Item 2.
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
Forward-Looking
Statements
This report contains forward-looking statements within the
meaning of the securities laws, for which we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by
terminology such as expect, anticipate, intend, may, plan, will, should, could, would, assume, believe,
estimate, predict, potential, project, continue, seek and similar expressions, as well as statements in the future tense. We have based these forward-looking statements on our
current expectations and projections about future events, based on information currently available to us. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications
of the times at, or means by, which such performance or results will be achieved.
18
Forward-looking statements are subject to risks, uncertainties and assumptions, including those
described in the section entitled Risk Factors and elsewhere in our Annual Report on
Form 10-K
for the fiscal year ended September 30, 2016, filed with the Securities and Exchange
Commission. Unforeseen developments could cause actual performance or results to differ substantially from those expressed in or suggested by the forward-looking statements. Management does not assume responsibility for the accuracy or completeness
of these forward-looking statements. There is no regulation requiring an update of any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations.
Our business activities are affected by many factors, including, without limitation, redemptions by mutual fund shareholders, general economic
and financial conditions, movement of interest rates, competitive conditions, industry regulation, and fluctuations in the stock market, many of which are beyond the control of our management. Further, the business and regulatory environments in
which we operate remain complex, uncertain, and subject to change. We expect that regulatory requirements and developments will cause us to incur additional administrative and compliance costs. In addition, while domestic economic conditions are
relatively stable, further increases in short-term interest rates, policy changes from the new administration in Washington D.C. and developments in international financial markets could influence economic and financial conditions significantly.
Notwithstanding the variability in our economic and regulatory environments, we remain focused on the investment performance of the Hennessy Funds and on providing high quality customer service to investors.
Our business strategy centers on (i) the identification, completion and integration of future acquisitions and (ii) organic growth,
through both the retention of the mutual fund assets we currently manage and the generation of inflows into the mutual funds we manage. The success of our business strategy may be influenced by the factors discussed in the section entitled
Risk Factors in our Annual Report on
Form 10-K
for the fiscal year ended September 30, 2016. All statements regarding our business strategy, as well as statements regarding market trends
and risks and assumptions about changes in the marketplace, are forward-looking by their nature.
Overview
Our primary operating activity is providing investment advisory services to 14
open-end
mutual funds
branded as the Hennessy Funds. With respect to four of the funds,
sub-advisors
act as portfolio managers for the funds, subject to our oversight. We oversee the selection and continued employment of each
sub-advisor,
review each
sub-advisors
investment performance, and monitor each
sub-advisors
adherence to the applicable
funds investment objectives, policies, and restrictions. In addition, we conduct ongoing reviews of the compliance programs of
sub-advisors
and make
on-site
visits
to
sub-advisors.
Our secondary operating activity is providing shareholder services to Investor Class shares of each of the Hennessy Funds.
We completed several changes to the Hennessy Funds product lineup during our prior quarter ended March 31, 2017. For the Hennessy
Technology Fund, there was a change in investment strategy, a change in portfolio management, a decrease in the management fee from 0.90% to 0.74%, and the adoption of an expense limitation agreement. Additionally, we added Institutional
Class shares to the Hennessy Gas Utility Fund, liquidated the Hennessy Core Bond Fund, and reorganized the Hennessy Large Value Fund into the Hennessy Cornerstone Value Fund.
19
We derive our operating revenue from investment advisory fees and shareholder service fees paid
to us by the Hennessy Funds. These fees are calculated as a percentage of the average daily net assets in each of the Hennessy Funds. The percentage amount of the investment advisory fees vary from fund to fund, but the percentage amount of the
shareholder service fees is consistent across all funds. The dollar amount of the fees we receive fluctuates with changes in the average net asset value of each of the Hennessy Funds, which is affected by each funds investment performance,
purchases and redemptions of shares, general market conditions and the success of our marketing, sales, and public relations efforts.
The
majority of the Hennessy Funds are solely invested in the U.S. equity markets, while two funds are solely invested in the Japanese equity markets and one fund has exposure to the fixed income markets.
U.S. equity markets posted strong gains for the
nine-month
period ended June 30, 2017. At the
start of the period, U.S. equities reacted positively to the election of President Trump, a Republican, to the White House, and to Republican majorities in both houses of Congress, buoyed by hopes of higher government infrastructure spending and tax
reform. Towards the end of the period, evidence of continued steady domestic economic activity, a recovery in corporate earnings growth and relatively good economic conditions abroad kept equity prices rising. The Federal Reserve, which appeared to
feel confident about the overall strength of the economy and the labor market, raised the federal funds rate three times over the period, by a quarter point each time.
