Hennessy Advisors, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2019. The filing was signed August 7, 2019. Financial amounts below are in U.S. dollars; millions are used unless stated otherwise.
Business context
Hennessy earns investment advisory and shareholder service fees from its family of 16 open-end mutual funds. Fees are primarily based on funds’ average daily net assets (AUM). The company also oversees sub-advisers for certain funds and provides shareholder services.
Financial performance and liquidity
| Metric | Three months ended June 30, 2019 | Nine months ended June 30, 2019 |
|---|---|---|
| Total revenue | $10.44 million, down 23.0% year over year | $32.54 million, down 21.4% |
| Net operating income | $3.94 million; 37.7% of revenue | $12.50 million; 38.4% of revenue |
| Net income | $2.66 million, down 37.0%; diluted EPS $0.34 | $8.62 million, down 49.2%; diluted EPS $1.10 |
| Operating expenses | $6.50 million; 62.3% of revenue | $20.04 million; 61.6% of revenue |
| Operating cash flow | Not reported as a quarterly figure | $10.22 million, versus $14.66 million |
For comparison, third-quarter 2018 net operating income was $6.13 million (45.2% of revenue) and net income was $4.22 million (31.1% margin). Nine-month 2018 net operating income was $18.82 million (45.5% margin) and net income was $16.96 million (41.0% margin). Interest expense was $0.26 million for the quarter and $0.87 million year to date.
- AUM: $5.01 billion at June 30, down $1.38 billion, or 21.6%, from a year earlier. Nine-month average AUM was $5.3 billion, down 21.9% year over year.
- Cash and liquidity: Cash and cash equivalents were $23.75 million, compared with $25.40 million at September 30, 2018. Current assets were $28.09 million and current liabilities $9.53 million. Management said cash and other liquid assets should meet capital requirements for at least one year from issuance.
- Debt: Term-loan principal outstanding was $18.6 million ($18.5 million net of issuance costs), versus $21.9 million at September 30, 2018. Monthly principal payments are $364,583; maturity was extended to May 9, 2022. The effective rate was 4.690% at June 30. Debt is secured by substantially all company assets; the company reported covenant compliance.
- Cash uses: Year-to-date investing outflows were $1.95 million and financing outflows $9.92 million. Financing included $4.02 million of share repurchases, $2.57 million of dividends, and $3.28 million of loan principal payments. Cash declined $1.65 million over the nine months.
- Shareholder returns: Quarterly dividend declared was $0.11 per share, versus $0.10 a year earlier. The company repurchased 422,692 shares in May at an average $9.50 per share.
Material changes and management commentary
- Revenue declined mainly because average fund AUM fell, reflecting net outflows. Nine-month redemptions averaged 4.1% of AUM per month, versus 3.1% in the comparable prior-year period; quarterly redemptions averaged 3.0%, versus 3.5% a year earlier.
- Quarterly operating expenses fell 12.6% and nine-month expenses fell 11.2% in dollars, but expense ratios rose as revenue contracted. Lower incentive compensation was a principal reason compensation expense declined.
- For the nine months, Hennessy Focus Fund had the largest outflows ($675 million), followed by Mid Cap 30 ($348 million) and Gas Utility ($152 million). Japan Fund had $149 million of net inflows and Total Return Fund $2 million.
- Management cited market appreciation and the October 2018 BP Funds acquisition as partial offsets to outflows. The acquisition added nearly $200 million of AUM; the initial purchase payment was $1.6 million.
- The nine-month 2018 comparison includes a one-time, non-cash $4.2 million tax benefit from remeasurement of deferred taxes following the 2017 Tax Act. The 2019 nine-month effective tax rate was 27.5%, versus 5.7% in 2018; management attributed the difference mainly to that prior-year benefit.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance was provided. Management’s strategy emphasizes acquisitions and organic growth through asset retention and fund inflows.
- Management highlighted risks including redemptions, fund performance, market and economic conditions, interest rates, competition, and regulatory developments that may increase compliance costs. Revenue and cash generation depend on average AUM.
- A May 2019 loan amendment lowered applicable LIBOR margins, extended maturity, and added a covenant requiring AUM of at least $3.75 billion. A July 17 amendment increased the permitted stock repurchase authorization from 1.0 million to 1.5 million shares.
- A further BP Funds purchase payment is due in October 2019 and depends on successor-fund net asset values at the one-year measurement date. The amount could not be reasonably estimated at June 30, so no contingent liability was recorded.
- Management reported no impairment of management contracts. The filing noted no material lease changes or other material subsequent events requiring disclosure. Adoption of the new lease standard was expected to increase reported assets and liabilities.
- Disclosure controls were assessed as effective, with no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether AUM outflows stabilize, particularly in the Focus, Mid Cap 30, and Gas Utility funds, and how flows affect fee revenue.
- Progress on the AUM covenant threshold of $3.75 billion and compliance with all loan covenants.
- The October 2019 BP Funds contingent payment once the applicable net asset values are determined.
- Whether operating margins and cash generation can recover as expenses adjust to lower revenue; note the prior-year tax benefit when comparing net income.
- The company’s remaining repurchase authorization and future use of cash for buybacks, dividends, debt repayment, and acquisitions.