Hennessy Advisors, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended September 30, 2017. The filing also provides unaudited fourth-quarter results. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context
Hennessy is an investment manager whose primary business is managing, servicing, and marketing 14 open-end mutual funds. Revenue is principally advisory and shareholder-service fees calculated on funds’ average daily net assets; four funds use sub-advisors. Average assets under management (AUM) were approximately $6.6 billion.
Financial performance and position
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $52.955 | $51.410 | +3.0% |
| Operating income | $24.346 | $23.790 | +2.3% |
| Operating margin | 46.0% | 46.3% | Down 0.3 percentage points |
| Net income | $14.942 | $14.367 | +4.0% |
| Net margin | 28.2% | 27.9% | Up 0.3 percentage points |
| Diluted EPS | $1.92 | $1.86 | +3.2% |
| Operating cash flow | $19.193 | $18.186 | +5.5% |
FY2017 fourth-quarter revenue was $13.247 million, operating income $5.723 million, net income $3.358 million, and diluted EPS $0.42.
- Investment advisory fees rose 4.1% to $48.297 million, mainly reflecting higher average daily AUM. Shareholder-service fees fell 7.2% to $4.658 million as assets shifted toward Institutional Class shares, which do not incur that fee.
- Operating expenses rose 3.6% to $28.609 million. Compensation and benefits increased 7.7% to $12.862 million; sub-advisor fees increased 5.5% to $9.225 million. Distribution expense declined 64.6% to $0.274 million, partly reflecting use of fund 12b-1 plans to offset distribution costs.
- Ending AUM was $6.613 billion, down 1.3% from $6.699 billion. Net outflows of $943 million were partly offset by $857 million of market appreciation. Redemptions averaged 2.7% of AUM monthly, versus 3.2% in FY2016.
- Cash and cash equivalents were $15.700 million, versus $3.535 million a year earlier. Total current assets were $22.900 million and current liabilities $12.459 million. Total assets were $97.927 million; stockholders’ equity was $51.530 million.
- Gross bank debt was $26.250 million ($25.956 million net of debt issuance costs), down from $30.625 million gross. The floating-rate loan carried an effective rate of 4.237% at year-end, is secured by substantially all company assets, and matures September 17, 2019. The company reported covenant compliance.
- Cash flow was $19.193 million from operations, $(0.445) million from investing, and $(6.583) million from financing, resulting in a $12.165 million increase in cash. Dividends paid totaled $2.210 million.
Material changes and notable items
- Compared with FY2016, revenue growth slowed to 3.0% from 14.9%, and ending AUM declined rather than increased. FY2017 net income nevertheless rose 4.0%.
- The company liquidated the Hennessy Core Bond Fund and reorganized the Hennessy Large Value Fund into the Cornerstone Value Fund in February 2017. It changed the Technology Fund’s strategy and management team, reduced its advisory fee from 0.90% to 0.74%, and adopted an expense limitation agreement. Institutional Class shares launched for the Gas Utility Fund.
- On December 1, 2017, after fiscal year-end, Hennessy acquired management-related assets for the Rainier Large Cap Equity and Rainier Mid Cap Equity Funds, adding approximately $122 million of AUM for a $1.0 million cash purchase price. Shareholder approval for the Rainier Small/Mid Cap Equity Fund remained pending as of the filing date.
- The $74.628 million management-contract intangible asset was treated as indefinite-lived and was not impaired at September 30, 2017. Its value depends on estimates, including anticipated cash flows tied to AUM.
- The company early adopted stock-compensation accounting guidance during FY2017; management said the adoption reduced the effective tax rate. A 3-for-2 stock split was effected in March 2017; reported per-share data reflect the split.
Outlook, commentary, and risks
No specific earnings, revenue, or AUM guidance was provided. Management said it expects cash and liquid assets on hand to meet short-term capital needs, while noting that additional borrowing or capital-market funding could be needed for longer-term requirements. Its stated strategy is to pursue organic growth and selective acquisitions, while focusing on fund performance, investor service, asset retention, and inflows. Management anticipated continuing regulatory and compliance costs and described economic, market, and regulatory conditions as uncertain.
- Revenue is highly sensitive to market levels, fund performance, purchases, and redemptions because fees are based on average AUM. The business is concentrated: the Focus, Gas Utility, and Cornerstone Mid Cap 30 Funds represented 78% of average AUM and 76% of revenue in FY2017.
- Competitive fee pressure, passive-investment growth, third-party distribution access, fund rankings, and short-term performance may reduce AUM or margins. Advisory and servicing contracts require annual renewal and may be terminated on 60 days’ notice.
- Floating-rate debt exposes earnings and liquidity to interest-rate increases; the loan also contains covenants and is secured by substantially all company assets. Management identified acceleration of debt following default as a significant risk.
- Other disclosed risks include potential impairment of management-contract intangibles, acquisition and integration risks, sub-advisor dependence, regulatory and litigation exposure, cybersecurity and technology failures, and foreign-exchange and market risks in the Japan funds.
- Management and the auditor reported effective internal control over financial reporting as of September 30, 2017. The independent auditor issued an unqualified opinion on the financial statements. The filing reported no legal proceedings and no off-balance-sheet arrangements.
Key facts for investors to verify
- Whether net outflows continue and how AUM, particularly in the three largest funds, affects fee revenue and margins.
- The completion or outcome of the remaining Rainier transaction, including shareholder approval for the Small/Mid Cap Equity Fund.
- Debt amortization, covenant compliance, floating-rate exposure, and the November 2017 loan amendments.
- Whether the management-contract intangible remains recoverable if AUM or expected cash flows weaken.
- The sustainability of dividends: the board controls future declarations; the filing reported $0.29 per share declared for FY2017 and a subsequent $0.075-per-share dividend announced for December 2017.