Hennessy Advisors, Inc. — FY2015 Form 10-K
Reporting period: Fiscal year ended September 30, 2015; comparison is primarily with FY2014. Hennessy is an investment manager whose main business is advising and servicing 16 open-end mutual funds. Fees are principally based on funds’ average daily assets under management (AUM).
Financial and operating performance
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Revenue | $44.7 million | $34.5 million | +29.6% |
| Operating income | $19.8 million | $14.1 million | +40.1% |
| Net income | $11.4 million | $7.7 million | +48.5% |
| Diluted EPS | $1.91 | $1.30 | Up $0.61 |
| Operating margin | 44.3% | 41.0% | +3.3 percentage points |
| Net margin | 25.5% | 22.2% | +3.3 percentage points |
| Operating cash flow | $14.5 million | $9.4 million | +$5.0 million |
- AUM: Year-end AUM was $5.988 billion, up 8.5% ($467 million); average AUM was approximately $6.0 billion, up 24%. Net inflows of $642 million were partly offset by $175 million of market depreciation. Redemptions rose to an average 2.7% of AUM per month from 2.1%.
- Revenue mix: Advisory fees were $41.2 million (+22.6%); shareholder service fees were $3.6 million, up from $0.9 million. Hennessy began earning service fees from all funds on March 1, 2015, contributing to the increase.
- Expenses: Operating expenses rose 22.3% to $24.9 million, slower than revenue growth. Compensation and benefits increased 31.5% to $9.8 million; sub-advisor fees increased 23.2% to $7.3 million. Distribution expense declined slightly to $2.4 million, partly because the Gas Utility Fund’s 12b-1 plan offset certain distribution costs.
- Liquidity and debt: Cash and cash equivalents were $3.1 million, down from $7.6 million. Current assets were $9.4 million versus current liabilities of $10.3 million. Total bank debt was $35.0 million ($4.4 million current and $30.6 million long-term), compared with $26.7 million total debt a year earlier. The floating-rate loan carried an effective 4.0% rate at year-end, is secured by substantially all company assets, and matures in 2019. The company reported compliance with its covenants.
- Capital allocation: FY2015 financing cash outflow was $18.6 million, including a $25.0 million self-tender repurchase of 1 million shares at $25 per share, partly funded by refinancing and increasing the bank loan. Cash dividends paid were $1.4 million; declared dividends were $0.23 per share.
- Balance sheet: Total assets were $73.1 million and stockholders’ equity was $23.1 million, compared with $75.3 million and $37.4 million, respectively, in FY2014. Purchased management contracts, an indefinite-lived asset, totaled $62.7 million.
Material changes and management commentary
- FY2015 AUM growth came from net inflows despite negative market contribution. The largest reported inflows were to the Cornerstone Mid Cap 30 Fund ($609 million), Focus Fund ($375 million), and Equity and Income Fund ($96 million).
- Hennessy completed its self-tender offer in September 2015 and refinanced its prior loan, increasing borrowings to $35 million. The board had authorized potential additional repurchases, subject to conditions.
- Ten of the 16 funds had negative one-year returns; all 16 had positive annualized returns over the reported three-, five-, ten-year and since-inception periods. These are fund returns, not returns on Hennessy’s common stock.
- Management described volatile U.S. equity markets, uncertainty about interest-rate increases, and concerns about China; it said domestic economic growth and labor conditions remained supportive. The company intends to pursue organic growth and strategic acquisitions, but provided no specific financial guidance or quantified forecast.
- Management anticipated continuing regulatory and compliance costs and said its focus remained fund performance and investor service. It stated that available cash and liquid assets were expected to meet short-term capital needs; additional long-term capital could require borrowing or accessing capital markets.
Risks, contingencies and unusual items
- Revenue is sensitive to market declines, fund performance, investor redemptions, and competition. AUM and revenue are concentrated: Focus, Gas Utility, and Cornerstone Mid Cap 30 represented 32%, 26%, and 16% of year-end AUM, respectively, and 36%, 21%, and 10% of revenue.
- Management and servicing agreements require annual renewal and can generally be terminated on 60 days’ notice. Six funds use unaffiliated sub-advisors; loss of a sub-advisor or distribution-platform access could affect assets and fees.
- Debt is floating-rate and secured by substantially all assets; covenants and potential default or acceleration could constrain operations and liquidity. Management noted that higher short-term rates could raise interest expense.
- The $62.7 million management-contract asset depends on estimates of future cash flows and is subject to impairment review. Management reported no impairment at September 30, 2015.
- The company recorded approximately $0.5 million of unrecognized tax benefits and $0.12 million of accrued interest and penalties. Management could not estimate the potential change in the tax liability over the next 12 months, but did not expect it to be material. No legal proceedings were reported.
- Five additional funds’ 12b-1 plans became effective November 1, 2015. A $0.06-per-share dividend announced October 30, 2015 was scheduled for payment in December, subject to board discretion.
Important facts for investors to verify
- Whether AUM inflows continue to exceed redemptions, particularly in the three funds driving a large share of assets and revenue.
- Debt repayment, interest-rate exposure, covenant headroom, and the cash available after the tender offer and dividends.
- Whether the expanded shareholder-service and 12b-1 arrangements produce durable net revenue after distribution and servicing costs.
- Key assumptions behind the valuation and impairment testing of management contracts, and the status of open tax years and uncertain tax positions.
- Future dividend and repurchase decisions, which remain subject to board discretion and financial, market, and contractual conditions.