Hennessy Advisors, Inc. — FY2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended September 30, 2018; it is not a quarterly report. Hennessy is an investment manager whose revenue is primarily advisory fees, plus shareholder-service fees, calculated on mutual-fund assets. It managed 14 funds at fiscal year-end. The company filed November 28, 2018.
Key financial and operating metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Total revenue | $54.6 million | $53.0 million |
| Operating income | $24.5 million; 44.8% margin | $24.5 million; 46.3% margin |
| Net income | $20.6 million; 37.8% margin | $14.9 million; 28.2% margin |
| Diluted EPS | $2.61 | $1.92 |
| Operating cash flow | $21.5 million | $19.8 million |
| Cash and cash equivalents at year-end | $25.4 million | $15.7 million |
| Gross bank debt at year-end | $21.9 million | $26.3 million |
- Investment advisory fees were $50.2 million, up 4.0%; shareholder-service fees were $4.4 million, down 6.5%. Sub-advisor fees totaled $10.5 million.
- Average assets under management (AUM) were $6.7 billion, up 1.3%; ending AUM was $6.20 billion, down $415 million, or 6.3%. Redemptions of $2.38 billion exceeded organic inflows of $1.19 billion; $393 million of market appreciation and $374 million of Rainier acquisition inflows partly offset the outflows.
- Net cash increased $9.7 million. Investing activities used $3.9 million, including Rainier transaction costs; financing activities used $7.9 million, including $2.9 million in dividends and $4.4 million of loan principal payments.
- Current assets were $30.7 million versus current liabilities of $12.0 million. Debt was secured by substantially all company assets; the effective rate was 4.854%, and the stated final principal installment was due September 2020. The company reported covenant compliance.
Material changes versus FY2017
- Revenue rose 3.1%, but operating income was essentially flat as operating expenses rose 5.8%, chiefly from higher sub-advisor fees and distribution expense.
- Net income increased 38.0%, primarily because income-tax expense fell to $2.8 million from $8.3 million. The FY2018 result included a one-time, non-cash $4.0 million tax benefit from remeasuring deferred taxes after the 2017 Tax Act; management attributed $0.54 of diluted EPS to this item. The reported effective tax rate was 11.9%, versus 35.7%.
- The Rainier asset purchases added approximately $374 million of AUM during FY2018. In October 2018, after year-end, the company completed its BP Funds purchase, adding nearly $200 million of AUM and two funds.
- Quarterly dividends increased from $0.075 to $0.10 per share in January 2018. A subsequent October announcement set the next quarterly dividend at $0.11 per share, subject to board discretion.
Outlook, commentary, risks, and unusual items
- No specific earnings, revenue, or AUM guidance is provided. Management said it would focus on fund performance, customer service, organic growth, and identifying, completing, and integrating acquisitions. It expected cash and other liquid assets to meet short-term needs for at least one year from the report date, while noting additional capital might be needed for longer-term needs.
- Management described generally rising U.S. and Japanese equity markets during the year, alongside trade-tariff concerns and higher interest rates. Thirteen of 14 funds had positive one-year returns; all 14 had positive returns over the stated three-, five-, ten-year, and since-inception periods. Several funds nevertheless trailed their listed benchmarks over the one-year period, including Cornerstone Growth, Mid Cap 30, Total Return, Balanced, Gas Utility, and Technology.
- Revenue exposure is concentrated: the Focus Fund generated 47% of company revenue and represented 40% of average AUM; Gas Utility represented 17% of average AUM, and Cornerstone Mid Cap 30 generated 15% of revenue. Focus, Mid Cap 30, and Gas Utility had the largest FY2018 net outflows.
- Principal risks include market declines and redemptions, fund performance and fee pressure, reliance on a few funds and third-party distribution platforms, sub-advisor relationships, floating-rate secured debt, acquisition integration and intangible-asset impairment, regulatory and litigation exposure, and cybersecurity or operational disruption.
- The company reported no legal proceedings and no off-balance-sheet arrangements. Its auditor gave an unqualified opinion on the financial statements and internal controls; management also concluded controls were effective. The California tax audit concluded after year-end with a stated $3,004 benefit to the company.
Important facts for investors to verify
- Whether AUM outflows and monthly redemption rates continue, particularly in the Focus, Mid Cap 30, and Gas Utility funds.
- Fund performance relative to benchmarks and the effects of asset concentration on advisory revenue and margins.
- Debt repayment, floating-rate exposure, covenant headroom, and the ability to fund future acquisitions while maintaining dividends.
- Integration and retention of AUM in the BP Funds acquired after year-end, including the deferred purchase-price calculation and sub-advisory economics.
- The sustainability of reported earnings after excluding the $4.0 million non-cash tax benefit, and the eventual impact of new lease accounting on the balance sheet.