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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Hello and welcome to the Hamilton Lane Q1 Fiscal 2020 Earnings Call. Today, the call will be hosted by Mario Giannini, CEO; Erik Hirsch, Vice Chairman; and Randy Stilman, CFO.
Before the Hamilton Lane team discusses the quarter's results, we want to remind you that they will be making forward-looking statements based on their 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 2019 10-K and subsequent reports the company filed with the SEC. 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 products. 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, let me turn the call over to Erik Hirsch.
Thank you, Julianne. Beginning on the Slide 3. It was another strong quarter for us. Let me go through some quick highlights, and then we'll provide some additional detail and color. For the first fiscal quarter, our revenue from management and advisory fees grew 19% versus the prior year fiscal first quarter. This resulted in non-GAAP EPS of $0.45 based on approximately $24 million of adjusted net income.
Our GAAP net income was over $11 million, which translated into GAAP EPS of $0.42. In our previous earnings call, we announced that our Board approved a 29% increase in our dividend. This increase reflects both management's and the Board's view that the business is growing strong and remains well positioned.
In keeping with this, we have declared a dividend of $0.275 this quarter, which keeps us on track for the $1.10 for fiscal year 2020. Also, on April 16, we officially announced our expanded presence in North America by opening an office in Toronto, Canada. The Toronto office represents our 16th location worldwide and positions us well to further expand into a large and growing market.
Turning to Slide 4. You have heard us state in prior earnings calls that growth continues to come from a wide range of sources and this quarter was no different. Our growth remains diversified by geography, type of investor and size of investor. Our total asset footprint of approximately $473 billion remains significant. And as we stated before, our scale has a competitive advantage in this asset class. And we believe our clients continue to benefit from our growing footprint.
AUA for the quarter decreased slightly by $6 billion or 1% compared to the prior year period. However, our advisory and reporting revenue categories were up 3% compared to the prior year period. We will continue to caution that AUA and AUA-related revenue are not directly linked.
On Slide 5, we highlight our fee-earning AUM, this is a combination of our customized separate accounts and our specialized funds. Our total fee-earning AUM was up $4.3 billion or 14% versus the prior year period, with solid growth across both our specialized funds and our customized separate accounts. As we have stated in the past, fee-earning AUM is the most significant driver of our business as it makes up over 80% of our management and advisory fees. And as we've also stated, we remain most focused on annualized growth given that managing growth around a particular quarter is challenging due to the long-term nature of our business.
We're asking clients to enter into lengthy contracts. When they ultimately approve and sign those contracts is outside of our control. Our growth continues to come from 4 consistent channels: one, re-ups from existing clients; two, adding brand-new client relationships; three, raising new specialized funds; and four, growing existing funds.
In the past 12 months, we have added net fee-earning AUM of $2.3 billion to our customized separate accounts. And over the same time period, we have added nearly $2 billion of net fee-earning AUM across our specialized funds. Lastly, our fee rates across our fee-earning AUM continue to remain steady.
And with that, let me turn it over to Mario for an update on our specialized funds.
Thanks, Erik, and good morning. Before providing an update on our existing specialized funds, I wanted to take a moment and announce a new product that we're very excited about, a semi-liquid Evergreen Fund. This fund introduces a new structure into our lineup of specialized products and represents our entrance into the Evergreen Fund market.
With this product, we are offering an innovative alternative for investors, providing access to the private markets outside of traditional closed-end fund structures. This fund represents a globally diversified pool of assets and is primarily targeting the high net worth individual space and geographies where Evergreen Funds are already offered and have an established market presence, such as Australia and throughout Europe.
While an Evergreen Fund structure is a new foray for Hamilton Lane, this type of product and structure have been in existence for some time. And a select number of firms, such as Partners Group in Switzerland, managed somewhat similar offerings. We believe that we are well-positioned to successfully deliver on this strategy for clients and, while very early days, we see the potential for strong demand across the target audience. You've heard us speak in the past regarding strategically addressing and capitalizing on opportunities where we see a path to growth and scale and this evergreen product is a great example of that.
