Hamilton Lane INC: Form 10-Q for the period ended Sep 30, 2023

The following information should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto included in this Form 10-Q, and our audited financial statements, notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2023 Form 10-K for a more complete understanding of our financial position and results of operations.

The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Investors should review the “Cautionary Note Regarding Forward-Looking Information” above and the “Risk Factors” detailed in Part I, Item 1A of our 2023 Form 10-K for a discussion of those risks and uncertainties that have the potential to cause actual results to be materially different. Our results of operations for interim periods are not necessarily indicative of results to be expected for the full year or for any other period. Unless otherwise indicated, references in this Form 10-Q to fiscal 2023 and fiscal 2022 are to our fiscal years ended March 31, 2023, and 2022, respectively.

Business Overview

We are a global private markets investment solutions provider and operate our business in a single segment. We offer a variety of investment solutions to address our clients’ needs across a range of private markets, including private equity, private credit, real estate, infrastructure, natural resources, growth equity, venture capital and impact. These solutions are constructed from a range of investment types, including primary investments in funds managed by third-party managers, direct investments alongside such funds and acquisitions of secondary stakes in such funds, with a number of our clients utilizing multiple investment types. These solutions are offered in a variety of formats covering some or all phases of private markets investment programs:

• Customized Separate Accounts: We design and build customized portfolios of private markets funds and direct investments to meet our clients’ specific portfolio objectives with regard to return, risk tolerance, diversification and liquidity. We generally have discretionary investment authority over our customized separate accounts, which comprised $89.7 billion of our assets under management (“AUM”) as of September 30, 2023.
• Specialized Funds: We organize, invest and manage specialized primary, secondary and direct investment funds. Our specialized funds invest across a variety of private markets and include equity, equity-linked and credit funds offered on standard terms, as well as shorter duration, opportunistically oriented funds. We launched our first specialized fund in 1997. Since then, our product offerings have grown steadily and now include evergreen offerings that primarily invest in secondaries and direct investments in equity and credit and are available to certain high-net-worth individuals. Specialized funds comprised $29.5 billion of our AUM as of September 30, 2023.
• Advisory Services: We offer investment advisory services to assist clients in developing and implementing their private markets investment programs. Our investment advisory services include asset allocation, strategic plan creation, development of investment policies and guidelines, the screening and recommending of investments, the monitoring of and reporting on investments and investment manager review and due diligence. Our advisory clients include some of the largest and most sophisticated private markets investors in the world. We had $734.8 billion of assets under advisement (“AUA”) as of September 30, 2023.
• Distribution Management: We offer distribution management services to our clients through active portfolio management to enhance the realized value of publicly traded stock they receive as distributions in-kind from private equity funds.
• Reporting, Monitoring, Data and Analytics: We provide our clients with comprehensive reporting and investment monitoring services, usually bundled into our broader investment solutions offerings, but also on a stand-alone, fee-for-service basis. We also provide comprehensive research and analytical services as part of our investment solutions, leveraging our large, global, proprietary and high-quality database for transparency and powerful analytics. Our data, as well as our benchmarking and forecasting models, are accessible through our proprietary technology solution, Cobalt LP, on a stand-alone, subscription basis.

Our client and investor base is broadly diversified by type, size and geography. Our client base primarily comprises institutional investors that range from those seeking to make an initial investment in alternative assets to some of the world’s largest and most sophisticated private markets investors. As we offer a highly customized, flexible service, we are equipped to provide investment services to institutional clients of all sizes and with different needs, internal resources and investment objectives. Our clients include prominent institutional investors in the United States, Canada, Europe, the Middle East, Asia, Australia and Latin America. We provide private markets solutions and services to some of the largest global pension, sovereign wealth and U.S. state pension funds. In addition, we believe we are a leading provider of private markets solutions for U.S. labor union pension plans, and we serve numerous smaller public and corporate pension plans, sovereign wealth funds, financial institutions and insurance companies, endowments and foundations, as well as family offices and high-net-worth individuals.

Key Financial and Operating Measures

Our key financial measures are discussed below.

Revenues

We generate revenues primarily from management and advisory fees, and to a lesser extent, incentive fees.

Management and advisory fees comprise specialized fund and customized separate account management fees, advisory and reporting fees and distribution management fees.

Revenues from customized separate accounts are generally based on a contractual rate applied to committed capital or net invested capital under management. These fees often decrease over the life of the contract due to built-in declines in contractual rates and/or as a result of lower net invested capital balances as capital is returned to clients. In certain cases, we also provide advisory and/or reporting services, and, therefore, we also receive fees for services such as monitoring and reporting on a client’s existing private markets investments. In addition, we may provide for investments in our specialized funds as part of our customized separate accounts. In these cases, we generally reduce the asset-based and/or incentive fees or carried interest on customized separate accounts to the extent that assets in the accounts are invested in our specialized funds so that our clients do not pay duplicate fees.

Revenues from specialized funds are based on a percentage of limited partners’ capital commitments to, net invested capital or net asset value in, our specialized funds. The management fee during the investment period is often charged on capital commitments and after the investment period (or a defined anniversary of the fund’s initial closing) is typically reduced by a percentage of the management fee for the preceding year or charged on net invested capital or net asset value. In the case of certain funds, we charge management fees on capital commitments, with the management fee increasing during the early years of the fund’s term and declining in the later years. Management fees for certain funds are discounted based on the amount of the limited partners’ commitments, whether the limited partners commit early in the offering period or if the limited partners are investors in our other funds.

Revenues from advisory and reporting services are generally annual fixed fees, which vary depending on the services we provide. In limited cases, advisory service clients are charged basis point fees annually based on the amounts they have committed to invest pursuant to their agreements with us. In other cases where our services are limited to monitoring and reporting on investment portfolios, clients are charged a fee based on the number of investments in their portfolio.