The Japanese equity market rose significantly in local currency terms over the nine-month period ended June 30, 2017. A fall in Japanese
yen early in the period caused equity prices to rise, led by export-oriented Japanese equities. Subsequently, evidence of a solid recovery in industrial production, an acceleration in corporate profits growth and a stable inflation rate helped drive
the overall Japanese equity market higher.
U.S. government bond yields increased precipitously after the U.S. elections in response to
the perceived increased risks of faster economic growth and higher inflation. However, bond yields drifted gently downwards for the rest of the period, encouraged by more moderate inflation reports and continued modest increases in labor costs.
We seek to provide positive annualized returns to investors in the Hennessy Funds on average over a market cycle and to generate inflows into
the Hennessy Funds through our marketing and sales efforts. We regularly target over 120,000 financial advisors through our marketing and sales program, and currently serve over 18,000 advisors who utilize the Hennessy Funds for their clients. More
than one in five of those advisors owns two or more of the Hennessy Funds. We continually seek to expand our team of sales professionals to serve our advisor community and to assist us with providing services to our over 330,000 mutual fund accounts
across the country. In addition, we have a rigorous public relations effort with the Hennessy brand name appearing on TV, radio, print or online media on average once every two to three days.
20
As of June 30, 2017, all 14 of the Hennessy Funds posted positive performance over the
1-year,
3-year,
5-year,
10-year
and since inception periods. Total assets under management as
of June 30, 2017, were $6.5 billion, an increase of 2.9%, or $184 million, from $6.3 billion as of June 30, 2016 (the end of the prior comparable period). The increase in total assets is attributable to market appreciation
of $793 million and the purchase of assets related to the management of The Westport Funds of $435 million, and was offset by net outflows from the Hennessy Funds of $1.044 billion.
The following table illustrates the changes in total assets under management from June 30, 2016, through June 30, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets Under Management
|
|
|
|
At Each Quarter End, June 30, 2016 through June 30, 2017
|
|
|
|
6/30/2016
|
|
|
9/30/2016
|
|
|
12/31/2016
|
|
|
3/31/2017
|
|
|
6/30/2017
|
|
|
|
(In thousands)
|
|
Beginning assets under management
|
|
$
|
6,424,453
|
|
|
$
|
6,342,902
|
|
|
$
|
6,698,519
|
|
|
$
|
6,592,589
|
|
|
$
|
6,635,802
|
|
Acquisition inflows
|
|
|
|
|
|
|
434,530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Organic inflows
|
|
|
557,343
|
|
|
|
296,459
|
|
|
|
327,308
|
|
|
|
376,440
|
|
|
|
249,043
|
|
Redemptions
|
|
|
(654,042
|
)
|
|
|
(593,539
|
)
|
|
|
(647,952
|
)
|
|
|
(554,606
|
)
|
|
|
(496,768
|
)
|
Market appreciation (depreciation)
|
|
|
15,148
|
|
|
|
218,167
|
|
|
|
214,714
|
|
|
|
221,379
|
|
|
|
138,679
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending assets under management
|
|
$
|
6,342,902
|
|
|
$
|
6,698,519
|
|
|
$
|
6,592,589
|
|
|
$
|
6,635,802
|
|
|
$
|
6,526,756
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The principal asset on our balance sheet, management contracts, represents the capitalized costs incurred in
connection with the purchase of assets related to the management of mutual funds. As of June 30, 2017, this asset had a balance of $74.5 million, compared to $74.4 million as of September 30, 2016. The current period increase is
mainly due to payments in connection with the purchase of assets related to the management of The Westport Funds.
The principal liability
on our balance sheet is the bank debt incurred in connection with the purchase of assets related to the management of mutual funds and the repurchase of 1,000,000 shares of the Companys common stock pursuant to the completion of its
self-tender offer in September 2015. As of June 30, 2017, this liability had a gross balance of $27.3 million ($27.0 million net of reclassed deferred loan fees of $0.3 million, further discussed in Footnote 4).