Let me quickly touch upon some key differentiating features of our Evergreen Fund for the benefit of those less familiar with open-end structures. Unlike our products that generally follow a defined raise-and-deploy strategy, our evergreen product is effectively always open, taking in capital from investors on a monthly basis. Similarly, the fund also provides a monthly liquidity option for investors. We expect to see the majority of the capital coming from individuals and coming via wealth management platforms with whom we already have or are developing relationships.
With regard to economics, the structure is similar to what you already know about our other products, with both management and performance fees at rates similar to our other funds. However, unlike our other funds that are based on committed or net invested capital, due to the evergreen nature of this vehicle, management fees will be tied to net asset value, which we view as a positive both for us and our investors.
Again, we are very early in the launch, and this is a product that we expect to grow and build for years to come. That said, in our first few months of marketing, we have already seen inflows totaling $91 million as of August 5, 2019.
Now a quick update on the other specialized funds. As a reminder, on June 24, we announced the final closing on our fourth co-investment fund with $1.7 billion in total commitments, putting us above the stated target for the fund raise. As of August 5, we have invested or committed 61% of that fund's capital. We also held our first closing in April on our fifth secondary fund, with $700 million in commitments.
As a reminder, we have at least 18 months from the date of the first close, that being April 2019, to complete fundraising and so expect several additional closings to come. We are pleased with the initial support and interest so far. This fund is also actively investing capital. And as a result, subsequent closing will result in retro management fees.
Lastly, the 2019 series of our credit-oriented vehicle closed recently on more than $760 million in commitments. Recall that this product is essentially an annual fundraise in which we raise and invest capital throughout the year based on the available opportunity set. As such, we are already actively raising capital for the 2020 series, and we'll continue to do so well into the next calendar year.
Product pipeline is strong, and we're very excited with the new launch of our evergreen product. With that, let me turn it back to Erik.
Thank you, Mario. Before we move on, we want to discuss a new line item that, due to a change in accounting principles around revenue recognition, we've now begun to include in the management and advisory fee breakout section during the last fiscal year. The line item is titled Fund reimbursement revenue, and last fiscal year that amounted to approximately $2 million and represented less than 1% of our management and advisory fee total revenue.
What this figure represents is simply a reimbursement of costs that we bear in connection with the creation of specialized funds. Said more specifically, we incur certain costs related to the organization and distribution of a fund, and these costs generally include professional fees, legal fees and other related items. This is an industry-standard concept and that you would find this in the vast majority of private market fund vehicles. The reimbursable amount is negotiated with the LPs and is usually based on the fund size and generally allows for full reimbursement.
We expense these costs as they are incurred, which has an immediate and direct impact on our G&A expenses. But once the fund is successfully formed and has held its first closing, the fund is then able to reimburse us for these costs and we are able to recognize that as revenue. What you can tell, however, is that there will be a timing mismatch before the first close. We are incurring expenses early to create the fund and then ultimately getting them reimbursed later once the closings begin. These costs cause G&A to look like it is rising and subsequently causes revenues to rise. We would encourage investors to realize this is simply offsetting with a built-in timing mismatch.
The key takeaway is that while these costs may have a short-term impact on our operating margins, ultimately they are a sign of continued growth for the platform as a whole since rising fees means we are forming and raising more and larger specialized funds.
On to technology. As you have heard us emphasize in the past, technology plays an important role in how we implement our industry-leading best practices in the private market space. In addition to integrating technology solutions into our daily work streams, we have strategically invested a small portion of our balance sheet capital into select leading technology firms with whom we partner to try to drive innovation across the industry.
With that, I am pleased to announce that on May 29, one of our technology partners agreed to be acquired. We view the acquisition as continued validation of our successful technology strategy. And while the transaction represents a full exit for Hamilton Lane as an investor, we remain a strategic client and look forward to continued partnership with the team on our customized solution.
As disclosed in our fiscal 2019 10-K and based upon the current terms of the acquisition agreement, we estimate that we will record a gain of approximately $5 million in connection with the transaction, resulting in a 3x multiple of our investment. We will recognize the gain from the sale of the investment as income in the second fiscal quarter as the transaction closed in July, subsequent to the June quarter end.
This is now our third successful exit of a strategic technology investment, with the first 2 exits representing returns of 2.6x and 8x multiples of our money. And while that return is not the key driver of why we are pursuing these relationships, we think it does clearly speak to the success and impact our partners are having on this industry.