Distribution management fees are generally earned by applying a percentage to AUM or proceeds received. Certain active management clients may elect a fee structure under which they are charged an asset-based fee plus a fee based on net realized and unrealized gains and income net of realized and unrealized losses.

Incentive fees comprise carried interest earned from our specialized funds and certain customized separate accounts structured as single-client funds in which we have a general partner commitment, and performance fees earned on certain other specialized funds and customized separate accounts.

For each of our secondary funds, direct investment funds, strategic opportunity funds and evergreen funds, we generally earn carried interest equal to a fixed percentage of net profits, usually 10.0% to 12.5%, subject to a compounded annual preferred return that is generally 6.0% to 8.0%. To the extent that our primary funds also directly make secondary investments and direct investments, they generally earn carried interest on a similar basis. Furthermore, certain of our primary funds earn carried interest on their investments in other private markets funds on a primary basis that is generally 5.0% of net profits, subject to the fund’s compounded annual preferred return.

We recognize carried interest when it is probable that a significant reversal will not occur. The primary contingency regarding incentive fees is the “clawback,” or the obligation to return distributions in excess of the amount prescribed by the applicable fund or separate account documents. Incentive fees are typically only required to be returned on a net of tax basis due to a clawback. As such, the tax-related portion of incentive fees is typically not subject to clawback and is therefore recognized as revenue immediately upon receipt. In the event that a payment is made before it can be recognized as revenue, this amount would be included as deferred incentive fee revenue on our Condensed Consolidated Balance Sheets and recognized as income in accordance with our revenue recognition policy.

Performance fees, which are a component of incentive fees, are based on the aggregate amount of realized gains earned by the applicable specialized fund or customized separate account, subject to the achievement of defined minimum returns to the clients. Performance fees range from 5.0% to 12.5% of net profits, subject to a compounded annual preferred return that varies by account but is generally 6.0% to 8.0%. Performance fees are recognized when the risk of clawback or reversal is not probable.

Expenses

Compensation and benefits is our largest expense and consists of (a) base compensation comprising salary, bonuses and benefits paid and payable to employees, (b) equity-based compensation associated with the grants of restricted stock and performance awards and (c) incentive fee compensation, which consists of carried interest and performance fee allocations. We expect to continue to experience a general rise in compensation and benefits expense commensurate with expected growth in headcount and with the need to maintain competitive compensation levels as we expand geographically and create new products and services.

Our compensation arrangements with our employees contain a significant bonus component driven by the results of our operations. Therefore, as our revenues, profitability and the amount of incentive fees earned by our customized separate accounts and specialized funds increase, our compensation costs rise.

Certain current and former employees participate in a carried interest program whereby approximately 25% of incentive fees from certain of our specialized funds and customized separate accounts are awarded to plan participants. We record compensation expense payable to plan participants as the incentive fees become estimable and collection is probable.

General, administrative and other includes travel, accounting, legal and other professional fees, commissions, placement fees, office expenses, depreciation and other costs associated with our operations. Our occupancy-related costs and professional services expenses, in particular, generally increase or decrease in relative proportion to the number of our employees and the overall size and scale of our business operations.

Other Income (Expense)

Equity in income (loss) of investees primarily represents our share of earnings from our investments in our specialized funds and certain customized separate accounts in which we have a general partner commitment. Equity income primarily comprises our share of the net realized and unrealized gains (losses) and investment income partially offset by the expenses from these investments.

We have general partner commitments in our specialized funds and certain customized separate accounts that invest solely in primary funds, secondary funds and direct investments, as well as those that invest across investment types. Equity in income (loss) of investees will increase or decrease as the change in underlying fund investment valuations increases or decreases. Since our direct investment funds invest in underlying portfolio companies, their quarterly and annual valuation changes are more affected by individual company movements than our primary and secondary funds that have exposures across multiple portfolio companies in underlying private markets funds. Our specialized funds and customized separate accounts invest across industries, strategies and geographies, and therefore our general partner investments do not include any significant concentrations in a specific sector or area outside the United States.

Interest expense includes interest paid and accrued on our outstanding debt, along with the amortization of deferred financing costs, amortization of original issue discount and the write-off of deferred financing costs due to the repayment of previously outstanding debt.

Interest income is income earned on cash and cash equivalents.

Non-operating income (expense) consists primarily of gains and losses on certain investments, changes in liability under the tax receivable agreement and other non-recurring or non-cash items.

Other income (expense) of consolidated variable interest entities (“VIEs”) consists primarily of the share of earnings of investments of consolidated general partner entities, which are not wholly-owned by us, in our specialized funds and certain customized separate accounts in which they have a general partner commitment, interest income on our consolidated funds and interest income on investments held in trust, and changes in fair value of liabilities of our previously-sponsored special purpose acquisition company (“SPAC”).

Income Tax Expense

We are a corporation for U.S. federal income tax purposes and therefore are subject to U.S. federal and state income taxes on our share of taxable income generated by HLA. HLA is treated as a pass-through entity for U.S. federal and state income tax purposes. As such, income generated by HLA flows through to its limited partners, including us, and is generally not subject to U.S. federal or state income tax at the partnership level. Our non-U.S. subsidiaries generally operate as corporate entities in non-U.S. jurisdictions, with certain of these entities subject to non-U.S. income taxes. Additionally, certain of our subsidiaries are subject to local jurisdiction income taxes at the entity level. Accordingly, the tax liability with respect to income attributable to non-controlling interests (“NCI”) in HLA is borne by the holders of such NCI.