21
Results of Operations
Three Months Ended June 30, 2017, Compared to Three Months Ended June 30, 2016
The following table sets forth items in the statement of income as dollar amounts and as percentages of total revenue for the three months
ended June 30, 2017 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
|
(In thousands, except percentages)
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory fees
|
|
$
|
12,020
|
|
|
|
91.2
|
%
|
|
$
|
11,747
|
|
|
|
90.4
|
%
|
Shareholder service fees
|
|
|
1,158
|
|
|
|
8.8
|
|
|
|
1,248
|
|
|
|
9.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
13,178
|
|
|
|
100.0
|
|
|
|
12,995
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
|
3,124
|
|
|
|
23.7
|
|
|
|
3,017
|
|
|
|
23.2
|
|
General and administrative
|
|
|
1,332
|
|
|
|
10.1
|
|
|
|
1,301
|
|
|
|
10.0
|
|
Mutual fund distribution
|
|
|
80
|
|
|
|
0.6
|
|
|
|
231
|
|
|
|
1.8
|
|
Sub-advisor
fees
|
|
|
2,281
|
|
|
|
17.3
|
|
|
|
2,225
|
|
|
|
17.1
|
|
Amortization and depreciation
|
|
|
91
|
|
|
|
0.7
|
|
|
|
88
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
6,908
|
|
|
|
52.4
|
|
|
|
6,862
|
|
|
|
52.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating income
|
|
|
6,270
|
|
|
|
47.6
|
|
|
|
6,133
|
|
|
|
47.2
|
|
Interest expense
|
|
|
281
|
|
|
|
2.1
|
|
|
|
279
|
|
|
|
2.1
|
|
Other income
|
|
|
(3
|
)
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
5,992
|
|
|
|
45.5
|
|
|
|
5,855
|
|
|
|
45.1
|
|
Income tax expense
|
|
|
2,032
|
|
|
|
15.4
|
|
|
|
1,961
|
|
|
|
15.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,960
|
|
|
|
30.1
|
%
|
|
$
|
3,894
|
|
|
|
30.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues Investment Advisory Fees and Shareholder Service Fees
Total revenue increased 1.4% from the prior comparable period to $13.2 million in the three months ended June 30, 2017. Investment
advisory fees increased 2.3% from the prior comparable period to $12.0 million in the three months ended June 30, 2017. The increase in investment advisory fees is due to increased average daily net assets of the Hennessy Funds. This was
slightly offset by a reduction in the investment advisory fee from 0.90% to 0.74% and the implementation of an expense limitation agreement for the Hennessy Technology Fund, each effective as of February 28, 2017. Average daily net assets of
the Hennessy Funds for the three months ended June 30, 2017, increased by $124 million, or 1.9%, to $6.6 billion, versus the prior comparable period. Shareholder service fees decreased 7.2% from the prior comparable period to
$1.2 million in the three months ended June 30, 2017.
22
The decrease in shareholder service fees is due to a change in the composition of average daily net assets. Assets held in Institutional Class shares of the Hennessy Funds are not subject to
a shareholder service fee, whereas assets held in Investor Class shares of the Hennessy Funds are subject to a shareholder service fee. The average daily net assets held in Institutional Class shares increased, while the average daily net
assets held in Investor Class shares decreased versus the prior comparable period.
The Company collects investment advisory fees
from each of the Hennessy Funds at differing rates. These annual rates previously ranged between 0.40% to 1.20% of average daily net assets, but now range between 0.40% and 0.90% of average daily net assets because the annual rate of the investment
advisory fee for the Hennessy Japan Fund was reduced from 1.00% to 0.80% and the annual rate of the investment advisory fee for the Hennessy Japan Small Cap Fund was reduced from 1.20% to 0.80%, each effective as of March 1, 2016. The Hennessy
Fund with the largest average daily net assets for the three months ended June 30, 2017, was the Hennessy Focus Fund, with $2.58 billion. The Company collects an investment advisory fee from the Hennessy Focus Fund at an annual rate of
0.90% of average daily net assets. However, the Company pays a
sub-advisor
fee at an annual rate of 0.29% to the Funds
sub-advisor,
which reduces the net operating
profit contribution of the Fund to the Companys financial operations. The Hennessy Fund with the second largest average daily assets for the three months ended June 30, 2017, was the Hennessy Gas Utility Fund, with $1.46 billion. The
Company collects an investment advisory fee from the Hennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets.
