Hennessy Advisors, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended December 31, 2019; comparisons are with the three months ended December 31, 2018 unless otherwise noted. Financial statement amounts are in millions of dollars unless indicated.
Business context
Hennessy provides investment advisory and shareholder services to 16 open-end mutual funds. It manages 10 funds internally and uses sub-advisors for six. Revenue is primarily fees tied to funds’ average daily net assets. Assets under management (AUM) at December 31, 2019 were $4.979 billion, up $91 million (1.9%) year over year; management attributed the increase to market appreciation, partly offset by net outflows.
Financial results and liquidity
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $10.244 | $11.644 | Down 12.0% |
| Investment advisory fees | $9.449 | $10.738 | Down 12.0% |
| Shareholder service fees | $0.795 | $0.906 | Down 12.3% |
| Operating expenses | $6.513 | $7.039 | Down 7.5% |
| Net operating income | $3.731 | $4.605 | Down 19.0% |
| Net income | $2.628 | $3.067 | Down 14.3% |
| Diluted EPS | $0.35 | $0.39 | Down $0.04 |
| Operating margin | 36.4% | 39.5% | Down 3.1 percentage points |
| Net margin | 25.7% | 26.3% | Down 0.6 percentage points |
Revenue fell mainly because average daily fund AUM declined 11.4% year over year to $4.9 billion. Redemptions as a share of AUM improved, averaging 2.2% per month versus 6.0% in the prior-year quarter. The effective tax rate decreased to 27.0% from 29.9%, partly offsetting lower operating income.
- Cash flow: Operating cash flow was $1.285 million, versus $1.832 million. Investing cash outflow was $0.744 million, versus $1.797 million; financing cash outflow was $2.773 million, versus $1.984 million. Cash declined $2.232 million to $22.455 million.
- Balance sheet and liquidity: Total assets were $108.660 million and total liabilities $31.736 million at December 31, 2019. Current assets were $26.925 million against current liabilities of $8.876 million. Management said cash and liquid assets were expected to meet capital requirements for at least one year from the report’s issuance.
- Debt: Term-loan principal was $16.4 million ($16.3 million net of issuance costs), down from $17.5 million at September 30, 2019. The effective interest rate was 3.947%; monthly principal payments are $364,583, with final payment due May 9, 2022. Debt is secured by substantially all assets. The company reported compliance with loan covenants.
- Capital returns: The company declared dividends of $0.14 per share and paid $1.032 million in dividends during the quarter. It repurchased 64,787 shares for $0.685 million, at an average $10.57 per share.
Material changes and unusual items
- Operating expenses decreased in dollars but rose from 60.5% to 63.6% of revenue, contributing to lower operating margin. Compensation expense fell 13.3%, primarily due to lower incentive compensation; mutual fund distribution expense increased 13.0%.
- Interest expense fell 39.7%, primarily due to lower debt principal and interest rates.
- Effective October 1, 2019, the company adopted the lease accounting standard and recorded operating lease right-of-use assets of $0.653 million and lease liabilities of $0.769 million. Adoption did not affect retained earnings, income, or cash flows. At quarter-end, lease assets were $0.558 million and lease liabilities totaled $0.660 million.
- The company reported $80.643 million of purchased management contracts, unchanged from September 30, 2019, and no impairment. It made a $0.710 million payment related to the BP Funds management-contract acquisition during the quarter.
Outlook, commentary, and risks
The filing provides no specific financial guidance. Management described its strategy as pursuing acquisitions and organic growth through asset retention and inflows, while focusing on fund performance and investor service. It noted favorable market appreciation during the quarter, but net outflows continued to weigh on AUM. Key sensitivities include fund performance, shareholder redemptions, market and interest-rate movements, competition, taxes, and changing regulatory requirements and compliance costs. Fund advisory agreements generally require annual renewal and may be terminated on 60 days’ notice. The company uses a one-month LIBOR-based loan rate renewed monthly and says it will continue while it remains the most favorable option. No material subsequent events were reported; management stated disclosure controls were effective and there were no material quarterly changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the improvement in redemption rates and AUM growth persists, and whether organic inflows can offset outflows.
- The drivers of the 11.4% decline in average AUM and its effect on advisory-fee revenue and operating margins.
- Debt repayment capacity, covenant compliance, secured borrowing terms, and the transition away from LIBOR.
- Continued renewal of fund advisory agreements, management-contract valuations, and any changes in acquisition or impairment assumptions.