Non-controlling interests

NCI reflect the portion of income or loss and the corresponding equity attributable to third-party equity holders and employees in certain consolidated subsidiaries that are not 100% owned by us. NCI are presented as separate components in our consolidated statements of income to clearly distinguish between our interests and the economic interests of third parties and employees in those entities.

Fee-Earning AUM

Fee-earning AUM is a metric we use to measure the assets from which we earn management fees. Our fee-earning AUM comprise assets in our customized separate accounts and specialized funds from which we derive management fees that are generally derived from applying a certain percentage to the appropriate fee base. We classify customized separate account revenue as management fees if the client is charged an asset-based fee, which includes the majority of our discretionary AUM accounts but also includes certain non-discretionary AUA accounts. Our fee-earning AUM is equal to the amount of capital commitments, net invested capital and net asset value (“NAV”) of our customized separate accounts and specialized funds depending on the fee terms. The vast majority of our customized separate accounts and specialized funds earn fees based on commitments or net invested capital, which are not affected by market appreciation or depreciation. Therefore, revenues and fee-earning AUM are not significantly affected by changes in market value.

Our calculations of fee-earning AUM may differ from the calculations of other asset managers, and as a result, this measure may not be comparable to similar measures presented by other asset managers. Our definition of fee-earning AUM is not based on any definition that is set forth in the agreements governing the customized separate accounts or specialized funds that we manage.

Consolidated Results of Operations

The following is a discussion of our consolidated results of operations for the three and six months ended September 30, 2023 and 2022. This information is derived from our accompanying condensed consolidated financial statements prepared in accordance with GAAP.

($ in thousands)

29

Revenues

The following table shows total revenues of the Company and its consolidated VIEs:

($ in thousands)

Three months ended September 30, 2023 compared to three months ended September 30, 2022

Total revenues decreased $26.5 million, or 17%, to $126.9 million, for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to a decrease in incentive fees, partially offset by an increase in management and advisory fees.

Management and advisory fees increased $16.3 million to $109.2 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Specialized funds revenue increased $15.2 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to a $9.6 million increase in revenue from our latest secondary fund and a $5.5 million increase in revenue from our evergreen funds, which added $2.0 billion and $1.8 billion, respectively, in fee-earning AUM between periods. Revenue from our latest secondary fund included $6.1 million in retroactive fees for the three months ended September 30, 2023. Retroactive fees are management fees earned in the current period from investors that commit to a specialized fund towards the end of the fundraising period and are required to pay a catch-up management fee as if they had committed to the fund at the first closing in a prior period. Customized separate accounts revenue increased $2.7 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 due to the addition of several new accounts, additional allocations from existing accounts, and continued investment activity. Fund reimbursement revenue decreased by $2.0 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to the recognition of fund reimbursements from our latest secondary fund in the prior year period.

Incentive fees decreased $42.8 million to $17.7 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to decreases in incentive fees from our specialized funds.

Six months ended September 30, 2023 compared to six months ended September 30, 2022

Total revenues decreased $37.0 million, or 13%, to $251.9 million, for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to a decrease in incentive fees, partially offset by an increase in management and advisory fees.

Management and advisory fees increased $35.8 million to $214.6 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022. Specialized funds revenue increased $29.3 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to a $17.5 million increase in revenue from our latest secondary fund and a $9.7 million increase in revenue from our evergreen funds, which added $2.0 billion and $1.8 billion, respectively, in fee-earning AUM between periods. Revenue from our latest secondary fund included $8.8 million in retroactive fees for the six months ended September 30, 2023. Customized separate accounts revenue increased $6.0 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022 due to the addition of several new accounts, additional allocations from existing accounts, and continued investment activity.

Incentive fees decreased $72.7 million, to $37.3 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to decreases in incentive fees from our specialized funds.

Expenses

Three months ended September 30, 2023 compared to three months ended September 30, 2022

Total expenses decreased $12.3 million, or 15%, to $71.3 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to a decrease in compensation and benefits expenses.

Compensation and benefits expenses decreased $14.4 million to $45.9 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due to decreases in base compensation and benefits and incentive fee compensation. Base compensation and benefits decreased $4.8 million, for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due to a decrease in our bonus plan accrual related to the decrease in incentive fee revenue, partially offset by an increase in salary expense from additional headcount in the current year period compared to the prior year period. Incentive fee compensation decreased $10.7 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due to the decrease in incentive fee revenue.

General, administrative and other expenses increased $2.2 million to $25.3 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This change consisted primarily of a $2.7 million increase in third-party commissions primarily attributed to the increase in gross subscriptions to our evergreen funds, partially offset by a $0.7 million decrease in consulting and professional fees.

Six months ended September 30, 2023 compared to six months ended September 30, 2022

Total expenses decreased $15.2 million, or 10%, to $141.4 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to a decrease in compensation and benefits expenses.

Compensation and benefits expenses decreased $22.5 million to $90.0 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to decreases in base compensation and benefits and incentive fee compensation. Base compensation and benefits decreased $6.3 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due to a decrease in our bonus plan accrual related to the decrease in incentive fee revenue, partially offset by an increase in salary expense from additional headcount in the current year period compared to the prior year period. Incentive fee compensation decreased $18.2 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due to the decrease in incentive fee revenue.

General, administrative and other expenses increased $7.4 million to $51.3 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022. This change consisted primarily of a $4.5 million increase in third-party commission primarily attributed to the increase in gross subscriptions to our evergreen funds, a $1.0 million increase in fund reimbursement expense attributed to the timing of newly created funds, and a $0.8 million increase in travel expense.