Total assets under management as of June 30, 2017, were $6.5 billion, a decrease of 1.6% or $109 million, compared with
$6.6 billion as of March 31, 2017. The decrease in total assets under management over the three months ended June 30, 2017, was due to aggregate net outflows from the Hennessy Funds of $248 million, partly offset by aggregate
market appreciation of $139 million. The Hennessy Funds with the three largest amounts of net inflows for the three months ended June 30, 2017, were as follows:
|
|
|
Hennessy Japan Fund: $15 million
|
|
|
|
Hennessy Japan Small Cap Fund: $13 million
|
|
|
|
Hennessy Technology Fund: $0.02 million
|
The Hennessy Funds with the three largest amounts of net
outflows for the three months ended June 30, 2017, were as follows:
|
|
|
Hennessy Mid Cap 30 Fund:
-$95 million
|
|
|
|
Hennessy Focus Fund:
-$55 million
|
|
|
|
Hennessy Gas Utility Fund:
-$45 million
|
Redemptions as a
percentage of assets under management decreased from an average of 3.4% per month during the three months ended June 30, 2016, to 2.5% per month during the three months ended June 30, 2017.
23
Operating and Other Expenses
Total operating expenses increased 0.7% to $6.91 million in the three months ended June 30, 2017, from $6.86 million in the
prior comparable period. The increase is due primarily to a decrease in mutual fund distribution expense, but was partially offset by increases in compensation and benefits expense,
sub-advisor
fee expense,
and general and administrative expense. As a percentage of total revenue, total operating expenses decreased 0.4 percentage points to 52.4% in the three months ended June 30, 2017, as compared to 52.8% in the prior comparable period.
Compensation and Benefits Expense
: Compensation and benefits expense increased 3.5% to $3.1 million in the three months ended
June 30, 2017, from $3.0 million in the prior comparable period. The increase is primarily due to an increase in the Companys incentive-based compensation expense related to the Companys increased profitability in the current
period versus the prior comparable period. As a percentage of total revenue, compensation and benefits expense increased 0.5 percentage points to 23.7% for the three months ended June 30, 2017, compared to 23.2% in the prior comparable period.
General and Administrative Expense
: General and administrative expense increased 2.4% to $1.33 million in the three months
ended June 30, 2017, from $1.30 million in the prior comparable period. The increase resulted from increased professional service expenses in the current period versus the prior comparable period. As a percentage of total revenue, general
and administrative expense increased 0.1 percentage points to 10.1% in the three months ended June 30, 2017, compared to 10.0% in the prior comparable period.
Mutual Fund Distribution Expense
: Mutual fund distribution expense decreased 65.4% to $0.1 million in the three months ended
June 30, 2017, from $0.2 million in the prior comparable period. As a percentage of total revenue, mutual fund distribution expense decreased 1.2 percentage points to 0.6% for the three months ended June 30, 2017, compared to 1.8% in
the prior comparable period ended June 30, 2016.
Mutual fund distribution expense consists of fees paid to various financial
institutions that offer the Hennessy Funds as potential investments to their clients. When the Hennessy Funds are purchased through one of these financial institutions, the institution typically charges an
asset-based
fee, which is recorded in mutual fund distribution expense in our statement of operations to the extent paid by us. When the Hennessy Funds are purchased directly, we do not incur any
such expense. These fees generally increase or decrease in line with the net assets of the Hennessy Funds held through these financial institutions, which are affected by inflows, outflows and fund performance.
The decrease in mutual fund distribution expense in the current
three-month
period is primarily due to
the timing of payments made by the Company to financial intermediaries following the completion of contract negotiations in the prior period.
Sub-Advisor
Fee Expense
:
Sub-advisor
fee expense
increased 2.5% to $2.28 million in the three months ended June 30, 2017, from $2.23 million in the prior comparable period. The increase is a result of an increase in average assets under management in the
sub-advised
Hennessy Funds, with a slight offset as a result of the Company no longer paying
sub-advisor
fees with respect to the Hennessy Core Bond Fund following its
liquidation as of February 17, 2017, or with respect to the Hennessy Large Value Fund following
24
its reorganization into the Hennessy Cornerstone Value Fund as of February 28, 2017. As a percentage of total revenue,
sub-advisor
fee expense
increased 0.2 percentage points to 17.3% for the three months ended June 30, 2017, compared to 17.1% in the prior comparable period.
Amortization and Depreciation Expense
: Amortization and depreciation expense increased 3.4% to $0.091 million in the three months
ended June 30, 2017, from $0.088 million in the prior comparable period. The increase is a result of a higher fixed asset base for the three months ended June 30, 2017, compared to the prior comparable period. As a percentage of total
revenue, amortization and depreciation expense remained the same at 0.7% for the three months ended June 30, 2017, compared to the prior comparable period.
Interest Expense
: Interest expense increased 0.7% to $0.281 million in the three months ended June 30, 2017, from
$0.279 million in the prior comparable period. The increase is due to increased LIBOR rates and partially offset by a decrease to the Companys principal loan balance compared to the prior comparable period. As a percentage of total
revenue, interest expense remained the same at 2.1% for the three months ended June 30, 2017, compared to the prior comparable period.
