Business context and reporting period
Hennessy Advisors, Inc. filed this unaudited Form 10-Q for its fiscal second quarter and six months ended March 31, 2019. The company earns investment advisory and shareholder-service fees from its family of 16 mutual funds; advisory fees are primarily based on fund assets under management (AUM).
Financial and operating results
Unless noted, amounts are in millions. Quarterly comparisons are with the three months ended March 31, 2018; six-month comparisons are with the six months ended March 31, 2018.
| Metric | Quarter | Six months |
|---|---|---|
| Revenue | $10.46, down 25.3% | $22.10, down 20.6% |
| Net operating income | $3.96, down 36.8%; 37.9% margin vs. 44.7% | $8.56, down 32.5%; 38.7% margin vs. 45.6% |
| Net income | $2.90, down 36.3%; diluted EPS $0.37 vs. $0.58 | $5.97, down 53.2%; diluted EPS $0.75 vs. $1.62 |
| Operating cash flow | Not separately presented | $5.46 vs. $8.24 |
| Cash and cash equivalents | $25.07 at March 31, 2019, versus $25.40 at September 30, 2018 | |
| Debt | $19.7 outstanding ($19.6 net of issuance costs); effective rate 5.239%; maturity September 17, 2020 |
Quarterly operating expenses fell 16.1% to $6.50 million, but rose to 62.1% of revenue from 55.3%. For the six months, expenses fell 10.5% to $13.54 million but rose to 61.3% of revenue from 54.4%. Cash declined $0.32 million over the six-month period after $5.46 million of operating cash flow, $1.86 million of investing outflows, and $3.93 million of financing outflows. Current assets were $29.65 million and current liabilities $8.48 million at March 31.
AUM was $5.14 billion at March 31, down 21.9% ($1.4 billion) year over year. For the six months, average AUM was $5.4 billion, down 21.4% year over year. The company reported $516.6 million of redemptions and $242.6 million of organic inflows in the March quarter; market appreciation added $522.4 million. The $0.11-per-share quarterly dividend was unchanged from the prior quarter and up from $0.10 a year earlier.
Material changes and unusual items
- Lower average fund assets drove most of the revenue decline. Six-month redemptions averaged 4.7% of AUM per month, versus 2.9% a year earlier; the quarterly rate was 3.4% in both periods.
- Despite lower expense dollars, operating and net margins contracted as revenue fell faster than costs. Compensation expense declined mainly because incentive-based compensation was lower.
- Six-month 2018 results included a one-time, non-cash $4.2 million tax benefit from remeasuring deferred taxes after the 2017 Tax Act. This makes the reported six-month net-income comparison unusually unfavorable; the 2019 effective tax rate was 26.5%, versus negative 5.1% in the prior period.
- The October 2018 BP Funds acquisition added nearly $200 million in AUM. A further purchase-price payment is due in October 2019, based on successor-fund AUM; the amount was not reasonably estimable and no contingent liability was recorded at March 31.
- Management reported no impairment of management contracts, whose carrying value was $79.9 million. A new lease accounting standard is expected to increase reported assets and liabilities upon adoption.
Outlook, commentary and risks
Management said cash and other liquid assets should be sufficient for capital requirements for at least one year from issuance of the report; it gave no numerical earnings or revenue guidance. Management’s strategy emphasizes acquisitions and organic growth through asset retention and inflows. It described volatile markets, weaker consumer spending and some business indicators, while noting the Federal Reserve’s shift toward pausing rate increases and a strong market rebound in early 2019. The company highlighted risks from fund redemptions, investment performance, market and economic conditions, interest rates, competition, regulation, and acquisition integration. It also expects regulatory developments to increase administrative and compliance costs.
The term loan is secured by substantially all company assets and carries financial-ratio covenants; the company reported compliance. Management stated that disclosure controls were effective and that there had been no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether fund outflows, particularly from the Focus and Mid Cap 30 Funds, continue to pressure AUM and fee revenue.
- How margins and operating cash flow respond if revenues remain below prior-year levels.
- The size and funding of the contingent BP Funds purchase-price payment due in October 2019.
- Debt repayment progress, interest-rate exposure, covenant compliance, and the September 2020 maturity.
- The performance and asset-retention outlook for the funds; the filing states 14 funds had positive annualized returns over the three-, five-, 10-year, and since-inception periods, while nine did so over the one-year period ended March 31, 2019.