Other Income (Expense)

The following table shows the equity in income (loss) of investees of the Company and its consolidated VIEs included in other income (expense):

($ in thousands)

Three months ended September 30, 2023 compared to three months ended September 30, 2022

Other income increased $7.5 million, to $10.8 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to an increase in equity in income (loss) of investees and other income attributed to the consolidated VIEs, partially offset by a decrease in non-operating income (loss).

Equity in income (loss) of investees increased $16.1 million to an $8.5 million gain for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This was due primarily to the gains of public market valuations during the period.

Non-operating income (loss) decreased $13.0 million to a $1.2 million loss for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due primarily to a $1.2 million unrealized loss on a technology investment during the quarter ended September 30, 2023 compared to a $1.0 million unrealized gain on a technology investment and a $9.8 million gain on the sale of our investment in a joint venture during the quarter ended September 30, 2022.

Other consolidated VIE related amounts increased $4.8 million to $5.1 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due to $2.8 million of interest income and $2.2 million of unrealized gains related to our consolidated funds during the three months ended September 30, 2023.

Six months ended September 30, 2023 compared to six months ended September 30, 2022

Other income increased $15.1 million, to $23.6 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to an increase in equity in income of investees and other income related to our consolidated VIEs, partially offset by a decrease in non-operating income (loss).

Equity in income (loss) of investees increased $28.0 million to a $20.5 million gain for the six months ended September 30, 2023 compared to the six months ended September 30, 2022. This was due primarily to the gains from increases in public market valuations during the period.

Non-operating income (loss) decreased $17.1 million to a loss of $1.0 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to the recognition of a realized gain of $9.8 million on the sale of our interest in a joint venture and $6.7 million of unrealized gains on a technology investment during the six months ended September 30, 2022.

Other consolidated VIE related amounts increased $5.4 million to $7.6 million for the six months ended September 30, 2023 compared to the six months ended September 30, 2022, due primarily to $4.6 million of interest income and $3.0 million of unrealized gains related to our consolidated funds during the six months ended September 30, 2023.

Income Tax Expense

Our effective tax rate was 2.8% and 21.2% for the three months ended September 30, 2023 and 2022, respectively, and 13.6% and 19.2% for the six months ended September 30, 2023 and 2022, respectively. These rates were different from the statutory tax rates due to the portion of income allocated to non-controlling interests, change in valuation allowance recorded against deferred tax assets and discrete tax adjustments recorded in the periods. The effective tax rate for the three and six months ended September 30, 2023 was lower than the effective tax rate for the three and six months ended September 30, 2022 primarily due to a reduction in valuation allowance against deferred tax assets and discrete tax adjustment to true-up prior fiscal year estimated investment taxable income to actual investment taxable income reported to the Company after the prior fiscal year end.

Fee-Earning AUM

The following table provides the period to period rollforward of our fee-earning AUM.

($ in millions)

(1) Contributions represent (i) new commitments from customized separate accounts and specialized funds that earn fees on a committed capital fee base and (ii) capital contributions to underlying investments from customized separate accounts and specialized funds that earn fees on a net invested capital or NAV fee base.

(2) Distributions represent (i) returns of capital in customized separate accounts and specialized funds that earn fees on a net invested capital or NAV fee base, (ii) reductions in fee-earning AUM from separate accounts and specialized funds that moved from a committed capital to net invested capital fee base and (iii) reductions in fee-earning AUM from customized separate accounts and specialized funds that are no longer earning fees.

(3) Foreign exchange, market value and other consists primarily of (i) the impact of foreign exchange rate fluctuations for customized separate accounts and specialized funds that earn fees on non-U.S. dollar denominated commitments and (ii) market value appreciation (depreciation) from customized separate accounts and specialized funds that earn fees on a NAV fee base.

Three months ended September 30, 2023

Fee-earning AUM increased $1.8 billion to $61.4 billion during the three months ended September 30, 2023, due primarily to contributions from customized separate accounts and specialized funds.

Customized separate accounts fee-earning AUM increased $0.4 billion, or 1%, to $36.2 billion for the three months ended September 30, 2023. Customized separate accounts contributions were $1.3 billion for the three months ended September 30, 2023, due primarily to new allocations from existing clients and the addition of new clients. Distributions were $0.9 billion for the three months ended September 30, 2023, due primarily to $0.5 billion from accounts moving from a committed to net invested capital fee base, $0.2 billion from returns of capital in accounts earning fees on a net invested capital or NAV fee base, and $0.2 billion from accounts reaching the end of their fund term.

Specialized funds fee-earning AUM increased $1.4 billion, or 6%, to $25.2 billion for the three months ended September 30, 2023. Specialized fund contributions were $1.6 billion for the three months ended September 30, 2023, due primarily to $0.6 billion from our latest secondary fund and $0.7 billion from our evergreen funds. Distributions were $0.3 billion for the three months ended September 30, 2023, due primarily to returns of capital in funds earning fees on a net invested capital or NAV fee base.

Six Months Ended September 30, 2023

Fee-earning AUM increased $4.1 billion to $61.4 billion during the six months ended September 30, 2023, due primarily to contributions from customized separate accounts and specialized funds.

Customized separate accounts fee-earning AUM increased $1.6 billion, or 4%, to $36.2 billion for the six months ended September 30, 2023. Customized separate accounts contributions were $3.1 billion for the six months ended September 30, 2023, due primarily to new allocations from existing clients and the addition of new clients. Distributions were $1.6 billion for the six months ended September 30, 2023, due primarily to $0.8 billion from accounts moving from a committed to net invested capital fee base, $0.4 billion from returns of capital in accounts earning fees on a net invested capital or NAV fee base, and $0.4 billion from accounts reaching the end of their fund term.