Income Tax Expense
: The provision for income tax expense increased 3.6% to $2.03 million in the three months ended June 30,
2017, from $1.96 million in the prior comparable period. This change is due to increased income before income tax expense in the current period. As a percentage of total revenue, income tax expense increased 0.3 percentage points to 15.4% for
the three months ended June 30, 2017, compared to 15.1% in the prior comparable period.
Net Income
Net income increased by 1.7% to $4.0 million in the three months ended June 30, 2017, from $3.9 million in the prior comparable
period, as a result of the factors discussed above. As a percentage of total revenue, net income increased 0.1 percentage points to 30.1% for the three months ended June 30, 2017, compared to 30.0% in the prior comparable period.
25
Nine Months Ended June 30, 2017, Compared to Nine Months Ended June 30, 2016
The following table sets forth items in the statement of income as dollar amounts and as percentages of total revenue for the nine months ended
June 30, 2017 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
|
(In thousands, except percentages)
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory fees
|
|
$
|
36,192
|
|
|
|
91.1
|
%
|
|
$
|
34,561
|
|
|
|
90.1
|
%
|
Shareholder service fees
|
|
|
3,516
|
|
|
|
8.9
|
|
|
|
3,779
|
|
|
|
9.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
39,708
|
|
|
|
100.0
|
|
|
|
38,340
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
|
9,613
|
|
|
|
24.2
|
|
|
|
8,873
|
|
|
|
23.1
|
|
General and administrative
|
|
|
4,122
|
|
|
|
10.4
|
|
|
|
4,245
|
|
|
|
11.1
|
|
Mutual fund distribution
|
|
|
213
|
|
|
|
0.5
|
|
|
|
682
|
|
|
|
1.8
|
|
Sub-advisor
fees
|
|
|
6,862
|
|
|
|
17.3
|
|
|
|
6,429
|
|
|
|
16.8
|
|
Amortization and depreciation
|
|
|
275
|
|
|
|
0.7
|
|
|
|
265
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
21,085
|
|
|
|
53.1
|
|
|
|
20,494
|
|
|
|
53.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating income
|
|
|
18,623
|
|
|
|
46.9
|
|
|
|
17,846
|
|
|
|
46.5
|
|
Interest expense
|
|
|
825
|
|
|
|
2.1
|
|
|
|
949
|
|
|
|
2.4
|
|
Other income
|
|
|
(3
|
)
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
17,801
|
|
|
|
44.8
|
|
|
|
16,899
|
|
|
|
44.1
|
|
Income tax expense
|
|
|
6,217
|
|
|
|
15.6
|
|
|
|
6,072
|
|
|
|
15.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
11,584
|
|
|
|
29.2
|
%
|
|
$
|
10,827
|
|
|
|
28.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues Investment Advisory Fees and Shareholder Service Fees
Total revenue increased 3.6% from the prior comparable period to $39.7 million in the nine months ended June 30, 2017. Investment
advisory fees increased 4.7% from the prior comparable period to $36.2 million in the nine months ended June 30, 2017. The increase in investment advisory fees is due to increased average daily net assets of the Hennessy Funds. This was
slightly offset by a reduction in the annual rate of the investment advisory fee for the Hennessy Japan Fund from 1.00% to 0.80% and for the Hennessy Japan Small Cap Fund from 1.20% to 0.80%, each effective as of March 1, 2016, and by a
reduction in the investment advisory fee from 0.90% to 0.74% and the implementation of an expense limitation agreement for the Hennessy Technology Fund, each effective as of February 28, 2017. Average daily net assets of the Hennessy Funds for
the nine months ended June 30, 2017, increased by $292 million, or 4.7%, to $6.58 billion, versus the prior comparable period. Shareholder service fees decreased 7.0%
26
from the prior comparable period to $3.5 million in the nine months ended June 30, 2017. The decrease in shareholder service fees is due to a change in the composition of average daily
net assets. Assets held in Institutional Class shares of the Hennessy Funds are not subject to a shareholder service fee, whereas assets held in Investor Class shares of the Hennessy Funds are subject to a shareholder service fee. The
average daily net assets held in Institutional Class shares increased, while the average daily net assets held in Investor Class shares decreased versus the prior comparable period.
