Business context and reporting period
Hennessy Advisors, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2017, its fiscal third quarter, with comparative results for the three and nine months ended June 30, 2016. The company provides investment advisory services to 14 mutual funds and shareholder services to fund investors. Revenue is primarily based on each fund’s average daily net assets.
Financial performance and position
Amounts below are in millions except per-share data and percentages.
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Nine months ended June 30, 2017 | Nine months ended June 30, 2016 |
|---|---|---|---|---|
| Revenue | $13.18 | $13.00 | $39.71 | $38.34 |
| Net operating income | $6.27 | $6.13 | $18.62 | $17.85 |
| Operating margin | 47.6% | 47.2% | 46.9% | 46.5% |
| Net income | $3.96 | $3.89 | $11.58 | $10.83 |
| Net margin | 30.1% | 30.0% | 29.2% | 28.2% |
| Diluted EPS | $0.51 | $0.50 | $1.49 | $1.41 |
- For the quarter, revenue rose 1.4% and net income rose 1.7% year over year. For the nine-month period, revenue grew 3.6% and net income grew 7.0%.
- Nine-month investment advisory fees increased 4.7% to $36.19 million, while shareholder service fees declined 7.0% to $3.52 million, reflecting a shift from fee-bearing Investor Class assets to Institutional Class assets.
- Nine-month operating expenses increased 2.9% to $21.09 million. Compensation and benefits rose 8.3% to $9.61 million, and sub-advisor fees rose 6.7% to $6.86 million; mutual fund distribution expense fell 68.8% to $0.21 million.
- Cash from operations was $13.88 million for the nine months, versus $13.17 million in 2016. Investing used $0.28 million and financing used $4.81 million; cash increased $8.79 million to $12.33 million.
- At June 30, 2017, total assets were $93.40 million and stockholders’ equity was $48.69 million. Current assets were $18.48 million and current liabilities were $10.14 million.
- Gross bank debt was $27.34 million ($27.01 million net of unamortized debt costs), down from $30.63 million gross at September 30, 2016. The effective interest rate was 4.051%; the loan is secured by substantially all company assets and matures September 17, 2019. The company reported compliance with its financial covenants.
- Dividends paid during the nine months totaled $1.64 million. The company reported cash and other liquid assets on hand as sufficient for short-term capital requirements.
Material changes and management commentary
- Assets under management were $6.53 billion at June 30, 2017, up $184 million (2.9%) from June 30, 2016, but down $172 million (2.6%) from September 30, 2016. Over the nine months, $747 million of net outflows were partly offset by $575 million of market appreciation. For the quarter, net outflows were $248 million and market appreciation was $139 million.
- Management attributed higher advisory fees to increased average daily fund assets. Fee reductions and an expense limitation for the Hennessy Technology Fund, effective February 28, 2017, partially offset that growth. Average daily assets were $6.58 billion for the nine-month period, up 4.7% year over year.
- The company cited strong U.S. and Japanese equity markets during the nine-month period and said all 14 funds had positive performance over the one-, three-, five-, and ten-year and since-inception periods as of June 30, 2017. Management emphasized fund performance, investor service, acquisitions, and organic growth.
- The company announced a pending purchase of management-related assets for three Rainier U.S. Funds, with closing expected in fiscal Q4 2017, subject to customary conditions including shareholder approval. The purchase payment will be based on fund net assets near closing; the filing does not provide a clear purchase price.
- Recent fund lineup changes included a revised investment strategy and management, lower advisory fee, and expense limitation for the Technology Fund; adding Institutional Class shares to the Gas Utility Fund; liquidation of the Core Bond Fund; and reorganization of the Large Value Fund into the Cornerstone Value Fund.
Outlook, risks, contingencies, and unusual items
- No specific revenue, earnings, or AUM guidance was provided. Management stated short-term capital needs should be met from available cash and liquid assets; additional capital may be sought if longer-term needs are not covered, with no assurance financing will be available.
- Results depend on fund assets and fee rates and are exposed to shareholder redemptions, investment performance and market movements, competition, interest rates, regulation, and broader economic conditions. Management expects regulatory developments to increase administrative and compliance costs.
- The company reported no material change in market risk and no material change in internal control over financial reporting; management concluded disclosure controls were effective.
- Management contracts of $74.52 million are indefinite-lived and require impairment testing; management reported no impairment. The filing notes that valuation depends on estimates and assumptions.
- The filing disclosed no material subsequent events and no material lease changes. Federal tax returns for 2013 and later remained open to examination; some state returns may remain open indefinitely.
- The company effected a 3-for-2 stock split in March 2017; share and per-share figures in the filing reflect the split. Early adoption of ASU 2016-09 affected income tax accounting and may increase effective tax-rate volatility.
Important facts for investors to verify
- Whether net outflows, particularly from the Mid Cap 30, Gas Utility, and Focus Funds, continue or change, and the resulting effect on AUM and advisory revenue.
- Completion timing, shareholder approval, final net-asset-based consideration, and integration effects of the Rainier transaction.
- Debt repayment progress, variable-rate exposure, covenant compliance, and the company’s ability to fund future acquisitions and obligations.
- Trends in Investor versus Institutional Class assets, advisory-fee reductions, and expense limitations, including their effects on recurring fee revenue and margins.
- Assumptions supporting the carrying value and impairment assessment of management contracts.