Specialized funds fee-earning AUM increased $2.5 billion, or 11%, to $25.2 billion for the six months ended September 30, 2023. Specialized fund contributions were $2.9 billion for the six months ended September 30, 2023, due primarily to $1.2 billion from our evergreen funds and $1.1 billion from our latest secondary fund. Distributions were $0.5 billion for the six months ended September 30, 2023 due to $0.4 billion from returns of capital in funds earning fees on a net invested capital or NAV fee base and $0.1 billion from accounts moving from a committed to net invested capital fee base.

Non-GAAP Financial Measures

Below is a description of our unaudited non-GAAP financial measures. These are not measures of financial performance under GAAP and should not be considered a substitute for the most directly comparable GAAP measures, which are reconciled below. These measures have limitations as analytical tools, and when assessing our operating performance, you should not consider these measures in isolation or as a substitute for GAAP measures. Other companies may calculate these measures differently than we do, limiting their usefulness as a comparative measure.

Fee Related Earnings

Fee Related Earnings (“FRE”) is used to highlight earnings from recurring management fees. FRE represents net income excluding (a) incentive fees and related compensation, (b) interest income and expense, (c) income tax expense, (d) equity in income of investees, (e) other non-operating income and (f) certain other significant items that we believe are not indicative of our core performance. We believe FRE is useful to investors because it provides additional insight into the operating profitability of our business. FRE is presented before income taxes.

Adjusted EBITDA

Adjusted EBITDA is an internal measure of profitability. We believe Adjusted EBITDA is useful to investors because it enables them to better evaluate the performance of our core business across reporting periods. Adjusted EBITDA represents net income excluding (a) interest expense on our outstanding debt, (b) income tax expense, (c) depreciation and amortization expense, (d) equity-based compensation expense, (e) other non-operating income and (f) certain other significant items that we believe are not indicative of our core performance.

The following table shows a reconciliation of net income attributable to Hamilton Lane Incorporated to FRE and Adjusted EBITDA for the three and six months ended September 30, 2023 and 2022:

($ in thousands)

(1) Incentive fee related compensation includes incentive fee compensation expense and bonus related to carried interest that is classified as base compensation.

Non-GAAP Earnings Per Share

Non-GAAP earnings per share measures our per-share earnings excluding certain significant items that we believe are not indicative of our core performance and assuming all Class B and Class C units in HLA were exchanged for Class A common stock in HLI. Non-GAAP earnings per share is calculated as adjusted net income divided by adjusted shares outstanding. Adjusted net income is income before taxes fully taxed at our estimated statutory tax rate and excludes any impact of changes in carrying amount of our redeemable non-controlling interest. Adjusted shares outstanding for the six months ended September 30, 2023 and 2022 are equal to weighted-average shares of Class A common stock outstanding - diluted. We believe adjusted net income and non-GAAP earnings per share are useful to investors because they enable them to better evaluate total and per-share operating performance across reporting periods.

The following table shows a reconciliation of adjusted net income to net income attributable to Hamilton Lane Incorporated for the three and six months ended September 30, 2023 and 2022:

(in thousands, except share and per-share amounts)

(1) Represents corporate income taxes at our estimated statutory tax rate of 23.6% and 23.9% for the three and six month periods ended September 30, 2023 and 2022, respectively, applied to adjusted pre-tax net income. The 23.6% is based on a federal tax statutory rate of 21.0% and a combined state income tax rate net of federal benefits of 2.6%. The 23.9% is based on a federal tax statutory rate of 21.0% and a combined state income tax rate net of federal benefits of 2.9%.

Investment Performance

The following tables present information relating to the historical performance of our specialized funds with fund families having at least two distinct vintages and most recent fund sizes of greater than $500 million per fund. The data are presented from the date indicated through June 30, 2023 and have not been adjusted to reflect acquisitions or disposals of investments subsequent to that date.

When considering the data presented below, note that the historical results of our specialized funds are not indicative of the future results you should expect from such investments, from any future investment funds we may raise or from an investment in our Class A common stock, in part because:

• market conditions and investment opportunities during previous periods may have been significantly more favorable for generating positive performance than those we may experience in the future;
• the performance of our funds is generally calculated on the basis of the NAV of the funds’ investments, including unrealized gains, which may never be realized;
• our historical returns derive largely from the performance of our earlier funds, whereas future fund returns will depend increasingly on the performance of our newer funds or funds not yet formed;
• our newly-established funds may generate lower returns during the period that they initially deploy their capital;
• in recent years, there has been increased competition for investment opportunities resulting from the increased amount of capital invested in private markets alternatives and high liquidity in debt markets, and the increased competition for investments may reduce our returns in the future;
• the performance of particular funds also will be affected by risks of the industries and businesses in which they invest; and
• we may create new funds that reflect a different asset mix and new investment strategies, as well as a varied geographic and industry exposure, compared to our historical funds, and any such new funds could have different returns than our previous funds.

The historical and potential future returns of the investment funds we manage are not directly linked to returns on our Class A common stock. Therefore, you should not conclude that continued positive performance of the investment funds we manage will necessarily result in positive returns on an investment in our Class A common stock. As used in this discussion, internal rate of return (“IRR”) is calculated on a pooled basis using daily cash flows. See “Performance Methodology” below for more information on how our returns are calculated.

Specialized Fund Performance

We organize, invest and manage specialized primary, secondary and direct investment funds. Our specialized funds invest across a variety of private markets and include equity, equity-linked and credit funds offered on standard terms, as well as shorter duration, opportunistically oriented funds. Below is performance information across our various specialized funds. Substantially all of these funds are globally focused, and they are grouped by the investment strategy utilized.