The Company collects investment advisory fees from each of the Hennessy Funds at differing rates. These annual rates previously ranged between
0.40% to 1.20% of average daily net assets, but now range between 0.40% and 0.90% of average daily net assets because the annual rate of the investment advisory fee for the Hennessy Japan Fund was reduced from 1.00% to 0.80% and the annual rate of
the investment advisory fee for the Hennessy Japan Small Cap Fund was reduced from 1.20% to 0.80%, each effective as of March 1, 2016. The Hennessy Fund with the largest average daily net assets for the nine months ended June 30, 2017, was
the Hennessy Focus Fund, with $2.52 billion. The Company collects an investment advisory fee from the Hennessy Focus Fund at an annual rate of 0.90% of average daily net assets. However, the Company pays a
sub-advisor
fee at an annual rate of 0.29% to the Funds
sub-advisor,
which reduces the net operating profit contribution of the Fund to the Companys
financial operations. The Hennessy Fund with the second largest average daily assets for the nine months ended June 30, 2017, was the Hennessy Gas Utility Fund, with $1.45 billion. The Company collects an investment advisory fee from the
Hennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets.
Total assets under management as of June 30, 2017,
were $6.5 billion, a decrease of 2.6% or $172 million, compared with $6.7 billion as of September 30, 2016. The decrease in total assets under management over the nine months ended June 30, 2017, was due to aggregate net
outflows from the Hennessy Funds of $747 million, partly offset by aggregate market appreciation of $575 million. The Hennessy Funds with the three largest amounts of net inflows for the nine months ended June 30, 2017, were as
follows:
|
|
|
Hennessy Japan Fund: $69 million
|
|
|
|
Hennessy Small Cap Financial Fund: $35 million
|
|
|
|
Hennessy Japan Small Cap Fund: $23 million
|
The Hennessy Funds with the three largest amounts of net
outflows for the nine months ended June 30, 2017, were as follows:
|
|
|
Hennessy Mid Cap 30 Fund:
-$448 million
|
|
|
|
Hennessy Gas Utility Fund:
-$145 million
|
|
|
|
Hennessy Focus Fund:
-$102 million
|
Redemptions as a percentage
of assets under management decreased from an average of 3.3% per month during the nine months ended June 30, 2016, to 2.9% per month during the nine months ended June 30, 2017.
27
Operating and Other Expenses
Total operating expenses increased 2.9% to $21.1 million in the nine months ended June 30, 2017, from $20.5 million in the prior
comparable period. The increase is due primarily to increases in compensation and benefits expense and
sub-advisor
fee expense, but was partially offset by decreases in both mutual fund distribution expense
and general and administrative expense. As a percentage of total revenue, total operating expenses decreased 0.4 percentage points to 53.1% in the nine months ended June 30, 2017, as compared to 53.5% in the prior comparable period.
Compensation and Benefits Expense
: Compensation and benefits expense increased 8.3% to $9.6 million in the nine months ended
June 30, 2017, from $8.9 million in the prior comparable period. The increase is primarily due to an increase in the Companys incentive-based compensation expense related to the Companys increased profitability in the current
period versus the prior comparable period. As a percentage of total revenue, compensation and benefits expense increased 1.1 percentage points to 24.2% for the nine months ended June 30, 2017, compared to 23.1% in the prior comparable period.
General and Administrative Expense
: General and administrative expense decreased 2.9% to $4.1 million in the nine months
ended June 30, 2017, from $4.2 million in the prior comparable period. The decrease mainly resulted from decreased variable sales-related costs in the current period versus the prior comparable period. As a percentage of total revenue,
general and administrative expense decreased 0.7 percentage points to 10.4% in the nine months ended June 30, 2017, compared to 11.1% in the prior comparable period.
Mutual Fund Distribution Expense
: Mutual fund distribution expense decreased 68.8% to $0.2 million in the nine months ended
June 30, 2017, from $0.7 million in the prior comparable period. As a percentage of total revenue, mutual fund distribution expense decreased 1.3 percentage points to 0.5% for the nine months ended June 30, 2017, compared to 1.8% in
the prior comparable period ended June 30, 2016.
Mutual fund distribution expense consists of fees paid to various financial
institutions that offer the Hennessy Funds as potential investments to their clients. When the Hennessy Funds are purchased through one of these financial institutions, the institution typically charges an
asset-based
fee, which is recorded in mutual fund distribution expense in our statement of operations to the extent paid by us. When the Hennessy Funds are purchased directly, we do not incur any
such expense. These fees generally increase or decrease in line with the net assets of the Hennessy Funds held through these financial institutions, which are affected by inflows, outflows and fund performance.