And with that, I'll turn the call over to Randy for additional financial highlights from the quarter.
Thank you, Erik. Slide 8 of our presentation shows the financial highlights for the first quarter of fiscal 2020. We continue to see very solid growth in our business, with management and advisory fees up 19% versus the prior year period driven by strong results across each of our core products and services. Revenue from our customized separate accounts increased over $1.6 million or 8% compared to the prior year period due to the addition of several new accounts and additional allocations from existing clients.
For our advisory revenue, we experienced 3% growth compared to the prior year period driven by new client adds in our advisory, back office reporting and technology and analytics offerings. Our specialized funds revenue increased $5.9 million or 28% compared to the prior year period driven by $700 million raised in our latest secondary fund in the current year period and $800 million raised between periods for our latest co-investment fund.
We recognized $2.8 million in retro fees from this co-investment fund compared to $500,000 in the prior year period. As many of you are likely aware, investors that come into later closes of the fund raise for many of our products, a retroactive fees dating back to the fund's first close. Therefore, you typically see a spike in management fees related to that fund for the quarter in which subsequent closes occur. The final component of our revenue is incentive fees. Incentive fees for the period were $4.1 million or approximately 6% of total revenue.
Moving to Slide 9. We provide some additional detail on our unrealized carry balance. We saw strong growth this quarter with the balance up 25% from the prior year, even as we recognized $26.2 million of incentive fees over the last 12 months. As you can see from this slide, the growth came from both adding new carry generating funds as well as appreciation in existing vehicles. To the right, we show our unrealized carry balance by vintage. Approximately 70% of our unrealized carry balance is less than 8 years old, reflecting the early stage of a large portion of our carry dollars. Overall, we think the carry's story continues to be a strong one. Significant diversification of carry dollars spread across more than 60 vehicles and thousands of underlying companies coupled with strong investment performance continues to drive solid carry results.
Turning to Slide 10, which profiles our earnings. Our fee-related earnings were up 19% year-over-year as a result of the revenue growth we discussed earlier. In regard to our expenses, total expenses were flat compared with the prior year period. Total compensation and benefits decreased $3 million compared to the prior year period, due primarily to a $2.8 million acquisition earn-out expense recognized in the prior year. That was a onetime -- that was onetime in nature. G&A increased $3.0 million due to increases in commissions from fund closings in the current year period, an increase in consulting and professional fees and an increase in the fund reimbursement expenses that Erik discussed earlier.
Moving to our balance sheet on Slide 11. Our largest asset on the balance sheet is investments alongside customized separate accounts and specialized funds. The growth of this asset, which increased 16% compared to the prior year period, reflects the growth of our business. In regard to our liabilities, our senior debt is our largest liability and we continue to be modestly levered. It was another strong quarter.
And with that, we are happy to open up the call for questions. Thank you.
[Operators Instructions] Your first question comes from Ken Worthington from JPMorgan.
Maybe just a little more on the Evergreen Fund. Can you talk about how you're managing the inflows and the liquidity offered in the new product? So on the inflows, are you limiting the monthly inflows based on your ability to deploy the capital? Or do excess inflows just sort of sit in cash until they're deployed? And then on the other side, when you're giving monthly liquidity, how are you accessing that liquidity? And I guess what I'm hoping to hear is to what extent is Hamilton Lane either lending or taking any risk there?
Ken, it's Mario. I'll take each of those. On the inflow side, we are not limiting the inflow, but we are certainly very careful in terms of growing that product and managing the inflow. Because you're right. As the inflow comes in, it goes into cash. Cash has a lower return than private equity returns, and so you manage that very carefully in terms of the deal flow that you have compared to the amount of cash. You can see the amount of cash coming in to some extent because you're having discussions with people that are interested in investing. So it is a balance as you figure out what is the deal flow versus what is the cash coming in. And it's why, as we said in our comments, we are really looking at this on a long-term basis in terms of managing it, having a good result for investors and being careful not to take in too much capital where you can't invest it reasonably in a monthly time frame.