Performance Methodology

The indices presented for comparison are the S&P 500, MSCI World, Credit Suisse High Yield II (“CS HY II”) and Credit Suisse Leverage Loan (“CS LL”), calculated on a public market equivalent (“PME”) basis. We believe these indices are commonly used by private markets and credit investors to evaluate performance. The PME calculation methodology allows private markets investment performance to be evaluated against a public index and assumes that capital is being invested in, or withdrawn from, the index on the days the capital was called and distributed from the underlying fund managers. The S&P 500 Index is a total return capitalization-weighted index that measures the performance of 500 U.S. large cap stocks. The MSCI World Index is a free float-adjusted market capitalization-weighted index of over 1,600 world stocks that is designed to measure the equity market performance of developed markets. The CS HY II Index, formerly known as the DLJ High Yield Index, is designed to mirror the investable universe of the U.S. dollar denominated high yield debt market. Prices for the CS HY II Index are available on a weekly basis. The CS LL Index is an index designed to mirror the investable universe of the U.S. dollar denominated leveraged loan market. Loans must be rated 5B or lower and the index frequency is monthly.

Our IRR represents the pooled IRR for all discretionary investments for the period from inception to June 30, 2023. Gross IRR is presented net of management fees, carried interest and expenses charged by the general partners of the underlying investments, but does not include our management fees, carried interest or expenses. Our gross IRR would decrease with the inclusion of our management fees, carried interest and expenses. Net IRR is net of all management fees, carried interest and expenses charged by the general partners of the underlying investments, as well as by us. Net IRR figures for our funds do not include cash flows attributable to the general partner. Note that secondary portfolio IRRs can be initially impacted by purchase discounts (or premiums) paid at the closing of a transaction, the impact of which will diminish over time.

“Capital Invested” refers to the total amount of all investments made by a fund, including commitment-reducing and non-commitment-reducing capital calls. “Multiple” represents total distributions from underlying investments to the fund plus the fund’s market value divided by total contributed capital. “Gross Multiple” is presented net of management fees, carried interest and expenses charged by the fund managers of the underlying investments.

Specialized fund and pre-fund performance does not include ten funds-of-funds that have investor-specific investment guidelines.

Many of our specialized funds utilize revolving credit facilities, which provide capital that is available to fund investments or pay partnership expenses and management fees. Borrowings may be paid down from time to time with investor capital contributions or distributions from investments. The use of a credit facility affects the fund’s return and magnifies the performance on the upside or on the downside.

Liquidity and Capital Resources

Historical Liquidity and Capital Resources

We have managed our historical liquidity and capital requirements primarily through the receipt of management and advisory fee revenues. Our primary cash flow activities involve: (1) generating cash flow from operations, which largely includes management and advisory fees; (2) realizations generated from our investment activities; (3) funding capital commitments that we have made to certain of our specialized funds and customized separate accounts; (4) making dividend payments to our stockholders and distributions to holders of HLA units; and (5) borrowings, interest payments and repayments under our outstanding debt. As of September 30, 2023 and March 31, 2023, our cash and cash equivalents were $128.1 million and $99.7 million, respectively.

Our material sources of cash from our operations include: (1) management and advisory fees, which are collected monthly or quarterly; (2) incentive fees, which are volatile and largely unpredictable as to amount and timing; and (3) fund distributions related to investments in our specialized funds and certain customized separate accounts that we manage. We use cash flow from operations primarily to pay compensation and related expenses, general, administrative and other expenses, debt service, capital expenditures and distributions to our owners and to fund commitments to certain of our specialized funds and customized separate accounts. If cash flows from operations were insufficient to fund distributions to our owners, we expect that we would suspend paying such distributions.

We have also accessed the capital markets and used proceeds from sales of our Class A common stock to settle in cash exchanges of HLA membership interests by direct and indirect owners of HLA pursuant to our exchange agreement.

Finally, we have used available cash and borrowings from our Loan Agreements (defined below) to make strategic investments in companies that seek to offer technology-driven private markets data and wealth management solutions.

Loan Agreements

We maintain a Term Loan and Security Agreement (as amended, the “Term Loan Agreement”), Revolving Loan and Security Agreement (as amended, the “Revolving Loan Agreement”), a 2020 Multi-Draw Term Loan and Security Agreement (as amended, the “2020 Multi-Draw Term Loan Agreement”) and a 2022 Multi-Draw Term Loan and Security Agreement (the “2022 Multi-Draw Term Loan Agreement” and, together with the Term Loan Agreement, Revolving Loan Agreement and 2020 Multi-Draw Term Loan Agreement, the “Loan Agreements”) with JPMorgan Chase & Co. (“JPMorgan”), as successor to First Republic Bank. In early May 2023, JPMorgan announced its purchase of First Republic Bank after that bank’s failure. The purchase included the Loan Agreements. The Loan Agreements are cross-collateralized and cross-defaulted and the aggregate principal amount of loans that may be outstanding under all of the Loan Agreements is subject to an aggregate cap of $325 million (the “Cap”).

The 2022 Multi-Draw Term Loan Agreement has a maturity date of October 1, 2029 and the interest rate is a floating per annum rate equal to the prime rate minus 1.50% subject to a floor of 3.00%. As of September 30, 2023, we did not have an outstanding balance under the 2022 Multi-Draw Term Loan Agreement. We are entitled to request term loans not to exceed $75 million in the aggregate, subject to the Cap, through September 30, 2025.

The Term Loan Agreement has a maturity date of January 1, 2030 and the interest rate is a floating per annum rate equal to the prime rate minus 1.25% subject to a floor of 3.00%. As of September 30, 2023, we had an outstanding balance of $98 million under the Term Loan Agreement. We are entitled to request additional uncommitted term advances not to exceed $25 million in the aggregate, subject to the Cap, through December 31, 2023.