28
The decrease in mutual fund distribution expense in the current
nine-month
period is primarily due to the timing of payments made by the Company to financial intermediaries following the completion of contract negotiations in the prior period and also, to a lesser extent,
the implementation of a Distribution
(Rule 12b-1)
Plan for each of the following Hennessy Funds as of the given dates:
|
|
|
|
|
|
|
November 1, 2015:
|
|
Hennessy Cornerstone Growth Fund
Hennessy
Cornerstone Mid Cap 30 Fund
Hennessy Cornerstone Large Growth Fund
Hennessy Cornerstone Value Fund
Hennessy Large Value
Fund*
|
|
|
|
|
|
March 1, 2016:
|
|
Hennessy Japan Fund
Hennessy Japan Small Cap
Fund
|
|
*
|
The Hennessy Large Value Fund was reorganized into the Hennessy Cornerstone Value Fund as of February 28, 2017.
|
These distribution plans charge their respective funds an annual rate of 0.15% (though 0.25% is the maximum allowable) of average daily net assets to pay for
sales, distribution and other expenses. Each distribution plan therefore allows its fund to use its distribution plan fees to offset fees charged by financial institutions that offer the Hennessy Funds as potential investments to their clients.
Therefore, as of the dates listed above, a portion of the mutual fund distribution expense previously paid by the Company began to be offset by payments made by the respective Hennessy Funds pursuant to their distribution plans.
Sub-Advisor
Fee Expense
:
Sub-advisor
fee expense
increased 6.7% to $6.9 million in the nine months ended June 30, 2017, from $6.4 million in the prior comparable period. The increase is a result of an increase in average assets under management in the
sub-advised
Hennessy Funds, with a slight offset as a result of the Company no longer paying
sub-advisor
fees with respect to the Hennessy Core Bond Fund following its
liquidation as of February 17, 2017, or with respect to the Hennessy Large Value Fund following its reorganization into the Hennessy Cornerstone Value Fund as of February 28, 2017. As a percentage of total revenue,
sub-advisor
fee expense increased 0.5 percentage points to 17.3% for the nine months ended June 30, 2017, compared to 16.8% in the prior comparable period.
Amortization and Depreciation Expense
: Amortization and depreciation expense increased 3.8% to $0.28 million in the nine months
ended June 30, 2017, from $0.27 million in the prior comparable period. The increase is a result of a higher fixed asset base for the nine months ended June 30, 2017, compared to the prior comparable period. As a percentage of total
revenue, amortization and depreciation expense remained the same at 0.7% for the nine months ended June 30, 2017, compared to the prior comparable period.
Interest Expense
: Interest expense decreased 13.1% to $0.8 million in the nine months ended June 30, 2017, from
$0.9 million in the prior comparable period. The decrease is due primarily to a decrease to the Companys principal loan balance compared to the prior comparable period. As a percentage of total revenue, interest expense decreased 0.3
percentage points to 2.1% for the nine months ended June 30, 2017, compared to 2.4% in the prior comparable period.
29
Income Tax Expense
: The provision for income tax expense increased 2.4% to
$6.2 million in the nine months ended June 30, 2017, from $6.1 million in the prior comparable period. This change is due to increased income before income tax expense in the current period and is partially offset by a lower effective
tax rate resulting from the early adoption of ASU
2016-09
(see further discussion in Footnote 10). As a percentage of total revenue, income tax expense decreased 0.3 percentage points to 15.6% for the nine
months ended June 30, 2017, compared to 15.9% in the prior comparable period.
Net Income
Net income increased by 7.0% to $11.6 million in the nine months ended June 30, 2017, from $10.8 million in the prior comparable
period, as a result of the factors discussed above. As a percentage of total revenue, net income increased 1.0 percentage points to 29.2% for the nine months ended June 30, 2017, compared to 28.2% in the prior comparable period.
Critical Accounting Policies
Our
financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates, judgments, and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. These accounting policies, methods, and estimates are an integral part of the financial statements
prepared by management and are based upon managements current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies,
methods, and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from managements current judgment. For a
discussion of the accounting policies that we believe are most critical to understanding our results of operations and financial position, see the section entitled Managements Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on
Form 10-K
for the fiscal year ended September 30, 2016.
Liquidity and Capital Resources
We
continually review our capital requirements to ensure that we have funding available to support our business model. Management anticipates that cash and other liquid assets on hand as of June 30, 2017, will be sufficient to meet our short-term
capital requirements. To the extent that liquid resources and cash provided by operations are not adequate to meet long-term capital requirements, management plans to raise additional capital by either, or both of, seeking to increase our borrowing
capacity or accessing the capital markets. There can be no assurance that we will be able to raise additional capital.