On the outflow side, the liquidity -- there is a certain amount of liquidity that investors can have on a monthly basis, and so that is also managed. And there is no Hamilton Lane guarantee. There is no Hamilton Lane balance sheet commitment behind the liquidity. And there's liquidity as you note from the amount of the money coming in on any period of time. So you'd have some liquidity there. And then you're also managing the investments you make. As we talked about, these investments cover a wide variety of assets, some of which provide liquidity on a monthly basis. So you're managing it that way. And there's a credit line that the fund has in order to provide liquidity.
Okay. Okay, great. That makes sense. And then on the customized separate accounts side, what types of investments are your clients building funds around these days? Are you seeing any changes in interest in private equity versus private credit versus infrastructure? Or any of the other idiosyncratic sort of investments you're looking at? And then any help on pipeline, both from the gross sales perspective here as well as the gross outflows?
Ken, it's Mario again. I would say on the separate account, I would divide it in some ways. I think on new separate accounts, I would say the interest is what it's always been, primarily private equity but with people increasingly one -- want private credit and infrastructure as part of it and looking to build, I'll call it a diversified private markets' portfolio. But private equity generally is still the largest part of it. On existing clients, since many of them have already built a more seasoned private equity portfolio. You probably see at the margin more demand for credit and infrastructure Real Assets as they look to grow that and, for many of them, not have quite as seasoned a portfolio as they may have had on the private equity side. But I would say in general, not -- no big changes in trends over the last year. It is what it has been for the last few years. I would not say that we're seeing something dramatically different happening in the market.
In terms of the question on pipeline and what we're seeing there, I would say it's been what it has been for the last period of time, the last few years. I think the pipeline -- you see people increasingly interested in separate accounts, whether to do their entire portfolio or to branch into pieces of it. So I want a separate account for Europe investing or Asian investing. I would say the appetite for separate accounts across all of the different categories, private equity, private credit, Real Assets, remains strong. It is a way people want to access the private markets in their portfolios.
Your next question comes from Michael Cyprys from Morgan Stanley.
This is Peter Kaloostian standing in for Michael Cyprys. Can you just talk about any new costs associated with the evergreen strategy? And how this could impact expenses going forward?
It's Erik. Thanks for the question. I think as Mario pointed out, this is about building this over time. I think some of the infrastructure in place, particularly around the distribution, we've already put in place. We had announced a couple of quarters ago that we have made a couple of significant senior hires on our business development team that were particularly focused on targeting distribution relationships with wealth management platforms around the globe. The investment activity, as Mario also noted, is very much in line with what we are already doing across separate accounts and across our specialized funds. So no change to -- there's no different or unique investment activity today around this product that we're not already doing some place else. So we think this is a great addition to the stable of products that we have without the need today to go off and build significant new infrastructure that doesn't already exist.
Your next question comes from Alex Blostein from Goldman Sachs.
So just building on the evergreen strategy. Could you guys help us think longer term, kind of how you would define success for that part of the model? Either kind of your -- kind of near-term goals, maybe over the next kind of 12 months and longer term? Maybe as a percentage of total assets or something like that? I'm just trying to think -- get a feel of how meaningful of a business contributor you envision this type of business to be for Hamilton Lane?
Alex, it's Mario. Thanks. We're clearly not going to give specific numbers in terms of -- we expect x or y. But look, you've seen how we built products before, and we've built them very carefully in terms of what we've said earlier, being able to deploy the capital and doing it in a way that makes sense for us and for investors. So we don't -- I don't think we look at as having specific targets. I think we look at it as you see our platform, you see how much capital we can invest. And so as we look at that, we think the product can continue to grow. We think there's demand for it because people want this kind of a product with some of the features. So I'm not going to get pinned down on giving a specific target or a specific number, but we think this is a product that has some legs and that the market will react positively to and we can invest.
Yes. Fair enough. Shifting gears a little bit. Just want to get you guys' thoughts on the current realization opportunity set. Obviously accrued carry for Hamilton Lane continues to grow pretty nicely. This has been a bit of a lighter quarter for realizations and that's something similar we've seen from many of your private equity alternative asset management peers. But anything on the horizon that you guys see that could expedite the realization, some of that carry? Or anything kind of structural in the marketplace that you see today that's just kind of prolonging the realization cycle this time around?