The Revolving Loan Agreement provides that the aggregate outstanding balance will not exceed $50 million, subject to the Cap, and has a maturity date of March 24, 2025. The interest rate is a floating per annum rate equal to the prime rate minus 1.50% subject to a floor of 2.25%. As of September 30, 2023, we did not have an outstanding balance under the Revolving Loan Agreement.

The 2020 Multi-Draw Term Loan Agreement provides for a term loan in the aggregate principal amount of $100 million with a maturity date of July 1, 2030. The interest rate is a fixed per annum rate of 3.50%. As of September 30, 2023, we had an outstanding balance of $100 million under the 2020 Multi-Draw Term Loan Agreement.

The Loan Agreements contain covenants that, among other things, limit HLA’s ability to incur indebtedness, transfer or dispose of assets, merge with other companies, create, incur or allow liens, make investments, pay dividends or make distributions, engage in transactions with affiliates and take certain actions with respect to management fees. The Loan Agreements also require HLA to maintain, among other requirements, (i) a specified amount of management fees, (ii) a specified amount of adjusted EBITDA, as defined in the Loan Agreements, and (iii) a specified minimum tangible net worth, during the term of each of the Loan Agreements. The obligations under the Loan Agreements are secured by substantially all the assets of HLA. As of September 30, 2023 and March 31, 2023, the principal amount of debt outstanding equaled $198 million and $214 million, respectively. We had $127 million in availability under the Loan Agreements as of September 30, 2023.

Future Sources and Uses of Liquidity

We generate significant cash flows from operating activities. We believe that we will be able to continue to meet our short-term and long-term liquidity and capital requirements through our cash flows from operating activities, existing cash and cash equivalents and our ability to obtain future external financing. However, the availability of capital from the Loan Agreements and our cash balances are exposed to the credit risks of the financial institutions at which they are held. If events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions or the financial services industry generally, or concerns or rumors about any such events, occur, our ability to access existing cash, cash equivalents and investments, or to access existing or enter into new banking arrangements or facilities to pay operational and other costs, may be threatened or lost.

We believe we will also continue to evaluate opportunities, based on market conditions, to access the capital markets and use proceeds from sales of our Class A common stock to settle in cash exchanges of HLA membership interests by direct and indirect owners of HLA pursuant to our exchange agreement. The timing or size of any potential transactions will depend on a number of factors, including market opportunities and our views regarding our capital and liquidity positions and potential future needs. There can be no assurance that any such transactions will be completed on favorable terms, or at all.

We will also continue to evaluate opportunities to make strategic investments in companies that seek to offer technology-driven private markets data and wealth management solutions.

In November 2018, we authorized a program to repurchase up to 6% of the outstanding shares of our Class A common stock, not to exceed $50 million (the “Stock Repurchase Program”). The Stock Repurchase Program does not include specific price targets or timetables and may be suspended or terminated by us at any time. We intend to finance the purchases using available working capital and/or external financing. The Stock Repurchase Program expires 12 months after the date of the first acquisition under the authorization. We have not repurchased any shares of our Class A common stock under the Stock Repurchase Program, and therefore the full purchase authority remains available. Our board of directors periodically reviews the Stock Repurchase Program and most recently re-approved it in December 2022.

We expect that our primary short-term and long-term liquidity needs will comprise cash to: (1) provide capital to facilitate the growth of our business; (2) fund commitments to our investments; (3) pay operating expenses, including cash compensation to our employees; (4) make payments and/or exercise early termination buyout rights under the tax receivable agreement; (5) fund capital expenditures and make strategic investments; (6) pay interest and principal due on our outstanding debt; (7) pay income taxes; (8) make dividend payments to our stockholders and distributions to holders of HLA units in accordance with our distribution policy; (9) settle exchanges of HLA membership interests by direct and indirect owners of HLA pursuant to our exchange agreement from time to time; and (10) fund purchases of our Class A common stock pursuant to the Stock Repurchase Program.

We are required to maintain minimum net capital balances for regulatory purposes for certain of our foreign subsidiaries and our broker-dealer subsidiary. These net capital requirements are met by retaining cash. As a result, we may be restricted in our ability to transfer cash between different operating entities and jurisdictions. As of September 30, 2023 and March 31, 2023, we were required to maintain $5.0 million and $4.8 million, respectively, in liquid net assets within these subsidiaries to meet regulatory net capital and capital adequacy requirements. We are in compliance with these regulatory requirements.

Dividend Policy

The declaration and payment by us of any future dividends to holders of our Class A common stock is at the sole discretion of our board of directors. We intend to continue to pay a cash dividend on a quarterly basis. Subject to funds being legally available, we will cause HLA to make pro rata distributions to its members, including us, in an amount at least sufficient to allow us to pay all applicable taxes, to make payments under the tax receivable agreement, and to pay our corporate and other overhead expenses.

Tax Receivable Agreement

We expect that periodic exchanges of membership units of HLA by members of HLA will result in increases in the tax basis in our share of the assets of HLA that otherwise would not have been available. These increases in tax basis are expected to increase our depreciation and amortization deductions and create other tax benefits and therefore may reduce the amount of tax that we would otherwise be required to pay in the future. The tax receivable agreement will require us to pay 85% of the amount of these and certain other tax benefits, if any, that we realize (or are deemed to realize in the case of an early termination payment, a change in control or a material breach by us of our obligations under the tax receivable agreement) to the pre-IPO members of HLA.