Total assets under
management as of June 30, 2017, were $6.5 billion, which was an increase of $184 million, or 2.9%, from June 30, 2016. The primary source of our revenue, liquidity and cash flow are our investment advisory fees and shareholder
service fees, which are based on and generated by our average assets under management. Property and equipment and management contracts purchased totaled $74.8 million as of June 30, 2017. As of June 30, 2017, we had cash and cash
equivalents of $12.3 million.
30
The following table summarizes key financial data relating to our liquidity and use of cash for
the nine months ended June 30, 2017 and 2016:
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(Unaudited, in thousands)
|
|
Cash flow data:
|
|
|
|
|
|
|
|
|
Operating cash flows
|
|
$
|
13,881
|
|
|
$
|
13,171
|
|
Investing cash outflows
|
|
|
(277
|
)
|
|
|
(448
|
)
|
Financing cash outflows
|
|
|
(4,812
|
)
|
|
|
(4,390
|
)
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
$
|
8,792
|
|
|
$
|
8,333
|
|
|
|
|
|
|
|
|
|
|
The increase in cash provided by operating activities of $0.7 million is mainly due to an increase in net
income, partially offset by the timing of the payout of accrued expenses in the current period versus the prior comparable period.
The
decrease in cash used in investing activities of $0.2 million is mainly related to costs in the prior comparable period associated with the special proxy vote for the approval of a Distribution
(Rule 12b-1)
Plan for the Hennessy Funds that did not previously have a
12b-1
plan.
The increase in cash used in financing activities of $0.4 million is due to an increase in the dividend payments in the current period
versus the prior comparable period.
The Company has an outstanding bank loan with U.S. Bank National Association, as administrative agent
(in such capacity, Agent) and as a lender, and California Bank & Trust, as syndication agent and as a lender, which replaced and refinanced the bank loan previously entered into by the Company and U.S. Bank National Association
on October 26, 2012, and amended on November 1, 2013. Immediately prior to September 17, 2015, the Companys bank loan had an outstanding principal balance of $23.0 million. On September 17, 2015, in anticipation of the
repurchase of up to 1,000,000 shares of the Companys common stock at $25 per share pursuant to its
self-tender
offer, the Company entered into a new term loan agreement to fund in part its
self-tender
offer, thereby increasing its total loan balance to $35.0 million (consisting of a $20.0 million promissory note to U.S. Bank National Association and a $15.0 million promissory note to
California Bank & Trust). Then, on September 19, 2016, the Company entered into an amendment to its term loan agreement with the Agent and the lenders to allow it to consummate the purchase of assets related to the management of the
Westport Fund and the Westport Select Cap Fund. In addition, the amendment revised one of the financial covenants in the term loan agreement.
31
The current term loan agreement requires 48 monthly payments in the amount of $364,583 plus
interest, at our option, at either:
(1) LIBOR plus a margin that ranges from 2.75% to 3.25%, depending on the Companys ratio of
consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization (excluding, among other things, certain
non-cash
gains and losses) (EBITDA), or
(2) the sum of (a) the highest of the prime rate set by U.S. Bank from time to time, the Federal Funds Rate plus 0.50%, or
one-month
LIBOR plus 1.00%, and (b) a margin that ranges from 0.25% to 0.75%, depending on the Companys ratio of consolidated debt to consolidated EBITDA.
From the effective date of the current term loan agreement through February 29, 2016, the interest rate in effect was U.S. Banks
prime rate plus a margin based on the Companys ratio of consolidated debt to consolidated EBITDA. Effective March 1, 2016, the Company converted $32.8 million of its principal loan balance to a
1-month
LIBOR contract, which has been renewed each subsequent month. As of June 30, 2017, the effective rate is 4.051%, which is comprised of the LIBOR rate of 1.051% as of June 1, 2017, plus a
margin of 3.0% based on the Companys ratio of consolidated debt to consolidated EBITDA as of March 31, 2017. The Company intends to renew the
1-month
LIBOR contract on a monthly basis provided that
the
LIBOR-based
interest rate remains favorable to the prime
rate-based
interest rate.
All borrowings under the term loan agreement are secured by substantially all of the Companys assets. The final installment of the
then-outstanding
principal and interest is due September 17, 2019.
The term loan agreement
includes certain reporting requirements and loan covenants requiring the maintenance of certain financial ratios. The Company was in compliance for the periods ended June 30, 2017 and 2016.