a counterweight for high volatility periods when stocks are sliding.

Turning to Slide 12, we are also at a point of record levels of opportunities for investors in the private markets. Choice allows for more tactical and deliberate portfolio construction. For us, it also highlights the need for investors to find a partner. Most investors simply do not see the depth and breadth of deal flow that we do and certainly don't have the global resources necessary to vet each of the opportunities.

Reflecting on previous market downturn, Hamilton Lane has served as an important and valuable resource to our clients. Uncertain times have caused investors in private markets to want to seek the help of the market expert, someone who can help them understand what they own, forecast results under different scenarios, analyzing consider various approaches to the private markets, and act as a well-resourced outsourcing partner to help staff that are mostly often laboring under personnel and budgetary constraints.

As an example of this, during the global financial crisis, and as you can see on the chart that Erik referenced a few minutes ago, Hamilton Lane actually saw its assets under management grow from 2007 to 2008, and grow again from 2008 to 2009, despite the markets being low and substantial downward pressure on valuations. As you know, we continue growing in every subsequent year. While we don't know what the next downturn may hold, or when it may come, we see our history as a positive indicator for our strong market position and the value proposition that we offer existing and prospective clients.

In short, we see many opportunities to further grow our business as markets drive rate (ph) by expanding client relationships, attracting new clients and taking advantage of expected increases and attractive investment opportunities. We are proud of another strong quarter of performance and are excited about what lies ahead.

With that, I will turn this over to our CFO, Randy to cover our financial performance for the first nine months of fiscal year 2019.

Randy M. Stilman -- Chief Financial Officer and Treasurer

Thank you, Hartley. Slide 14 of our presentation shows the financial highlights for the quarter. We continue to see very solid growth in our business with total year-to-date revenue up 11% versus the prior year period. Management and advisory fees grew 9% versus the prior-year period, driven by strong results across each of our core products and services.

Revenue from our customized separate accounts offering increased $4.8 million compared to the prior year-to-date period, due to the addition of several new accounts and additional allocations from existing accounts. For our advisory and reporting management offerings, we experienced 18% growth compared to the prior year-to-date period, driven by new client adds in our advisory back office reporting and technology and analytics offerings. Our specialized funds revenue increased $3.6 million compared to the prior year-to-date period, driven by the $1.2 billion raised to date in our co-investment fund currently in market. This fund had retro fees of almost $900,000 for the quarter. As many of you are likely aware, investors that come into later closes of the fund raise for many of our products pay retroactive fees dating back to the funds first close. Therefore, we typically see a spike in management fees related to that funds, for the quarter in which subsequent closes occur.

The final component of our revenue is incentive fees. Incentive fees year-to-date were $25.3 million, up more than $5 million from the prior year period. We also saw strong growth in our unrealized carry balance, which is up over 18% from the prior year, even as we've recognized over $50 million of incentive fees between periods. As a reminder, we do not recognize carry until it comes through its cash on our balance sheet. Overall, we think the carry story continues to be a strong one. Significant diversification of carry dollars spread across over 50 investment vehicles and thousands of underlying investments coupled with strong investment performance, continues to drive solid carry results.

Turning to Slide 15, which profiles our earnings. Our fee related earnings year-to-date was up over 5% compared to the prior year period as a result of the revenue growth we discussed earlier. In regards to our expenses, total expenses increased compared with the prior year period, driven by incentive fee compensation and acquisition earn-out expense. The earn-out expense is related to our real assets acquisition in August 2017, and is based on the strong performance of that business through the first anniversary of the acquisition, which occurred last quarter.

Total comp and benefits year-to-date were up $13 million compared to the prior year period due to an $8 million increase in incentive fee related compensation and $3.9 million from the earn-out. G&A was up $9.1 million, driven by a $2.7 million increase in reimbursable fund expenses recorded as expenses under the new revenue recognition standard. And a $3.4 million uptick in consulting and professional fees, which included $1.2 million in fees related to Private Market Connect, our joint venture formed in the prior-year period, which as we've noted before, is simply a swap of what had been personnel expense to now professional fees.

Wrapping up with our balance sheet on Slide 16. Our investments alongside clients and products, which is the largest part of our balance sheet continues to grow, reflecting the growth of the business and were up approximately 10% for the quarter. In regards to our liabilities, our senior debt is our largest liability and we continue to be modestly levered at less -- at well less than one times long-term -- I'm sorry, last 12 months adjusted EBITDA.

With that, we're happy to open up the call for questions. Thank you.

Questions and Answers:

Operator

(Operator Instructions) Your first question comes from the line of Ken Worthington from JP Morgan. Your line is now open.

Kenneth Worthington -- JP Morgan -- Analyst

Hi, good morning. Thank you for taking my questions. I guess, maybe first, the results you report are somewhat lagged. And as you're getting December, the December quarter sort of performance and return information from the underlying investments, I guess what are you seeing thus far and what sort of implications does it have for accrued carry as we think about the next quarter?

Erik R. Hirsch -- Vice Chairman

Yeah. Thanks, Ken. It's Erik. Look, I think certainly on the unrealized carry marks, there is some level of correlation to the public markets. So as you noted here, we're reporting balances that are off of 9/30. We would expect to see some movement and some impact from what the fourth quarter looks like in the public market as we see the evaluations. That said, I think the other big driver of the carry is what Randy had mentioned, which is we just continue to expand the number of carry earning vehicles and the carry earning dollars, and that expansion is coming from a lot of different diverse sources. And so those assets are also not going to perform all-in direct line with each other. Some of the credit exposure, which continues to increase will be different than the equity exposure. We've got exposure across different industries, different sized businesses and different geographies. We think all of that is a real strength for what that book of carry dollars looks like.

Kenneth Worthington -- JP Morgan -- Analyst

Great. Thank you. And then on the tax rate, so it's declining last year. Can you talk about -- did something actually changed here? Was this just Hamilton Lane being conservative as it approached sort of its tax outlook? And then just to confirm the lower tax rate is really a permanently lower tax rate than what you had been accruing sort of heretofore?

Erik R. Hirsch -- Vice Chairman

Yeah. Ken, it's Erik again. I think this is the question of when you're dealing with taxes, our view is that, we want to be certain rather than to be speculative. And so now we have certainty. And that certainty is the result of a change in a lower tax rate. That change is permanent. Again, as the lawyers will say, borrowing any changes to state income tax regulations. But we do see this is a significant move on the tax rate. And as we noted here, we think it's a significant move on cash flow.

Kenneth Worthington -- JP Morgan -- Analyst

Got you. Okay, great. Thank you very much.

Erik R. Hirsch -- Vice Chairman

Thank you.

Operator

(Operator Instructions) There are no further questions at this time. I'll turn the call back over to the presenters.

Hartley R. Rogers -- Chairman and Managing Director

Great. We want to thank everyone for your time and we appreciate it. Thank you.

Operator

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

Duration: 24 minutes

Call participants:

Karen Greene -- Head of Investor Relations

Erik R. Hirsch -- Vice Chairman

Hartley R. Rogers -- Chairman and Managing Director

Randy M. Stilman -- Chief Financial Officer and Treasurer

Kenneth Worthington -- JP Morgan -- Analyst

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