Cash Flows

Six Months Ended September 30, 2023 and 2022

($ in thousands)

Operating Activities

Cash flows from our operating activities generally reflect our earnings in the respective periods after adjusting for significant non-cash activity, including equity in income (loss) of investees, equity-based compensation, lease expense and depreciation and amortization, all of which are included in earnings. For the six months ended September 30, 2023 and 2022, our net cash provided by operating activities was driven primarily by receipts of management fees and incentive fees, partially offset by payment of operating expenses, which includes compensation and benefits and general, administrative and other expenses.

Investing Activities

Cash flows from our investing activities generally reflect cash used for acquisitions, fixed asset purchases contributions to and distributions from our funds. For the six months ended September 30, 2023 and 2022, our net cash used in investing activities was driven primarily by purchases of furniture, fixtures and equipment, net contributions to our funds and purchases of non-fund investments. Additionally, during the six months ended September 30, 2023, our consolidated funds purchased investments.

Financing Activities

Cash flows from our financing activities generally reflect cash received from debt and equity financings, payments to owners in the form of dividends, distributions and repurchases of shares and scheduled repayments of our outstanding debt. For the six months ended September 30, 2023 and 2022, our net cash provided by (used in) financing activities was driven primarily by dividends paid to stockholders, distributions to HLA members, and repayment of borrowings under our Revolving Loan Agreement. Additionally, the six months ended September 30, 2023 included contributions from non-controlling interests in consolidated funds, and the six months ended September 30, 2022 included borrowings under our Term Loan Agreement.

Off-Balance Sheet Arrangements

There have been no material changes in our off-balance sheet arrangements discussed in our 2023 Form 10-K.

Contractual Obligations, Commitments and Contingencies

There have been no material changes outside of the ordinary course of business in our contractual obligations, commitments and contingencies from those specified in our 2023 Form 10-K.

Critical Accounting Policies

The preparation of our condensed consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent liabilities. We base our judgments on our historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making estimates about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For a more complete discussion of the accounting judgments and estimates that we have identified as critical in the preparation of our condensed consolidated financial statements, please refer to our Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2023 Form 10-K.

Recent Accounting Pronouncements

Information regarding recent accounting developments and their impact on our results can be found in Note 2, “Summary of Significant Accounting Policies” in the notes to the condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q.

In the normal course of business, we are exposed to a broad range of risks inherent in the financial markets in which we participate, including price risk, interest-rate risk, access to and cost of financing risk, liquidity risk, counterparty risk and foreign exchange-rate risk. Potentially negative effects of these risks may be mitigated to a certain extent by those aspects of our investment approach, investment strategies, fundraising practices or other business activities that are designed to benefit, either in relative or absolute terms, from periods of economic weakness, tighter credit or financial market dislocations.

Our predominant exposure to market risk is related to our role as general partner or investment manager for our specialized funds and customized separate accounts and the sensitivities to movements in the fair value of their investments, which may adversely affect our equity in income of investees. Since our management fees are generally based on commitments or net invested capital, our management fee and advisory fee revenue is not significantly impacted by changes in investment values.

Fair value of the financial assets and liabilities of our specialized funds and customized separate accounts may fluctuate in response to changes in the value of securities, foreign currency exchange rates, commodity prices and interest rates. The impact of investment risk is as follows:

• Equity in income of investees changes along with the realized and unrealized gains of the underlying investments in our specialized funds and certain customized separate accounts in which we have a general partner commitment. Our general partner investments include thousands of unique underlying portfolio investments with no significant concentration in any industry or country outside of the United States.
• Management fees from our specialized funds and customized separate accounts are not significantly affected by changes in fair value as the management fees are not generally based on the value of the specialized funds or customized separate accounts, but rather on the amount of capital committed or invested in the specialized funds or customized separate accounts, as applicable.
• Incentive fees from our specialized funds and customized separate accounts are not materially affected by changes in the fair value of unrealized investments because they are based on realized gains and subject to achievement of performance criteria rather than on the fair value of the specialized fund’s or customized separate account’s assets prior to realization. Minor decreases in underlying fair value would not affect the amount of deferred incentive fee revenue subject to clawback.

Exchange Rate Risk

Several of our specialized funds and customized separate accounts hold investments denominated in non-U.S. dollar currencies that may be affected by movements in the rate of exchange between the U.S. dollar and foreign currency, which could impact investment performance. The currency exposure related to investments in foreign currency assets is limited to our general partner interest, which is typically one percent of total capital commitments. We do not possess significant assets in foreign countries in which we operate or engage in material transactions in currencies other than the U.S. dollar. Therefore, changes in exchange rates are not expected to materially impact our financial statements.

Interest Rate Risk

As of September 30, 2023, we had $198.1 million in borrowings outstanding under our Loan Agreements. The annual interest rate on the Term Loan Agreement, which is at the prime rate minus 1.25%, subject to a floor of 3.00%, was 7.25% as of September 30, 2023.

Based on the floating rate component of our Loan Agreements payable as of September 30, 2023, we estimate that a 100 basis point increase in interest rates would result in increased interest expense of approximately $1.0 million over the next 12 months.

Credit Risk

We are party to agreements providing for various financial services and transactions that contain an element of risk in the event that the counterparties are unable to meet the terms of such agreements. In such agreements, we depend on the respective counterparty to make payment or otherwise perform. We generally endeavor to minimize our risk of exposure by limiting the counterparties with which we enter into financial transactions to reputable financial institutions. In other circumstances, availability of financing from financial institutions may be uncertain due to market events, and we may not be able to access these financing markets.

Disclosure Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2023. Our disclosure controls and procedures are intended to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at September 30, 2023.

Changes in Internal Control over Financial Reporting

There have been no changes to our internal control over financial reporting during the quarter ended September 30, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors previously disclosed in Part I, Item 1A of our 2023 Form 10-K.