Sure. Alex, it's Erik. I'll take that. I would say, we sort of think about the carry in pieces, really into 2 sort of sections. One, the -- that, that we can control and second that, that we can't. On the can't-control piece, we can't control the timing of the exit. That's up to the fund manager. And we can't control what's happening in the public markets that will certainly have some impact on our unrealized marks. The pieces that we can control, we feel like we're doing a very good job on. One, we can raise more assets and have more carry-generating dollars, and we're doing just that.
And secondly, we can control investment results by making good investment selections and finding the right partners, and that certainly drives both realized carry as well as unrealized gains, and we think we're doing a good job at that. I think your point on the market is right. I think we're seeing 2 features at play here. One, you're seeing across the asset class that hold periods for underlying private equity-owned companies are simply getting longer. We would say that's not surprising data in a market where your people are paying fairly wholesome prices in order to generate the great returns that we're continuing to see.
They're going to need to work those assets for longer periods of time, thus driving out the whole periods. And the second thing we see as we look back over history is that times of market volatility, which we're certainly experiencing, most fund managers don't find that the most opportune time to decide to sell an asset. So I think both of those are also clearly at play. As we look out, I think our view is pretty simple. Every day that goes by, considering the quality of the assets we have, puts us closer and closer to generating realized carry. And so we think that as on an annualized basis, the numbers continue to be strong and continues to be a solid contributor to revenue.
Your next question comes from Chris Harris from Wells Fargo.
You guys announced a new office in Toronto, Canada. So with that in mind, just wondering, bigger picture, can you guys give us an update on where you stand with respect to your non-U.S. growth initiatives?
Yes, Chris. It's Erik. I'll happily take that. I think what you've seen is that the mix has been pretty steady, which is -- we're basically generating about 60% of our revenue coming from kind of North American-based clients and about 40% from non. That ratio has stayed relatively steady for several years. And I think that's sort of telling you a couple of things. One, despite just simply bigger growth outside of the U.S. in some of these emerging markets, we're actually continuing to find an awful lot of growth in the North American market to kind of keep pace with that. I think our geographic footprint expansion continues, and that will likely continue. You saw that we've opened up offices over the last couple of years in Australia, in Germany, now in Toronto. We mostly already have a presence, i.e., client relationships in these markets before we go in and open up an office. But we find once the office itself opens, deal flow accelerates, additional client connections accelerate, our brand and presence in that space accelerates, all hopefully making it easier for us to raise assets and make new relationships.
So we think we've got a great footprint today. We will continue to look opportunistically about marketplaces where it might make sense over time for us to have a bigger presence, and we'll follow through on that.
Okay. And on the Evergreen Funds, are there any specific eligibility requirements for investors to be able to access that fund? Or is it going to be open for pretty much anybody who wants to participate?
It's Mario. No. I mean there are -- it depends on the jurisdiction. But there are, as you might imagine, a number of regulatory requirements and compliance. No, it's not one of those things where you just walk in and put a sign up and say, come invest in Hamilton Lane's [ GPA ] product. So yes, there are requirements, but they vary by jurisdiction and fairly detailed around that.
[Operators Instructions] Your next question comes from Chris Kotowski from Oppenheimer & Co.
I'm just curious, on the Evergreen Funds, were these kinds of products around in 2007 and '08? Were they tested in that market?
It's Mario. Yes, they were around in that period. I mean they were starting to form where they were around. Also, I think they were around in the real estate side more than on the private equity side. But they were small in that market period. So they were around, but would you call it a test of that market period? I don't know. I think they were small relative to where they are today.
So presumably that's the test you have in mind when you're setting the gates for liquidity, right?
Well, I think the gates are set for a number of reasons. You're setting it for that. You're setting it in order to -- for the benefit of all investors managed cash balances and the liquidity around the product itself. I mean it's not just for market environments. I think the goal of the product is to provide investors not with something that they can get out of when things are bad, but for something that they can use to rebalance portfolios or whatever they need to do. But I think in this case, again, a key feature of that requirement or of the gating, if you will, is to protect all of the investors, whether it's a good or a bad environment.
Okay. And then you mentioned the $91 million in inflows. Could you tell us what period of time that you've been marketing this?
That's probably been, I would say 2 months, 3 months, over that period of time.
We have no further questions at this time. I'll turn the call back over to the presenters.
Great. We want to thank everyone as always for your time and support, and have a good day.
This concludes today's conference call.
You may now disconnect.