Hennessy Advisors, Inc. — Q2 FY2018 Form 10-Q
Business and period: The unaudited report covers the quarter and six months ended March 31, 2018 (fiscal Q2 and first half). Hennessy earns investment advisory and shareholder-service fees from its 14 open-end mutual funds; fees are primarily tied to average assets under management (AUM).
Financial performance
| Metric | Three months ended March 31, 2018 | Six months ended March 31, 2018 | Comparable 2017 period |
|---|---|---|---|
| Revenue | $14.0 million, +5.8% | $27.8 million, +4.9% | $13.2 million; $26.5 million |
| Net operating income | $6.2 million | $12.6 million | $6.1 million; $12.4 million |
| Operating margin | 44.4% (46.2% in 2017) | 45.4% (46.6% in 2017) | — |
| Net income | $4.6 million, +25.6% | $12.7 million, +67.1% | $3.6 million; $7.6 million |
| Diluted EPS | $0.58 | $1.62 | $0.47; $0.98 |
| Operating cash flow | Not separately stated | $8.2 million | $8.1 million |
Quarterly advisory fees rose 6.9% to $12.9 million, while shareholder-service fees declined 5.1% to $1.1 million. For the six months, advisory fees increased 5.8% to $25.6 million and shareholder-service fees fell 4.4% to $2.3 million. Management attributed advisory-fee growth to higher average daily AUM. Operating expenses rose 9.2% for the quarter and 7.2% for the half-year; sub-advisor fees and compensation were key drivers. The respective period operating-expense ratios increased to 55.6% and 54.6% of revenue.
Financial position, liquidity and AUM
- At March 31, cash and cash equivalents were $16.6 million; current assets were $22.3 million and current liabilities $9.6 million. Total assets were $100.9 million and stockholders’ equity $64.0 million.
- Gross bank debt was $24.1 million ($23.8 million net of issuance costs), down from $26.3 million gross at September 30, 2017. The secured term loan bears a reported effective rate of 4.414%; final principal and interest are due September 17, 2019. The company reported compliance with its loan covenants.
- Six-month investing cash outflow was $3.6 million, mainly reflecting $3.1 million of Rainier U.S. Funds management-contract acquisitions. Financing cash outflow was $3.6 million, including $1.4 million of dividends and $2.1 million of loan principal payments. Cash increased $0.9 million.
- March 31 AUM was $6.58 billion, down 0.9% year over year and 5.0% from December 31, 2017. In the March quarter, $460.9 million of organic inflows and $252.5 million of acquisition inflows were outweighed by $700.7 million of redemptions and $359.4 million of market depreciation. Rainier-related acquisitions totaled approximately $375 million of AUM across two closings.
Material changes, outlook and risks
- The 2017 Tax Act led to an approximately $4 million non-cash tax benefit in the December 2017 quarter from remeasuring deferred taxes. The first-half tax line was a $0.6 million benefit versus $4.2 million of expense a year earlier; this one-time item materially lifts first-half net income and EPS comparisons. Q2 tax expense was $1.4 million versus $2.2 million.
- Effective February 28, 2018, SPARX sub-advisory fee terms for the Japan and Japan Small Cap funds changed to tiered rates. The Japan Small Cap rate increased from 0.20% to 0.35% for assets below $500 million; both funds were below that threshold at filing.
- Management gave no quantified revenue, earnings, or AUM guidance. It said cash and other liquid assets should meet short-term capital needs, while future strategy relies on acquisitions and organic asset retention and inflows. Additional capital may be sought if resources and operating cash flow are insufficient for long-term needs; availability is not assured.
- Results are sensitive to fund performance, redemptions, market conditions, competition, interest rates, tax changes, and regulation. Management expects regulatory developments to increase administrative and compliance costs. The loan’s variable rate and monthly LIBOR renewal are additional financing considerations.
- The company reported no material changes in market risk, no material subsequent events, and effective disclosure controls. Management reported no impairment of management contracts. Federal tax years 2014 onward remained open to examination; certain state filings may remain open indefinitely.
Investor facts to verify
- Whether AUM flows and investment performance sustain advisory-fee growth despite recent redemptions and market depreciation.
- The extent to which reported earnings growth reflects recurring operations versus the approximately $4 million non-cash tax remeasurement benefit.
- Future sub-advisory costs, including the effect of amended SPARX terms, and whether expense growth moderates.
- Debt amortization, floating-rate exposure, covenant compliance, and capacity to fund acquisitions and dividends.
- Whether acquired Rainier assets are retained and generate returns sufficient to support the recorded management-contract value.