Hennessy Advisors, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended September 30, 2016; filed December 1, 2016. Hennessy manages and services 16 open-end mutual funds. Revenue is primarily advisory and shareholder-servicing fees calculated on fund assets under management (AUM).
Financial performance and position
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $51.4 million | $44.7 million | +14.9% |
| Operating income | $23.8 million | $19.8 million | +20.1% |
| Operating margin | 46.3% | 44.3% | +2.0 percentage points |
| Net income | $14.4 million | $11.4 million | +26.1% |
| Net margin | 27.9% | 25.5% | +2.4 percentage points |
| Diluted EPS | $2.79 | $1.91 | +46.1% |
| Operating cash flow | $18.2 million | $14.5 million | +$3.7 million |
| Cash and cash equivalents at year-end | $3.5 million | $3.1 million | +$0.4 million |
| Bank debt at year-end | $30.6 million | $35.0 million | -$4.4 million |
Year-end AUM was $6.70 billion, up 11.9% from $5.99 billion; average AUM was $6.33 billion. Total assets were $85.4 million and stockholders’ equity was $37.3 million. Current assets of $10.1 million were below current liabilities of $11.4 million. Management said cash and liquid assets on hand were expected to meet short-term capital needs.
Operating cash flow funded much of the year’s $11.9 million investing outflow, principally acquisition-related payments. Financing cash outflow was $5.9 million, including $4.4 million of loan principal payments and $1.5 million in dividends. The company declared $0.30 per share in FY2016 dividends, versus $0.23 in FY2015.
Material changes versus FY2015
- Revenue grew as average AUM rose by $319 million, or 5.3%; shareholder-service fees also benefited from earning fees across all funds from March 2015.
- AUM increased by $711 million: market appreciation contributed $525 million and the Westport acquisition added approximately $435 million, offset by $249 million of net outflows. Organic purchases were $2.17 billion against redemptions of $2.42 billion.
- The Westport transaction closed September 23, 2016. Hennessy paid $11.3 million, capitalized total costs of $11.4 million, and added approximately $435 million of AUM.
- Net outflows were concentrated in the Gas Utility Fund ($311 million), Equity and Income Fund ($126 million), and Small Cap Financial Fund ($65 million). The Focus Fund had the largest net inflow ($398 million). Monthly redemptions as a percentage of AUM increased from an average 2.7% to 3.2%.
- Operating expenses rose 10.8% to $27.6 million, slower than revenue growth. Distribution expense fell 67.7% to $0.8 million, largely because fund-level 12b-1 plans began offsetting distribution costs; compensation rose 22.5% and sub-advisor fees rose 20.0%.
- Advisory fees for the Japan Fund and Japan Small Cap Fund were reduced to 0.80% effective March 1, 2016. Advisory rates across funds were then 0.40%–0.90% of average daily net assets.
- Debt declined from $35.0 million after scheduled principal payments. The loan amendment permitted the Westport acquisition and revised a financial covenant; the debt is floating-rate, secured by substantially all company assets, and due September 2019.
Outlook, risks, and unusual items
No specific earnings, revenue, or AUM guidance was provided. Management described its strategy as pursuing organic growth and selective acquisitions, while focusing on fund performance, marketing, distribution access, and investor service. It expected additional regulatory and compliance costs and stated that long-term capital needs could require increased borrowing or access to capital markets, with no assurance financing would be available on acceptable terms.
- Revenue and earnings are sensitive to market performance, AUM flows, and investor redemptions. The three largest funds represented 75% of average AUM and 77% of revenue: Focus (36% of AUM; 46% of revenue), Gas Utility (23%; 15%), and Cornerstone Mid Cap 30 (16%; 16%).
- Other key risks include competition and fee pressure, annual renewal and short-notice termination of advisory contracts, reliance on distribution intermediaries and sub-advisors, floating-rate debt, and potential impairment of indefinite-lived management contracts. The contract asset was $74.4 million; management reported no impairment.
- The April 2016 Department of Labor fiduciary rule could alter intermediary practices and affect fund flows. The filing also highlights regulatory, litigation, cybersecurity, key-personnel, and Japanese-market/currency risks.
- The company reported no legal proceedings and no off-balance-sheet arrangements. Auditors issued unqualified opinions on the financial statements and internal control; management and the auditor concluded internal controls were effective as of year-end.
- Subsequent events included October 2016 executive agreement amendments and a declared $0.10-per-share dividend payable in December 2016; future dividends remain at the board’s discretion.
Important facts for investors to verify
- Whether fund flows improved after FY2016, particularly the Gas Utility outflows and the Focus Fund’s inflows, and whether redemption rates moderated.
- Post-acquisition AUM retention and the Westport purchase’s contribution to fees, earnings, and cash generation.
- Debt amortization, covenant headroom, floating-rate exposure, and the company’s capacity to fund acquisitions and dividends with modest cash and current assets below current liabilities.
- The sustainability of margins and distribution-cost savings, including the effects of fund-level 12b-1 fees and the reduced Japan fund advisory rates.
- Whether concentrated AUM and revenue exposure, fee pressure, or impairment indicators affect the $74.4 million management-contract asset.