Hennessy Advisors, Inc. — Q3 FY2016 Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2016. The company provides investment advisory and shareholder services to the Hennessy mutual funds. Financial statements are unaudited; dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Three months ended June 30, 2016 | Year-over-year change | Nine months ended June 30, 2016 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $13.00 | +8.6% | $38.34 | +18.8% |
| Operating income | $6.13 | +8.0% | $17.85 | +28.8% |
| Operating margin | 47.2% | 47.5% prior year | 46.5% | 43.0% prior year |
| Net income | $3.89 | +17.9% | $10.83 | +36.0% |
| Net margin | 30.0% | 27.6% prior year | 28.2% | 24.7% prior year |
| Diluted EPS | $0.76 | $0.56 prior year | $2.11 | $1.34 prior year |
| Operating cash flow | Not provided for quarter | $13.17 | $10.22 prior year |
Balance sheet and liquidity: At June 30, cash and cash equivalents were $11.42, total current assets $17.73, and total current liabilities $9.80. Total debt was $31.72, including $4.38 current and $27.34 long-term; total liabilities were $47.78 and stockholders’ equity $33.88. Cash increased $8.33 over the nine months. Investing activities used $0.45 and financing activities used $4.39, including $3.28 of loan principal payments and $1.12 of dividends.
Assets under management (AUM): AUM was $6.34 billion at June 30, 2016, up 4.4% ($268 million) from June 30, 2015. For the quarter, AUM fell 1.3% ($82 million), as $97 million of net outflows outweighed $15 million in market appreciation. For the nine months, AUM rose $355 million: $333 million from market appreciation and $22 million from net inflows.
Material changes and management commentary
- Quarterly advisory fees rose 10.6% to $11.75 million, mainly from higher average AUM; shareholder service fees fell 7.3% to $1.25 million as more assets were in Institutional shares, which do not incur those fees. Nine-month shareholder service fees rose 68.8%, largely because fees applied to all Investor Class funds for the full current period, following an expansion effective March 1, 2015.
- Nine-month operating expenses rose 11.4% to $20.49 million, but declined to 53.5% of revenue from 57.0%. Compensation and sub-advisor fees increased with AUM, staffing and profitability; mutual fund distribution expense fell 67.5% to $0.68 million after Rule 12b-1 plans shifted some distribution costs to participating funds.
- Quarterly redemptions averaged 3.4% of AUM per month, versus 2.4% a year earlier; nine-month redemptions averaged 3.3%, versus 2.5%. Management cited continuing market volatility and emphasized fund performance, investor service, marketing, retention, organic growth and acquisitions.
- The company reduced advisory-fee rates effective March 1, 2016, for the Japan Fund (1.00% to 0.80%) and Japan Small Cap Fund (1.20% to 0.80%). It reported an effective loan rate of 3.45665% at June 30, after converting $32.8 million to a one-month LIBOR contract. Debt is secured by substantially all company assets, matures September 17, 2019, and the company reported compliance with financial covenants.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said regulatory requirements may add administrative and compliance costs and identified redemptions, market and economic conditions, interest rates, competition, regulation and fund performance as factors affecting results.
- A May 2016 agreement to acquire management-related assets of the Westport Fund and Westport Select Cap Fund was pending. Based on stated AUM of approximately $644.1 million, the purchase price was expected to be approximately $11.3 million, with completion anticipated in Q4 FY2016. Closing required regulatory review and approvals from the relevant fund boards and Westport fund shareholders; the funds were expected to merge into the Hennessy Cornerstone Mid Cap 30 Fund.
- Management reported no impairment indicators for the $63.0 million carrying value of management contracts. The filing also disclosed continuing tax examination exposure for federal tax years 2012 and later, and lease commitments, including the Novato headquarters lease through March 2017.
Important facts for investors to verify
- Whether the Westport transaction closed, its final purchase price and subsequent integration or fund-merger effects.
- Current AUM flows and redemption trends, particularly in funds with significant outflows, and whether market performance sustains advisory-fee growth.
- Debt repayment capacity, the variable interest rate, collateral terms and ongoing covenant compliance.
- Effects of Rule 12b-1 arrangements, advisory-fee reductions and Investor versus Institutional share mix on recurring revenue and margins.
- Whether management-contract valuations, tax exposures and other commitments changed after June 30, 2016.